Strategic Analysis for Eskom

1 January 2017

Introduction For this assignment I will be focusing on the strategic analysis of Eskom, where I will be critically reviewing Eskom’s growth strategy in line with the case study given, Eskom – is there light at the end of the tunnel. I will be making use of the different schools of thought and aligning them to the Eskom strategy. Question One It is important for an organization to know and acknowledge its stakeholders. As Louw and Venter (2008: 60) state, stakeholders are those parties who have either a direct or indirect interest in the way an organistion does business as well as in its success. They can be both internal and external and typically include employees, shareholders, customers, the community and suppliers. According to Louw and Venter (2010) an organisation’s stakeholder can be divided into primary and secondary stakeholders.

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Primary stakeholders are those whose continuing participation is vital to the corporation, or those who have direct and well established legal claim on an organisation’s resources, for example shareholders, creditors, employees and government. Secondary stakeholders are those groups that are affected by the organisation but not essential to its survival, or that do not have a legal claim but rather rely on non binding or ethical obligations. The process of stakeholder analysis requires: Firstly to identifying individuals and groups that can be affected by the decision and Prioritizing these individuals and groups in the decision making process. According to (University of South Africa, 2010. the modern strategic manager has to deal with conflicting claims of different stakeholders which make strategic decisions very complex. However these decisions need to be made in order to for the organisation to take all aspects into account. And striking a balance between conflicting stakeholder interests is a fundamental challenge for any board of director (University of South Africa, 2010. ). For this reason the following steps are recommended in order to incorporate stakeholders’ conflicting claims, according to (University of South Africa, 2010. ) the steps are as follows: First to identify all stakeholders, then understand the stakeholders’ 2 pecific claim, reconcile these claims, assign priorities to the claims and lastly to coordinate the claims with other components of the mission statement With regards to Eskom I have identified their stakeholders and their legal claim. The stakeholders of Eskom are Government, customers, employees, Eskom management, local and provincial government departments, municipalities, local business representatives, suppliers, community-based organisations, non-governmental organisations (NGOs), local media, farmers’ associations and affected communities. Government has legal claim and is a primary stakeholder because it is the sole shareholder in organization so they have an invested interest in the well being of the organisation, in terms of the return on investment and also for the economic development of the country.

Customers are a primary stakeholder and have a legal claim as they are directly affected by the service provided by Eskom, as the consumer benefits from this service and that all people in South Africa can benefit from having the supply of electricity. Also being affected by power outages or load shedding, it is within the customer’s right to be an engaged stakeholder. The other stakeholders that are also primary is the investors, the state owned enterprises, which had to contribute towards the infrastructure of the programmes. This was a vested interest in the economic growth. The other stakeholders were the Independent private sector participants who also invested in the capital expansion programme making a provision of thirty percent.

The employees of Eskom are primary stakeholders as they would want their roles to be permanent and stable in the environment they’re in, possibly there may be growth in skills development and creating of jobs, meaning economic growth. Question two The macro environment is the broad condition operating outside an organization’s industry and markets. The macro environment tends to exert forces from outside the organization’s sphere of influence and the forces are usually beyond its control. 3 However it has a major influence on the industry environment in which the organization operates. An organization must scan its external environment continuously to identify possible opportunities and threats that may emerge.

This is why environmental scanning is so important as this is the tool that organizations use to avoid strategic surprises and ensure long term health in their industry. According to Louw and Venter (2010) macro environmental forces tend to exert forces that have a major influence on industries and hence on the organisations operating in those industries. These macro environmental forces do not affect all industries and organisations in those industries, in the same way. The forces emanating from macro environmental factors in the global environment and/or from individual countries may have profound impact on the organisations strategic direction, competitiveness, profitability and ultimately on its survival.

The factors to consider when assessing the macro environment are Political/legal environment, Economic environment, technical environment, social environment, ecological environment and lastly the international environment. Eskom’s macro environment needs to deal with the following factors. Firstly the political/legal environment, according to the (University of South Africa, 2010. ) it has three parts : existing laws under which the organisations must operate, laws of amendments to which the public is advised in advance and unannounced new laws and regulation or suspended clauses of existing laws. Politically, there are issues such as the perceptions and action of powerful actors, like organised labour and the business sector, in respect of regulation and competition.

Cosatu holds very strong policy views on the nature and extent of the role of the state in the South African economy and in regulation and competition. The Basic Conditions of Employment Act, Labour Relations Act, Employment Equity Act and the Skills Development Act affect employment in the industry. 4 The Economic environment also contributes to Eskom’s industry as Government being the sole shareholder. It is important for government to see returns and increase the economy’s GDP through their stake in Eskom. Unfortunately with the electricity crisis, this had a negative impact on the South African economy and damaged consumer, business and foreign investor confidence.

It also had implications on the GDP growth, employment, capital formation, capital inflows, the rand, inflation and interest rates. Technological Environment is affected in that Eskom saw the opportunity to increase their capacity as it is; they were not meeting the required supply as it is constantly growing. In order to meet the demand, an opportunity presents itself for Eskom to build new capacity, by so doing also conducting exhaustive research into future power technologies and energy sources. Eskom has projects supporting the development of renewable energies. Ecological Environment, Eskom needs to adapt their manufacturing process to become more environmentally friendly. Eskom needs to reduce its carbon footprint and waste measurement and management.

International Environment is extremely important to include as the international environment has an impact on the activities of organisations, especially with globalization. According to (University of South Africa, 2010. ) the variables such as international laws, human rights, boycotts to mention a few, have become variables that can easily derail even the small local organisation. Eskom’s building programme needed extensive funding therefore foreign investment was needed however with the global meltdown this proved to be a hurdle but also because its expansion spending had to be substantially adjusted on an annual basis to reflect international realities.

Question Three According to Louw and Venter (2010) to understand the external sources of competitive advantage fully, Grant suggested that organisations need to understand their industry key success factors. These are factors in the organisation’s external environment that determine the organisation’s ability to survive and prosper. Note that key success 5 factors apply to all organisations in an industry. Key success factors depend on the three C’s as defined by Ohmae: Customers- what do customers want? Secondly, Competition- How can the organisation compete successfully? And lastly, CorporationWhat unique resources does the organisation possess?

The key success factors for Eskom would be low cost operation and service delivery to meet customer demands. According to (Vikesh RajPaul: 2002) low cost sustainable production with minimum plant down time. Compliance with strict environmental legislation and strict corporate governance would also be critical to success. The selected strategies are evaluated in the light of a commercialised environment to determine whether they sufficiently prepare the station to out-compete rivals in such an environment. Reduced operating cost is also one of the key success factors in a commercialised environment, but the power station can still do more to reduce costs even further. A good strategy boosts performance.

The intention of the cost minimisation strategy is to boost organisation performance by improving operating efficiency, which would both increase organisation profitability and improve the organisation’s competitive strength. Question four According to Louw and Venter (2010), the organisation’s interaction with competitors, customers and other industry role players can have a profound impact on its relative competitive advantage and profitability and that of other industry players. Industries differ in many respects. Each industry has its own structures, types of rivalry, profit potential and so on. Organisations compete mainly within the boundaries spanned by the industry in which they operate, although these boundaries are becoming increasingly vague in the contemporary business environment (University of South Africa, 2010. ).

In order to get a better understanding of the industry analysis, the environment is analysed in two broad steps. Firstly by defining the industry and secondly by examining the relationships that shape the industry. Michael Porters five frameworks is widely used in analyzing the industry structure. It is built around five forces interacting in any industry. Porter argues 6 that these five forces determine the profitability of the industry. He also states that it is important to look beyond the immediate competitors as there are other determinants of profitability. Porter’s five forces are threat of new entrants, rivalry among existing organisations, bargaining power of buyers, bargaining power of suppliers and substitutes.

Threats of new entrants is the extent to which new entrants are a threat depends on the existence and level of barriers to entry into the industry, where barriers to entry provide an advantage to existing companies over new entrants. Barriers to entry are many and varied, including the level of capital requirements, economies of scale, absolute cost advantages, product differentiation, access to distribution channels, legal/regulatory barriers as well as the likelihood of retaliation (University of South Africa, 2010. ). Barriers to entry These are the important structural components within an industry to limit or prohibit the entrance of new competitors.

The major components in South Africa are economies of scale enjoyed by both Eskom and the municipalities; they have an understanding of the buyer needs based on experience. Eskom and the municipalities also enjoy brand image and loyalty. New entrants would also face a risk premium. The existing suppliers have access to distribution channels. Therefore it may be assumed that the barriers to entry are high. Threat of Substitutes The presence of substitute products can lower industry attractiveness and profitability because they limit price levels. The threat of substitute products depends on: firstly the buyers’ willingness to substitute, secondly the relative price and performance of substitutes and last the costs of switching to substitute.

These are products or solutions that basically perform the same function but are often based on a different technology. Presently there is a threat of substitution from alternative energy sources like lowpressure gas, coal, paraffin and solar. With the introduction of competition, the suppliers 7 of electricity will also have to deal with generic substitution from other private electricity suppliers. Bargaining Power of Suppliers The cost of items bought from suppliers (e. g. raw materials, components) can have a significant impact on an organisation’s profitability. If suppliers have high bargaining power over organisation, then in theory the organisation’s industry is less attractive.

The bargaining power of suppliers will be high when: There are many buyers and few dominant suppliers. There are undifferentiated, highly valued products. Suppliers threaten to integrate forward into the industry (e. g. brand manufacturers threatening to set up their own retail outlets). Buyers do not threaten to integrate backwards into supply. The industry is not a key customer group to the suppliers. Suppliers can exert their bargaining power over participants by threatening to raise prices or reduce the quality. Eskom is a dominant supplier. With the introduction of competition, Eskom’s power over the supply industry will decrease. Bargaining Power of Buyers Buyers are the people / organisations who create demand in an industry.

The bargaining power of buyers is greater when: • • • • • There are few dominant buyers and many sellers in the industry. Products are standardised. Buyers threaten to integrate backward into the industry. Suppliers do not threaten to integrate forward into the buyer’s industry. The industry is not a key supplying group for buyers. Through they’re bargaining power buyers can force the competitors to lower their prices or force higher quality or better service. The major factor determining the increasing bargaining power of electricity users is the high volume of the standardised product consumed. Rivalry amongst existing organisations The intensity of rivalry between competitors in an industry will depend on: 8

The structure of competition – for example, rivalry is more intense where there are many small or equally sized competitors; rivalry is less when an industry has a clear market leader. The structure of industry costs – for example, industries with high fixed costs encourage competitors to fill unused capacity by price cutting. Degree of differentiation – industries where products are commodities (e. g. steel, coal) have greater rivalry; industries where competitors can differentiate their products have less rivalry. Switching costs – rivalry is reduced where buyers have high switching costs i. e. there is a significant cost associated with the decision to buy a product from an alternative supplier.

Eskom is a monopolistic generator and there are only a few competitors in distribution. The industry has a slow growth, with high fixed costs. There is also minimal opportunity for differentiation. Electricity is a standardised product with high volume sales. Presently there is not much competition; however this would change with the introduction of competitive markets. Question five South Africa, which supplies two thirds of Africa’s electricity, is one of four cheapest electricity producers in the world. Ninety-two percent of South African electricity is produced from coal, with generation dominated by Eskom. The national electricity grid is owned and operated by Eskom.

Eskom supplies more than 96% of South Africa’s electricity and more than 50% of electricity consumed throughout Africa. In global terms, the utility is the fourth largest in generating capacity, the fifth largest in sales, and has the world’s biggest dry cooling power station. A massive electrification programme is under way with 1 000 electrical connections being made daily. Although Eskom is a public corporation, it is financed by net financial market liabilities and investments as well as reserves, and is run on business principles for the benefit of its customers (DME, 2000). While Eskom does not have exclusive generation rights, it has a practical monopoly on bulk electricity sales.

It also operates the integrated national high voltage transmission system and supplies directly to large consumers such as mines, mineral benefactors 9 and other large industries. In addition, it supplies electricity directly to commercial farmers and, through the National Electrification Programme, to a large number of residential consumers. It also sells in bulk to municipalities, which distribute to consumers within their boundaries. Both Eskom Distribution and the municipal distributors are monopolies in their licensed areas of supply (DME, 2000). At the moment the sector is facing numerous difficulties that need immediate attention if the reform process is to succeed.

These relate to financial instability, the inequitable treatment of customers and operational/management inefficiencies. Electricity supply throughout the world is undergoing a revolution. This being caused mainly, but not solely, by electricity utilities having to meet new pressures resulting from global markets and governments opening up their countries to foreign investors to help fund power sector expansion and development. As a result, utilities have to see themselves as businesses, and act accordingly. South Africa is not immune from these forces, and will have to move broadly in line with developments taking place in the rest of the world, while also ensuring that the industry evolution meets South Africa’s special requirements.

To ensure the success of the electricity supply industry as a whole, various developments will have to be considered by government over time, namely: giving customers the right to choose their electricity supplier; introducing competition into the industry, especially the generation sector; permitting open, non-discriminatory access to the transmission system; and Encouraging private sector participation in the industry. According to (Vikesh RajPaul: 2002:87) It was found that the fragmented South African electricity supply industry is complex and dynamic. The dominant players in the industry are Eskom and municipal electricity distributors. There is minimal competition from alternate energy sources such as solar, coal, nuclear and gas.

Customers of the electricity supply industry value, cost, reliability, and quality of supply and energy efficiency. Eskom is one of the top seven utilities in the world in terms of size and sales. 10 The South African Government should maintain this position by adopting strategies that strengthen its ability to react to changing requirements, while embracing flexibility to deal with uncertainty. South Africa has a strong natural resource base and a variety of energy options are available. South Africa has extensive coal resources and Eskom’s generation strategy and technology resulted in one of the world’s lowest cost producers of electricity.

The natural resources include: the abundant coal reserves of more than 200 years at the present rate of consumption, although the quantification of reserves versus grade is uncertain; Indigenous uranium reserves, and High solar radiation. A well-developed energy, rail, road, and grid infrastructure. An established research and educational infrastructure supports this. There is a limited national policy and vision for energy research and technology development. The energy industry has a supply side mentality and is not marketfocused. The following are some of its characteristics: • Energy suppliers are strong. • Strong groups influence policy makers. • Equipment is mainly imported and only limited local manufacture exists. • Financiers, consultants, and education are mainly focused on the supply of energy.

The economy is dependent on polluting primary energy sources (fossil fuels) that have a significant environmental impact. This leads to a poor international perception and image. Conclusion The Government along with Eskom should carry out different restructuring in each energy industry according to the characteristics of the industry so that the efficiency of the energy market can be maximised and the public interest in the energy industry can be considered. 11 References: 1. Louw, L & Venter, P. 2010. Strategic management: developing sustainability in South Africa. 2nd Edition. Cape Town: Oxford University Press 2. Thompson, J & Martin, F. 2010. Strategic Management: awareness and change. 6th Edition. London: Thomson. 3. RajPaul, R. 2002.

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