MODULE 6: THE EXTERNAL AUDIT

INTRODUCTION
MGT9 – STRATEGIC MANAGEMENT
This module examines the tools and concepts needed to conduct an external-strategic-
management audit (sometimes called environmental scanning or industry analysis). An external
audit focuses on identifying and evaluating rends and events beyond the control of a single firm.
It reveals key opportunities and threats confronting an organization, so managers can formulate
strategies to take advantage of the opportunities and avoid or reduce the impact of threats. This
lesson presents a practical framework for gathering, assimilating, and analyzing external
information.

LEARNING OUTCOMES:

After reading this module, the learner should be able to:

1. Analyze external environment of a given organization.
2. Explain Porter’s Five Forces Model and its relevance in formulating strategies.
3. Construct an EFE Matrix and Competitive Profile Matrix.

1 TIME: MODULE 6 – THE EXTERNAL AUDIT

The time allotted for this module is three hours.

LEARNER DESCRIPTION

The participants in this module are 3rd Year BSA students.

MODULE CONTENTS:

LESSON 6.1: The Purpose and Nature of an External Audit

The purpose of an external audit is to develop a finite list of opportunities that could
benefit a firm as well as threats that should be avoided. As the term finite suggests, the external
audit is not aimed at developing an exhaustive list of every possible factor that could influence
the business; rather it is aimed at identifying key variables that offer actionable responses. Firm
should be able to respond either offensively or defensively to the factors by formulating
strategies that take advantage of external opportunities of that minimize the impact of potential
threats.

Key External Forces

External forces can be divided into 5 broad categories:
 1. Economic forces
2. Social
3. Cultural
4. Demographic
5. Natural environment forces
MGT9 – STRATEGIC MANAGEMENT
Figure 1. Relationships between key external forces and an organization

Competitors

Economic forces Suppliers

Distributors

Social, cultural, Creditors

Customers
demographic, and Employees

natural Communities AN
environnment
managers
Stcokholders
ORGANIZATIONS
forces Labor Unions OPPORTUNITIES
Governments
AND THREATS
Technological Trade Associaions
Special interest groups
forces Products
services
Competitive forces markets
natural environment

Important Note: When identifying and prioritizing key external factors in strategic planning, make
2 sure the factors selected are:
MODULE 6 – THE EXTERNAL AUDIT

1. specific – quantified to the extent possible

2. actionable – meaningful in terms of having strategic implications
3. Stated as external trends, events or facts rather than as strategies the firm could pursue.
Changes in external forces translate into changes in consumer demand for both industrial
and consumer products and services. External forces affect the types of products developed,
the nature of positioning and market segmentation strategies, the type of services offered, and
the distributors. Identifying and evaluating external opportunities and threats enables
organizations to develop a clear mission, to design strategies to achieve long-term objectives,
and to develop policies to achieve annual objectives.

The Process of Performing an External Audit

The process of performing an external audit must involve as many managers and
employees as possible. Individuals appreciate having the opportunity to contribute ideas and
to gain a better understanding of their firm’s industry, competitors, and markets.
To perform external audit, a company first must gather competitive intelligence and
information about economic, social, cultural, demographic, environmental, political,
governmental, legal and technological trends. Individuals can be asked to monitor various
sources of information, such as key magazines, trade journals, and newspapers – and use
online sources. Suppliers, distributors, salespersons, customers, and competitors represent
other sources of vital information.
 After information is gathered, it should be assimilated and evaluated. A meeting or
series of meetings of managers is needed to collectively identify the most important
opportunities and threats facing the firm. A prioritized list of these factors must be obtained by
requesting that all managers individually rank the factors identified, from 1 (for the most
important opportunity/threat) to 20 (for least important opportunity/threat). Instead of ranking
MGT9 – STRATEGIC MANAGEMENT
factors, managers could simply place a checkmark by their most important “top10 factors”.
Then, by assuming the rankings, or the number of checkmarks, a prioritized list of factors is
revealed. Prioritization is absolutely essential in strategic planning because no organization can
do everything that would benefit the firm; tough choices among good choices have to be made.

The Industrial Organization (I/O) View

Industrial Organization view of strategic planning advocates that external (industry)
factors are more important than internal ones for gaining and sustaining competitive advantage.
Proponents of the I/O view such as Michael Porter, contend that organizational performance will
be primarily determined by industry forces, such as falling gas prices that no single firm can
control. Porter’s Five forces Model, is an example of I/O perspective, which focuses on
analysing external forces and industry variables as a basis for getting and keeping competitive
advantage.
Competitive advantage is determined largely by competitive positioning within an
industry, according to I/O advocates. Managing strategically from the I/O perspective entails
firms striving to compete in attractive industries, avoiding weak or faltering industries, and
gaining a full understanding of key external factor relationships within that attractive industries,
avoiding weak or faltering industries, and gaining a full understanding of key external factor
3 relationships within that attractive industry. I/O theorists content 6that
MODULE external
– THE factors-such
EXTERNAL AUDITas
economies of scale, barriers to market entry, product differentiation, the economy and level of
competitiveness – are more important than internal resources, capabilities, structure and
operations.

LESSON 6.2: Ten External Forces that Affect Organizations

Economic Forces
Economic factors affecting business include all important trends in the economy that can
help or hinder the company in achieving its objectives. Economic factors that commonly affect
businesses include consumer behaviour, employment factors, interest rates and banking and
inflation and overall economic indicators. They also include several legal regulations in the
country, which are described in: Legal factors affecting business. Analysis of economic factors
is integral part of every strategic analysis method including PEST analysis, STEEP analysis,
PESTEL analysis, PESTLE and other derivatives of strategic business environment analysis.

Social, Cultural, Demographic, and Natural Environment Forces

Number of marriages, number of divorces, number of births, number of deaths,
immigration and emigration rates, population changes by race, age, and geographic area,
regional changes in tastes and preferences, social security programs, life expectancy rates, per
capita income, social media pervasiveness, attitudes toward government, ethical concern. Be
mindful that in strategic planning and case analysis, relevant social, cultural, demographic and
 natural environment factors for a particular business must be quantified and actionable to be
useful.

Political, Governmental, and Legal Forces MGT9 – STRATEGIC MANAGEMENT

Federal, state, local and foreign governments are major regulators, deregulators,
subsidizers, employers and customers of organizations. Political, governmental, and legal
factors, therefore, can represent major opportunities or threats for both small and large
organizations. Politicians decide on tax rates. State and local income taxes and property taxes
impact where companies locate facilities and where people desire to live. The five states, in
rank order, with the lowest facilities and where people desire to live. For industries and firms
that depend heavily on government contracts or subsidies, political forecasts can be the most
important part of an external audit.

Some political, governmental, and legal variables

Government regulations and deregulations, changes in tax laws, special tariffs, number
of patents, changes in patent laws, environmental protection laws, legislation on equal
employment, political conditions in foreign countries, lobbying activities

Technological Forces
A variety of new technology such as the Internet of Things, 3D printing, the cloud, mobile
devices, biotech, analytics, autotech, robotics, and artificial intelligence are EXTERNAL
fuelling innovation
AUDITin
4 MODULE 6 – THE
many industries, and impacting strategic-planning decisions. Businesses are using mobile
technologies and applications to better determine customer trends and employing advanced
analytics data to make enhanced strategy decisions.
The internet has changed the nature of opportunities and threats by altering the life
cycles of products, increasing the speed of distribution, creating new products and services.
To effectively capitalize on e-commerce, a number of organizations are establishing two
new positions in their firms: chief information officer (CIO) and chief technology officer (CTO),
reflecting the growing importance of information technology in strategic management. A CIO
and CTO work together to ensure that information needed to formulate, implement and evaluate
strategies is available where and when it is needed. These individuals are responsible for
developing, maintaining, and updating the company’s information database. The CIO is more a
manager, managing the firm’s relationship with stakeholders; the CTO is more a technician,
focusing on technical issues such as data acquisition, data processing, decision-support
systems, and software and hardware acquisition.

Results of technological advancements are varied:

1. They represent major opportunities and threats that must be considered in formulating
strategies.
2. They can dramatically affect organizations; products, services, markets, suppliers,
distributors, competitors, customers, manufacturing processes, marketing practices, and
competitive position.
 3. They can create new markets, result in proliferation of new and improved products, change
the relative competitive cost positions in an industry, and render existing products and services
obsolete.
4. They can reduce or eliminate cost barriers between businesses, create shorter production
runs, create shorter production runs, create shortages in technical
MGT9 skills, and result
– STRATEGIC in changing
MANAGEMENT
values and expectations of employees, managers and customers.
5. They can create competitive advantages that are more powerful than existing advantages.
No company or industry today is insulated against emerging technological
developments. In high-tech industries, identification and evaluation of key technological
opportunities and threats can be the most important part of the external strategic-management
audit.

Examples of Impact of Wireless Technology

1. Airlines – many airlines are offering wirelines technology in flight.
2. Automotive – vehicles are becoming wireless
3. Banking – visa sends text message alerts after unusual transactions.
4. Education – many students may use smartphones for research
5. Healthcare – patients use mobile devices to monitor their own health
6. Politics – president Obama won election partly by mobilizing Facebook and Myspace users,
revolutionizing political campaigns. Obama announced his vice-presidential selection of Joe
Biden by a text message.
7. Publishing – e-books are increasingly available.
5 MODULE 6 – THE EXTERNAL AUDIT
Competitive Forces
An important part of an external audit is identifying rival firms and determining their
strengths, weaknesses, capabilities, opportunities, threats, objectives, and strategies.
Collecting and evaluating information on competitors is essential for successful strategy
formulation. Identifying major competitors is not always easy because many firms have
divisions that compete in different industries. Many multidivisional firms do not provide sales
and profit information on a divisional basis for competitive reasons. Also, privately held firms do
not publish any financial or marketing information. Addressing questions about competitors
such as stated below are important in performing an external audit.

Key Questions about competitors

1. What are the strengths of our major competitors?
2. What are the weakness of our major competitors?
3. What are the objectives and strategies of our major competitors?
4. How will our 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 distributorMGT9
relationships in this industry?
– STRATEGIC MANAGEMENT
12. To what extent could substitute products or services be a threat to our competitors?

Seven characteristics that describe competitive companies:

1. Strive to continually increase market share.
2. Use the vision/mission as a guide for all decisions.
3. Realize that the adage “If it’s not broke, don’t fix it” has been replaced by “Whether it’s
broke or not, fix it” in other words, continually strive to improve everything about the firm.
4. Continually adapt, innovate, and improve – especially when the firm is successful.
5. Strive to grow through acquisition whenever possible.
6. Hire and retain the best employees and managers possible.
7. Strive to stay cost-competitive on a global basis.

Competitive intelligence (CI), as formally defined by the Society of Competitive

Intelligence Professionals (SCIP), is a systematic and ethical process for gathering and
analysing information about the competition’s activities and general business trends to further a
business’s own goals.
The more information a firm can gather about its competitors, the more likely the firm
6 can formulate and implement effective strategies. MODULE 6 – THE EXTERNAL
Major competitor’s weaknessesAUDIT
can
represent external opportunities; major competitor’s strengths may represent key strengths.

Various legal and ethical ways to obtain competitive intelligence:

1. Hire top executives from rival firms.
2. Reverse engineer rival firm’s products.
3. Use surveys and interviews of customers, suppliers, and distributors.
4. Conduct drive-by and on-site visits to rival firm operations.
5. Search online databases.
6. Contact government agencies for public information about rival firms.
7. Systematically monitor relevant trade publications, magazines and newspapers.

The Fuld website explains that competitive intelligence is not the following:
1. Is not spying
2. Is not a crystal ball
3. Is not a simple Google search
4. Is not one-size fits all
5. Is not useful if no one is listening
6. Is not a job for one, smart person
7. Is not a fad
8. Is not driven by software ore technology
9. Is not based on internal assumptions about the market
 10. Is not a spreadsheet

Objectives of CI
1. Provide general understanding of an industry and its competitors
2. Identify areas in which competitors are vulnerable
MGT9and to assess theMANAGEMENT
– STRATEGIC impact strategic
actions would have on competitors
3. Identify potential moves that a competitor might make that would endanger a firm’s
position in the market.

LESSON 6.3: Porter’s Five-Forces Model

Former chair and CEO of PepsiCo Wayne Calloway said, “Nothing focuses the mind
better than the constant sight of a competitor that wants to wipe you off the map”. Porter’s Five
Model of competitive analysis is a widely used approach for developing strategies in many
industries. The intensity of competition among firms varies widely across industries.

Potential development of substitute product

Bargaining power of Rivalry among competing Bargaining power of

suppliers firms consumers
7 MODULE 6 – THE EXTERNAL AUDIT

Potential entry of new competitors

Figure 2. The Five Forces Model of Competition

Table 1.Competitiveness Across a Few Industries (2015 data)

It reveals the average gross profit margin and earnings per share (EPS). Note the substantial
variation among industries.
Operating Margin (%) EPS ($)
Pharmaceutical 13 0.61
Telecommunications 14 1.25
Fragrances/Cosmetics 12 2.23
Banking 34 1.58
Bookstores 6 0.16
Food Manufacturers 4 0.63
Oil and Gas 10 2.03
Airlines 10 0.09
Machinery/Construction 7 0.96
Paper Products 5 0.27
 For example, note that industry operating margins range from 4 to 34 percent, whereas
industry EPS values range from-16 to 2.23. Note that food manufacturers have the lowest
average profit margins (2.3), which implies fierce competition in that industry. Intensity of
competition is highest in lower-return industries. The collective impact of competitive forces is so
brutal in some industries that the market is clearly “unattractive” from a profit-making standpoint.
MGT9 – STRATEGIC MANAGEMENT
Rivalry among existing firms is severe, new rivals can enter the industry with relative ease, and
both suppliers and customers can exercise considerable bargaining leverage. According to
Porter, the nature of competitiveness in a given industry can be viewed as a composite of five
forces.
1. Rivalry among competing firms
2. Potential entry of new competitors
3. Potential development of substitute products
4. Bargaining power of suppliers
5. Bargaining power of consumers

Rivalry Among Competing Firms

The most powerful of the five competitive forces. The strategies pursued by one firm
can be successful only to the extent that they provide competitive advantage over the strategic
pursued by rival firms.
The intensity of rivalry among competing firms tends to increase as the number of
competitors increases, as competitors become more equal in size and capability, as demand for
the industry’s products declines, and as price cutting becomes common. Rivalry also increases
8 when consumers can switch brands easily; when barriers MODULE 6 –the
to leaving THE EXTERNAL
market AUDIT
are high; when
fixed costs are high when the product is perishable; when consumer demand is growing slowly
or declines such that rivals have excess capacity or inventory; when the products being sold are
commodities not easily differentiated, such as gasoline); when rival firms are diverse in
strategies, origins and culture; and when mergers and acquisitions are common in the industry.
As rivalry among competing firms intensifies, industry profit decline, in some cases to the point
where an industry becomes inherently unattractive. When rival firms sense weakness, typically
they will intensify both marketing and production efforts to capitalize on the “opportunity”.
Please see https://strategiccfo.com/intensity-of-rivalry-one-of-porters-five-forces/

Table 2 Conditions that Cause High Rivalry Among Competing Firms

1. when the number of competing firm is high

2. when competing firms are of similar size
3. when competing firms have similar capabilities
4. when the demand for the industry’s products is falling
5. when the producer or service prices in the
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 fixed costs are high among competing firms
 11. when rivals have excess capacity
12. when consumer demand is falling
13. when rivals have excess capacity
14. when rivals sell similar products/services
15. when mergers are common in the industry
MGT9 – STRATEGIC MANAGEMENT

Potential Entry of New Competitors

Whenever new firms can easily enter a particular industry, the industry of
competitiveness among firm’s increases. Barriers to entry, however, can include the need to
gain economies of scale quickly, the need to gin technology and specialized know-how, the lack
of experience, strong customer loyalty, strong brand preferences, large capital requirements,
lack of adequate distribution channels, government regulatory policies tariffs, lack of access to
raw materials, possession of patents, undesirable locations, counterattack by entrenched firms,
and potential saturation of the market.
Despite numerous barriers to entry, new firms sometimes enter industries with higher-
quality products, lower prices, and substantial marketing resources. The strategists’ job
therefore, is to identify potential new firms entering the market, to monitor the new rival firm’s
strategies, to counterattack as needed, and to capitalize on existing strengths and opportunities.
When the threat of new firms entering the market is strong, incumbent firms generally fortify
their positions and take actions to deter new entrants, such as lowering prices, extending
warranties, adding features, or offering financial specials.

Potential Development of Substitute Products

9 MODULE 6 – THE EXTERNAL AUDIT
The presence of substitute products puts a ceiling on the price that can be charged
before consumers will switch to the substitute product.
Competitive pressures arising from substitute products increase as the relative price of
substitute products declines and as consumers’ costs of switching decrease. The competitive
strength of substitute products is best measured by the inroads into the market share those
products obtain, as well as those firms’ plans for increased capacity and market penetration.

Bargaining Power of Suppliers

The bargaining power of suppliers affects the intensity of competition in an industry,
especially when there are few suppliers, when there are few good substitute raw materials, or
when the cost of switching raw materials is especially high. It is often in the best interest of both
supplier and producers to assist each other with reasonable prices, improved quality, and
development of new services, just-in-time deliveries, and reduced inventory costs, thus
enhancing long-term profitability for all concerned.
Firms may pursue a backward integration strategy to gain control or ownership of
suppliers. This strategy is especially effective when suppliers are unreliable, too costly, or nit
capable of meeting a firm’s needs on a consistent basis. Firms generally can negotiate more
favourable terms with suppliers when backward integration is a commonly used strategy among
rival firms in an industry.
However, in a many industries it is more economical to use outside suppliers of
component parts than to self-manufacture the items.
In more and more industries, sellers are forging strategic partnerships with select suppliers in an
effort to:
1. Reduce inventory and logistics costs
 2. Accelerate the availability of next-generation components
3. Enhance the quality of the parts and components being supplied and reduce defect rates
4. Squeeze out important cost savings for both themselves and their suppliers

Bargaining Power of Consumers MGT9 – STRATEGIC MANAGEMENT

When customers are concentrated or large in number or buy in volume, their bargaining
power represents a major force affecting the intensity of competition in an industry. Rival firms
may offer extended warranties or special services to gain customer loyalty whenever the
bargaining power of consumers is substantial. Bargaining power of consumers 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, and accessory packages to a
greater extent.
The bargaining power of consumers can be the most important force affecting
competitive advantage. Consumers gain increasing bargaining under the following
circumstances:
1. If they can inexpensively switch to competing brands or substitutes.
2. If they are particularly important to the seller.
3. If sellers are struggling in the face of falling consumer demand.
4. If they are informed about sellers’ products, prices and costs.
5. If they have discretion in whether and when they purchase the product.

LESSON 6.4: Sources of External Information

10 Unpublished sources – include customer surveys, market research,

MODULE speeches
6 – THE at professional
EXTERNAL AUDIT
and shareholders’ meetings, television programs, interviews, and conversations with
stakeholders.

Published sources – periodicals, journals, reports, government documents, abstracts, books,

directories, newspapers, and manuals.

A company website is usually an excellent place to start to find information about a firm,
particularly on the Investor Relations web pages. There are many excellent websites for
gathering strategic information, but three that the authors use routinely are:
1. http://finance.yahoo.com
2. www.hoovers.com
3. http://globaledge.msu.edu/industries/

An excellent source of industry information is provided by Michigan State University at

http://globaledge.msu.edu/industries/. Most college libraries subscribe to many excellent online
business databases that can then be used free by students to gather information to perform a
strategic management case analysis. Simply ask your reference librarian.

Great Online Sources of Company and Industry Information

1. IBISWorld – provides online USA Industry Reports (NAICS), U.S. Industry iExpert
Summaries, and U.S. Business Environment Profiles, a global version of IBIS is also available.
 2. Lexis-Nexis Academic – provides online access to newspaper articles (including New York
Times and Washington Post) and business information (including SEC filings)
3. Lexis-Nexis Company Dossier – provides online access to extensive current data on 13
million companies. It collects and compiles information into excellent documents.
4. Mergent online – provides online access to Mergent’s MGT9 – Manuals,
STRATEGIC which include trend,
MANAGEMENT
descriptive, and statistical information on hundreds of public companies and industries.
Company income statements and balance sheets are provided.
5. Regional business news – provides comprehensive full-text coverage for regional business
publications; incorporates coverage of more than 80 regional business publications covering all
metropolitan and rural areas within the United Sates.
6. Value Line Investment Survey – provides excellent online information and advice on
approximately 1,700 stocks, more than 90 industries, the stock market, and the economy.
Company income statements and balance sheets are provided.

LESSON 6.5: Forecasting Tools and Techniques

Forecasts are educated assumptions about future trends and events. Forecasting is
complex activity because of factors such as technological innovation, cultural changes, new
products, improved services, stronger competitors, and shifts in government priorities, changing
social values, unstable economic conditions, and unforeseen events. Managers often must rely
on published forecasts to effectively identify key external opportunities and threats.
11 MODULE 6 – THE EXTERNAL AUDIT
Making Assumptions
Planning would be impossible without assumption. McConkey defines assumptions as
the “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. Wild guesses should be made in formulating strategies but reasonable
assumptions based on available information must always be made.
By identifying future occurrences that could have a major effect on the firm and by
making reasonable assumptions about those factors, strategists can carry the strategic-
management process forward. Assumptions are needed only for future trends and events that
are most likely to have a significant effect on the company’s business.

Business Analytics
Business analytics is an MIS technique that involves using software to mine huge
volumes of data to help executives make decisions. Sometimes called predictive analytics,
machine learning or data mining, this software enable the researcher to assess and use the
aggregate experience of an organization, which is priceless strategic asset for a firm. The
history of a firm’s interaction with customers, suppliers, distributors, employees, rival firms and
more can all be tapped with data mining to generate predictive models. Business analytics is
 similar to the actuarial methods used by insurance companies to rate customers by the chance
of positive or negative outcomes.
Business analytics can provide a firm with proprietary business intelligence regarding,
for example, which segments of customers choose your firm versus those who defer, delay or
defect to a competitor and why. Business analysis canMGT9 reveal– where competitors
STRATEGIC are weak so
MANAGEMENT
that marketing and sales activities can be directly targeted to take advantage of resultant
opportunities (knowledge). In understanding consumer behavior better, which yields more
effective and efficient marketing, business analytics also is being used to slash expenses by for
example, withholding retention offers from customers who are going to stay with the firm
anyway, or managing fraudulent transactions involving invoices, credit-card purchases, tax
returns, insurance claims, mobile phone calls, online ad clicks, and more.
A key distinguishing feature of business analytics is that enables a firm to learn from
experience and to make current and future decisions based on prior information.

LESSON 6.6: The External Factor Evaluation Matrix

An External Factor Evaluation Matrix (EFE) Matrix allows strategists to summarize and
evaluate economic, social, cultural, demographic, environmental, political, governmental, legal,
technological, a competitive information. It can be developed in five steps:
1. List 20 key external factors as identified in the external-audit process, including both
opportunities and threats that affects the firm and its industry. List the opportunities first
and then threats. Be as specific as possible, using percentages, ratios and comparative
12 numbers whenever possible. Recall that Edward MODULE 6 – THE
Deming said EXTERNAL AUDIT
“In God, we trust.
Everyone else bring data”. In addition, utilize “actionable” factors.
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 that threats, but threats 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 to 1.0.
3. Assign a rating between 1 and 4 to each key external factor to indicate how effectively
the firm’s current strategies respond to the factor, where 4 = the response is superior, 3
= the response is above average, 2 = the response is average, and 1 = the response is
poor. Ratings are based on effectiveness of the firm’s strategies. Ratings are thus
company-based, whereas the weights in Step 2 are industry-based. It is important to
note that both threats and opportunities can receive 1,2,3 or 4.
4. Multiply each factors’ 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.
Regardless of the number of key opportunities and threats included in an 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 effects of external threats. A total score of 1.0
indicates that the firm’s strategies are not capitalizing on opportunities or avoiding external
threats.

MGT9 – STRATEGIC MANAGEMENT

Example:
EFE Matrix for a Local 10-Theater Cinema Complex
Key External Factors Weight Rating Weighted Score
Opportunities
1. Two new neighbourhoods 0.09 1 0.09
developing within 3 miles.
2. TDB University is expanding 0.08 4 0.32
6% annually.
3. Major competitor across town 0.08 3 0.24
recently closed.
4. Demand for going to cinemas 0.07 2 0.14
growing 10%.
5. Disposable income among 0.06 3 0.18
citizens up 5% in prior year.
6. Rowan Country is growing 8% 0.05 3 0.15
annually in population.
13 7. Unemployment rate in country 0.03 2
MODULE 6 – THE0.06
EXTERNAL AUDIT
declined 3.1%.
Threats
8. Trend toward healthy eating 0.12 4 0.48
eroding concession sales.
9. Demand for online movies and 0.06 2 0.12
DVD’s growing 10%.
10. Commercial property adjacent 0.06 3 0.18
to cinemas for sale.
11. TDB University installing an 0.04 3 0.12
on-campus movie theatre.
12. Country and city property 0.08 2 0.16
taxes increasing 25%.
13. Local religious groups object 0.04 3 0.12
to R-rated movies.
14. Movies rented at local Red 0.08 2 0.16
Box’s up 12%
15. Movies rented last quarter 0.06 1 0.06
from Time Warner up 15%.
TOTAL 1.00 2.58

Observe in the table that the most important factor to being successful in this business is
“Trend toward healthy eating eroding concession sales”, as indicated by the 0.12 weight. Also
note that the local cinema is doing excellent in regard to handling two factors. “TDB University
 is expanding 6 percent annually” and “Trend toward healthy eating eroding concession sales.”
Perhaps the cinema is placing flyers on campus and also adding yogurt and healthy drinks to its
concession menu. Note that you may have 1,2,3, or 4 anywhere down the Rating column.
Observe also that the factors are stated in quantitative terms to the extent possible, rather than
being stated in vague terms. Quantify the factors as much as possible in constructing an EFE
MGT9 – STRATEGIC MANAGEMENT
Matrix. Note also that all factors are “actionable” instead of being something like “The economy
is bad”. Finally, note that the total weighted score of 2.58 is above the average (midpoint) of
2.5, so this cinema business is doing pretty well, taking advantage of the external opportunities
and avoiding the threats facing the firm. There is definitely room for improvement, though
because the highest total weighted score would be 4.0. As indicated by ratings of 1, this
business needs to capitalize more on the “Two new neighborhoods developing [nearby]”
opportunity and the “movies rented from…Time Warner” threat. Notice also that there are many
percentage-based factors among the group. Be quantitative to the extent possible! Note, too,
that ratings range from 1 to 4 on both the opportunities and threats.
Example:
An Actual EFE Matrix for the Homebuilder D.R. Horton
Key External Factors Weight Rating Weighted Score
Opportunities
1. The 10 fastest growing states 0.12 3 0.36
by population are SC, WA,
AZ., FL SD, NV, TX, CO, UT
AN ND.
14 2. Most new technological 0.08 MODULE
2 6 – THE0.16
EXTERNAL AUDIT
advances in residential
building have come in the form
of green building.
3. New home sales are up over 0.08 3 0.24
40% (compared to 20% in
resales) with the South being
up 38% and the West being up
49%.
4. Lennar’s starting prices are 0.06 3 0.18
about 10% more nationwide.
5. More than 80% of people over 0.05 2 0.10
the age of 65 own a home.
6. Corporate social responsibility 0.04 1 0.04
pays; 53% of consumers said
they would pay up to 10%
more for a product from a CSR
firm.
7. It is more affordable to buy that 0.02 2 0.04
it is to rent in 98 out of 100
U.S. metros.
8. Interest rates have fallen 0.02 2 0.04
0.25% in the last year.
9. The availability of credit has 0.02 3 0.06
increased 16%.
10. The level of disposable income 0.01 3 0.03
 has increased 5%.
Threats
1. Framing lumber has 0.10 2 0.20
increased 45%. YTD
wages per hour are up
3.1%, cement costs are up MGT9 – STRATEGIC MANAGEMENT
3.8% and lumber costs are
up 6.1%
2. Lemar is growing faster 0.08 3 0.24
than any other top-5
builder, Lennar has built
69% more homes,
compared to DRH’s 44%.
3. Lennar operates using an 0.06 2 0.12
“everything’s included”
approach (supplying luxury
items as standard
features).
4. Lennar is building in just as 0.05 2 0.10
many, if not more,
communities in the South
and Southwest (some of
the fastest-growing areas)
5. USA has the lowest 0.05 3 0.15
number of mortgage
15 application in 2 years. MODULE 6 – THE EXTERNAL AUDIT
6. 76% of the pubic are 0.05 3 0.15
dissatisfied
with the direction of the
country, with 48% being
very dissatisfied.
7. FHA mortgage insurance 0.04 3 0.12
premiums increased 5 to 10
basis points and the time until
termination significantly
increased.
8. Lennar has a superior 0.03 2 0.06
website (includes community
involvement, how to take care
of your home, why buy now)
9. Homeowner percentage fell 0.02 3 0.06
from 69% to 65% between
2005 and 2015.
10. Personal savings rate is 0.02 3 0.06
5.7% up from 4.9% 6 months
ago.
TOTALS 1.00 2.51
 Note that the most important external threat facing the company, as indicated by a
weight of 0.10, deals with labor and supplier costs. They key factors are listed in order
beginning with the most important (highest weight). Notice how specific the factors are stated-
specificity is essential.
MGT9 – STRATEGIC MANAGEMENT

LESSON 6.7: The Competitive Profile Matrix

The Competitive Profile Matrix (CPM) identifies a firm’s major competitors and its
particular strengths and weaknesses in relation to a sample firm’s strategic position. The
weights and total weighted scores in both a CPM and an EFE have the same meaning.
However, critical success factors in a CPM include both internal an external issues; therefore,
the ratings refer to strengths and weaknesses, where 4 = major strength, 3 = minor strength, 2 =
minor weakness, and 1 = major weakness. The critical success factors in a CPM are not
grouped into opportunities and threats as they are in an EFE. In a CPM, the ratings and total
weights scores for rival firms can be compared to the sample firm. This comparative analysis
provides important internal strategic information. Avoid assigning the same rating to firms
included in your CPM analysis.
Sample CPM
Company 1 Company 2 Company 3
Critical Success Weight Rating Score Rating Score Rating Score
Factors
16 Advertising 0.20 1 0.20 4 MODULE 6 – THE 3
0.80 EXTERNAL0.60
AUDIT
Product Quality 0.10 4 0.40 3 0.30 2 0.20
Price 0.10 3 0.30 2 0.20 1 0.10
Competitiveness
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 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 2.20, Company 3 is
weakest overall. Only eight critical success factors are included for simplicity; in actuality,
however, this is too few.
In this example, the two most important factors to being successful in the industry are
“advertising” and “global expansion”, as indicated by weights of 0.20. If there were no weight
column in this analysis, note that each factor then would be equally important. Thus, having a
weight column makes for a more robust analysis because it enables the analyst to assign higher
and lower numbers to capture perceived or actual levels of importance. Company 1 is strongest
on “product quality” as indicated by a rating of 4, whereas Company 2 is strongest on
“advertising”. Overall, Company 1 is strongest, as indicated by the total weighted score of 3.15
and Company 3 is weakest.
 Other than critical success factors listed in the sample CPM, factors often included in this
analysis include breath of product line, effectiveness of sales distribution, proprietary or patent
advantages, location of facilities, production capacity and efficiency, experience, union relations,
technological advantages, and e-commerce expertise.
Just because one firm receives a 3.20 overallMGT9 rating–and
STRATEGIC MANAGEMENT
another receives a 2.80 in a
CPM, it does not necessarily follow that the first firm is precisely 14.3 percent better than the
second, but it does not suggest that the first firm is better in some areas. Regarding weights in
a CPM or EFE Matrix, be mindful that 0.08 is mathematically 33 percent higher than 0.06 so
even small differences can reveal important perceptions regarding the relative importance of
various factors. The aim with numbers is to assimilate and evaluate information in a meaningful
way that aids in decision making.
Sample: An Actual CPM for D.R. Horton
D.R. Horton Lennar PulteGroup
Critical Success Weight Rating Score Rating Score Rating Score
Factors
1.Price 0.16 4 0.64 3 0.48 2 0.32
2.Market Share 0.14 4 0.56 3 0.42 2 0.28
3.Geographical 0.12 4 0.48 2 0.24 3 0.36
Coverage
4.Quality 0.10 2 0.20 4 0.40 3 0.30
5.Customer service 0.09 2 0.18 3 0.27 4 0.36
6.Profitability 0.08 3 0.24 4 0.32 2 0.16
17 7.Financial Position 0.07 3 0.21 2 MODULE0.14
6 – THE EXTERNAL0.28
4 AUDIT
8.Energy Efficiencies 0.06 2 0.12 3 0.18 4 0.24
9.Growth 0.06 3 0.18 4 0.24 2 0.12
10.Website 0.05 3 0.15 4 0.20 2 0.10
11.Warranty Issues 0.04 3 0.12 2 0.08 4 0.16
12.Social 0.03 2 0.06 3 0.09 4 0.12
Responsibility
Totals 1.00 3.14 3.06 2.80

Note that the two rival firms, Lennar and PulteGroup, receive higher ratings on “Quality” than
D.R. Horton. Also note the factors are listed beginning with the most important (highest weight).
D.R.Horton, Lennar, and PulteGroup are headquartered in Fort Worth, Texas; Miami, Florida;
and Atlanta, Georgia; respectively.

MODULE REFERENCES:

Strategic Management A Competitive Advantage Approach, Concepts and Cases, 16th Edition,
Fred R. David, 2017