The importance of strategic frameworks for informing investment decisions

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While strategic frameworks are primarily intended for managers to inform their decision-making process, they are also useful for investors when considering investment decisions. From venture capital investment decisions in early-stage companies, to determine which stock to invest in, strategic frameworks can help investors understand the likely financial performance of companies. 

Understanding broad environmental changes: PESTEL Framework

The PESTEL framework helps simplify trends in a company’s broad environment. By systematically considering the political, economic, social, technology, ecological and legal factors that may impact a company, it is possible to identify likely trends that may impact an organization. 

From an investment standpoint, this analysis can be useful at identifying threats that could negatively impact a firm. Changes in social tastes or technology advancements are important to consider – identifying those firms better placed to capitalize on the environmental changes. 

Understanding industry structure: Porter's Five Forces

Beyond the broad environment that the firm operates in is the industry. Industry structure can significantly influence profitability, and Porter’s Five Forces is one of the most famous strategic frameworks for analyzing likely industry profitability. Strong supplier or buyer power, intense competition (particularly if it leads to price-based competition), substitute product indirectly compete with a company’s primary business, or new entrants can all substantially influence the profitability of an industry. 

One area of Porter’s Five Forces that can easily be overlooked is the barrier to entry (or lack thereof), which makes it difficult for new firms to enter into a market. If the barriers to entering an industry are low, then a seemingly successful company is likely to face substantially increased competition. The initial success spurs imitation, and if there are few things that make it difficult for new companies to enter the market space, then new entrants are quickly likely to follow. 

Understanding Resources and Capabilities of a firm

Beyond the macro environment and the industry that the firm operates in, the resources and capabilities of the company that you are considering investing in (as well as the difficulty other firms would have in acquiring those resources) will also substantially influence its profitability.

Understanding the underlying resources and capabilities is important for investors because it can give an indication of the likelihood that the company will be able to obtain an advantage over others. If a company is endowed with substantial rare resources (and especially if it is difficult for other firms to acquire or develop such capabilities), then it is likely to be able to create specific reasons for customers to come to that firm over others. If on the other hand, the resources that underpin the firm are either relatively common or can easily be acquired by others, then it is much more likely that other firms will compete on similar dimensions. 

The resources and capabilities of the firm underpin its success, considering whether a company has the foundations for success and distinction from other companies can help identify those companies positioned for long-term success in an industry.

 

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