The External Assessment

The External
Assessment
Copyright ©2017 Pearson Education, Limited 7-1

Copyright © 2011 Pearson Education, Inc.
Publishing as Prentice Hall Ch 3 -2
Chapter outline : Focus of the chapter
3.1 The Nature of external audit process

3.2 Key external factors
3.3 Sources of external information
3.4 Forecasting tools and techniques
3.5 Porter’s 5 Forces Model of Competition
3.6 EFE Matrix
3.7 Competitive Profile Matrix

External Audit
External audit
focuses on identifying and evaluating trends
and events beyond the control of a single firm
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

The Nature of an External Audit
The external audit is aimed at identifying
key variables that offer actionable
responses
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.

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, governmental, and legal forces
4. technological forces
5. competitive forces

Relationships Between Key External
Forces and an Organization

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

The Process of Performing an External
Audit
Information should be assimilated and

evaluated
A final list of the most important key

external factors should be communicated

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

I/O Perspective Firm Performance
Industry Properties
Economies of Scale
Barriers to Market Entry
Product Differentiation
The Economy
Level of Competitiveness

Economic Forces
 Shift to service economy  Income differences by region and
 Availability of credit consumer group
 Level of disposable income  Price fluctuations
 Propensity of people to spend  Foreign countries’ economic
 Interest rates conditions
 Inflation rates  Monetary and Fiscal policy
 GDP trends  Stock market trends
 Consumption patterns  Tax rate variation by country and
 Unemployment trends state
 Value of the dollar  European Economic Community
(EEC) policies
 Import/Export factors
 Organization of Petroleum
 Demand shifts for different goods
Exporting Countries (OPEC) policies
and services

Economic Forces
 GDP
 Trends in the dollar’s value
 Unemployment rates

Key Social, Cultural, Demographic, and
Natural Environmental Variables
 Population changes by race, age,  Attitudes toward retirement
and geographic area  Energy conservation
 Regional changes in tastes and  Attitudes toward product quality
preferences
 Attitudes toward customer
 Number of marriages
service
 Number of divorces
 Pollution control
 Number of births
 Attitudes toward foreign peoples
 Number of deaths
 Immigration and emigration rates  Energy conservation
 Social Security programs  Social programs
 Life expectancy rates  Number of churches
 Per capita income  Number of church members
 Social media pervasiveness  Social responsibility issues

Social, Cultural, Demographic, and
Natural Environmental Forces
Major Impact –
• Products
• Services
• Markets
• Customers

Ch 3 -15
Publishing as Prentice Hall
Political, Governmental, and
Legal Forces
The increasing global interdependence
among economies, markets, governments,
and organizations makes it imperative that
firms consider the possible impact of
political variables on the formulation and
implementation of competitive strategies.

Political, Government, and
Legal Variables
 Environmental  USA vs. other country

regulations relationships
 Political conditions in
 Number of patents foreign countries
 Changes in patent laws  Global price of oil
 Equal employment laws changes
 Local, state, and federal
 Level of defense laws
expenditures  Import–export regulations
 Unionization trends  Tariffs
 Antitrust legislation  Local, state, and national
elections

Political, Governmental, and
Legal Forces
Government Regulation
Key opportunities & threats

 Antitrust legislation
 Tax rates
 Lobbying activities
 Patent laws

Ch 3 -18
Political, Governmental, and Legal Forces
 Protectionist policies
 Governments taking equity stakes in

companies

Technological Forces
New technologies such as:
the Internet of Things
3D printing
the cloud
mobile devices
biotech
analytics
autotech
robotics and
artificial intelligence
are fueling innovation in many industries, and impacting strategic-
planning decisions.

Many firms now have a Chief Information
Officer (CIO) and a Chief Technology
Officer (CTO) who work together to
ensure that information needed to
formulate, implement, and evaluate
strategies is available where and when it is
needed

Results of Technological Advances
1. Major opportunities and threats that must be considered in formulating
strategies.
2. Can affect organizations’ products, services, markets, suppliers,
distributors, competitors, customers, manufacturing processes,
marketing practices, and competitive position.
3. Can create new markets, result in new and improved products, change
the relative competitive cost positions, and render existing products and
services obsolete.
4. Can reduce or eliminate cost barriers between businesses, create shorter
production runs, create shortages in technical skills, and result in
changing values and expectations of employees, managers, and
customers.
5. Can create new competitive advantages that are more powerful than
existing advantages.

Major Impact –
• Internet
• Essential for nearly every
strategic decision

Ch 3 -23
Competitive Forces
An important part of an external audit is
identifying rival firms and determining their
strengths, weaknesses, capabilities,
opportunities, threats, objectives, and
strategies

Competitive Forces
Characteristics of the most competitive
companies:
1. Strive to continually increase market share
2. Use the vision/mission as a guide for all decisions
3. Whether it's broke or not, fix it–make it better
4. Continually adapt, innovate, improve
5. Acquisition is essential to growth
6. Hire and retain the best employees and managers possible
7. Strive to stay cost-competitive on a global basis

Key Questions About Competitors
1. What are the strengths of our major competitors?
2. What are the weaknesses of our major competitors?
3. What are the objectives and strategies of our major competitors?
4. How will our major competitors most likely respond to current economic, social,
cultural, demographic, environmental, political, governmental, legal, technological,
and competitive trends affecting our industry?
5. How vulnerable are the major competitors to our alternative company strategies?
6. How vulnerable are our alternative strategies to successful counterattack by our
major competitors?
7. How are our products or services positioned relative to major competitors?
8. To what extent are new firms entering and old firms leaving this industry?
9. What key factors have resulted in our present competitive position in this industry?
10.How have the sales and profit rankings of our major competitors in the industry
changed over recent years? Why have these rankings changed that way?
11.What is the nature of supplier and distributor relationships in this industry?
12.To what extent could substitute products or services be a threat to our competitors?

Competitive Intelligence Programs
Competitive intelligence (CI)

a systematic and ethical process for gathering
and analyzing information about the
competition's activities and general business
trends to further a business's own goals

Competitive Intelligence Programs
The three basic objectives of a CI program are:
1. To provide a general understanding of an industry

and its competitors
2. To identify areas in which competitors are vulnerable

and to assess the impact strategic actions would
have on competitors
3. To identify potential moves that a competitor might make

that would endanger a firm's position in the market
The Five-Forces Model of Competition

https://www.business-to-you.com/porters-five-forces/

The Five-Forces Model of Competition
1. Identify key aspects or elements of each

competitive force that impact the firm.
2. Evaluate how strong and important each

element is for the firm.
3. Decide whether the collective strength of

the elements is worth the firm entering or
staying in the industry.
The Five-Forces Model
Rivalry among competing firms
Most powerful of the five forces
Focus on competitive advantage of

strategies over other firms

TABLE 7-7 Conditions That Cause High Rivalry Among Competing Firms
▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬
1. When the number of competing firms is high
2. When competing firms are of similar size
3. When competing firms have similar capabilities
4. When the demand for an industry’s products is falling
5. When the product or service prices in the industry are falling
6. When consumers can switch brands easily
7. When barriers to leaving the market are high
8. When barriers to entering the market are low
9. When fixed costs are high among competing firms
10. When the product is perishable
11. When rivals have excess capacity
12. When consumer demand is falling
13. When rivals have excess inventory
14. When rivals sell similar products/services
15. When mergers are common in the industry
Potential Entry of New
Competitors
Barriers to entry are important
Quality, pricing, and marketing can

overcome barriers

Barriers to Entry
 Need to gain economies of scale quickly
 Need to gain technology and specialized know-
how
 Lack of experience
 Strong customer loyalty
 Strong brand preferences
 Large capital requirements
 Lack of adequate distribution channels

Barriers to Entry
 Government regulatory policies
 Tariffs
 Lack of access to raw materials
 Possession of patents
 Undesirable locations
 Counterattack by entrenched firms
 Potential saturation of the market

Potential development of
substitute products
Pressure increases when:
Prices of substitutes decrease
Consumers' switching costs decrease

Bargaining Power of Suppliers is
increased when (there are):
Few suppliers
Few substitutes
Costs of switching raw materials is high
Backward integration is gaining control or
ownership of suppliers

Bargaining power of consumers
Customers being concentrated or
buying in volume affects intensity of
competition
Consumer power is higher where
products are standard or
undifferentiated

Conditions Where Consumers Gain
Bargaining Power
1. If buyers can inexpensively switch
2. If buyers are particularly important
3. If sellers are struggling in the face of falling
consumer demand
4. If buyers are informed about sellers' products,
prices, and costs
5. If buyers have discretion in whether and when
they purchase the product

Sources of External Information
 Unpublished sources include customer
surveys, market research, speeches at
professional and shareholders' meetings,
television programs, interviews, and
conversations with stakeholders.
 Published sources of strategic information
include periodicals, journals, reports,
government documents, abstracts, books,
directories, newspapers, and manuals.

Sources of External Information
http://finance.yahoo.com
 www.hoovers.com
 http://globaledge.msu.edu/industries/

Forecasting Tools and Techniques
Forecasts
educated assumptions about future

trends and events
no forecast is perfect

Making Assumptions
Assumptions
Best present estimates of the impact of
major external factors, over which the
manager has little if any control, but
which may exert a significant impact on
performance or the ability to achieve
desired results.

Business Analytics
Using software to mine huge

volumes of data
Helps executives make decisions

Industry Analysis: The External Factor
Evaluation (EFE) Matrix
Summarize and evaluate these factors:

Economic Political
Social Governmental
Cultural Legal
Demographic Technological
Environmental Competitive

The EFE matrix is the strategic tool used to evaluate firm existing strategies, EFE matrix can be
defined as the strategic tool to evaluate external environment or macro environment of the firm
include economic, social, technological, government, political, legal and competitive information.
EFE Matrix is an analytical technique for evaluation of external position of the organization or its
strategic intents.
Opportunities
Opportunities are the chances exist in the external environment, it depends firm whether the firm is
willing to exploit the opportunities or may be they ignore the opportunities due to lack of resources.
Threats
Threats are always evil for the firm, minimum no of threats in the external environment open many
doors for the firm. Maximum number of threats for the firm reduce their power in the industry.
RATING
Rating in EFE matrix represent the response of firm toward the opportunities and threats. Highest
the rating better the response of the firm to exploit opportunities and defend the threats. Rating
range from 1.0 to 4.0 and can be applied to any factor whether it comes under opportunities or
threats.[sky]

There are some important point related to rating in EFE matrix.
Rating is applied to each factor.

The response is poor represented by 1.0
The response is average is represented by 2.0
The response is above average represented by 3.0
The response is superior represented by 4.0
WEIGHT
Weight attribute in EFE matrix indicates the relative importance of factor to being successful in the
firm’s industry. The weight range from 0.0 means not important and 1.0 means important, sum of all
assigned weight to factors must be equal to 1.0 otherwise the calculation would not be consider
correct.
WEIGHTED SCORE
Weighted score value is the result achieved after multiplying each factor rating with the weight.
TOTAL WEIGHTED SCORE

The sum of all weighted score is equal to the total weighted score, final value of total weighted
score should be between range 1.0 (low) to 4.0(high). The average weighted score for EFE matrix
is 2.5 any company total weighted score fall below 2.5 consider as weak. The company total
weighted score higher then 2.5 is consider as strong in position.

Steps:
1. List key external factors as identified in the external‑audit process. Include a total of from ten to twenty
factors, including both opportunities and threats affecting 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.
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 too can receive high weights if they are especially
severe or threatening. Appropriate weights can be determined by comparing successful 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.
3. Assign a 1 to 4 rating 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.
4. Multiply each factor’s weight by its rating to determine a weighted score.
5. Sum the weighted scores for each variable to determine the total weighted score for the organization.

Interpreting the score:
Regardless of the number of key opportunities and threats included in an External Factor
Evaluation (EFE) Matrix, the highest possible total weighted score for an organization is
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 effect of external threats. A total score of 1.0 indicates that the firm’s
strategies are not capitalizing on opportunities or avoiding external threats.
The External Factor Evaluation (EFE) Matrix is similar to Internal Factor Evaluation (EFE)
Matrix. The major difference between the EFE matrix and the IFE matrix is the type of
factors that are included in the model. While the IFE matrix deals with internal factors, the
EFE matrix is concerned solely with external factors.

EFE Matrix for a Local Ten-Theater
Cinema Complex

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

internal and external issues

CPM
CPM, or the CPM Matrix, stands for Competitive Profile Matrix and is a powerful strategic
analysis tool. CPM allows business owners, stockholders and other interested parties to see
the strengths and weaknesses of all major competitors in an industry on a single page.
The Competitive Profile Matrix (CPM) is a tool that compares the firm and its rivals and
reveals their relative strengths and weaknesses.
In order to better understand the external environment and the competition in a particular
industry, firms often use CPM. The matrix identifies a firm’s key competitors and compares
them using industry’s critical success factors. The analysis also reveals company’s relative
strengths and weaknesses against its competitors, so a company would know, which areas it
should improve and, which areas to protect. An example of a matrix is demonstrated below.
Competitive profile matrix is an essential strategic management tool to compare the firm with
the major players of the industry. Competitive profile matrix show the clear picture to the firm
about their strong points and weak points relative to their competitors. The CPM score is
measured on basis of critical success factors, each factor is measured in same scale mean
the weight remain same for every firm only rating varies. The best thing about CPM that it
include your firm and also facilitate to add other competitors make easier the comparative
analysis.

Ch 3 -55
WEIGHT
Weight attribute in CPM indicates the relative importance of factor to being successful in
the firm’s industry. The weight range from 0.0 means not important and 1.0 means
important, sum of all assigned weight to factors must be equal to 1.0 otherwise the
calculation would not be consider correct.
WEIGHTED SCORE
Weighted score value is the result achieved after multiplying each factor rating with the
weight.
TOTAL WEIGHTED SCORE

The sum of all weighted score is equal to the total weighted score, final value of total
weighted score should be between range 1.0 (low) to 4.0(high). The average weighted
score for CPM matrix is 2.5 any company total weighted score fall below 2.5 consider as
weak. The company total weighted score higher then 2.5 is consider as strong in
position.The other dimension of CPM is the firm with higher total weighted score
considered as the winner among the competitors.

Ch 3 -56
Industry Analysis: Competitive Profile Matrix (CPM)
 Identifies firm’s major competitors and their strengths & weaknesses in relation
to a sample firm’s strategic positions
 Critical success factors include internal and external issues
 Rating in CPM represent the response of firm toward the critical success factors.
Highest the rating better the response of the firm towards the critical success
factor ,rating range from 1.0 to 4.0 and can be applied to any factor.
Rating is applied to each factor.

The response is poor represented by 1.0
The response is average is represented by 2.0
The response is above average represented by 3.0
The response is superior represented by 4.0

Ch 3 -57
Ch 3 -58
An Example Competitive
Profile Matrix
TABLE 7-12 An Example Competitive Profile Matrix
▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬
Company 1 Company 2 Company 3____________
Critical Success
Factors_ ___ _ Weight Rating Score Rating Score Rating Score____ ____
Advertising 0.20 1 0.20 4 0.80 3 0.60
Product Quality 0.10 4 0.40 3 0.30 2 0.20
Price Competitiveness 0.10 3 0.30 2 0.20 1 0.10
Management 0.10 4 0.40 3 0.20 1 0.10
Financial Position 0.15 4 0.60 2 0.30 3 0.45
Customer Loyalty 0.10 4 0.40 3 0.30 2 0.20
Global Expansion 0.20 4 0.80 1 0.20 2 0.40
Market Share 0.05 1 0.05 4 0.20 3 0.15
Total 1.00 3.15 2.50 2.20
Note: The ratings values are as follows: 1 = major weakness, 2 = minor weakness, 3 = minor strength, 4 =
major strength. As indicated by the total weighted score of 2.50, Competitor 2 is weakest. Only eight
critical success factors are included for simplicity; this is too few in actuality.

Industry Analysis CPM
Important –
Just because one firm receives a 3.2 rating
and another receives a 2.8 rating, it does not
follow that the first firm is 20 percent better
than the second.

Ch 3 -62

The External Assessment

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The External Assessment

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The External

Copyright ©2017 Pearson Education, Limited 7-1

3.1 The Nature of external audit process

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Information should be assimilated and

A final list of the most important key

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Barriers to Market Entry

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 Trends in the dollar’s value

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 Environmental  USA vs. other country

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Key opportunities & threats

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 Governments taking equity stakes in

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Competitive intelligence (CI)

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The three basic objectives of a CI program are:

1. To provide a general understanding of an industry

2. To identify areas in which competitors are vulnerable

3. To identify potential moves that a competitor might make

Copyright ©2017 Pearson Education, Limited 7-29

Copyright © 2011 Pearson Education, Inc.

1. Identify key aspects or elements of each

2. Evaluate how strong and important each

3. Decide whether the collective strength of

Most powerful of the five forces

Focus on competitive advantage of

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Barriers to entry are important

Quality, pricing, and marketing can

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Prices of substitutes decrease

Consumers' switching costs decrease

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educated assumptions about future

no forecast is perfect