Chapter Three

External Environmental
Analysis/scanning
 External Environment

• It refers to the conditions, forces, events and

situations within which business enterprises have
to operate.
• examination and study of the environment of a
business unit in order to identify its survival and
prosperity chances.
• involves knowing beforehand the risks and
uncertainties as well as threats to the business
unit.
 Cont…
• Purpose: is to develop a finite list of opportunities
that could benefit a firm and threats that should
be avoided. Or
• 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.
• 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.
 Essential

• 1) Prime Influence –
• 2) A tool to anticipate Changes –
• 3) Time for adjustment –
• 4) Early Warning system
 Cont…
• External environment affects:-
 the types of products developed
 the nature of positioning and
 market segmentation strategies
 the type of services offered, and
 the choice of businesses to acquire or sell.
 Cont….
• External forces directly affect both suppliers and
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.
 External environment forces
• External forces can be divided into five
broad categories:
– political, governmental, and legal forces
– economic forces
– social, cultural, demographic, and natural
environment forces
– technological forces; and
– competitive forces.
 Political, Governmental, and Legal Forces

• Government control extend from the business structured

and organized, how enterprises deal with employees,
remunerate and motivate the people and even the degree
of profits the make.
• Commercial activities are also regulated overtly or
covertly, in terms of what we can sell, how we sell and
whom we sell to, in terms of prices we can charge, the
distribution channels we can use, the promotion activities
we can employ.

• Understanding the political environment involves the

study of attitudes, philosophies and actions of political
parties, government leaders and legislators.
 Cont…
• Political ideology,
• rate of change of political direction,
• political stability,
• changes in patent laws,
• antitrust legislation,
• tax laws, and
• lobbying activities can affect firms
significantly.
 Cont…
• The increasing global interdependence among
economies, markets, governments, and
organizations makes it imperative that firms
consider the possible impact of political variables
on the formulation and implementation of
competitive strategies.
• For industries and firms that depend heavily on
government contracts or subsidies, political
forecasts can be the most important part of an
external audit
 Cont…
• Forces are that should gathered information for
best utilizing the opportunities and to best
defend the threats are Government regulations
or deregulations, Changes in tax laws, Special
tariffs, Political instability, and location of
government Protests, Number of patents,
Changes in patent laws, Level of defense
expenditures, Legislation on equal employment,
Level of government subsidies, Antitrust
legislation.
 Economic Forces

• Increasing numbers of two-income households is an

economic trend in the world.
• Individuals place a premium on time.
• Improved customer service, immediate availability, trouble-
free operation of products and dependable maintenance
and repair services are becoming more important.
• People today are more willing than ever to pay for good
service if it limits inconvenience.
• E.g. Purchasing power, rate of growth of the economy,
unemployment rate, recession, Interest rate, Availability of
credit, Level of disposable income, Inflation rates, Gross
domestic product, Monetary policies, Fiscal policies, Tax
rates and etc
 Cont…
• Economic factors have a direct impact on the
potential attractiveness of various strategies.
• For example, when interest rates rise, funds
needed for capital expansion become hard to get
so it limits us our expansion strategy.
• When interest rates rise, discretionary income
declines, and the demand for discretionary goods
falls.
• When the value of the birr falls, tourism-oriented
firms benefit because foreigners visit and vacation
more in the Ethiopia.
 Social-Cultural, Demographic, and Natural Environment Forces

• The socio- cultural aspect of environment is

probably the most difficult to understand,
quantify and predict, dealing as it does with
people and human behavior.
• The socio-cultural is composed of the beliefs,
attitudes, values, desires, expectations, degrees
of intelligence and education, customs, opinions,
life styles of people in the society, traditions,
class structure and social group pressure, social
institutions.
 Cont….
• The values and attitudes of customers and
employees can affect the strategy of
organizations.
• Social, cultural, demographic, and environmental
changes have a major impact on virtually all
products, services, markets, and customers.
• Small, large, for-profit, and nonprofit
organizations in all industries are being staggered
and challenged by the opportunities and threats.
 Cont…
• E.g. value placed on leisure time, • population changes by
• Attitudes toward business,
• Lifestyles,
city, county, state, region,
• Attitudes toward government, and country, Average
• Attitudes toward work, Buying habits, level of education,
• Ethical concerns,
• Attitudes toward saving, Sex roles,
• no. of births/deaths,
• Attitudes toward investing, • Life expectancy rates,
• Regional changes in tastes and
preferences,
• waste mgt, recycling,
• Number of women and minority • air pollution,
workers,
• Attitudes toward product quality, • ozone depletion,
• Attitudes toward customer service, • endangered species,
Number of churches/mosques & their
members size
 Technological Forces
• Total Federal Spending for R&D
• Total Industry Spending for R&D
• Focus of Technological Efforts
• Patent Protection
• Wireless Communications
• Nanotechnology
• Productivity Improvements
 Technological Forces

• Technological advancements can dramatically affect

organizations’ products, services, markets, suppliers,
distributors, competitors, customers, manufacturing
processes, marketing practices, and competitive position.
• Technological advancements can create new markets, result
in a proliferation/spread of new and improved products,
change the relative competitive cost positions in an
industry, and render existing products and services
obsolete.
• Technological changes can reduce or eliminate cost barriers
between businesses, create shorter production runs, create
shortages in technical skills, and result in changing values
and expectations of employees, managers, and customers.
 Cont…
• Technological advancements can create new 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.
• Technological changes are rapid and to keep pace with it,
businessmen need to be alert and flexible in order to quickly
incorporate them in their business organization so as to
survive and succeed in the competitive business world.
 Cont…
• 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,
and competitors.
•
 Cont….
• Technological forces represent major opportunities and threats
that must be considered in formulating strategies. Technological
advancements can dramatically affect organizations’ products,
services, markets, suppliers, distributors, competitors,
customers, manufacturing processes, marketing practices, and
competitive position.
• Technological advancements can create new markets, result in a
proliferation of new and improved products, change the relative
competitive cost positions in an industry, and render existing
products and services obsolete.
• Technological changes can reduce or eliminate cost barriers
between businesses, create shorter production runs, create
shortages in technical skills, and result in changing values and
expectations of employees, managers, and customers.
 Cont…
• Technological advancements can create new competitive advantages that are
more powerful than existing advantages.
• 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.
• Firms should pursue strategies that take advantage of technological
opportunities to achieve sustainable, competitive advantages in the marketplace.
• Not all sectors of the economy are affected equally by technological
developments. The communications, electronics, aeronautics, and
pharmaceutical industries are much more volatile than the textile, forestry, and
metals industries.
• Example
• Airlines—many airlines now offer wireless technology in flight.
• Automotive—Vehicles are becoming wireless.
• Banking—Visa sends text message alerts after unusual transactions.
• Education—Many secondary (and even college) students may use smart phones
to get materials.
 Competitive Forces

• An important part of an external audit is identifying

rival firms and determining their strengths,
weaknesses, capabilities, opportunities, threats,
objectives, and strategies.
• Competitive intelligence 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.
• successful CI program include flexibility, usefulness,
timeliness, and cross-functional cooperation.
 Cont…
• The three basic objectives of a CI program are
(1) to provide a general understanding of an industry and its
competitors,
(2) to identify areas in which competitors are vulnerable and to
assess the impact strategic actions would have on competitors,
and
(3) to identify potential moves that a competitor might make that
would endanger a firm’s position in the market.
• Competitive information is equally applicable for strategy
formulation, implementation, and evaluation decisions.

• Sources include trade journals, newspaper articles, and

government filings, as well as customers, suppliers, distributors,
competitors, and the Internet.
 Industry Analysis
• Industry is a collection of firms offering goods or
services that are close substitutes of each other. An
Industry consists of firms that directly compete with
each other.
• Porter’s Five-Forces Model
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
 Conditions That Cause High Rivalry among Competing Firms

• High number of competing firms • When fixed costs are high

• Similar size of firms competing among firms competing
• Similar capability of firms • When the product is perishable
competing • When rivals have excess
• Falling demand for the capacity
industry’s products • When consumer demand is
• Falling product/service prices in falling
the industry • When rivals have excess
• When consumers can switch inventory
brands easily • When rivals sell similar
• When barriers to leaving the products/services
market are high • When mergers are common in
• When barriers to entering the the industry
market are low
 Potential Entry of New Competitors

• Whenever new firms can easily enter a particular

industry, the intensity of competitiveness among firms
increases.
• Barriers to entry include the need to gain economies of
scale quickly, the need to gain technology and
specialized know-how, 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.
Potential Development of Substitute Products
• Substitute products are those products that appear
to be different but can satisfy the same need as
another product. For example bottled water is
substitute for a cola and tea for coffee and
aluminum is a substitute for steel in automobiles;
trains are a substitute for cars; films and theatre
are substitutes for each other.
• 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
materials is especially costly.
 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. 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.
 Cont…
• 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
 The External Factor Evaluation (EFE) Matrix

• Has five steps:

• 1. List key external factors as identified in the external-audit process.
Include a total of 15 to 20 factors, including both opportunities and
threats that affect the firm and its industry. List the opportunities first
and then the threats. Be as specific as possible, using percentages,
ratios, and comparative numbers whenever possible.
• 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 than 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 1.0.
 Cont…
• 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 a 1, 2, 3, or 4.
• 4. Multiply each factor’s 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.
Key External Factors Weight Rating Weighted Score

Opportunities
1 Rowan County is growing 8% annually in population 0.05 3 0.15
2 TDB University is expanding 6% annually 0.08 4 0.32
3 Major competitor across town recently ceased operations 0.08 3 0.24
4 Demand for going to cinema growing 10% annually 0.07 2 0.14
5 Two new neighborhoods being developed within 3 miles 0.09 1 0.09

6 Disposable income among citizens grew 5% in prior year 0.06 3 0.18

7 Unemployment rate in county declined to 3.1% 0.03 2 0.06
Threats
8 Trend toward healthy eating eroding concession sales 0.12 4 0.48
9 Demand for online movies and DVDs growing 10% annually 0.06 2 0.12

10 Commercial property adjacent to cinemas for sale 0.06 3 0.18

11 TDB University installing an on-campus movie theatre 0.04 3 0.12
12 County and city property taxes increasing 25% this year 0.08 2 0.16
13 Local religious groups object to R-rated movies being shown 0.04 3 0.12

14 Movies rented from local Blockbuster store up 12% 0.08 2 0.16

15 Movies rented last quarter from Time Warner up 15% 0.06 1 0.06
Total 1.00 2.58
 Cont…
• An example of an EFE Matrix is provided in the above Table for American’s
ten-theatre cinema complex. Note 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 a 1, 2, 3, or 4 anywhere down the Rating column. 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 nearby”
opportunity and the “movies rented from Time Warner” threat.
 Competitive Profile Matrix (CPM)

• 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 and external issues; therefore, the
ratings refer to strengths and weaknesses, where
4 = major strength, 3 = minor strength, 2 = minor
weakness, and 1 = major weakness.
• In a CPM, the ratings and total weighted scores
for rival firms can be compared to the sample
firm. This comparative analysis provides
important internal strategic information.
 Cont…
Company 1 Company 2 Company 3
Critical Success Weight Rating Weighted Rating Weighted Rating Weighted
Factors Score Score Score
Market share 0.15 3 0.45 2 0.30 4 0.60
Inventory system 0.08 2 0.16 2 0.16 4 0.32
Financial position 0.10 2 0.20 3 0.30 4 0.40
Product quality 0.08 3 0.24 4 0.32 3 0.24
Consumer loyalty 0.02 3 0.06 3 0.06 4 0.08
Sales distribution 0.10 3 0.30 2 0.20 3 0.30
Global expansion 0.15 3 0.45 2 0.30 4 0.60
Organization structure 0.05 3 0.15 4 0.20 2 0.10
Production capacity 0.04 3 0.12 2 0.08 4 0.16
E-commerce 0.10 3 0.30 1 0.20 4 0.40
Customer service 0.10 3 0.30 2 0.20 4 0.40
Price competitive 0.02 4 0.08 1 0.02 3 0.06
Management experience 0.01 2 0.02 4 0.04 2 0.02
Total 1.00 2.83 2.28 3.68