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

 Environmental influences and how to deal

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

 Thus, the interaction with the environment influence

how the organization operates and how and what it
produces.

 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

 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.

 Whereas, threats arise when conditions in the external

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

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 Cont’d

 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.
 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

 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.

 This enable the firm take advantage of external

opportunities or that minimize the impact of potential threats

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  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.

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 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.

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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
 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:

 Economic assessment must

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

 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:

 Political factors define the legal and regulatory

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

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 Political Factors: cont’d …

 Other political actions aimed at

protecting employees, customers, the
general public, and the environment.
 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:

These 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:
altering the life cycles of products,
increasing the speed of distribution,
creating new products and services,
erasing limitations of traditional
geographic markets

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 Technological Forces

The Internet has changed the very nature of

opportunities and threats by:
altering the life cycles of products,
increasing the speed of distribution,
creating new products and services,
erasing 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 …
 Analysis of the industry environment is focused
on the factors & conditions influencing the
firm’s profitability in the industry.
 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:
 Industry trends as a whole;
 Competition within the industry;
 Technologies employed;
 What it takes to succeed – the key success
factors (KSF);
 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
 The essence of strategy formulation is coping with
competition. Competition exists in the fight for market
share.
 Therefore, competition in an industry is rooted in its
underlying economics, and competitive forces.
 Thus, the collective strength of these forces determines the
ultimate profit potential of an industry.

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

 Thus, to cope with them the strategist must delve below the
surface and analyze the sources of competition. For
example:
 What makes the industry vulnerable to entry?
 What determines the bargaining power of suppliers?

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 Nature cont’d …

 Knowledge of these underlying sources of

competitive pressure provides the groundwork for a
strategic plan of action to:
 Highlight the critical strengths and weaknesses of
the company
 Animate the positioning of the company in its
industry
 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:
 Deter entry by forcing the aspirant either to
come in on large scale or accept a cost
disadvantage.

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

 Factors fostering brand identification are being first in the industry,

advertising, customer service, and product differences.

 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:

 The need to invest large financial resources in order to compete

creates a barrier to entry.

 Capital is necessary not only for fixed facilities but also for customer
credit, inventories, and absorbing start-up loses.

 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:

 These advantages can stem from the effects of:

 the learning curve, and proprietary technology,
 access to the best raw material sources,
 assets purchased at pre-inflation prices,
 government subsidies, favorable location, and
 official rights (patents)

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 Threat of Entry cont’d …

Access to distribution channels:

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

 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
 Existing firms might respond in different

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

 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
 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.

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

undifferentiated.

 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
The threat of substitute products
increases when:
 Buyers face few switching costs
 The substitute product’s price is lower
 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:

 There are numerous or equally balanced competitors
 Industry growth slows or declines
 There are high fixed costs or high storage costs
 There is a lack of differentiation opportunities or low
switching costs
 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

 Competitor analysis focuses on each

company against which a firm directly
competes.
 Analysis of competitors is focused on
predicting the dynamics of competitors'
actions, responses & intentions

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 Competitor Analysis cont’d …

 Competing firms are keenly interested in

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

 Furthermore, intense rivalry creates a strong

need to understand competitors.
 Competitor Analysis cont’d …
In a competitor analysis, the firm seeks to understand:
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 …

 Competitor intelligence is used to get

data and information about competing
firms.
 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 …

 Information about these different dimensions helps

the firm to prepare an anticipated response profile for
each competitor.
 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

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

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 Forecasting Tools and
Techniques
 Forecasts
 educated assumptions about future trends
and events
 quantitative, qualitative techniques

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

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 An Example Competitive
Profile Matrix

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