CHAPTER FIVE: THE INTERNAL ASSESSMENT

5.1. The Nature of an Internal Audit

• Internal Audit (organizational analysis/
corporate appraisal/profiling the organization)
is the process by which the strategists examine the
firm’s marketing and distribution, R & D, production/
operations, corporate resources and personnel,
finance, IT and general management factors to
determine where the firm has significant strengths
and weaknesses.
• It is the process through which strategists and
managers analyze the various factors of their
organization to evaluate their relative strengths and
weaknesses so as to meet the opportunities and
threats of the external environment.
BY: Woldetsadik Kagnew (Assist. Prof.) 1
 5.2. Key Internal Forces
For different types of organizations, such as
hospitals, universities, and government agencies,
the functional business areas, of course, differ.
In a hospital, for example, functional areas may
include cardiology, hematology, nursing,
maintenance, physician support, and receivables.
Functional areas of a university can include athletic
programs, placement services, housing, fund
raising, academic research, counseling, and
intramural programs.

BY: Woldetsadik Kagnew (Assist. Prof.) 2

 5.3. The Process of Performing an Internal
Audit
The internal audit requires gathering and assimilating
information about the firm's management, marketing,
finance/accounting, production/operations, research and
development (R&D), and computer information systems
operations. Strategic management is a highly
interactive process that requires effective coordination
among management, marketing, finance/accounting,
production/operations, R&D, and computer information
systems managers.
Identification of strategic internal factors and
Evaluation of Strategic Internal Factors.

BY: Woldetsadik Kagnew (Assist. Prof.) 3

 5.4. Approaches to undertake Internal
Environmental Analysis
A. Functional approach
B. Value chain approach
C. Resource Based View (RBV) approach
A) Functional approach
• Functional approach of organizational analysis
takes into account various functional areas
(Marketing, Finance/Accounting, HRM, R&D,
MIS, and Production/ Operations) and evaluates
these for identifying strengths and weaknesses.

BY: Woldetsadik Kagnew (Assist. Prof.) 4

 1. Marketing
Marketing can be described as the process of
defining, anticipating, creating, and fulfilling
customers' needs and wants for products and
services. There are seven basic functions of
marketing:
• (1) Customer analysis, (2) Selling
products/services, (3) Product and service
planning, (4) Pricing, (5) Distribution, (6)
Marketing research, and (7) Opportunity
analysis.

BY: Woldetsadik Kagnew (Assist. Prof.) 5

i) Customer Analysis: the examination and
evaluation of consumer needs, desires, and
wants—involves administering customer
surveys, analyzing consumer information,
evaluating market positioning strategies,
developing customer profiles, and determining
optimal market segmentation strategies.
ii) Selling Products/Services
Selling includes many marketing activities such as
advertising, sales promotion, publicity, personal
selling, sales force management, customer
relations, and dealer relations.

BY: Woldetsadik Kagnew (Assist. Prof.) 6

iii) Product and Service Planning: includes
activities such as test marketing; product and brand
positioning; devising warranties; packaging;
determining product options, product features,
product style, and product quality; deleting old
products; and providing for customer service.
Product and service planning is particularly
important when a company is pursuing product
development or diversification.
iV) Pricing: Five major stakeholders affect pricing
decisions are consumers, governments, suppliers,
distributors, and competitors.

BY: Woldetsadik Kagnew (Assist. Prof.) 7

v) Distribution: includes warehousing,
distribution channels, distribution coverage, retail
site locations, sales territories, inventory levels and
location, transportation carriers, wholesaling, and
retailing.
vi) Marketing Research: is the systematic
gathering, recording, and analyzing of data about
problems relating to the marketing of goods and
services. Marketing research can uncover critical
strengths and weaknesses, and marketing
researchers employ numerous scales, instruments,
procedures, concepts, and techniques to gather
information.

BY: Woldetsadik Kagnew (Assist. Prof.) 8

vii) Opportunity Analysis: involves assessing the
costs, benefits, and risks associated with marketing
decisions. Three steps are required to perform a
cost/benefit analysis:
• Compute the total costs associated with a
decision,
• Estimate the total benefits from the decision, and
• Compare the total costs with the total benefits.
2. Finance/Accounting
• According to James Van Horne, the functions of
finance/accounting comprise three decisions: the
investment decision, the financing decision,
and the dividend decision
BY: Woldetsadik Kagnew (Assist. Prof.) 9
i) Investment decision, (capital budgeting) is
the allocation and reallocation of capital and
resources to projects, products, assets, and
divisions of an organization.
ii) Financing decision concerns determining the
best capital structure for the firm and includes
examining various methods by which the firm
can raise capital (for example, by issuing stock,
increasing debt, selling assets, or using a
combination of these approaches).
iii) Dividend decisions concern issues such as
the percentage of earnings paid to stockholders,
the stability of dividends paid over time, and
the repurchase or issuance of stock.
BY: Woldetsadik Kagnew (Assist. Prof.) 10
 3. Production/Operations
• The production/operations function of a business consists of
all those activities that transform inputs into goods and services.
The Basic Functions of Production Management
Function Description

1. Process Process decisions concern the design of the physical production system. E.g.
choice of technology, facility layout, process flow analysis, facility location, line
balancing, process control, and transportation analysis.

2. Capacity Capacity decisions concern determination of optimal output levels for the
organization— e.g. forecasting, facilities planning, aggregate planning,
scheduling, capacity planning, and queuing analysis.

3. Inventory Inventory decisions involve managing the level of raw materials, work in
process, and finished goods. E.g. what to order, when to order, how much to
order, and materials handling.

4. Workforce Workforce decisions are concerned with managing the skilled, unskilled,
clerical, and managerial employees.

5. Quality Quality decisions are aimed at ensuring that high-quality goods and services
are produced. E.g. quality control, sampling, testing, quality assurance, 11
BY: Woldetsadik Kagnew (Assist. Prof.)
and
cost control.
 4. Research and Development (R&D)
• Research and development expenditures are directed
at developing new products before competitors do,
improving product quality, or improving
manufacturing processes to reduce costs.
5. Management Information Systems
It is also referred to as information technology
management. The study of information systems is
usually a commerce and business administration
discipline, and frequently involves software
engineering, but also distinguishes itself by
concentrating on the integration of computer systems
with the aims of the organization.
In business, information systems support business
processes and operations, decision-making, and
competitive strategies.
BY: Woldetsadik Kagnew (Assist. Prof.) 12
 B. Value Chain Approach
• A value chain is a systematic way of viewing the
series of activities a firm performs to provide a
product to its customers.
• Value chain disaggregates a firm into its
strategically relevant activities in order to
understand the behavior of the firm’s cost and its
existing or potential source of differentiation.
• Value chain analysis considers where and how a firm
adds value (i.e. the internal factors that drive
profitability).
• Every firm can be viewed (disaggregated) as a
collection of value activities that are performed to
design, produce, market, deliver, and support its
products.
• As portrayed in a figure below, these activities can
be grouped into nine basic categories for virtually
any firm.
BY: Woldetsadik Kagnew (Assist. Prof.) 13
• Through the systematic identification of these
discrete activities, managers using value chain
approach can target potential strength and
weakness for further evaluation.
• The capability of the organization depends on the
quality of co-ordination across these activities,
not just on competence in each individual
activity.
• So strengths and weaknesses are based on how
well value chain activities are performed.
• Building linkages will increase value added.
• This provides a further mechanism to
differentiate your company from its competitors,
and thereby create ‘margin’ (as indicated on the
right hand side of the value chain figure ). 14

BY: Woldetsadik Kagnew (Assist. Prof.)

 Firm Infrastructure

Human Resource Management

Margin
Support activities

Technology Development

Procurement

Marketing and sales

Outbound Logistics
Inbound logistics

Margin
Services
Operations

Primary activities
BY: Woldetsadik Kagnew (Assist. Prof.) 15
• The basic categories of activities can be grouped
into two broad types: primary activities and
the supporting activities.
• Primary activities are those involved in the
physical creation of the firm’s products, its
delivery and marketing to the buyer, and its
after sale support.
• The primary activities are generally quite
distinct, having different economies and, in large
organizations, separate cost centers.
• Overarching each of these are support activities,
which provide input or infrastructure allowing
primary activities to take place on an ongoing 16
basis.
BY: Woldetsadik Kagnew (Assist. Prof.)
• The primary (i.e. the main value-adding) activities
are grouped into five main areas:
a. Inbound Logistics – concerned with receiving,
storing, and distributing inputs;
b. Operations – transforming the inputs into the
final product/service;
c. Outbound Logistics – moving the product to
buyers (including warehousing and distribution);
d. Marketing and Sales – bringing the product to
buyers and inducing them to buy and use it;
e. Service – activities to enhance or maintain the
value of the product service (including
installation, repairs, maintenance, training and17
other services).
BY: Woldetsadik Kagnew (Assist. Prof.)
 Primary Activities and Factors for Assessment
Inbound Outbound Marketing & Sales Customer
Logistics Operations Logistics Service
 Soundness of  Productivity of  Timeliness and  Effectiveness of  Means to solicit
material and equipment efficiency of market research to customer input
inventory compared to delivery of identify customer for product
control that of key finished goods segments & needs improvements
systems competitors and services  Innovation in sales  Promptness of
 Efficiency of  Appropriate  Efficiency of & promotion attention to
raw material automation of finished goods  Evaluation of customer
warehousing production warehousing alternate complaints
activities processes activities distribution  Appropriateness
 Effectiveness channels of warranty and
of production  Motivation and guarantee
control systems competence of sales policies
to improve force  Quality of
quality and  Development of customer
reduce costs image of quality and education and
 Efficiency of a favorable training
plant layout reputation  Ability to
and work-flow  Extent of brand provide
design loyalty among replacement parts
customers and repair service
 Extent of market
dominance within
18
the market segment
or overall market
BY: Woldetsadik Kagnew (Assist. Prof.)
• Each of these five primary activities is linked
with four supporting activities:
a. Procurement: processes for acquiring
resources;
b. Technology Development: covering product,
process and raw material development and
‘know-how’;
c. Human Resource Management: including
recruitment, training, development and
rewards;
d. Firm Infrastructure: chiefly the management
systems, e.g. planning, finance accounting and
quality control.
19

BY: Woldetsadik Kagnew (Assist. Prof.)

 Secondary Activities and Factors for Assessment
Firm Human Resource Technology Procurement
Development
Infrastructure
 Capability to  Effectiveness of  Success of R&D  Development of
identify new procedures for activities in leading alternate sources
product market recruiting, to product and for inputs to
opportunities and process innovations
training, and minimize
potential  Quality of working
environmental promoting all relationship between dependence on a
threats levels of R&D personnel and single supplier
 Quality of the employees other departments  Procurement of
strategic planning  Appropriateness  Timeliness of raw materials on
system to achieve of reward technology timely basis at
corporate objectives systems development lowest possible
 Coordination and  Relations with activities in meeting cost and at
integration of all critical deadlines
trade unions acceptable levels
value chain  Qualifications &
activities  Levels of experience of of quality
 Ability to obtain employee laboratory  Development for
relatively low cost motivation and technicians and criteria for lease-
funds for capital job satisfaction scientists vs.-buy decisions
expenditures and  Ability of work  Good, long-term
working capital environment to relationships with
 Timely & accurate encourage creativity suppliers
information on and innovation 20
general and
competitive
BY: Woldetsadik Kagnew (Assist. Prof.)
environments
Where to Find Information for Value Chain Analysis?
• Up to three years of annual reports of the
company can be analyzed to see how the costing
of the activities are changing over the period and
whether they are in unison with the competitive
strategy of the firm.
• In order to gain knowledge about the core
competence of the company, analysts can look at
the company and competitor websites.
• journal articles, trade publications and
magazines are useful sources of information to
identify how value is created in the particular
industry in which the company operates and
which activities play a key role in the generation
of that value.
BY: Woldetsadik Kagnew (Assist. Prof.) 21
 Limitations of Value Chain Analysis
• It describes an industrial organization which
essentially buys raw materials and transforms
these into physical products, i.e. not services
• The real value of the product is assessed when
the product reaches the final customer, and any
assessment of that value before that moment is
only something that is true in theory.

BY: Woldetsadik Kagnew (Assist. Prof.) 22

c. Resource Based View / RBV/
Approach
• The RBV is a model of firm performance
analysis that focuses on the resources
(including capabilities) controlled by a
firm to determine the firm’s internal position.
• The resource based view suggests that the
performance for any firm are largely
determined by characteristics inside the firm.
• Resources in the RBV are defined as the
tangible and intangible assets that a firm
controls that it can use to conceive and
implement its strategies.
23

BY: Woldetsadik Kagnew (Assist. Prof.)

• Resources are an organization’s assets and are
thus the basic building blocks of the
organization.
• Capabilities are a subset of a firm's resources
and are defined as the tangible and
intangible assets that enable a firm to take
full advantage of the other resources it
controls.
• They consist of business processes and routines
that manage the interaction among resources to
turn inputs into value added outputs.
• A capability is functionally based and is resident
in a particular function. 24

BY: Woldetsadik Kagnew (Assist. Prof.)

• Thus, there are marketing capabilities,
manufacturing capabilities, and human resource
management capabilities.
• For example, a company’s marketing capability
can be based on the interaction among its
marketing specialists, distribution channels, and
sales people.
• When these capabilities are constantly being
changed and reconfigured to make them more
adaptive to an uncertain environment, they are
called dynamic capabilities.
• A competency is a cross-functional integration
and coordination of capabilities. 25

BY: Woldetsadik Kagnew (Assist. Prof.)

• For example, a competency in new product
development in one division of a firm may be the
consequence of integrating management of
information systems (MIS) capabilities,
marketing capabilities, R&D capabilities, and
production capabilities within the division.
• A core competency is a collection of
competencies that crosses divisional boundaries,
is widespread within the corporation, and is
something that the corporation can do
exceedingly well. Thus, new product
development is a core competency if it goes
beyond one division. For example, FedEx has a
core competency in its application of information26
technology to all its operations.
BY: Woldetsadik Kagnew (Assist. Prof.)
• A company must continually reinvest in a core
competency or risk its becoming a core rigidity or
deficiency, that is, a strength that over time matures
and may become a weakness.
• Although it is typically not an asset in the
accounting sense, a core competency is a very
valuable resource—it does not “wear out” with use.
• In general, the more core competencies are used, the
more refined they get, and the more valuable they
become.
The Process of RBV Approach to internal analysis
begins with an audit of the firm’s resources.
• This should enable management to decide on how
well the resources are being utilized – i.e. how
efficiently and effectively they are being used and
how well they are being controlled. 27

BY: Woldetsadik Kagnew (Assist. Prof.)

• This analysis, in the context of the firm’s
activities, will identify the company’s key
strengths (i.e. good attributes) as well as identify
missing or ‘poor’ resources that need to be
attended to.
• A firm's resources (including capabilities) can
be classified as follows hence the analysis can
be done accordingly: (6 r/ces)
1. Physical resources. These include buildings,
materials, production facilities, production
techniques, information systems, distribution
networks, research facilities.
• Efficiency will concern capacity fill, unit costs, 28
yield, layout and materials flow.
BY: Woldetsadik Kagnew (Assist. Prof.)
• Effectiveness should be measured by the match
between the various resources.
• Relative position will be in respect of
benchmarking against rivals, e.g. over values of
fixed assets, age of capital equipment, scale of
plant and flexibility of plant and equipment.
2. Human resources: This is in terms of the
number of employees, their productivity (set
against wages and salaries), the extent and
balance of technical and other skills (also
competence, versatility, flexibility, adaptability),
knowledge (awareness), experience, attitudes
(commitment, loyalty, degree of interest and
effort, team spirit, management style) and their
demographic characteristics (age structure). 29
BY: Woldetsadik Kagnew (Assist. Prof.)
• Key indicators include educational, technical and
professional qualifications of employees,
compensation and pay relative to the industry,
record on labour disputes and employee turnover
rate.
3. Organizational Resources: Whereas human
resources are an attribute of single individuals,
organizational resources are an attribute of
groups of individuals.
Organizational resources include a firm's formal
reporting structure; its formal and informal
planning, controlling, and coordinating
systems; its culture and reputation; and
informal relations among groups within a firm
and between a firm and those in its environment. 30
BY: Woldetsadik Kagnew (Assist. Prof.)
• Key indicators may include the efficiency and
effectiveness of organizational structure,
transparency of controlling systems,
conduciveness of organizational culture and
organizational perceived image by the general
public.
4. Financial resources: The financial capability
depends on factors like financial size, growth
pattern, profitability, use of working capital, the
costing system, budgets and investment appraisal
procedures.
• Key indicators include the price–earnings ratio,
asset structure and capital structure, debt to
equity ratio, the ratio of net cash to capital
expenditure and the company’s credit rating. 31
BY: Woldetsadik Kagnew (Assist. Prof.)
5. Technological Resources: These cover two
aspects: the stock of technology and the
resources for innovation.
• The former is concerned with the form of
proprietary technology (e.g. patents, copyright,
trade secrets) and expertise in the application of
technology (i.e. know-how).
• The latter relates to research facilities and
technical and scientific employees.
• Key indicators for the firm might include the
number and significance of patents, revenue from
patent licences and R&D staff as a percentage of
total firm employment.
32

BY: Woldetsadik Kagnew (Assist. Prof.)

6. Intangibles: This category is especially
important for firms in the service sector, where
value depends on ‘goodwill’ arising from brand
names, company image, reputation, good contacts,
etc.
• Key indicators may include brand recognition,
premium over competing brands, percentage of
repeat buying and the level and consistency of
company performance.
• In addition the company might consider
objective measures of company performance with
respect to other interested parties, such as
suppliers (including material suppliers, banks
and other lenders, and employees), government
and regulatory bodies, and with the community.33
BY: Woldetsadik Kagnew (Assist. Prof.)
 5.5. The Internal Factor
Evaluation (IFE) Matrix
 A summary step in conducting an internal strategic-

management audit is to construct an Internal Factor

Evaluation (IFE) Matrix. This strategy-formulation tool

summarizes and evaluates the major strengths and

weaknesses in the functional areas of a business, and it

also provides a basis for identifying and evaluating

relationships among those areas. Intuitive judgments are

required in developing an IFE Matrix.

BY: Woldetsadik Kagnew (Assist. Prof.) 34
 Steps in developing an IFE Matrix
Step-1:
 List key internal factors as identified in the internal-
audit process. Use a total of from 10 to 20 internal
factors, including both strengths and weaknesses. List
strengths first and then weaknesses. Be as specific as
possible, using percentages, ratios, and comparative
numbers. Recall that Edward Deming said, “In God we
trust. Everyone else bring data.”

BY: Woldetsadik Kagnew (Assist. Prof.) 35

 Cont…
Step-2:
 Assign a weight that ranges from 0.0 (not important) to 1.0 (all-
important) to each factor. The weight assigned to a given factor
indicates the relative importance of the factor to being
successful in the firm’s industry. Regardless of whether a key
factor is an internal strength or weakness, factors considered to
have the greatest effect on organizational performance should
be assigned the highest weights. The sum of all weights must
equal 1.0.

BY: Woldetsadik Kagnew (Assist. Prof.) 36

 Cont…
Step-3:
 Assign a 1-to-4 rating to each factor to indicate whether
that factor represents a major weakness (rating = 1), a
minor weakness (rating = 2), a minor strength (rating =
3), or a major strength (rating = 4). Note that strengths
must receive a 3 or 4 rating and weaknesses must receive
a 1 or 2 rating. Ratings are thus company-based, whereas
the weights in step 2 are industry-based.

BY: Woldetsadik Kagnew (Assist. Prof.) 37

 Cont…
Step-4:
 Multiply each factor’s weight by its rating to
determine a weighted score for each variable.

Step-5:

Sum the weighted scores for each variable to

determine the total weighted score for the
organization.

BY: Woldetsadik Kagnew (Assist. Prof.) 38

 Cont…
 Regardless of how many factors are included in an IFE Matrix,

the total weighted score can range from a low of 1.0 to a high of

4.0, with the average score being 2.5. Total weighted scores well

below 2.5 characterize organizations that are weak internally,

whereas scores significantly above 2.5 indicate a strong internal

position. Like the EFE Matrix, an IFE Matrix should include

from 10 to 20 key factors. The number of factors has no effect

upon the range of total weighted scores because the weights

always sum to 1.0.

BY: Woldetsadik Kagnew (Assist. Prof.) 39
 A Sample Internal Factor Evaluation
Matrix for a Retail Computer Store
Key Internal Factors Weight Rating Weighted
Score
Strengths
Inventory turnover increased from 5.8 to 6.7 0.05 3 0.15

Average customer purchase increased from $97 to $128 0.07 4 0.28

Employee morale is excellent 0.10 3 0.30
In-store promotions resulted in 20 percent increase in 0.05 3 0.15
sales
Newspaper advertising expenditures increased 10 percent 0.02 3 0.06
Revenues from repair/service segment of store up 16 % 0.15 3 0.45
In-store technical support personnel have MIS degrees 0.05 4 0.20
Store’s debt-to-total assets ratio declined to 34 percent 0.03 3 0.09
Revenues per employee up 19 percent 0.02 3 0.06
BY: Woldetsadik Kagnew (Assist. Prof.) 40
 Cont…
Key Internal Factors Weight Rating Weighted
Score
Weaknesses
Revenues from software segment of store down 12 % 0.10 2 0.20
Location of store negatively impacted by new Highway 0.15 2 0.30

Carpet and paint in store somewhat in disrepair 0.02 1 0.02

Bathroom in store needs refurbishing 0.02 1 0.02
Revenues from businesses down 8 percent 0.04 1 0.04
Store has no Web site 0.05 2 0.10
Supplier on-time delivery increased to 2.4 days 0.03 1 0.03
Often customers have to wait to check out 0.05 1 0.05
Total 1.00 2.50

BY: Woldetsadik Kagnew (Assist. Prof.) 41

•THANK YOU!!!

BY: Woldetsadik Kagnew (Assist. Prof.) 42