CHAPTER 3: EXTERNAL ENVIRONMENT

ANALYSIS
Chapter Objectives
Up on completion of this unit, the learner is expected
to:
 Identify the nature of external audit
 List the Sources of external information
 Analysis of key external factors
– General external factors
– Industry analysis
– Competitive analysis:
 Identify Forecasting tools and techniques

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 3.1. INTRODUCTION
• Environmental scanning is the monitoring, evaluation,
and dissemination of information from the external
and internal environments to key people within the
corporation
• External environment impact on the organization
accounted as opportunities or threats to the
organization.
• Opportunities arise when an organization can take
advantage
• threats arise when conditions in the external
environment endanger the integrity of the
organization's activities.

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 3.2 THE NATURE OF EXTERNAL AUDIT
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
 an aging society,
 information technology, and
 the computer revolution
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.
As the term finite suggests, the external audit 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.
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 Conti…

• The typical process of external environment

analysis includes four activities:
• Scanning - identifying early signals of external
environment changes and trends
• Monitoring - detecting meaning through ongoing
observations of external environmental changes
and trends.
• Forecasting - developing projections of anticipated
outcomes based on monitored changes and trends
• Assessing - determining the importance of macro
environmental changes and trends for the
organization's strategic plans.
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 3.3 ANALYSIS OF KEY EXTERNAL FACTORS
• The external analysis is the first stage of the
auditing process.
• It creates the information and analysis necessary
for an organization to begin to identify the key
issues it will need to address in order to develop
a successful strategy.
• The chapter explores the process of PEST
analysis, industry analysis, and competitor
analysis.

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A. General External environment factors

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 1. Economic Forces
• Economic factors have a direct impact on the potential
attractiveness of various strategies.
• For example, as interest rates rise, then funds needed for
capital expansion become more costly or unavailable.
• Also, as interest rates rise, discretionary income declines,
and the demand for discretionary /optional goods falls.
• As stock prices increase, the desirability of equity as a
source of capital for market development increases.
• Also, as the market rises, consumer and business wealth
expands. Price fluctuation refers to general price
fluctuation.
• They affect the economic factors and affect the customers
buying behaviors.
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 Economic Forces

• The customers are more conscious about the economic

changes and responds according to the changes in key
variable factors.
• So, any change in the price affects the customer buying
trend directly.
• Monetary policies and Fiscal policies are changed
every year. \
• The person or businesses engaged in business for profit
making or nonprofit organizations always have to keep
an eye on the economic structure of the countries.
• As far as the tax rates are concerned, government also
changes the tax rate with the passage of time.
• So it affects the economic forces.
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 Economic Forces
• It is important to monitor key economic factors
such as:
• Foreign countries’ economic conditions
• Import/export factors
• Demand shifts for goods/services
• Income differences by region/customer
• Price fluctuations
• Exportation of labor & capital
• Monetary policies
• Fiscal policies
• Tax rates etc. 9
 2. Social, Cultural, Demographic, and Environmental Forces

• Social, cultural, demographic, and environmental

changes have a major impact upon virtually all
products (Preferences change), services, markets, and
customers.
• Small, large, for-profit, and nonprofit organizations in
all industries are being staggered and challenged by
the opportunities and threats arising from changes in
social, cultural, demographic, and environmental
variables.
• We may use the following analysis in understanding
the Social, Cultural, Demographic, and Environmental
Forces:
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 Social, Cultural, Demographic, and Environmental Forces
 Population growing older
 Increase in younger population
 Ethnic balance changing
 Gap between rich and poor widening
• Ethnic balance changes due to the migration of the people
from different areas to different areas.
• As the traditions and norms are very much different in
different areas, therefore the behavior of the migrated people
also have a major affect on the behavior of the resident
people.
• Due to the increased gap between rich and the poor, there is
a tremendous change in the social behavior of the people
• Particularly in industries such as healthcare, retail,
education, and social services. 11
 3. Political, Governmental, and Legal Forces
• Change in government regulations which create
opportunities and threats.
• For example, antitrust legislation where there is an effort to
ban/prohibit the monopolies.
• Some organizations think that monopolies should be
banned.
• Similarly, tax rates and lobbying efforts for special,
lobbying entries are those efforts which are made in order
to pass special resolution laws of their own choice.
• Patents law and intellectual are also relates to the same
stories.
• Federal, state, local, and foreign governments are major
regulators, deregulators, subsidizers, employers, and
customers of organizations. 12
 Political, Governmental, and Legal Forces
• Changes in patent laws, antitrust legislation, tax
rates, and lobbying activities can affect firms
significantly.
• Impact of political variables on government
regulations:
 Government regulation/deregulation
 Tax law changes
 Special tariffs
 Political Action Committees (PACs)
 Voter participation rates
 Number of patents
 Changes in patent laws 13
 Technological forces
• Technological advancements dramatically can affect
organizations' products, services, markets, suppliers,
distributors, competitors, customers, manufacturing
processes, marketing practices, and competitive
position.
• 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. 14
B. Porter’s 5 Forces Model(industry Analysis)
• Industry analysis is a process of reviewing the profitability
of an industry at the moment and in the future to explain
why one industry is very profitable and why another
industry has much lower profit
• Industry analysis helps to answer the following questions
of business strategy:
– Is this industry a source of superior profits?" - for
potential investors
– How can we make sure that we perform better than our
competitors? “ -for actual investors
• To determine the intensity/power of competition and the
level of profitability in an industry Porter’s five forces of
competition framework applied; the five forces of
competition are: 15
16
The Threat of The Entry of New Competitors
• The threat of entry depends on the presence of entry
barriers and the reaction that can be expected from
existing competitors.
• An entry barrier is an obstruction that makes it difficult
for a company to enter an industry. Some of the
possible barriers to entry are:
• Economies of scale
• Product differentiation
• Capital requirements: e.g. Boeing and Airbus.
• Switching costs: Once a software program such as
Excel or Word becomes established in an office, office
managers are very reluctant to switch to a new program
because of the high training costs.
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The Threat of The Entry of New Competitors
• Access to distribution channels
• Government policy: Governments can limit entry into
an industry through licensing requirements by
restricting access to raw materials
• The easier the barriers for new companies to enter or
difficult to exit, the more competition there will be in
the industry.
• The principal sources of barriers to entry are capital
requirements, economies of scale, cost advantages,
product differentiation, and access to channels of
distribution, governmental and legal barriers, and
retaliation, while to exit are specialized assets, high
exit costs, interrelated businesses, etc.
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The Threat of The Entry of New Competitors
• Absolute cost advantages refers to the ability of a
business to produce more, sell more of a good or
service than competitors, using the same amount of
resources.
• Barriers to entry arise from several sources:
1. Government creates barriers
2. Patents and proprietary knowledge serve to restrict
entry into an industry.
3. Asset specificity inhibits entry into an industry.
4. Organizational (Internal) Economies of Scale.

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B. The bargaining power of suppliers

• Suppliers can affect an industry through their ability to

raise prices or reduce the quality of purchased goods and
services.
• Suppliers to the company can be a source of power over
the firm when:
 There are very few suppliers of a particular product or
service,
 there are no substitutes,
 switching to another (competitive) product are very costly,
 The product is extremely important to buyers - can't do
without it, and
 The supplying industry has a higher profitability than the
buying industry.
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cont…

The pressure suppliers can place on a particular

business can be limited if;
There is many competitive suppliers - (tire
industry relationship to automobile
manufacturers),
backward integration threat by purchasers (timber
producers relationship to paper companies),
concentrated purchasers (garment industry
relationship to major department stores), and
customers weak (travel agents' relationship to
airlines)
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 C. The bargaining power of buyers
• Buyers affect an industry through their ability to force
down prices, bargain for higher quality or more
services, and play competitors against each other.
• Some of the reasons enable buyers to have a large
enough impact to affect a company's margins and
volumes are:
Size and concentration of buyers relative to
suppliers –
Buyers purchase a significant proportion of
output
Buyers possess a credible backward integration
Buyer Information
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 Cont..
While, buyers’ pressure can be weak if:
– Producers threaten forward integration - producer
can take over own distribution/retailing
– High buyer switching costs -products not
standardized and buyer cannot easily switch to
another product
– Buyers are fragmented (many, different)
– Producers supply critical portions of buyers' input
– distribution of purchases (Intel's relationship with
PC manufacturers)

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 D. The threat of substitute products or services
• In Porter's model, substitute products refer to
products in other industries.
• To the economist, a threat of substitutes exists when
a product's demand is affected by the price change
of a substitute product.
• A product's price elasticity is affected by substitute
products - as more substitutes become available, the
demand becomes more elastic since customers have
more alternatives.
• A close substitute product constrains the ability of
firms in an industry to raise prices. Eg. TV, Beer, Soft-
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drink …..etc
 Cont.
• The price customers are willing to pay for a product
depends, in part, on the availability of substitute products,
products in other industries.
• Thus, the absence of close substitutes for a product
means that consumers are comparatively insensitive to
price - demand is inelastic with respect to price.
• The existence of close substitutes means that customers
will switch to substitutes in response to price increases for
the product (i.e., demand is elastic with respect to price).
• However, the extent to which substitutes limit prices and
profits depends on; the propensity of buyers to substitute
between alternatives and relative price/performance
relationship of substitutes.
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 E. Rivalry among Existing Firms
• Industry competitiveness can take the form of price
wars, advertising campaigns, new product introductions,
or expanded service offerings.
• The intensity of competition tends to increase when an
industry is characterized by
a number of well-balanced competitors and
concentration,
a slow rate of industry growth (firms are able to
improve revenues simply because of fight for
market share),
 fixed costs conditions (scale economies and the
ratio of fixed to variable costs),
a lack of differentiation between products . 26
 Cont.
• competition among rival/opposing firms
drives profits to zero.
• The intensity of rivalry among firms
varies across industries, and strategic
analysts are interested in these differences.
• Economists measure rivalry by indicators
of industry concentration.
• The Concentration Ratio indicates the
percent of market share held
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 The intensity of rivalry is influenced by

1. A larger number of firms increase rivalry because

more firms must compete for the same customers and
resources.
• The rivalry intensifies if the firms have similar market
share, leading to a struggle for market leadership.
2. Slow market growth causes firms to fight for market
share.
3. High fixed costs result in an economy of scale effect
that increases rivalry.
4. High storage costs or highly perishable products
cause a producer to sell goods as soon as possible
5. Low levels of product differentiation are associated
with higher levels of rivalry. 28
 Conti…

6. Low switching costs increases rivalry.

• When a customer can freely switch from one product
to another there is a greater struggle to capture
customers.
7. Strategic stakes are high when a firm is losing
market position or has potential for great gains.
• This intensifies rivalry.
8. High exit barriers cause a firm to remain in an
industry, even when the venture is not profitable.
9. A diversity of rivals with different cultures, histories,
and philosophies make an industry unstable.
Rivalry is volatile due to race, religious, local language,
charitable institutions, cooperative with one another and
so on. 29
 B. Competitor Analysis

•In formulating business strategy, managers must

consider the strategies of the firm's competitors.
•While in highly fragmented commodity industries
the moves of any single competitor may be less
important, in concentrated industries competitor
analysis becomes a vital part of strategic planning.
•We have the following steps
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 Steps of Competitive Analysis

The following provides a step-by-step process in

creating your competitive analysis.
• 1) Identify your competitors:
• Determine both local and international
competitors.
• Be sure to define the competitive landscape
broadly.
• Your competitor includes anything that could
draw customers away from your business.
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2) Gather information about competitors:
• At this stage you need to know:
What markets or market segments your
competitors serve;
What benefits your competitors offer;
Why customers buy from them;
And as much as possible about their products
and/or services, pricing, and promotion
strategies.
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 3. Gathering Information on Competitors

Using which you can learn about:

• promotion strategies by visiting their
business site
• Prices.
• your competitors’ customers
• Vendors or suppliers, and their employees.
• trade shows
• Publicly available information - from
Newspapers, magazines, press releases and
online publications. 33
 4. Analyzing the Competition
• After studying the information you have gathered
about each of your competitors, ask yourself these
primary questions:
• How are you going to compete with that company?
• By identifying market niche (a small segment
market).
• Is there a particular segment of the market that
your competitors has overlooked?
• Is there a service that customers or clients want
that your competitors do not supply?
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 5. Develop a pricing
• The last step in the process is to develop
a pricing model that represents what you
are offering the market and the value
you bring to your target buyers.
• By considering cost of production, cover
overhead, profit you think, and
marketing costs

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 3.4 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, and
speech at professionals and shareholders’ meetings, Television programs,
interviews, and conversations and stakeholders.
•Published sources of strategic information include periodicals, journals,
reports, government documents, abstracts, books, directories, newspapers
and manual.
•The Internet provides another source for gathering strategic information,
as do corporate, university, and public libraries.
•Suppliers, distributors, salespersons, customers, and competitors represent
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 3.5 Forecasting tools and techniques
•Forecasting is a complex activity because of factors such as
technological innovation, cultural changes, new products,
improved services, stronger competitors, and shifts in
government priorities, social values, unstable economic
conditions, and unforeseen events.
•Managers often must rely upon published forecasts to identify
key external opportunities and threats effectively.
•Forecasting tools can be broadly categorized in to two groups:
1. Quantitative techniques and
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 Qualitative techniques
• Qualitative forecasting technique is a technique
that is used when there is no historical data
available about past performance.
• These forecasting techniques are subjective and
judgmental in nature and most of the time they
are based on opinion and expertise judgment.
• Qualitative forecasting techniques rely on analysis
of subjective inputs obtained from customers,
sales Person, managers and experts.

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 The method are appropriate when:

1. Forecasts must be prepared quickly in a short

period of time.
2. Up to date information might not be available
because of rapid and continuous changes in the
external environment such as economic and
political conditions.
3. Historical data cannot be available like demand
for a newly introduced product, and
4. The forecasting period is long range that past
events will not repeat themselves in a similar
fashion. 39
 .
Types Of Qualitative Forecasting Techniques
• Expert opinion method
• Sales opinion
• Consumer surveys
• Delphi technique
1. Expert Opinion methods
One of the most simple and widely used method of
forecasting which consists of collecting opinions and
judgments of individuals who are expected to have the
best knowledge of current activities or future plans.

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 2. Sales force Opinions

• In this method, the sales representatives are required

to estimate the demand for each product and the
forecast of each sales representative is consolidated to
prepare the overall forecast for the company.
• This forecasting technique has also its own advantages
and disadvantages
3. Consumer Surveys
• This forecasting technique is based on the data which is
collected from the consumers.
• Because it is the consumers who ultimately determine
demand, it seems important to solicit/seek information
from them.
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 Delphi Method

• It involves the development, distribution,

collection and analysis of series of
questionnaires to get the views of expertise
that are located at different geographic areas
to generate the forecast.
• A moderator/mediator collect results and
formulates a new questionnaire that is again
submitted to the same group of experts.
• The goal is to achieve a consensus forecast.
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 Quantitative Forecasting Techniques
• Quantitative techniques consist of mainly
analyzing objective or hard data.
• This usually avoids personnel biases that
sometimes contaminate qualitative methods.
• It is based on actual historical statistical
data using mathematical and statistical
methods to forecast demand.
• Thus, it is objective and is also called
statistical forecasting. 43
 Types of quantitative forecasting
techniques
• There are two types of quantitative
forecasting techniques:
• Time Series Analysis
• Causal Methods

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 Time Series Analysis

• A time series is a set of some variable (demand)

overtime (e.g. hourly, daily, weekly, quarterly
annually).
• Time series analyses are based on time and do not
take specific account of outside or related factors.
• Time series analysis is a time-ordered series of
values of some variables.
• The variables value in any specific time period is a
function of four factors:
a) Trend c) Cycles
b) Seasonality d) Randomness 45
 Conti…
Trend – is a general pattern of
change overtime. It represents a
long time secular movement,
characteristic of many economic
series.
Seasonality- refers to any regular
pattern recurring with in a time
period of no more than one year.
These effects are often related to
seasons of the year. 46
 Conti…
• Example:
• Weather variations – sales of winter and
summer
• Vacations or holidays – air line travel,
greeting card, visitors at tourists and resort
centers.
• Theaters/play demand on weekends
• Daily variations: banks may over crowded
during the afternoon.
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 Conti…

• Cycle – are long-term swings about

the trend line and are usually
associated with a business cycle
(phases of growth and decline in a
business cycle).
• Randomness – are sporadic/irregular
effects due to chance and unusual
occurrences
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•End
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