Chapter Three

The External Assessment

“It is not the strongest species that

survive, nor the most intelligent, but the
one most responsive to change”

Charles Darwin

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 Introduction

v Environmental influences and how to deal

with them plays a key role in strategic
management.
v Environment change affect organization
either negatively or positively
v The changes could be emanated from the
external environment or internal
environment in which the organizations
operate.
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 Con’d

v Thus, the interaction with the environment influence

how the organization operates and how and what it
produces.

v As a result, analyses of the external and internal

environment help to understand the forces outside and
inside the organizational boundaries in order to shape
the organization.
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 The environment that exists outside the organization,
the external environment (also called as general or
remote environment).
External environment impact on the organization
accounted as opportunities or threats to the
organization

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 Cont’d

v Opportunities arise when an organization can take

advantage of conditions in its external environment to
formulate and implement strategies that enable it to
improve performance.

v Whereas, threats arise when conditions in the external

environment endanger the integrity of the organization's
activities.
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 OPPORTUNITIES:
v An opportunity is a major favorable situation in a firm’s
environment
THREATS:
v A threat is a major unfavorable situation in a
firm’s environment.
v Threats are key ingredients to the firm’s
current or desired opposition.

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 Cont’d
v Opportunities and threats refer to economic, social,
cultural, demographic, environmental, political,
legal, governmental, technological, and competitive
trends and events that could significantly benefit or
harm an organization.
v Therefore, a basic tenet of strategic management is that firms need to
formulate strategies to take advantage of external opportunities and to
avoid or reduce the impact of external threats

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 Analyzing the external
environment

v The purpose of an external environment analysis is to

develop a finite list of opportunities that could benefit a

firm and threats that should be avoided.

v This enable the firm take advantage of external

opportunities or that minimize the impact of potential

threats
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 v External audit
9 focuses on identifying and evaluating trends
and events beyond the control of a single
firm.
9 reveals key opportunities and threats
confronting an organization so that managers
can formulate strategies to take advantage of
the opportunities and avoid or reduce the
impact of threats.

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 The Nature of an External Audit

v The external audit is aimed at identifying key

variables that offer actionable responses.

v Firms should be able to respond either offensively

or defensively to the factors by formulating
strategies that take advantage of external
opportunities or that minimize the impact of
potential threats.
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 Key External Forces

External forces can be divided into five

broad categories:
1. economic forces
2. social, cultural, demographic, and natural
environment forces
3. Political and legal forces
4. technological forces
5. competitive forces

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 The Process of Performing an
External Audit
1. First, gather competitive intelligence and
information about economic, social, cultural,
demographic, environmental, political,
governmental, legal, and technological trends.

2. Information should be assimilated and

evaluated
3. A final list of the most important key external
factors should be communicated

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 The Process of Performing an
External Audit
Key external factors should be:
1. Important to achieving long-term and annual
objectives
2. Measurable-
3. Applicable to all competing firms, and
4. hierarchical in the sense that some will pertain
to the overall company and others will be more
narrowly focused on functional or divisional
areas.

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 The Industrial Organization
(I/O) View
v The Industrial Organization (I/O)
approach to competitive advantage
advocates that external (industry) factors
are more important than internal factors in
a firm for achieving competitive
advantage.

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 Economic Factors:

v Economic assessment must

address:
v The overall economic forecast and the
likely funding stream that will be
available.

v The international and national forces that

can affect the economic well being of the
organization should be analyzed.
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 Economic Factors: cont’d …

Some key economic variables:

§ Availability of credit
§ Level of disposable income
§ Interest rates
§ Inflation rates
§ Unemployment trends
§ Consumption patterns
§ Stock market trends
§ Import/Export factors
§ Demand shifts
§ Price fluctuations
§ Fiscal policies
§ Tax rates

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 Political Factors:

v Political factors define the legal and regulatory

parameters of organizations’ operation.
vThere are laws that could restrict the
potential profits of businesses: fair trade
decisions , tax programs, minimum wage
legislation, pollution & pricing policies.
v Subside

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 Political Factors: cont’d …

v Other political actions aimed at

protecting employees, customers, the
general public, and the environment.
v There are also political actions that are
designed to benefit and protect
organizations: patent laws, government
subsidies,

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 Political Factors: cont’d …

Some key Political (Gov’al & legal) variables

§ Tax laws
§ Environmental protection laws
§ Level of government subsidies
§ Terrorist activities
§ Import/Export regulations
§ Size of Government budget
§ Local, state & national elections
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 Social Factors:

vThese factors include the beliefs,

values, attitudes, opinions, and life
style of persons depending up on
cultural, demographic, religious, and
ethnic conditioning.

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 Social Factors: cont’d …
Some key socio-cultural variables:
§ Changing work values
§ Ethical standards
§ Growth rate of population
§ Life expectancies
§ Rate of family formation
§ Consumer activism
§ Geographic shifts in population
§ Attitudes towards business
§ Average level of education
§ Attitudes towards leisure time
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 Technological Factors:

Organizations must strive to understand the existing

scientific or technological advances:

• To avoid obsolescence and promote innovation, the

organization must be conscious of technological
changes that could affect its operation
• It should understand that new technologies might
require new operation systems and bring about
sudden and dramatic effect on an organization’s
environment.

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 Technological Factors: cont’d …

Some key technological variables

§ R&D activity
§ automation
§ technology incentives
§ rate of technological change

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 The Internet has changed the very nature of
opportunities and threats by:
valtering the life cycles of products,
vincreasing the speed of distribution,
vcreating new products and services,
verasing limitations of traditional
geographic markets

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 Technological Forces

The Internet has changed the very nature of

opportunities and threats by:
valtering the life cycles of products,
vincreasing the speed of distribution,
vcreating new products and services,
verasing limitations of traditional geographic
markets

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 Industry
and
Competitor Analysis

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 Content
1. Industrial Analysis (Porter’s
five force model)

2. Competitor Analysis

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 The Industry
Environment

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 Definition cont’d …
v Analysis of the industry environment is
focused on the factors & conditions
influencing the firm’s profitability in the
industry.
v Compared to the general environment,
the industry environment has a more
direct effect on the firm’s strategic
competitiveness & capability of earning
above-average returns
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 Definition cont’d …
It refers to the analysis of:
v Industry trends as a whole;
v Competition within the industry;
v Technologies employed;
v What it takes to succeed – the key
success factors (KSF);
v Comparing the firm, its products, its
systems, its technology etc., with other
firms in the industry.

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 Nature And Degree Of Competition

The nature and degree of competition in an

industry hinge on five forces:
1.The threat of new entrants
2.The bargaining power of suppliers
3.The bargaining power of buyers
4.The threat from substitute products
5.Rivalry (competition) among existing
firms
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 The Five-Forces Model of
Competition

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 Nature cont’d …
How Competitive Forces Shape Strategy
v The essence of strategy formulation is coping with
competition. Competition exists in the fight for
market share.
v Therefore, competition in an industry is rooted in
its underlying economics, and competitive forces.
v Thus, the collective strength of these forces
determines the ultimate profit potential of an
industry.

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 Nature cont’d …
v The weaker the forces collectively the greater the
opportunity for superior performance in the
industry would be.

v Thus, to cope with them the strategist must delve

below the surface and analyze the sources of
competition. For example:
9 What makes the industry vulnerable to entry?
9 What determines the bargaining power of
suppliers?

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 Nature cont’d …

v Knowledge of these underlying sources of

competitive pressure provides the
groundwork for a strategic plan of action
to:
9 Highlight the critical strengths and
weaknesses of the company
9 Animate the positioning of the company
in its industry
9 Clarify the areas where strategic changes
may yield the greatest payoff

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 Threat of Entry
There are six major sources of
barriers to entry:
1. Economies of scale (saving the cost of
production through mass production)
2.Product differentiation
3. Capital requirements
4. Cost disadvantages
5. Access to distribution channels
6. Government policy
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 Threat of Entry cont’d …
Economies of scale:
v Deter entry by forcing the aspirant
either to come in on large scale or
accept a cost disadvantage.

v Scale of economies in production,

research, marketing, and service
are probably the key barriers to
entry in the industry.

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 Threat of Entry cont’d …

Product differentiation:
v Brand identification creates a barrier by forcing
entrants to spend heavily to overcome customer loyalty.

v Factors fostering brand identification are being first in

the industry, advertising, customer service, and product
differences.

v Product differentiation is perhaps the most important

barrier in soft drinks, cosmetics, and investment
banking.

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 Threat of Entry cont’d …

Capital requirements:

v The need to invest large financial resources in order to

compete creates a barrier to entry.

v Capital is necessary not only for fixed facilities but also

for customer credit, inventories, and absorbing start-up
loses.

v The huge capital requirements in certain fields, such as

computer manufacturing and mineral extraction, limit
other entrants.

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 Threat of Entry cont’d …
Cost disadvantages independent of scale:

v These advantages can stem from the effects

of:
9 the learning curve, and proprietary
technology,
9 access to the best raw material sources,
9 assets purchased at pre-inflation prices,
9 government subsidies, favorable location,
and
9 official rights (patents)
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 Threat of Entry cont’d …

Access to distribution channels:

v When there are limited wholesale

or retail channels and the existing
competitors occupied them, entry
into the industry will be tougher.

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 Threat of Entry cont’d …

Government policy:
v The government can limit or even
foreclose entry to industries with such
controls as license requirements and
limits on access to raw materials.

v The government also can play a major

indirect role by effecting entry barriers
through controls such as air and water
pollution standards and safety
regulations.

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 Threat of Entry cont’d …

Expected Retaliation
v Existing firms might respond in

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different ways when new comers
inter into the market.
Example – Lowering price
v Responses by existing competitors
may depend on a firm’s present
stake in the industry and available
business options
 Powerful Suppliers

v Suppliers can exert bargaining power

on participants in an industry by
raising prices or reducing the quality
of purchased goods and services
affecting the profitability of the
industry.
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 Powerful Buyers
v Customers can force down prices, demand higher quality or

more service, and play competitors off against each other – all

at the expense of industry profits.

v The product buyers’ purchase from the industry is standard or

undifferentiated.

9 In this situation, the buyers are always sure that they can

find alternative suppliers, may play one company against

another.
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 Threat of Substitute Products
vThe threat of substitute products
increases when:
9 Buyers face few switching costs
9 The substitute product’s price is
lower
9 Substitute product’s quality and
performance are equal to or greater
than the existing product

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 Rivalry Among Competing Firms

Industry rivalry increases when:

v There are numerous or equally balanced
competitors
v Industry growth slows or declines
v There are high fixed costs or high storage costs
v There is a lack of differentiation opportunities
or low switching costs
v When high exit barriers prevent competitors
from leaving the industry

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 Interpreting Industry Analyses

Low entry barriers

Unattractive
Suppliers & buyers
have strong positions industry

Strong threats from

substitute products

Intense rivalry
Low profit
among competitors potential

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 Interpreting Industry Analyses cont’d …

High entry barriers

Suppliers & buyers Attractive

have weak positions
industry
Few threats from
substitute products

Moderate rivalry High profit

among competitors
potential

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 Competitor Analysis

v Competitor analysis focuses on each

company against which a firm
directly competes.
v Analysis of competitors is focused on
predicting the dynamics of
competitors' actions, responses &
intentions
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 Competitor Analysis cont’d …

v Competing firms are keenly

interested in understanding each
other’s objectives, strategies,
assumptions and capabilities.

v Furthermore, intense rivalry creates

a strong need to understand
competitors.
 Competitor Analysis cont’d …
In a competitor analysis, the firm seeks to
understand:
v What drives the competitor, as shown by its
future objectives.
§ What the competitor is doing and can do, as
revealed by its current strategy.
§ What the competitor believes about its own firm
and the industry, as shown by its assumptions.
§ What the competitor’s capabilities are, as shown
by its strengths and weaknesses.
 Competitor Analysis cont’d …

v Competitor intelligence is used to

get data and information about
competing firms.
v Competitor intelligence is the set of
data and information the firm gathers
to better understand and better
anticipate competitor’s objectives,
strategies, assumptions and
capabilities.
 Competitor Analysis cont’d …

v Information about these different dimensions

helps the firm to prepare an anticipated
response profile for each competitor.
v Thus, the result of an effective competitor
analysis helps a firm to understand, interpret
and predict its competitors’ actions and
responses.
 Sources of External Information

v marketwatch.multexinvestor.com
v moneycentral.msn.com
v finance.yahoo.com
v www.clearstation.com
v us.etrade.com/e/t/invest/markets
v www.hoovers.com
v globaledge.msu.edu/industries/

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 Forecasting Tools and
Techniques
v Forecasts
9 educated assumptions about future trends
and events
9 quantitative, qualitative techniques

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 Industry Analysis: The External
Factor Evaluation (EFE) Matrix
v Economic v Political
v Social v Governmental
v Cultural v Technological
v Demographic v Legal
v Environmental

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 EFE Matrix Steps

1. List key external factors

2. Weight from 0 to 1
3. Rate effectiveness of current strategies
4. Multiply weight * rating
5. Sum weighted scores

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 EFE Matrix for a Local Ten-
Theater Cinema Complex

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 Industry Analysis: Competitive
Profile Matrix (CPM)
v Identifies firm’s major competitors and
their strengths & weaknesses in relation
to a sample firm’s strategic positions
v Critical success factors include internal
and external issues

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 An Example Competitive
Profile Matrix

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