Chapter 3

The External Assessment

Ch 3 -1
 "It is not the strongest of the species
that survive, nor the most intelligent,
but the one most responsive to
change.“

Charles Darwin

Copyright 2007 Prentice Hall Ch 3 -2

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 threats
that should be avoided.

• Finite refers that the audit is aimed at

identifying key variables that offer
actionable responses.
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… The Nature of an External Audit

• 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.

Copyright 2007 Prentice Hall Ch 3 -5

Key External Forces

• are divided into five broad categories:

1. economic forces;
2. social, cultural, demographic, and natural
environment forces;
3. political, governmental, and legal forces;
4. technological forces; and
5. competitive forces.

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 Key External Forces & the Organization
Beyond control of organization!

Competitors
Suppliers
Distributors
Creditors
Key Customers Opportunities
External Employees &
Forces
Communities Threats to the
Managers Orgn
Stockholders
Labor Unions
Special Interest Groups
Products
Services

Copyright 2007 Prentice Hall Ch 3 -7

Performing External Audit
• must involve as many managers and
employees as possible.
• a) first must gather competitive
intelligence and information about
external factors (sources of information:
key magazines, trade journals,
newspapers, internet, corporate,
university, and public libraries; suppliers,
distributors, salespersons, customers,
and competitors.)
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… Performing External Audit

• b) The gathered information should be

assimilated and evaluated
• c) Identify the most important
opportunities and threats facing the
firm (through a meeting or series of
meetings of managers is needed to
collectively).

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… Performing External Audit

• These key external factors should be

listed on flip charts or a chalkboard.
• A prioritized list of these factors could
be obtained by requesting that all
managers rank the factors identified,
from 1 for the most important
opportunity/threat to 20 for the least
important opportunity/threat.

Copyright 2007 Prentice Hall Ch 3 -10

… Performing External Audit

Long-term orientation

Measurable
External
Factors Applicable to
competing firms

Hierarchical

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… Performing External Audit

• These 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 and others
will be more narrowly focused on
functional or divisional areas.
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… Performing External Audit

d) A final list of the most important key

external factors should be communicated
and distributed widely in the
organization.

Copyright 2007 Prentice Hall Ch 3 -13

I/O Perspective Firm Performance

• The Industrial Organization (I/O)

approach to competitive advantage
advocates that external (industry)
factors are more important than
internal factors in a firm achieving
competitive advantage.
• Michael Porter is advocator of this
approach

Copyright 2007 Prentice Hall Ch 3 -15

I/O Perspective Firm Performance

• External factors in general and the

industry in which a firm chooses to
compete has a stronger influence on the
firm’s performance than do the internal
functional decisions managers make in
marketing, finance, and the like.
• The global economic recession’s impact on both strong and weak
firms has added credence of late to the notion that external forces
are more important than internal. Many thousands of internally
strong firms in 2006–2007 disappeared in 2008–2009.

Copyright 2007 Prentice Hall Ch 3 -16

 Porter’s Five Forces
Potential development
of substitute products

Bargaining power Rivalry among Bargaining power

of suppliers competing firms of consumers

Potential entry of new

competitors

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Ch 63 -17
-17
• Effective integration and understanding
of both external and internal factors is
the key to securing and keeping a
competitive advantage.

Copyright 2007 Prentice Hall Ch 3 -18

Social, Cultural, Demographic &
Environmental Forces
• Social, cultural, demographic, and
environmental trends are shaping the
way People live, work, produce, and
consume.

• New trends are creating a different type

of consumer and, consequently, a need
for different products, different
services, and different strategies.
Copyright 2007 Prentice Hall Ch 3 -24
Political, Government & 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.

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… Political, Government & Legal Forces

• For industries and firms that depend

heavily on government contracts or
subsidies, political forecasts can be the
most important part of an external
audit.

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… Political, Government & Legal Forces
Some Political, Governmental, and Legal
Variables
•Government regulations or deregulations
•Changes in tax laws
•Special tariffs
•Political action committees
•Voter participation rates
•Number, severity, and location of
government protests

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… Political, Government & Legal Forces
Some Political, Governmental, and Legal Variables
•Number of patents
•Changes in patent laws
•Environmental protection laws
•Level of defense expenditures
•Legislation on equal employment
•Level of government subsidies
•Antitrust legislation
•Etc.

Copyright 2007 Prentice Hall Ch 3 -28

Technological Forces
• 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.

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Technological Forces
Examples of the Impact of Wireless
Technology
•Airlines—Many airlines now offer
wireless technology in flight.
•Automotive—Vehicles are becoming
wireless.
•Banking—Visa sends text message
alerts after unusual transactions.

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Technological Forces
• Education—Many secondary (and even
college) students may use smart phones for
math because research shows this to be
greatly helpful.
• Energy—Smart meters now provide power
on demand in your home or business.
• Health Care—Patients use mobile devices to
monitor their own health, such as calories
consumed.
• Etc.
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Competitive Forces

• Collecting and evaluating information

on competitors is essential for
successful strategy formulation.

Copyright 2007 Prentice Hall Ch 3 -33

Competitive Forces

Competitive Intelligence Programs

•Competitive intelligence (CI), is a
systematic and ethical process for
gathering and analyzing information
about the competition’s activities and
general business trends to further a
business’s own goals (SCIP Web site).

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Competitive Forces
• Good competitive intelligence in business, as
in the military, is one of the keys to success.
• The more information and knowledge a firm
can obtain about its competitors, the more
likely it is that it can formulate and implement
effective strategies.
• Major competitors’ weaknesses can represent
external opportunities; major competitors’
strengths may represent key threats.

Copyright 2007 Prentice Hall Ch 3 -35

Competitive Forces
Market Commonality and Resource
Similarity
•One way to analyze competitiveness
between two or among several firms is to
investigate market commonality and
resource similarity issues while looking
for areas of potential competitive
advantage along each firm’s value chain.

Copyright 2007 Prentice Hall Ch 3 -36

 The Five-Forces Model of Competition (Porter)

Potential development
of substitute products

Bargaining power Rivalry among Bargaining power

of suppliers competing firms of consumers

Potential entry of new

competitors

Copyright 2007 Prentice Hall Ch 3 -37

The Five-Forces Model of Competition
(Porter)
• Three steps indicate whether competition in
a given industry is such that the firm can
make an acceptable profit:
– 1. Identify key aspects or elements of each
competitive force that impact the firm.
– 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.
Copyright 2007 Prentice Hall Ch 3 -38
 The Five-Forces Model of Competition
(Porter)
Conditions That Cause High Rivalry Among Competing
Firms
– 1. High number of competing firms
– 2. Similar size of firms competing
– 3. Similar capability of firms competing
– 4. Falling demand for the industry’s products
– 5. Falling product/service prices in the industry
– 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

Copyright 2007 Prentice Hall Ch 3 -39

 The Five-Forces Model of Competition
(Porter)
Conditions That Cause High Rivalry Among
Competing Firms
– 9. When fixed costs are high among firms
competing
– 10. When the product is perishable
– 11. When rivals have excess capacity
– 12. When consumer demand is falling
– 13. When rivals have excess inventory
– 14. When rivals sell similar products /services
– 15. When mergers are common in the industry
Copyright 2007 Prentice Hall Ch 3 -40
 The Five-Forces Model of Competition
(Porter)
Potential Entry of New Competitors
•Barriers to entry include:
– the need to gain economies of scale quickly,
– the need to gain technology and specialized
know-how,
– the lack of experience,
– strong customer loyalty,
– strong brand preferences,
– large capital requirements,
– lack of adequate distribution channels,
Copyright 2007 Prentice Hall Ch 3 -41
 The Five-Forces Model of Competition
(Porter)
Potential Entry of New Competitors
•Barriers to entry include:
– 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.

Copyright 2007 Prentice Hall Ch 3 -42

 The Five-Forces Model of Competition
(Porter)
Potential Development of Substitute Products
•Competitive pressures arising from substitute
products increase as
– the relative price of substitute products
declines and
– consumers’ switching costs decrease.

Copyright 2007 Prentice Hall Ch 3 -43

 The Five-Forces Model of Competition
(Porter)
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,
– there are only a few good substitute raw
materials, or
– the cost of switching raw materials is
especially costly.
Copyright 2007 Prentice Hall Ch 3 -44
 The Five-Forces Model of Competition
(Porter)
Bargaining Power of Consumers
•Consumers gain increasing bargaining power 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

Copyright 2007 Prentice Hall Ch 3 -45

Sources of External Information

• Unpublished sources include

– customer surveys,
– market research,
– speeches at professional and
shareholders’ meetings,
– television programs,
– interviews, and conversations with
stakeholders.

Copyright 2007 Prentice Hall Ch 3 -46

Sources of External Information

• Published sources of strategic

information include
– periodicals,
– journals,
– reports,
– government documents,
– abstracts,
– books, directories, newspapers, and
manuals.
Copyright 2007 Prentice Hall Ch 3 -47
Industry Analysis: The External Factor
Evaluation (EFE) Matrix
• Allows strategists to summarize and
evaluate the external factors.
• Steps
– List 15-20 factors (opportunities and
threats)
– Assign weight 0.0 (not important) to 1.00
(very important)

Copyright 2007 Prentice Hall Ch 3 -49

Industry Analysis: The External Factor
Evaluation (EFE) Matrix
– 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.
Copyright 2007 Prentice Hall Ch 3 -50
Industry Analysis: The External Factor
Evaluation (EFE) Matrix
– Multiply each factor’s weight by its rating
to determine a weighted score.
– Sum the weighted scores for each variable
to determine the total weighted score for
the organization.
• The highest possible total weighted
score for an organization is 4.0 and the
lowest possible total weighted score is
1.0.
Copyright 2007 Prentice Hall Ch 3 -51
Industry Analysis: The External Factor
Evaluation (EFE) Matrix

Summarize & Evaluate

Government
Economic Demographic
al
Technologic
Social Environmental
al
Cultural Political Competitive

Copyright 2007 Prentice Hall Ch 3 -52

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External Factors

• It’s hard to write them!

• Weekend Exercise for Intuit

Copyright 2007 Prentice Hall Ch 3 -54

Industry Analysis EFE

Total weighted score of 4.0

• Organization response is outstanding to threats
and opportunities

Total weighted score of 1.0

• Firm’s strategies not capitalizing on opportunities
or avoiding threats

Copyright 2007 Prentice Hall Ch 3 -55

Industry Analysis: Competitive Profile
Matrix (CPM)

Identifies firm’s major

competitors and their strengths
& weaknesses in relation to a
sample firm’s strategic positions
Provides important internal
strategic information.
Copyright 2007 Prentice Hall Ch 3 -56
 Gateway Apple Dell
Wt Rating Wt’d Ratin Wt’d Rating Wt’d
CSF’s Score g Score Score

Market share 0.15 3 0.45 2 0.30 4 0.60

Inventory sys 0.08 2 0.16 2 0.16 4 0.32
Fin. position 0.10 2 0.20 3 0.30 3 0.30
Prod. Quality 0.08 3 0.24 4 0.32 3 0.24
Cons. Loyalty 0.02 3 0.06 3 0.06 4 0.08
Sales Distr 0.10 3 0.30 2 0.20 3 0.30
Global Exp. 0.15 3 0.45 2 0.30 4 0.60
Org. Structure 0.05 3 0.15 3 0.15 3 0.15

Copyright 2007 Prentice Hall Ch 3 -57

 Gateway Apple Dell
Wt Rating Wt’d Ratin Wt’d Rating Wt’d
CSF’s (cont’d) Score g Score Score

Prod. Capacity 0.04 3 0.12 3 0.12 3 0.12

E-commerce 0.10 3 0.30 3 0.30 3 0.30
Customer Serv 0.10 3 0.30 2 0.20 4 0.40
Price
0.02 4 0.08 1 0.02 3 0.06
competitive
Mgt. 0.01 2 0.02 4 0.04 2 0.02
experience

Total 1.00 2.83 2.47 3.49

Copyright 2007 Prentice Hall Ch 3 -58

UST—Key External Factors Weighte
Weight Rating d
Opportunities score
Global markets untapped .15 1 .15
Increased demand .05 3 .15
Astronomical Internet growth .05 1 .05
Pinkerton leader in discount market .15 4 .60
More social pressure to quit .10 3 .30
smoking
Threats
Legislation against the tobacco .10 2 .20
industry
Production limits on tobacco .05 3 .15
Smokeless market SE region U.S. .05 2 .10
Bad media exposure from FDA .10 2 .20
Clinton Administration .20 1 .20
TOTAL 1.00 2.10
Copyright 2007 Prentice Hall Ch
Ch 63 -59
-59
 (CPM) Procter
Avon L’Oreal &
Gamble
Critical Success Weigh Ratin Scor Ratin Scor Ratin Score
Factor t g e g e g
Advertising 0.20 0.2 0.8 3 0.60
1 4
Product Quality 0.10 0
0.4 0
0.4 3 0.30
4 4
Price Competition 0.10 0
0.3 0
0.3 4 0.40
3 3
Management 0.10 0
0.4 0
0.3 3 0.30
4 3
Financial Position 0.15 0
0.6 0
0.4 3 0.45
4 3
Customer Loyalty 0.10 0
0.4 5
0.4 2 0.20
4 4
Global Expansion 0.20 0
0.8 0
0.4 2 0.40
4 2
Market Share 0.05 0
0.0 0
0.2 3 0.15
1 4
1.00 5
3.1 0
3.2 2.80
Total
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Ch 63 -60
-60
 Competitive Profile Matrix – Royal Caribbean

RCL CCL POC

Critical Success Weight Rating Weighted Rating Weighted Rating Weighted
Factors Score Score Score
Market Share 0.20 3 0.60 4 0.80 2 0.40
Customer Loyalty 0.15 3 0.45 4 0.60 2 0.30
Distribution Network 0.15 4 0.60 3 0.45 2 0.30
Financial Position 0.10 1 0.10 4 0.40 3 0.30
Global Expansion 0.05 4 0.20 3 0.15 2 0.10
Advertising 0.05 3 0.15 4 0.20 2 0.10
Product Quality 0.15 4 0.60 3 0.45 2 0.30
Expansion of 0.15 4 0.60 3 0.45 2 0.30
departure ports
Total 1.00 3.30 3.50 2.10

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EFE Matrix

Key External Factors Weight Rating Weighted Score

Opportunities
Nearly 88% of North Americans have never been on 0.15 4 0.60
a cruise.
Cruise vacations are seen as a choice of older 0.08 3 0.24
travelers; leaving minorities and young adult markets
virtually untapped

Distribution networks at home and abroad may be an 0.07 3 0.21

untapped source for generating increased business
Internet use is increasing; commonly the tool used to 0.08 3 0.24
secure reservations for many travelers
Several markets overseas, such as, France, Italy, have 0.10 2 0.20
a market of would be cruisers
Threats
Increase in regulation by US regarding 0.08 2 0.16
environmental issues and economic downturns
Alaskan legislators are considering a $50 tax per 0.05 2 0.10
cruise ship passenger
Location and severity of terrorist attacks; namely 0.10 3 0.30
September 11th events
War and political uprisings 0.10 3 0.30
Drastic changes in the world oil market and currency 0.02 1 0.02
exchange
Existing and potential litigation 0.02 1 0.02
Increased capacity of competitors and pricing wars 0.05 2 0.10
Transfer of information through collective bargaining 0.03 1 0.03
agreements
Competitors: Carnival and P & O 0.07 2 0.14
Copyright 2007 Prentice Hall
Total 1.00 2.56 Ch 3 -62
Assignment Exercises

• Develop an EFE Matrix for your

College/ University

• Identify two colleges or universities

and develop a Competitive Profile
Matrix

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Copyright 2007 Prentice Hall Ch 3 -64