Chapter Four

External Environment Analysis

• An external Audit focuses on identifying and evaluating
trends and events beyond the control of a single firm.
The nature of external audit
• The purpose of an external audit is to develop a finite list of
opportunities that could benefit a firm and threats that should
be avoided
• Firms should be able to respond either offensively or
defensively to the factors by formulating strategies that take
advantage of external opportunities or that minimize the
impact of potential threats.
Key external forces
• External forces can be divided in to five broad
categories:
• (1) Economic forces;
(2)social, Cultural, Demographic, And
Environmental forces;
(3) political, governmental, and legal forces;
• (4) technological forces; and
• (5) competitive forces
• Changes in external forces translate in to 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 types of services
offered, and the choice of businesses to acquire or
sell.
• External forces directly affect both suppliers and
distributors.
• Identifying and evaluating external opportunities and
threats enable 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.
• To perform an external audit, a company must first
gather competitive intelligence and information
about social, cultural, demographic, environmental,
economic, political, legal, governmental, and
technological trends. Individuals can be asked to
monitor various sources of information such as key
magazines, trade journals, and news papers. Suppliers,
distributors, salespersons, customers, and competitors
represent other sources of vital information.
• Once information is gathered it should be assimilated
and evaluated. Key success factors should be listed on
flipcharts or a blackboard
• key success factors (KSFs) are those competitive factors that
most affect industry members’ ability to prosper in the
marketplace—the particular strategy elements, product
attributes, resources, competencies, competitive capabilities,
and market achievements that spell the difference between
being a strong competitor and a weak competitor and
sometimes between profit and loss.
Key success factors should be
• Important to achieving long-term and annual objectives,
• Measurable,
• Relatively few in number,
• Applicable to all competing firms, and
• Hierarchical in the sense that some will pertain to the overall
company and others will be more narrowly focused on
functional or divisional areas.
 Sources of external information
• A wealth of strategic information is available to organizations from
both published and unpublished sources. Unpublished sources
include customer surveys, market research, speeches in meetings,
television programs, interviews, and conversation with stakeholders.
Published sources include periodicals, journals, reports, government
documents, abstracts, books, directories, newspapers, and
manuals.
• Indexes: a number of excellent indexes reveal the location of
strategic information by subject, topic, source, author, company, and
industry. Indexes can save managers considerable time and effort
in identifying and evaluating opportunities and threats.
• Online databases: millions of people today use online services for both business and
personal purpose. There are various companies which provide commercial online services.
• Library publications: it includes various published sources of strategic information
 Forecasting tools and techniques
• Forecasts are educated assumptions about future trends
and events. Managers often must rely upon published
forecasts to identify key external opportunities and threats
effectively.
• When published forecasts of key external or internal
variables are not available, organizations must develop their
own projections.
• Forecasting tools can be broadly categorized into two
groups: quantitative techniques and qualitative techniques.
• Quantitative forecasts are most appropriate when historical
data are available and when the relationships among key
variables are expected to remain the same in the future.
The six basic qualitative approaches to
forecasting are
• Sales force estimate(this approach involves
the opinions of the sales force and these
opinions are primarily taken into consideration
for forecasting future sales).
• Jury of executive opinion( this is the method
by which the relevant opinions of experts are
taken, combined and averaged).
• Anticipatory surveys or market research
• Scenario forecasts,
• Brainstorming
• Delphi forecasts (It is basically a more formal
version of jury of executive opinion method. A panel
of experts are given a situation and asked to make
initial predictions about it. On the basis of the
prescribed questionnaire, these experts develop a
written opinion. These responses are analyzed and
summarized by a central coordinator and submitted
back to the panel for further consideration,
evaluation and refinement. This process is repeated
until consensus is obtained. This method is very
useful where either the past patterns are not
available or where the past data is not indicative of
future events and the issues are general in nature).
• Qualitative or judgmental forecasts are particularly
useful when historical data are not available or when
constituent variables are expected to change
significantly in the future. By identifying future
occurrences that could have a major effect on the
firm and making reasonable assumption about those
factors, strategists can carry the strategic-
management process forward.
 Competitive analysis: Porter’s five forces
model
• Porter’s five-force 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. According to porter, the
nature of competitiveness in a given industry can be
viewed as a composite of five forces:
1) Rivalry among competitive forces
2) Potential entry of new competitors
3) Potential; development of substitute products
4) Bargaining power of suppliers
5) Bargaining power buyers
RIVALRY AMONG COMPETING FIRMS:
• 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 being pursued by rival
firms. Changes in strategy by one firm may be met with
retaliatory countermoves, such as lowering price, enhancing
quality, adding features, providing services, extending
warranties, and increasing advertising.
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 decline, and
• As price cutting becomes common.
 POTENTIAL ENTRY OF NEW COMPETITORS

• Whenever new firms can easily enter a particular industry, the

intensity of competitiveness among firms increases
• The strategist’s job is, therefore, to identify potential new firms
entering the market, to monitor the new firms’ strategies, to
counter attack as needed, and to capitalize on existing
strengths and opportunities.

DEVELOPMENT OF SUBSTITUTE PRODUCTS:

• In many industries, firms are in close competition with
producers of substitute products in other industries. The
presence of substitute products puts a ceiling/upper limit on
the price that can be charged before the 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’ switching costs decrease.
 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 material 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 newer 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. The strategy is especially
effective when suppliers are unreliable, too costly, or not
capable of meeting the firm’s needs on a consistent
basis. Firms can generally negotiate more favorable
term switch suppliers when backward integration is a
commonly used strategy among rival firms in an
industry.
 Bargaining Power of Consumers

• When customers are concentrated, large, or buy in volume, their

bargaining power represents a major forces affecting intensity of
competition in an industry.
• Rival firms may offer extended warranties or special services to gain
customer loyalty whenever the bargaining power of consumer is
substantial.
• Bargaining power of consumers is also higher when the products
being purchased are standard or undifferentiated.
• When this is the case, consumers can often negotiate selling price,
warranty coverage, and necessary packages to a greater extent.