Lesson Proper for Week 3

Nature of External Audit

According to David (2011), the main “purpose of an external audit is to develop a finite list of opportunities that could
benefit a firm and threats that should be avoided.”
Listing the opportunities and threats does not mean that organization should list down everything they have known or
gathered. That is why as per the external audit purpose, it's finite, only limited.
On the other hand, doing external audits should only aim to identify variables that organizations need an actionable
response. Because any organizations if they are not careful in doing their external audit, there are things that they
would have read or considered for their auditing but it doesn’t directly concern their business or its something outside
the purpose of their external audit.
Organizations should not just know those important factors rather formulate strategies that capitalize on those factors.
According to David (2011), external forces are categories in five: (1) economic forces; (2) social, cultural,
demographic, environment natural forces; (3) political, legal, governmental forces; (4) technological forces; (5)
competitive forces.

Process of External Auditing

There are five steps on how an organization can do an external auditing:
Step (1) assigning the task of gathering information;
Step (2) gathering of information and intelligence about
(A) economic forces,
(B) social, cultural, demographic, and natural environment forces,
(C) political, governmental, and legal forces,
(D) technological forces, and
(E) competitive forces;
Step (3) - reporting;
Step (4) assimilated and evaluated;
Step (5) Communication and distribution.

Step (1) Assigning the Task of Gathering of Information - This is where the main leader of the auditing assigns the
tasks to a specific person or department.
Organizations do have different ways of doing this, some companies do want to leave out the external auditing solely
to a specific department where not all the managers and its department are involved.
On the other hand, there are organizations that want to maximize their employees, so they give tasks to almost
everyone. This strategy is much more beneficial because organizations can have a wider perspective and could
gather more. But on the other hand, having a lot of people involved requires more time of evaluation eventually.

Step 2 Gathering of Information and Intelligence About the External Factors - This is where individual checks into
different resources for the economic, social, cultural, demographic, natural environment forces, political,
governmental, legal forces, technological forces, and competitive forces.
In gathering information, assigned people should be careful as to what they should be only looking into. There can be
a chance that an individual will look into something that is no longer the scope of what they should be searching.
Especially nowadays, everyone is bombarded with a lot of information.
Some example of resources where an organization can look into for information are news that provides a timely
information on what’s new in different topics; articles which are timeless documents that are research based and
done by a credible professionals; supplier, distributor, customers which are an individual's that employees are
encountering on their daily business; internet that has a lot of information that are available to humankind; and
competitors etc.
In gathering information regarding competitors, there are organizations that they will send out people from their firm
that will act as if they are a real customer just to gather information. There are times where they go beyond in just
acting, rather truly purchase their competitor products and services just to gather real and actual information.

Step (3) Reporting - According to David (2011), “individuals can monitor various sources and can submit periodically
to managers”.
By means of this, the manager received steady and timely information.
Managers should set a deadline for reports, so that their employees will not slack on doing research and would
require each individual to have something to present to the manager.

Step (4) Assimilated and Evaluated - Managers or even a regular employee that is relevant in strategic planning
meet. Each one lay down everything they have gathered in line with what is assigned to them.
Information and data can be pretty overwhelming at this stage since it came from a greater number of people.
Though managers could’ve scanned it beforehand which makes it easier for them to evaluate.
Since tons of information could’ve been involved, managers should only focus on the things that are important and
remove from the list that are irrelevant to save time and effort.
According to David (2011), managers should only identify the most important opportunities and threats, it’s also highly
suggested that to make it collaborative as the more managers involved in identifying it the better since they have
different kinds of expertise. This strategy also makes the manager also to be aware of the other side of the
perspective due to its personal involvement which can result for them to formulate better strategies within their scope
of work.
Freund emphasized that these 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.

Step (5) Communication and Distribution - This is where the output of the meeting shall be scattered to the
appropriate people and departments
Any organization that does an external auditing without communicating the result to its whole organization will do
them no good.
This is relevant as this is what will determine how the departments in the organization should respond to the external
factors. The more a department knows the better.

External Factors
Economic Force - According to David (2011), “an economic variable of significant importance in strategic planning is
gross domestic product (GDP)”.
According to investopedia, “Gross Domestic Product (GDP) is the monetary value of all finished goods and services
made within a country during a specific period.
GDP provides an economic snapshot of a country, used to estimate the size of an economy and growth rate. Its
an indicator that shows how well does the economy of a country.
GDP can be calculated in three ways, using expenditures, production, or incomes.”
Lower GDP means, only few jobs are available because few productions were made; retrenchment of employees
become a norm; businesses are closing; investors are reluctant to invest money in the country, citizens have lower
income and spending less etc.
On the other hand, if GDP is higher, it indicates that a lot of jobs are currently rolling because a lot of products were
produced, citizens have higher income and are spending a lot. This can be an opportunity for businesses to invest.

(situational example)

If a company is thinking to invest and expand their business abroad, though there are a lot of
indicators before deciding, one thing this business will surely look into is the countries’ GDPs.
The lower the GDP can mean two things for the organization, they need to answer the question
“will it be more beneficial for us to invest in that country since power to buy our products is
also low?” not that those people of that country cannot afford to buy products they are just
thinking as to whether they will be able to get a return of investment fast enough to cope up
their expectation or will there be really a return of investment. Another question to answer is
“will there be a potential for their market to grow?” businesses can take the opportunity while
the country is on its GDP down low because things can be much cheaper in that country rather
than a country with a higher GDP. In which, in the long run, if that country's economy rises,
they make a small investment and get a big return in return

Social, Cultural, Demographic, and Natural Environment Forces - According to David (2011), “social, cultural,
demographic, and environmental changes have a major impact on virtually all products, services, markets, and
customers”
Some of the key variables in demographic are childbearing rates, number of special-interest groups, number of
marriages, number of divorces, number of births, number of deaths, immigration and emigration rates, sex roles etc.

(situational example)

As of 28 June 2020 according to Worldometers, the population of the Philippines hits

109,563,304. It is expected to reach roughly 142 million by 2045 with average annual growth
by 1.21% from 2010 as projected by Philippine Statistics Authority. This growing population of
the Philippines can be beneficial for school entrepreneurs. The more people there are in a
country, the more schools are needed to educate its citizens. Philippine government has been
open in commercializing the education of the Philippine, though there are state colleges and
universities, yet still we cannot deny the fact that government funded schools are not enough to
cater everyone due to limited resources of the government and the increasing population of the
country. Another point as well is that some parents are also willing to pay a big amount of
money for their children's education so long as their children would experience comfort in
studying in private schools.

Political, Governmental, and Legal Forces - According to David, “Local, state, and federal laws; regulatory agencies;
and special-interest groups can have a major impact on the strategies of small, large, for-profit, and nonprofit
organizations”.
Evidently, every organization that wants to do business, whether tangible or intangible products, whether online or
offline services, whether micro or a big company; they all need to be registered first.
In the Philippines, there are five to six steps you need to go through and transact to different government agencies to
formally register your business.
Aside from licensing, the government also regulates and deregulates any form of business and its stakeholders
during its business. For this reason, according to David (2011), “political, government, and legal forces can be a
source of threats and opportunities for both small and large organizations”.

(situational example)

In dealing with COVID-19, last 15 June 2020, President Duterte announced that the Metro
Manila shall be put to “General Community Quarantine” from its previous state “Enhanced
Community Quarantine” effective from June 1 to June 30. This act allows the malls to be more
open to public and even restaurants to accommodate dine-in customers with certain
restrictions. In this situation, this kind of move will affect the high soaring state of the food
delivery business. Instead of ordering food online, some people will now choose to eat their
food in a dine-in setup since they have been in quarantine for a long time even though there’s a
risk of getting a COVID-19. People tend to choose this even though it wasn’t that 100% safe
compare to food delivery simply because they wanted to break from their usual setup at home.
On the other hand, this kind of regulation that impacts restaurants gives another reason for
health material suppliers to increase their productions. As restaurants comply with health
regulations given by the national and local government, more businesses would be needing
their product.

Technological Forces - According to David (2011), “revolutionary technological changes and discoveries are having a
dramatic impact on organizations”.

(situational example)
The way of purchasing and accessing products or services using the medium of the internet is
now on demand, this is called e-commerce. Before e-commerce comes, businesses are required
to maintain a physical store to allow their customers to see and avail their product or service.
But nowadays, due to the convenience of the internet, a lot of businesses are now more focused
on showing and giving an experience to purchase their goods at their website. Because of this,
there are some businesses who no longer have their own physical store to sell their products,
everything they sell are already posted on the internet. It lessens their expenses because they
don’t have to pay anymore a rent fee for their store. In addition, there are a lot of free platforms
that are available to build your business online presence. Some of them are Facebook and
Instagram. These platforms are like a physical marketplace, customers are just in one place.

Competitive Forces - Any business that battles a certain business in terms customers and supplies are considered
competitor. Basically, businesses that have the same market or same customers are battling over market share.
Competitors do have a direct impact on how organizations do their business. Either competitor can be an opportunity
to expand your market share or they are taking away market share on your end.
Identifying major competitors is not that easy, though there are things that are too obvious in the naked eye as to
know which business is the major competitor.
However, getting facts and real data is a different story than just merely an observation. Because it gives you a real
figure who really is your major competitor.
Initially business due to competition, business does not blatantly bring out their data into wide open but there are
instances that they must. Like in the Philippines, corporations need to submit on a yearly basis their financial
statement in the Securities and Exchange Commission. Once a business submits, it becomes a public document in
which anyone could have access.
But on the other hand, information inside such as how the products of a certain business were made, their marketing
information, and what the business' future plans are is considered strictly confidential. Because of this, it becomes
hard for a lot of businesses to identify who is their major competitor right at the moment.

Industry Analysis: The External Factor Evaluation (EFE) Matrix

This matrix allows the organization to summarize and evaluate the external factors that can affect the organization.
According to David (2011), this matrix can be developed in five steps:

Step 1 List key external factors as identified in the external-audit process - Include a total of15 to 20 factors, including
both opportunities and threats, that affect the firm and its industry.
List the opportunities first and then the threats.
Be as specific as possible, using percentages, ratios, and comparative numbers whenever possible.

Step 2 Assign to each factor a weight that ranges from 0.0 (not important) to 1.0 (very important) - The weight
indicates the relative importance of that factor to being successful in the firm’s industry.
Opportunities often receive higher weights than threats, but threats can receive high weights if they are especially
severe or threatening.
Appropriate weights can be determined by comparing success with unsuccessful competitors or by discussing the
factor and reaching a group consensus. The sum of all weights assigned to the factors must equal 1.0.
Step 3 - Assign a rating between 1 and 4 to each key external factor to indicate how effectively the firm’s current
strategies respond to the factor, where 4 = the response is superior, 3 = the response is above average, 2 = the
response is average, and 1 = the response is poor.
Ratings are based on effectiveness of the firm’s strategies. Ratings are thus company-based, whereas the weights in
Step 2 are industry-based.
It is important to note that both threats and opportunities can receive a 1, 2, 3, or 4.

Step 4 Multiply each factor’s weight by its rating to determine a weighted score.

Step 5 Sum the weighted scores for each variable to determine the total weighted score for the organization.

It does not matter how many key opportunities and threats there are in EFE Matrix, the highest possible total
weighted score for an organization is always 4.0 and the lowest possible total weighted score is 1.0. The average
total weighted score is 2.5. A total weighted score of 4.0 indicates that an organization is responding in an
outstanding way to existing opportunities and threats in its industry. In other words, the firm’s strategies effectively
take advantage of existing opportunities and minimize the potential adverse effects of external threats. A total score
of 1.0 indicates that the firm’s strategies are not capitalizing on opportunities or avoiding external threats.

(example)

EFE Matrix done for Local Ten-Theatre Cinema Complex:

External Factor Evaluation Matrix
Key External Factors Weight Rating Weighted Score
Opportunities
1. Rowan County is growing 8% annually in 0.05 3 0.15
population
2. TDB University is expanding 6% annually 0.08 4 0.32
3. Major Competitor across town recently ceased 0.08 3 0.24
operations
4. Demand for going to cinema is growing 10% 0.07 2 0.14
annually
5. Two new neighborhoods being developed within 3 0.09 1 0.09
miles
6. Disposable income among citizens grew 5% in 0.06 3 0.18
prior year
7. Unemployment rate in county declines to 3.1% 0.03 2 0.06
 Threats
8. Trend toward healthy eating eroding concession 0.12 4 0.48
sales
9. Demand for online movies and DVDs growing 10% 0.06 2 0.12
annually
10. Commercial property adjacent to cinemas for sale 0.06 3 0.18
11. TDB University installing an on-campus movie 0.04 3 0.12
theatre
12. County and city property taxes increasing 25% 0.08 2 0.16
this year
13. Local religious groups object to R-rated movies 0.04 3 0.12
being shown
14. Movies rented from local blockbuster store up 0.08 2 0.16
12%
15. Movies rented last quarter from Time Warner up 0.06 1 0.06
15%
Total 1.0 2.28

Interpretation and Recommendation:

“Note that the most important factor to being successful in this business is “Trend toward
healthy eating eroding concession sales” as indicated by the 0.12 weight. Also note that the
local cinema is doing excellent in regard to handling two factors, “TDB University is expanding
6 percent annually” and “Trend toward healthy eating eroding concession sales.” Perhaps the
cinema is placing flyers on campus and adding yogurt and healthy drinks to its concession
menu. Note that you may have a 1, 2, 3, or 4 anywhere down the Rating column. Finally, note
that the total weighted score of 2.58 is above the average (midpoint) of 2.5, so this cinema
business is doing pretty-well, taking advantage of the external opportunities and avoiding the
threats facing the firm. There is room for improvement, though, because the highest total
weighted score would be 4.0. As indicated by ratings of 1, this business needs to capitalize more
on the “two new neighborhoods nearby” opportunity and the “movies rented from Time
Warner” threat.

The Competitive Profile Matrix (CPM)

CPM Matrix is about identifying major competitors and their strengths and weaknesses in relation to the firm’s
strategic position.
Step 1 – Identify the critical success factor. In the table, the critical success factors are the viable factors that can
contribute for a business firms to be successful in their own industry. Take note that, the critical success factors are
different for different industry. For instance, part of critical success factors of food business are the food quality and
supply of ingredients. On the other hand, the critical success factors of a salon industry include the service quality
and level of the skill of the workers.
Step 2 – Identify the weight of each critical success factor. Note that, the higher the factor’s weight means that this
factor contributes greatly to the success of a business in the industry. On the other hand, the lesser the factor’s
weight means that this factor is less valued or only has a less impact in terms of the success of a business in the
industry. In doing this it should be always remember that the total of all the weight should be 1.0.
Step 4 - Once the critical success factor and its specific weight are determined the subject business is then evaluated
based on their current standing on the different critical success factors. Whereas 4 = if the factor is their major
strength, 3 = if their minor strength, 2 = if minor weakness, and 1 = if major weakness.
Step 5 – Compute the score of each factor based on the subject business standing. This is done by multiplying the
weight of the certain factor to its subject business corresponding rating. For instance, if Advertising has 0.20 weight
and the rating the strategist gave for Business #1 is 3 because it is considered as minor strength the score is 0.60.
Whereas 0.20 x 3 = 0.60. Another example, if the Business #2 has a rating of 2 on the Advertising that has a weight
of 0.20 the score is then 0.40. Whereas 0.20 x 2 = 0.40.
Step 6 – Add all the score of each subject business to know the total score.

(example)

Competitive Profile Matrix

Business 1 Business 2 Business 3
Critical Success Factors Weight
Rating Score Rating Score Rating Score
1. Advertising 0.20 1 0.20 4 0.80 3 0.60
2. Product Quality 0.10 4 0.40 3 0.30 2 0.20
3. Price Competitiveness 0.10 3 0.30 2 0.20 4 0.40
4. Management 0.10 4 0.40 3 0.20 3 0.30
5. Financial Position 0.15 4 0.60 2 0.30 3 0.45
6. Customer Loyalty 0.10 4 0.40 3 0.30 2 0.20
7. Global Expansion 0.20 4 0.80 1 0.20 2 0.40
8. Market Share 0.05 1 0.05 4 0.20 3 0.15
Total 1.0 3.15 2.50 2.70

Interpretation and Explanation:

In this example, the two most important factors to being successful in the industry are
“advertising” and “global expansion,” as indicated by weights of 0.20. If there were no weight
column in this analysis, note that each factor then would be equally important. Thus, having a
weight column makes for a more robust analysis, because it enables the analyst to assign higher
and lower numbers to capture perceived or actual levels of importance. Note that Company 1 is
strongest on “product quality,” as indicated by a rating of 4, whereas Company 2 is strongest
on “advertising.” Overall, Company 1 is strongest, as indicated by the total weighted score of
3.15. Other than the critical success factors listed in the example CPM, factors often included in
this analysis include breadth of product line, effectiveness of sales distribution, proprietary or
patent advantages, location of facilities, production capacity and efficiency, experience, union
relations, technological advantages, and e-commerce expertise. A word on interpretation: Just
because one firm receives a 3.2 rating and another receives a 2.80 rating in a Competitive
Profile Matrix, it does not follow that the first firm is 20 percent better than the second.
Numbers reveal the relative strengths of firms, but their implied precision is an illusion.
Numbers are not magic. The aim is not to arrive at a single number, but rather to assimilate
and evaluate information in a meaningful way that aids in decision making”