3.

1 The Nature & Purpose of an External Audit

(EA)
III 3.2 The Industrial Organization (I/O) View
The EA
3.3 The Key External Forces & The Process of
Performing an EA
3.4 Competitive Analysis: Porter’s Five-Forces
3.5 Sources of External Information
3.6 Industry Analysis: Forecasting Tools & Techniques
 The External Factor Evaluation Matrix (EFEM)
Contents
 The Competitive Profile Matrix (CPM)

1
 III  The purpose of an EA is to develop a finite list
The EA of Os that could benefit a firm and Ts that should
be avoided.
 As the term finite suggests, the EA is not aimed
The at developing an exhaustive list of every
Nature possible factor that could influence the business;
& rather, it is aimed at identifying key variables
Purpose that offer actionable responses.
of an EA  Firms should be able to respond either
offensively or defensively to the factors by
formulating strategies that take advantage of
external Os or that minimize the impact of
potential Ts.
2
 The Key External Forces (KEF) can be divided into Ten:
 Economic, Social, Cultural, Demographic,
III Environmental, Political, Governmental, Legal,
The EA Technological & Competitive (PESTEC).
 Changes in external forces translate into changes in
consumer demand for both industrial and consumer
products and services.
The Key  External forces affect the types of products & services,
the nature of positioning & market segmentation
External strategies & the choice of businesses to acquire or sell.
Forces

3
 Relationships B/N the KEFs and an Org
Competitors
Suppliers
Distributors
Creditors
Customers
Communities
Employees
STEEPC Managers An Org’s
Shareholders Os & Ts
Labour Unions
Governments
Trade Associations
Special Interest Group
Products
Services
Markets
Natural Environment
4
  External forces directly affect both suppliers
III
and distributors.
The EA
 Identifying and evaluating external Os & Ts
enable orgs. to develop a clear mission & design
strategies to achieve long-term objectives &
develop policies to achieve annual objectives.
The Key  The increasing complexity of business today is
External evidenced by more countries are developing the
Forces capacity to compete aggressively in the world
markets.
 Foreign businesses and countries are willing to
learn, adapt, innovate, and invent to compete
successfully in the market place.

5
  The process of performing an EA must involve
III
many Mgrs and key employees.
The EA
 The involvement in the SM process can lead to
understanding and commitment from org’l
The members.
Process  Individuals appreciate having the opportunity to
of contribute ideas & gain a better understanding of
Performi their firms’ industry, competitors, and markets.
ng an  To perform an EA, a company 1st must gather
EA competitive intelligence and information about the
trends in the KEFs.

6
  Individuals can be asked to monitor various sources of
III info & submit periodic scanning reports to a cmmtt of
The Mgrs charged with performing the EA.
EA  This approach provides a continuous stream of timely
strategic information & involves many individuals in
the EA process.
The  Suppliers, distributors, salespersons, customers &
Process competitors represent other sources of vital info.
of  Once info. is gathered, it should be assimilated and
Perfor evaluated.
ming  A meeting or series of meetings of Mgrs is needed to
an EA collectively identify the most important Os & Ts
facing the firm..

7
 III  The Industrial Organization (I/O) approach to competitive
The advantage (CA) advocates that external (industry) factors
EA are more important than internal factors in a firm
achieving CA.
 However, it is not a question of whether external or
internal factors are more important in gaining &
The sustaining CA.
I/O  Effective integration&understanding of both E&I factors
View is the key to securing and keeping a CA.
 In fact, matching the key external Os&Ts with the key
internal Ss&Ws provides the basis for successful strategy
formulation.

8
  Economic factors have a direct impact on the
III potential attractiveness of various strategies.
The EA  For example, when interest rates rise, funds needed
for capital expansion become more costly or
unavailable.
 The Key Economic Forces to be monitored include:
Economi availability of credit, propensity of people to spend,
c Forces interest rates, inflation rates, GDP trends,
consumption patterns, unemployment trends, worker
productivity levels & other factors.

9
 III  SCD & Environmental changes have a major impact
The on virtually all products, services, markets &
EA customers.
 Orgs. of different sizes, for-profit & nonprofit orgs. in
all industries are being staggered and challenged by
the Os&Ts arising from changes in SCD &
Social,
Environmental variables.
Cultural,
Demogr  The Key SCDE Forces include: number of marriages,
aphic & number of divorces, number of births, number of
Natural deaths, attitudes toward business, lifestyles, life
Environ expectancy rates, per capita income, attitudes toward
ment work, buying habits and other factors
Forces

10
  Federal, state, local, & foreign govts. are the major
regulators, deregulators, subsidizers, employers &
III
customers of orgs.
The EA
 PGL forces, therefore, can represent the key Os or Ts
for orgs of any size.
Political  For industries & firms that depend heavily on govt
, Govern contracts or subsidies, political forecasts can be the
mental most important part of an EA.
& Legal  The increasing global interdependence among
(PGL) economies, markets, governments & orgs makes it
Forces imperative that firms consider the possible impact of
political variables on the formulation &
implementation of competitive strategies.

11
 III  Includes: government regulations or
The deregulations, changes in tax laws, special
EA tariffs, political action committees; number,
severity & location of government protests,
changes in patent laws, environmental
Some
protection laws, legislation on equal
Political, employment, level of government subsidies &
Gov’tal & other factors.
Legal  Local, state & federal laws; regulatory agencies
Variables & special-interest groups can have a major
impact on the strategies of orgs of all sizes, for-
profit & nonprofit orgs.

12
 III  Revolutionary technological changes & discoveries are
The having a dramatic impact on orgs.
EA  The Internet has changed the very nature of Os & Ts by
altering the life cycles of products, increasing the speed of
distribution, creating new products & services, removing
limitations of traditional geographic markets & changing
the historical trade-off between production standardization
Techn
& flexibility.
o-
 To effectively capitalize on e-commerce, a number of orgs
logica are establishing two new positions in their firms: Chief
l Information Officer (CIO) & Chief Technology Officer
Forces (CTO).
 These trends reflect the growing importance of IT in SM.

13
  Technological forces represent major Os&Ts that
III must be considered in formulating strategies.
The EA  Technological advancements can dramatically affect
orgs’ products, services, markets, suppliers,
distributors, competitors, customers, MFG processes,
MKG practices & competitive position.
Techno-  Not all sectors of the economy are affected equally
by technological developments.
logical
 The communications, electronics, aeronautics &
Forces
pharmaceutical industries are much more volatile
than the textile, forestry, & metals industries.

14
 III  Collecting and evaluating info on competitors is
The essential for successful strategy formulation.
EA
 Identifying major competitors is not always easy
b/s many firms have divisions that compete in
different industries.
Compet
 Many multidivisional firms do not provide sales
itive
Forces and profit info on the divisional basis for
competitive reasons.

15
 III What is competitive intelligence (CI)?
The  CI, as formally defined by the Society of CI
EA Professionals (SCIP), is a systematic & ethical process
for gathering & analyzing info about the competitors’
activities & general business trends to further a
business’s own goals.
 Good CI in the business, as in the military, is one of the
CI keys to success.
 The more info & knowledge a firm can obtain about its
Prog
rams competitors, the more likely it can formulate &
implement effective strategies.
 Major competitors’ Ws can represent external Os; Ss
may represent the key Ts.
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 1.What are the major competitors’ Ss?
III
2.What are the major competitors’ Ws?
The
EA 3.What are the major competitors’ objectives and
strategies?
4.How will the major competitors most likely respond
Key to current Key STEEPCL trends affecting the
industry?
Question
s About 5.How vulnerable are the major competitors to our
Compe- alternative company strategies?
titors 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?
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 8.To what extent are new firms entering & old firms
III leaving the current industry?
The
9.What key factors have resulted in the present
EA
competitive position in the industry?
10.How have the sales and profit rankings of major
Key Qs competitors in the industry changed over recent years?
About Why have these rankings changed that way?
Compe
11.What is the nature of supplier & distributor
-titors
relationships in this industry?
12.To what extent could substitute products or services
be a threat to competitors in this industry?

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  By definition, competitors are firms that offer
III similar Ps&Ss in the same market.
The EA
 Markets can be geographic or product areas or
segments. For ex, in the insurance industry the
markets are broken down into
Market
commercial/consumer or Europe/Asia.
Commo
nality  Researchers use the terms market commonality
and resource similarity to study rivalry among
&
competitors.
Resourc
e
Similari
ty

19
 III  Market commonality can be defined as the
The number & significance of markets that a firm
competes in with rivals, where as resource
EA similarity is the extent to which the type and
amount of a firm’s internal resources are
Market comparable to a rival.
Commo 
One way to analyze competitiveness between two
nality
or among several firms is to investigate market
& commonality & resource similarity issues while
Resourc looking for areas of potential competitive
e advantage along each firm’s value chain.
Similari
ty

20
  Porter’s Five-Forces Model of competitive
III analysis is a widely used approach for developing
The EA strategies in many industries.
 The intensity of competition among firms varies
Competi
tive widely across industries.
Analysis According to Michael Porter, the nature of
: competitiveness in a given industry can be viewed
Porter’s as a composite of five forces: rivalry among
Five- competing firms, potential entry of new
Forces competitors, potential development of substitute
Model products, bargaining power of suppliers &
bargaining power of consumers.

21
 III  The following three steps for using Porter’s Five-
The Forces Model can indicate whether competition in
EA a given industry is such that the firm can make an
acceptable profit:
Compe 1. Identify key elements of each competitive force
titive that impact the firm.
Analysi 2. Evaluate how strong & important each element is
s: for the firm.
Porter’ 3. Decide whether the collective strength of the
s elements is worth the firm entering or staying in
Five- the industry.
Forces
Model
22
 The Five-Forces Model of Competition

Potential development of
.

substitute products

Rivalry among Bargaining

Bargaining power of
competing
power of consumers
firms
suppliers

Potential entry of new

competitors
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 III  Rivalry among competing firms is usually the most
The powerful of the five competitive forces.
EA  The strategies pursued by one firm can be
Rivalry successful only to the extent that they provide
Among competitive advantage (CA) over the strategies
Compet pursued by rival firms.
ing  Changes in strategy by one firm may be met with
Firms retaliatory countermoves, such as lowering prices,
enhancing quality, adding features, providing
services, extending warranties & increasing
advertising.

24
 III  The intensity of rivalry among competing firms
The EA
tends to increase as the number of competitors
increases, as competitors become more equal in
Rivalry size and capability, as demand for the industry’s
Among
products declines & as price cutting becomes
Compet
ing common.
Firms

25
 1.High number of competing firms
2.Similar size of competing firms
3.Similar capability of competing firms
III 4.Falling demand for the industry’s products
The 5. Falling prices for P/S in the industry
EA 6.When consumers can switch brands easily
Conditions 7.When barriers to leave the market are high
That Cause 8.When barriers to enter the market are low
High 9.When fixed costs are high among the competing firms
Rivalry 10.When the product is perishable
Among 11.When rivals have excess capacity
Competing 12.When rivals have excess inventory
Firms 13.When rivals sell similar products/services
14.When mergers are common in the industry

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  Whenever new firms can easily enter a particular
III industry, the intensity of competitiveness among
The firms increases.
EA
Barriers to entry, however, can include:
 [1]the need to gain economies of scale quickly,
Potential [2]the need to gain technology & specialized
Entry of know-how, [3]lack of experience, [4] strong
New customer loyalty, [5] strong brand preferences, [6]
Competit large capital requirements, [7] lack of adequate
ors distribution channels & [8] government
regulatory policies (like tariffs…)

27
 [9] lack of access to raw materials, [10] possession
III of patents, [11] undesirable locations, [12]
The EA counterattack by entrenched firms & [13] potential
saturation of the market.
 Despite numerous barriers to entry, new firms
Potential sometimes enter industries with higher-quality
Entry of products, lower prices & substantial marketing
New resources.
Competit
 The strategist’s job, therefore, is to identify
ors
potential new firms entering the market, to
monitor the new rival firms’ strategies, to
counterattack as needed & to capitalize on existing
Ss & Os.
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 III
 In many industries, firms are in close
The
EA competition with producers of substitute
products in other industries.
Potential
Develop  The presence of substitute products puts a
ment of ceiling on the price that can be charged before
Substitute
Products consumers will switch to the substitute product.

 Price ceilings equate to profit ceilings and more

intense competition among rivals.

29
  Competitive pressures arising from the
substitute products increase as the relative price
III
of it declines & as consumers’ switching costs
The EA
decrease.
Potential
Developm  The competitive strength of substitute products
ent is best measured by the inroads into the market
of
share those products obtain, as well as those
Substitute
Products firms’ plans for increased capacity & market
penetration.

30
 III • The bargaining power of suppliers affects the
The intensity of competition in an industry, especially:
EA  when there is a large number of suppliers,
 when there are only a few good substitute raw
materials or when the cost of switching to raw
Bargain materials is high.
ing  It is often in the best interest of both suppliers &
Power producers to assist each other with reasonable
of prices, improved quality, development of new
Supplie services, just-in-time deliveries & reduced
rs inventory costs, thus enhancing long-term
profitability for all concerned.

31
  Firms may pursue a backward integration
III strategy to gain control or ownership of
The EA suppliers.
 This strategy is especially effective when
Bargai suppliers are unreliable, too costly or not
ning capable of meeting a firm’s needs on a
Power consistent basis.
of
 Firms generally can negotiate more favorable
Supplie
terms with suppliers when backward
rs
integration is a commonly used strategy
(BPC) among rival firms in an industry.

32
  When customers are concentrated or buy in
III volume, their bargaining power (BP) represents a
The EA major force affecting the intensity of competition in
an industry.
 Rival firms may offer extended warranties or other
special services to gain customer loyalty whenever
the BPC is substantial.
BPCs  BPCs also is higher when the products being
purchased are standard or undifferentiated.
 When this is the case, consumers often can
negotiate selling price, warranty coverage &
accessory packages to a greater extent.

33
  The BPCs can be the most important force affecting
III the competitive advantage.
The • Consumers gain increasing bargaining power under
EA the following circumstances:
1.If they can inexpensively switch to competing brands
or substitutes
2.If they are particularly important to the seller
BPCs3.If sellers are struggling in the face of falling consumer
demand
4. If they are informed about sellers’ products, prices &
costs
5. If they have discretion in whether & when they
purchase the product

34
 III • A wealth of strategic info is available to orgs from
The both published and unpublished sources:
EA
 Unpublished sources include : customer surveys,
market research, speeches at professional &
shareholders’ meetings, television programs,
Source interviews & conversations with stakeholders.
s  Published sources include :periodicals, journals,
of reports, government documents, abstracts, books,
Extern directories, newspapers & manuals or directives.
al Info  The Internet has made it easier for firms to gather,
assimilate & evaluate info.

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 III
 Forecasts are informed assumptions about future
The
trends & events.
EA
 Forecasting is a complex activity b/s of factors
such as technological innovation, cultural
changes, new products & services, improved
Forecastin services, stronger competitors, shifts in
g government priorities, changing social values,
Tools & unstable economic conditions & unforeseen
Technique events.
s  Managers often rely on published forecasts to
(FTT) effectively identify key external Os&Ts.

36
  Forecasting tools can be broadly categorized into two
groups: quantitative & qualitative techniques.
III
The EA Quantitative forecasts are most appropriate when
historical data are available & when the relationships
among the key variables are expected to remain the
same in the future.
 No forecast is perfect & some forecasts are even
FTT wildly inaccurate.
 Key external Os&Ts can be effectively identified only
through good forecasts. Accurate forecasts can provide
major CAs for orgs.

37
  An EFEM allows strategists to summarize
III
The EA and evaluate: economic, social, cultural,
demographic, environmental, political,
The governmental, legal & competitive
External
information.
Factor
Evaluatio
n Matrix
(EFEM)

38
 III
The Step 1:
EA
 List key external factors (KEF) as identified in
the EA process & include a total of 15 to 20
factors, both Os & Ts that affect the firm & its
Steps in
industry.
developi
ng the  List the Os 1st & then the Ts. Be as specific as
EFEM possible, using percentages, ratios &
comparative numbers whenever possible.

39
 Step 2:
III • Assign to each factor a weight that ranges from 0
The EA (not important) to 1 (very important).
 The weight indicates the relative importance of
that factor to being successful in the firm’s
Steps in industry.
developi
 Os often receive higher weights than Ts, but Ts
ng the
EFEM can receive high weights if they are especially
severe or threatening.
 The sum of all weights assigned to the factors
must equal 1.0.

40
 • Step 3: Assign a rating b/n 1 & 4 to each KEF to
III indicate how effectively the firm’s current
The strategies respond to the factor, where 4 = the
EA
response is superior, 3 = above average, 2 = average
& 1 = poor.
Steps in
develop Ratings are based on effectiveness of the firm’s
ing strategies.
the  Ratings are thus company-based, whereas the
EFEM weights in Step 2 are industry based. It is important
to note that both Ts & Os can receive a weight of 1,
2, 3 or 4.

41
 III
Step 4: Multiply each factor’s weight by its rating
The
EA to determine a weighted score.
Step 5: Sum the weighted scores for each variable
to determine the total weighted score (TWS) for
Steps in the organization.
develop
ing  Regardless of the # of key Os&Ts included in
the an EFEM, the highest possible TWS for an org.
EFEM is 4.0 & the lowest possible TWS is 1.0.

42
 III  A TWS of 4.0 indicates that an org. is responding
The in an outstanding way to existing Os & Ts in its
EA industry.
 In other words, the firm’s strategies effectively take
the advantage of existing Os & minimize the
Steps potential adverse effects of external Ts.
in  A total score of 1.0 indicates that the firm’s
develo strategies are not capitalizing on Os or avoiding
ping external Ts.
the
EFEM

43
 EFEM for Theatre Cinema Complex
Key External Factor Weight Rating Weighted
Score

Opportunities
Rowan County is growing 8% annually in population 0.05 3 0.15

TDB University is expanding 6% annually 0.08 4 0.32

Major competitor across town recently closed 0.08 3 0.24

Demand for going to cinema growing 10% annually 0.07 2 0.14

Two new neighborhoods being developed within 3 0.09 1 0.09
miles

Disposable income among citizens grew 5% in prior 0.06 3 0.18

year

Unemployment rate in county declined to 3.1% 0.03 2 0.06

44
Key External Factor Weight Ratin Weighted
g Score
Cont….
Threats
Trend toward healthy eating eroding concession sales 0.12 4 0.48
Demand for online movies and DVDs growing 10% 0.06 2 0.12
annually
Commercial property adjacent to cinemas for sale 0.06 3 0.18
0.06
TDB University installing an on-campus movie theatre 0.04 3 0.12
County and city property taxes increasing 25% this 0.08 2 0.16
year
Local religious groups object to R-rated movies being 0.04 3 0.12
shown
Movies rented from local Blockbuster store up 12% 0.08 2 0.16

Movies rented last quarter from Time Warner up 15% 0.06 1 0.06

Total 1.00 2.58

45
  The CPM identifies a firm’s major competitors
III & its particular strengths and weaknesses in
The EA relation to a sample firm’s strategic position.
 The weights and TWSs in both a CPM and an
The EFEM have the same meaning.
Comp  However, critical success factors (CSF) in the
etitive CPM include both internal and external issues;
Profile therefore, the ratings refer to strengths and
Matrix weaknesses, where 4 = major strength, 3 =
minor strength, 2 = minor weakness, and 1 =
(CPM)
major weakness.

46
III
The  The CSF in a CPM are not grouped into
EA opportunities and threats as they are in an EFEM.
 In a CPM, the ratings and TWSs for rival firms can
CPM be compared to the sample firm.
 This comparative analysis provides important
internal strategic information.

47
 An Example Competitive Profile Matrix
Company 1 Company 2 Company 3

Critical Success Weight Rating Score Rating Score Rating Score

Factors

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 0.10 3 0.30 2 0.20 4 0.40

Competitiveness

Management 0.10 4 0.40 3 0.20 3 0.30

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 2.70

48
 The Ratings
• 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
the weakest.
 Only eight critical success factors are included for simplicity; this
is too few in actual terms.
 Overall, Company 1 is the strongest, as indicated by the total
weighted score of 3.15.

49
The End

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