External Environment and Organizational Structure Strategy

Introduction

Most management thinkers conceptualize the external environment through the use of models — the PEST analysis, Porter's Five Forces model, or the opportunities and threats component of the SWOT analysis. These models serve as a convenient framework that guides managers toward seeking certain kinds of knowledge. Whether used formally or informally, adapted or orthodox, these frameworks form the underlying basis by which managers understand their environment. Whether a manager adopts a reactionary or an anticipatory style, they will draw on the information contained in such analyses to help make strategic choices for their organization. This paper explores these theories and their impact on organizational structure. It then analyzes the most prevalent factors in the external environment today and the adjustments that managers may make in response to those factors.

Conceptualizing the External Environment

Michael Porter's influence on competitive strategy derives from his creation of simple models that explain how the external environment functions. His Five Forces model, created in 1979, remains relevant today for the accurate way in which it explains how economic value within an industry is apportioned. Firms can adjust their strategy based on such a conceptualization, because the analysis not only leads to conclusions about the firm's immediate environment but also provides clues about areas of the business where the competitive environment may be more favorable (Porter, 2008).

The simplicity of management frameworks has resulted in their near ubiquity in business schools and, as a consequence, in practical management as well. Other models have emerged alongside the Five Forces. Where the Five Forces analysis focuses on the competitive environment, the PEST analysis focuses on other facets of the external environment. The Blue Ocean strategy orients the competitive environment in a different way from the Five Forces. Management theorists expound upon the virtues of each technique (Burke, van Stel & Thurik, 2010) or offer their own adaptations of these frameworks (Grundy, 2006) with the intent of making them more practical for real-world management.

While these frameworks are widely taught, they may not be universally applied in practice. Their influence is nonetheless widely felt, not least because they accurately reflect the ways in which real-world managers conceptualize their environment. Academics and management thinkers seek to translate real-world complexity into neat models that are easily understood by managers. No matter which framework, model, or technique a manager chooses, the ways in which they react to the information and insight gained can vary considerably. Managers are ultimately guided in their decision-making by their own preferences, which in turn are shaped by their competency, the organizational culture in which they operate, and the constraints they face.

Today's External Environment

The common elements of the external environment are well established across models: political, legal, economic, technological, social, competitive, and environmental factors, among others. Managers today will face all of these, and the degree to which they do will vary depending on the particular business, industry, and country. In general, however, two or three of these have emerged as the most prevalent over the past decade or two — and are likely to remain so in the coming years.

The first is the economic environment. Economic considerations drive business in the most fundamental sense. Factors such as consumer spending, government expenditure, business investment, exchange rates, and interest rates have a profound impact on managerial decisions. Globalization — the greatest economic trend of the past twenty to thirty years — has impacted managerial strategy profoundly. In addition to the complex political and human resources issues that arise from globalization, firms are increasingly international, multinational, and even global in scope, which significantly raises the level of risk they face. Consider one growth economy in particular — Thailand. At one point christened a new "tiger" economy, Thailand has in the past fifteen years experienced a currency collapse, a coup, and ongoing political instability. Chunhachinda, de Boyrie, and Pak (2008) studied capital flight during times of political and economic instability in Thailand and found that political instability triggers capital flight, resulting in economic losses for firms operating in that market. These findings can reasonably be extrapolated to much of the developing world. Yet it is precisely the growth prospects of the developing world, combined with the maturity of Western markets, that has fueled globalization. Managers thirty years ago had little reason to concern themselves with Southeast Asian coups or currency collapses in South America — today they do. All global economies matter as businesses take on an increasingly global scope.

Another significant element of the external environment is the technological environment. The diffusion of capital around the world, increased emphasis on technology as a source of competitive advantage, and dramatic improvements in telecommunications have produced a pace of technological change never before experienced in human history. As a result, managers may find that their strategies can no longer unfold over the course of years but must be developed and implemented within months. Technology has, in effect, shortened the business cycle. Products reach maturity, are rendered obsolete, and are replaced by significantly improved variants within the span of a few years — a stark contrast to the pace of the business cycle throughout much of the industrial era. Technology shifts impact business in other ways as well, for example by increasing productivity and decreasing hours worked (Gali, 1999).

The third major element of the external environment most likely to affect managers today is the political environment. Globalization is not driven solely by improvements in global information diffusion; it has also been shaped by the World Trade Organization and other intergovernmental bodies. National, regional, and civic governments set the terms for business activity. Oversight bodies analyze and approve proposed mergers, and new laws increase the regulatory burden, adding costs to companies without always adding economic value — Sarbanes-Oxley in the United States being one example. Despite the prevalence of economically conservative regimes across much of the Western world, the political and legal environment still has a direct impact on most managers. Indeed, by setting the terms of competition within a given industry, the various levels of government exert as strong an influence over the economics of an industry — and therefore its behavior — as any other external factor.

Conclusion

These frameworks have proven useful and call attention to the most important elements of the external environment. Today, the elements managers are most likely to encounter are the economic, technological, and political. Research has shown that while there is a tendency toward increased consideration of the external environment in organizational structure development, responding structurally to short-term shocks is often a poor strategic decision. Organizational structure change can be traumatic for an organization and should not be undertaken lightly. It is best reserved for responses to long-term trends in the external environment rather than the short-term volatility that is so frequent today.