Presentation on

Chapter -3
THE EXTERNAL
ASSESSMENT

 Chapter 3 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 trends
and events beyond the control of a single firm, such as
increased foreign competition, population shifts to the Sun Belt,
an aging society, consumer fear of traveling, and stock market
volatility.
An external audit 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 chapter presents a practical framework and guidelines for
gathering,
assimilating,
and
analyzing
environmental
information.

External Strategic
Management Audit
Environmental Scanning

Industry Analysis

1. The nature of an
external audit
The purpose of an external audit is to develop a finite list of
opportunities that could benefit a firm and avoid threats.
A.

Key External Forces

1. External forces can be divided into five broad categories:

(1)
(2)
(3)
(4)
(5)

Economic forces;
Social, cultural, demographic, and natural environment forces;
Political, governmental, and legal forces;
Technological forces; and
Competitive forces.

2 Relations among these forces and an organization are depicted in

Figure 3-2. External trends and events significantly affect all
products, services, markets, and organizations in the world.
3.Changes in external forces translate into changes in consumer
demand for both industrial and consumer products and services.

1. The nature of an
external audit
contd.

B. The Process of Performing an External Audit

1. The process of performing an external audit must involve as many managers and
employees as possible.
2. To perform an external audit, a company first must gather competitive intelligence
and information about social, cultural, demographic, environmental, economic,
political, legal, governmental, and technological trends.
a. Individuals can be asked to monitor various sources of information such as key magazines,
trade journals, and newspapers.
b. The Internet is another source for gathering strategic information, as are corporate,
university, and public libraries.
c. Suppliers, distributors, salespersons, customers, and competitors represent other sources of
vital information.

3. Once information is gathered, it should be assimilated, evaluated, and prioritized.

4. Key external factors should be important to achieving long term and annual
objectives, measurable, applicable to all competing firms, and hierarchical in the
sense that some will pertain to the overall company while others will be more
narrowly focused.

Industrial
Organization (I/O)
View
Industry factors are more
important than internal factors

Performance determined by
industry forces

II. The industrial

organization (i/o) view
External Factors versus Internal Factors

External factors are more important than internal factors in a firm achieving
competitive advantage. Organizational performance is primarily determined by
industry forces.

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.

Factors Affecting Firm Performance

1. Firm performance is primarily based on industry properties such as
economies of scale, barriers to market entry, product differentiation, and
level of competitiveness.
2. The global economic recessions impact on both strong and weak firms
has added credence to the notion that external forces are more important
than internal. Many thousands of internally strong firms in 2006-2007
disappeared in 2008-2009.

I/O Perspective Firm Performance

Industry Properties
Economies of Scale
Barriers to Market Entry
Product Differentiation
The Economy
Level of Competitiveness

III. Economic forces

A. Economic Factors Have a Direct Impact
1. Economic factors have a direct impact on the potential attractiveness of various
strategies. For example, if interest rates rise, then funds needed for capital expansion
become more costly or unavailable.

2. The key economic variables that a firm should monitor are :(1) shifts to a service economy in the United States;
(2) availability of credit;
(3) level of disposable income;
(4) propensity of people to spend;
(5) interest rates;
(6) inflation rate;
(7) unemployment trends; and so on.
3. An economic variable of significant importance is gross domestic product,
especially across countries
4. Trends in the dollars value have significant and unequal effects on companies in
different industries and in different locations.

5. Rising unemployment rates across the United States has touched off a race among
states to attract businesses with tax breaks and financial incentives.

IV. Social , Cultural,

Demographic, and Natural
Environment forces
Major Impact
Products
Services
Markets
Customers

V. POLITICAL, GOVERNMENTAL, AND LEGAL

FORCES
Federal, state, local, and foreign governments are major regulators, deregulators, subsidizers,
employers, and customers of organizations. Political, governmental, and legal factors, therefore,
can represent key opportunities or threats for both small and large organizations.
For industries and firms that depend heavily on government contracts or subsidies, political
forecasts can be the most important part of an external audit.
Changes in patent laws, antitrust legislation, tax rates, and lobbying activities can affect firms
significantly.
In the face of a deepening global recession, countries worldwide are resorting to protectionism to
safeguard their own industries. Many economists point out that the current rash of trade
constraints will make it harder for global economic growth to recover from the global recession.

Governments are taking control of more and more companies as the global economic recession
cripples firms considered vital to the nations financial stability. As more and more companies
around the world accept government bailouts, those companies are being forced to march to
priorities set by political leaders.
Local, state, and federal laws, regulatory agencies, and special interest groups can have a major
impact on the strategies of small, large, for-profit, and nonprofit organizations.


VI. Technological forces

A. Revolutionary technological changes and discoveries are having a

dramatic impact on organizations.

The Internet is changing 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.

To effectively capitalize on information technology, a number of organizations are

establishing two new positions in their firms: chief information officer (CIO) and
chief technology officer (CTO). This trend reflects the growing importance of
information technology (IT) in strategic management.

B. Technological forces represent major opportunities and threats

that must be considered in formulating strategies.

Technological advancements can dramatically affect organizations product,

services, markets, suppliers, distributors, competitors, customers, manufacturing
practices, and competitive position.

Technology management is one of the key responsibilities of strategists. Firms

should pursue strategies that take advantage of technological opportunities to

VII. Competitive
Forces
Collection & evaluation of data on
competitors is essential for
successful strategy formulation

Competitive Forces
Identify Rival Firms
Strengths
Weaknesses
Capabilities
Opportunities
Threats
Objectives
Strategies

Key Questions Concerning

Competitors

Their strengths
Their weaknesses
Their objectives and strategies
Their responses to external variables
Their vulnerability to our alternative
strategies
Our vulnerability to strategic
counterattack

Key Questions Concerning

Competitors
Our product/service positioning
Entry and exit of firms in the industry
Key factors for our current position in
industry
Sales/profit ranking of competitors
over time
Nature of supplier and distributor
relationships
The threat of substitute
products/services

Competitive Forces

7 characteristics of most
competitive firms
Market share matters
Understanding what business you are
in
Broke or not, fix it
Innovate or evaporate
Acquisition is essential to growth
People make a difference
No substitute for quality

 Competitive Intelligence
A systematic and ethical process for
gathering and analyzing information
about the competitions activities and
general business trends to further a
businesss own goals

 Objectives of Competitive Intelligence

Provide a general understanding of
industry and competitors
Identify areas where competitors are
vulnerable and assess impact of actions
on competitors
Identify potential moves that a
competitor might make

 Sources of Competitive
Intelligence

Internet
Employees
Managers
Suppliers
Distributors
Customers
Creditors

Consultants
Trade journals
Want ads
Newspaper
articles
Government
filings
Competitors

 Market Commonality and Resource Similarity

The number and significance of markets that a firm
competes in with rivals
Competitors are firms that offer similar products in the same
market.

Markets can be geographic, product areas, or segments.

Market commonality can be defined as the number and significance

of markets that a firm competes in with rivals.

Resource similarity is the extent to which the type and amount of a

firms internal resources are comparable to a rival.

VIII. Competitive analysis:

Porters five-forces model
It is a framework for the analysis of
the structural factors that shape
competition within the industry.
The five forces:
Determine the level of competition in an
industry
Assess how attractive and potentially profitable
is an industry.

The Five-Forces Model

Rivalry among competing firms

Most powerful of the five forces
Focus on competitive advantage
of strategies over other firms

Threats of
substitute
products

Bargainin
g power
of
suppliers

Intensity of rivalry
within the industry

Threats of
new
entrants

The Five Force Model

of Competition

Bargaining
power of
Buyers
(customer
s)

The Five Force Model of

Competition

Steps to Determine if an Acceptable

Profit Can Be Earned
1. Identify key aspects or elements of
each competitive force
2. Evaluate how strong and important
each element is for the firm
3. Decide whether the collective
strength of the elements is worth
the firm entering or staying in the
industry

1. 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 industrys
products
Falling product/service prices in the
industry

Conditions that Cause High Rivalry

Among Competing Firms contd.
Consumers can switch brands easily
Barriers to leaving the market are
high
Barriers to entering the market are
low
Fixed costs are high among firms
competing
The product is perishable

Conditions that Cause High Rivalry

Among Competing Firms contd.

Rivals have excess capacity

Consumer demand is falling
Rivals have excess inventory
Rivals sell similar products/services
Mergers are common in the industry

2. Threat of new entrants

If new entrant moves into an industry
they will gain market share, rivalry will
accelerate and profits will decline.
Impediments to the entry of new firms are
known as barriers to the entry.
If it is difficult to enter an industry the
position of existing firms will be
strengthened.
If barriers to entry are low then the threat
of new entrants will be high, and vice

Barriers to entry
Capital cost of entry
High cost will deter entry
High capital requirements might mean that
only large firms can compete.

Economies of scale available to existing

firms
If they enjoy absolute cost advantages based
on large scale then it will be difficult for smaller
newcomers to break into the market and
compete effectively.

Regularity and legal restrictions

Each restriction act as a barrier to entry

What are the barriers to

entry?
Product differentiation ( including brands)
Will act to increase customer loyalty making it
difficult for newcomers to gain market share.

Access to raw material and distribution

channels
A lack of access will make it difficult for
newcomers to enter the market.

Retaliation by established products

Eg. The threat of price war
Will act to discourage newcomers.

Threats of new entrants

The main factors in determining this
level are:
Absolute cost advantage
Access to inputs/ distribution
Government policy
Economies of scale
Capital requirements
Brand identity
Switching costs

3. Bargaining power of suppliers

Suppliers are the businesses that supply
materials & other products into the
industry.
The cost of items bought from suppliers
(e.g. raw materials, components) can have
a significant impact on a company's
profitability.
If suppliers have high bargaining power
over a company, then in theory the

 The bargaining power of

suppliers will be high when:
- There are many buyers and few

dominant suppliers.
- There are undifferentiated, high valued
products.
- Suppliers threaten to integrate forward
into the industry (e.g. brand
manufacturers threatening to set up their
own retail outlets).
- Buyers do not threaten to integrate
backwards into supply.

4. Bargaining Power of Buyers

Buyers are the people / organizations
who create demand in an industry.
The bargaining power of buyers is
greater when:
There are few dominant buyers and many
sellers in the industry.
Products are standardized.
Buyers threaten to integrate backward into the
industry.
Suppliers do not threaten to integrate forward
into the buyer's industry.

Conditions Where Consumers Gain

Bargaining Power
If buyers can inexpensively switch
If buyers are particularly important
If sellers are struggling in the face of
falling consumer demand
If buyers are informed about sellers
products, prices, and costs
If buyers have discretion in whether
and when they purchase the product

5. Threat of substitute products

The presence of substitute products
can lower industry attractiveness and
profitability because they limit price
levels. The threat of substitute
products depends on:
- Buyers' willingness to substitute
- The relative price and performance of
substitutes

Threat of substitute products contd.

The substitute product can be
regarded as something that meets
the same need.
Substitute products are produced in a
different industry- but crucially
satisfy the same customer needs.

IX. Sources of external information

1. A wealth of information is available to
organizations from both published and
unpublished sources.
Unpublished sources include customer surveys,
market research, speeches at professional and
shareholders meetings, television programs,
interviews, and conversations with stakeholders.
Published sources of strategic information
include
periodicals,
journals,
reports,
government documents, abstracts, books,
directories, newspapers, and manuals

2. Web Sites for gathering strategic

information:

1.
2.
3.
4.
5.
6.

http://marketwatch.multexinvestor.com
http://moneycentral.msn.com
http://finance.yahoo.com
www.clearstation.com
https://us.etrade.com/e/t/invest/markets
www.hoovers.com

3. Standard & Poors (S&P) Industry Surveys include the

following sections of information:
Current environment
Industry trends
How the industry operates
Key industry ratios and statistics
How to analyze a company
Glossary of industry terms
Additional industry information
References
Comparative company financial analysis

X. Forecasting tools and techniques

A. Forecasts

1. Forecasts are educated assumptions about future trends and events.

2. Forecasting is a complex activity due to 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.
3. Forecasting tools can be broadly categorized into two groups: quantitative techniques and

qualitative

techniques.
a. Quantitative forecasts are most appropriate when historic data are available and when the relationships among
key variables are expected to remain the same in the future. Linear regression, for example, is based on the
assumption that the future will be just like the past.

b. Accurate forecasts can provide major competitive advantages for organizations. However, no forecast is
perfect, and some are wildly inaccurate.

B. Making Assumptions

4. By identifying future occurrences that could have a major effect on the firm and making reasonable
assumptions about those factors, strategists can carry the strategic-management process forward.
5. Assumptions are needed only for future trends and events that are most likely to have a significant
effect on the companys business.
6. Firms that have the best information generally make the most accurate assumptions, which can
lead to major competitive advantages.
7.

XI. Industry analysis: The

external factor evaluation
(EFE) matrix
An EFE Matrix allows strategists to summarize and evaluate economic, social,
cultural,
demographic,
environmental,
political,
governmental,
legal,
technological, and competitive information.

There are five steps in developing an EFE Matrix as :

1. List key external factors as identified in the external-audit process. Include a

total of 10-20 factors from both the opportunities and threats.
2. Assign to each factor a weight from .0 (not important) to 1.0 (very important).
These weights show the relative importance. The total of all the weights
should equal 1.0.
3. Assign a 1-4 rating to each factor to indicate how effectively the firms current
response strategy is: 1 = the response is poor, 2 = the response is average, 3
= the response is above average, and 4 = the response is superior.
4. Multiply each factors weight by its rating to get a weighted score.
5. Sum the weighted scores for each variable to determine the total weighted
score for the organization.

Industry Analysis
EFE
Total weighted score of 4.0
Organization response is outstanding to
threats and weaknesses

Total weighted score of 1.0

Firms strategies not capitalizing on

opportunities or avoiding threats

XII. The competitive profile matrix (CPM)

A. The CPM Matrix

The CPM identifies a firms major competitors and their

particular strengths and weaknesses in relation to a sample
firms strategic position.

There are some important differences between the EFE and

CPM.
First, the critical success factors in a CPM are broader.
These factors are also not grouped into opportunities and
threats as in the EFE.
In a CPM, the ratings and weighted scores can be compared
to rival firms.

Industry Analysis
CPM
Important

Just because one firm receives a 3.2

rating and another receives a 2.8
rating, it does not follow that the first
firm is 20 percent better than the
second.

 Thank you