CHAPTER THREE

ENVIRONMNETAL ANANLYSIS

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Contents
Internal environment analysis

The nature of an internal audit

The process of performing an internal audit

Key functional areas of business

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Contents
External environmental analysis
The nature of external audit
The process of performing an external audit
Analysis of key external factors
Competitive analysis
Sources of external information
Forecasting tools and techniques
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ENVIRONMNETAL ANANLYSIS
 Before an organization can begin strategy
formulation, it must scan the external environment
to identify possible opportunities and threats and
its internal environment for strengths and
weaknesses.
 Environmental scanning refers to possession and
utilization of information about occasions,
patterns, trends, and relationships within an
organization‘s internal and external environment.
 It helps the managers to decide the future path of
the organization. 4
Internal Environment Analysis
The nature of an internal audit
 Internal analysis of the environment is the first step
in the process of environmental scanning.

 Analysis of internal environment helps in identifying

strengths and weaknesses of an organization.

 All organizations have strengths and weaknesses in

the functional areas of business.

 No enterprise is equally strong or weak in all areas.

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The nature of an internal audit
 Internal strengths/weaknesses, coupled with
external opportunities/threats and a clear
statement of mission, provide the basis for
establishing objectives and strategies.

 Objectives and strategies are established with

the intention of capitalizing upon internal
strengths and overcoming weaknesses.
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The Process of Performing an Internal Audit
 The process of performing an internal audit
closely parallels the process of performing an
external audit.
 Representative managers and employees
throughout the firm need to be involved in
determining the firm‗s strengths and weaknesses.
 The internal audit requires gathering and
assimilating information about the firm‗s
management, marketing, finance/accounting,
production/operations, research and development,
and management information systems operations.
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The Process of Performing an Internal Audit
 Compared to the external audit, the process of
performing an internal audit provides more opportunity
for participants to understand how their jobs,
departments, and divisions fit into the whole
organization.
 This is a great benefit because managers and employees
perform better when they understand how their work
affects other areas and activities of the firm.
 For example, when marketing, finance and
manufacturing managers jointly discuss issues related to
internal strengths and weaknesses, they gain a better
appreciation of the issues, problems, concerns, and
needs of all the functional areas. 8
The Process of Performing an Internal Audit
 In organizations that do not use strategic management,
marketing, finance, and manufacturing managers often
do not interact with each other in significant ways.
 Performing an internal audit thus is an excellent forum
for improving the process of communication in the
organization.
 A firm‗s strengths that cannot be easily matched or
imitated by competitors are called distinctive
competencies.
 Building competitive advantages involves taking
advantage of distinctive competencies.
 Strategies are designed in part to improve on a firm‗s
weaknesses, turning them into strengths—and maybe
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even into distinctive competencies.
Functional areas of business
Marketing
 Marketing can be described as the process of
defining, anticipating, creating, and fulfilling
customers‘ needs and wants for products and
services.
 There are seven basic functions of marketing:
– Customer analysis
– Selling products and services
– Product and service planning
– Pricing
– Distribution
– Marketing Research
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– Cost/Benefit analysis.
Functional areas of business
Marketing…
 Understanding these functions helps strategists
identify and evaluate marketing strengths and
weaknesses—a vital strategy-formulation activity.
Finance/Accounting
 Comprise three decisions:
– Investment decision/Capital budgeting
– Financing decision
– Dividend decision
 Financial ratio analysis is the most widely used method
for determining an organization‘s strengths and
weaknesses in the investment, financing, and dividend
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areas.
Functional areas of business
Production/Operations
 The production/operations function of a business
consists of all those activities that transform inputs
into goods and services.
 Production/operations management comprises five
functions or decision areas:
– Process
– Capacity
– Inventory
– Workforce
– Quality 12
Functional areas of business
Research & Development (R&D)
 Firms pursuing a product development strategy
especially need to have a strong R&D orientation.
 R&D expenditures are directed at developing new
products before competitors do, at improving
product quality, or at improving manufacturing
processes to reduce costs.
 Effective management of the R&D function
requires a strategic and operational partnership
between R&D and the other vital business
functions. 13
External Environment Analysis
The nature of external audit
 An external audit focuses on identifying and
evaluating trends and events beyond the control of
a single firm.
 An external audit reveals key opportunities and
threats confronting an organization so that
managers can formulate strategies to take
advantage of the opportunities and avoid or reduce
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the impact of threats.
The Process of Performing an External Audit
 The process of performing an external audit must
involve as many managers and employees as
possible.
 To perform an external audit, a company first must
gather competitive intelligence and information
about:
– Economic
– Social
– Cultural
– Demographic
– Environmental
– Political, governmental, legal
– Technological trends. 15
The Process of Performing an External Audit
 Individuals can be asked to monitor various
sources of information such as key magazines,
trade journals, and newspapers.
 These persons can submit periodic scanning
reports to a committee of managers charged with
performing the external audit.
 This approach provides a continuous stream of
timely strategic information and involves many
individuals in the external-audit process.
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The Process of Performing an External Audit
 The internet provides another source for
gathering strategic information, as do corporate,
university, and public libraries.

 Suppliers, distributors, salespersons, customers,

and competitors represent other sources of vital
information.

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Analysis of Key External Factors
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 18
Analysis of Key External Factors
Some key socio-cultural, demographic variables
– Changing work values
– Ethical standards
– Growth rate of population
– Life expectancies
– Rate of family formation
– Geographic shifts in population
– Attitudes towards business
– Attitudes towards leisure time
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Analysis of Key External Factors
Political, Governmental, and Legal Forces
 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, anti-
trust laws, tax programs, minimum wage
legislation, pollution & pricing policies.
 There are also political actions that are designed
to benefit and protect organizations: patent laws,
government subsidies, and product research
grants. 20
Analysis of Key External Factors
Some key Political, Governmental, and Legal
Variables:
– Tax laws
– Environmental protection laws
– Level of government subsidies
– Terrorist activities
– Fiscal and monetary policies
– Size of government budget
– Local, state & national elections
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Analysis of Key External Factors
Technological Forces
 Revolutionary technological changes and discoveries are
having a dramatic impact on organizations.
 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, and changing the historical trade-off
between production standardization and flexibility.
 The Internet is altering economies of scale, changing
entry barriers, and redefining the relationship between
industries and various suppliers, creditors, customers,
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and competitors.
Competitive Analysis
 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.
 Porter‘s Five-Forces Model of competitive analysis
is a widely used approach for developing strategies
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in many industries.
Competitive Analysis
 According to Porter, the nature of competitiveness
in a given industry can be viewed as a composite of
five forces:
– Rivalry among competing firms

– Potential entry of new competitors

– Potential development of substitute products

– Bargaining power of suppliers

– Bargaining power of consumers

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Competitive Analysis
 Porter's Five-Forces Model can be used in the
following three steps to determine whether there is
enough competition in a certain area for a company
to earn a profit that is acceptable:
– Identify key aspects or elements of each
competitive force that impact the firm.
– Evaluate how strong and important each element
is for the firm.
– Decide whether the collective strength of the
elements is worth the firm entering or staying in
the industry. 25
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Competitive Analysis
1. Rivalry among Competing
 Rivalry among competing firms is usually 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 strategies pursued
by rival firms.
 Changes in strategy by one firm may be met with
retaliatory (correcting) countermoves, such as
lowering prices, enhancing quality, adding features,
providing services, extending warranties, and
increasing advertising. 27
Competitive Analysis
Conditions that Cause High Rivalry Among Competing Firms

 High number of competing firms

 Similar size of firms competing
 Similar capability of firms competing
 Falling demand for the industry‘s products
 Falling product/service prices in the industry
 When consumers can switch brands easily
 When barriers to leaving the market are high
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Competitive Analysis
Conditions that Cause High Rivalry Among Competing Firms

 When barriers to entering the market are low

 When fixed costs are high among firms competing
 When the product is perishable
 When rivals have excess capacity
 When consumer demand is falling
 When rivals have excess inventory
 When rivals sell similar products/services
 When mergers are common in the industry 29
Competitive Analysis
2. Potential Entry of New Competitors
 The strategist‘s job is to identify potential new
firms entering the market, to monitor the new rival
firms‘ strategies.
 When the threat of new firms entering the market is
strong, incumbent firms generally strengthen their
positions and take actions to deter new entrants,
such as lowering prices, extending warranties,
adding features, or offering financing specials to
counterattack as needed, and to capitalize on
existing strengths and opportunities.
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Competitive Analysis
3. Potential Development of Substitute Products
 In many industries, firms are in close competition with
producers of substitute products in other industries.
Examples are:
– Plastic container producers competing with glass,
paperboard, and aluminum can producer.
– Newspapers and magazines face substitute-product
competitive pressures from the Internet and 24-hour
cable television.
 Competitive pressures arising from substitute products
increase as the relative price of substitute products
declines and as consumers‘ switching costs decrease.
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Competitive Analysis
4. Bargaining Power of Suppliers
 The bargaining power of suppliers affects the
intensity of competition in an industry, especially
when there is a large number of suppliers, when there
are only a few good substitute raw materials, or when
the cost of switching raw materials is especially
costly.
 It is often in the best interest of both suppliers and
producers to assist each other with reasonable prices,
improved quality, development of new services, just-
in-time deliveries, and reduced inventory costs, thus
enhancing long-term profitability for all concerned.
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Competitive Analysis
5. Bargaining Power of Consumers
 When customers are concentrated or large or buy in
volume, their bargaining power represents a major force
affecting the intensity of competition in an industry.
 Consumers gain increasing bargaining power under the
following circumstances:
– If they can inexpensively switch to competing brands or
substitutes
– If they are particularly important to the seller
– If sellers are struggling in the face of falling consumer
demand
– If they are informed about sellers‘ products, prices, and
costs
– If they have discretion in whether and when they purchase
the product.
Sources of External Information
 Strategic information is available to organizations
from both published and unpublished sources.
 Unpublished sources include customer surveys,
market research, speeches at professional and
shareholders meeting, television programs,
interviews and conversations with stakeholders.
 Published sources of strategic information include
periodicals, journals, reports, government
documents, abstracts, books, directories, newspapers,
and manuals.
 Computerization has made it easier today for firms to
gather, assimilate and evaluate information. 34
Forecasting Tools and Techniques
 Forecasts are educated assumptions about future
trends and events.
 Forecasting is a complex activity because of
factors such as technological innovation, cultural
changes, new products, improved services,
stronger competitors, 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.
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Forecasting Tools and Techniques
I: Qualitative Techniques
Panel of Executive Opinion
 Panel of executive opinion is also called as a jury-of-
expert-opinion approach.
 It consists of combining and averaging top man-
agement‘s views about the future event.
 Jury of expert opinion method is usually followed when
there is a complex issue and the top-level expertise is
required to come into a conclusion.
Historical Analogy
 This is the most commonly used method.
 It is based on the belief that future trends will develop in
the same direction as past trends. 36
Forecasting Tools and Techniques
Delphi Technique
 It polls a panel of experts and gathers their opinions
on specific topics.
 The Delphi method is a forecasting process
framework based on the results of multiple rounds of
questionnaires sent to a panel of experts.
 Several rounds of questionnaires are sent out to the
group of experts, and the anonymous responses are
aggregated and shared with the group after each
round.
 The forecasting unit decides the experts whose
opinions it wants to know. 37
Forecasting Tools and Techniques
Market Survey
 In this approach, the forecaster can poll, in person or
by questionnaire, customers or clients about expected
future behaviour.
 This method is effective if the right people are sampled
in enough numbers.
 It asks a set of ―experts‖—consumers or potential
consumers—what they will do.
II: Quantitative (Time Series) Techniques
Trend Projection
 This method projects past data into the future.
 This can be done in a table or a graph. 38
Forecasting Tools and Techniques
Moving Average
 In this method, the average of a limited number of
significant results is calculated.
 A moving average is a technique to get an overall
idea of the trends in a data set; it is an average of
any subset of numbers.
Exponential Smoothing
 This technique is similar to the moving average,
except that it gives more weight to recent results
and less to earlier ones.
 This is usually more accurate than moving average.
Forecasting Tools and Techniques
III: Causal Modelling
Regression Analysis
 Regression models are equations created to predict
one variable on the basis of known other variables.
Econometric Models
 This method makes use of several multiple-regres-
sion equations to predict major economic shifts
and the potential impact of those shifts on the
organization.
Economic Indicators
 Economic indicators are data that can forecast the
future state of the economy.
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