CHAPTER 2: THE EXTERNAL

ASSESSMENT

W2 Part 2: Strategy Formulation

Chapter Objectives
1. Describe how to conduct an external audit
2. Discuss five broad external forces that affect
organizations
3. Discuss Porters Five-Forces Model
4. Sources of External Information
5. Forecasting Tools & Techniques
6. Discuss the application of EFE & CPM
The Nature of an External Audit
External Audit to develop a finite list of
opportunities that could benefit a firm and threats
that should be avoided.
Firms should be able to respond to the factors by
formulating strategies that take
i. Advantage of external opportunities or
ii. That minimize the impact of potential threats.
Key External Forces
External forces can be divided into 5 broad
categories:
Political,
governmental
Social, culture, and legal forces
demographic Technological
and forces
environmental
forces

Economic forces
External Competitive
Forces forces
Relationship Between Key external Forces and an
Organization

Competitors
Suppliers
Distributors
Creditors
Economic forces Customers
Employees
Social, culture,
demographic and Communities
environmental forces Managers ORGANIZATIONS
Political, Stockholders OPPORTUNITIES &
governmental and Labor Unions THREAT
legal forces
Governments
Technological forces
Trade associations
Competitive forces SIG
Products
Services
Markets
Natural environment
Key External Forces
Changes in external forces:
Translate into changes in consumer demand for both
industrial and consumer products and services.
Affect:
The type of products developed
Market segmentation strategies
Type of services offered
Choice of businesses to acquire or sell

Also affect suppliers & distributors

Key External Forces
Identifying and evaluating external opportunities &
threats:
Enables firm to develop clearer mission,
To design strategies to achieve long-term objectives and

To develop policies to achieve annual objectives.

The Process of Performing an External
Audit
Must involve as many managers & employees as
possible.
Involvement leads to understanding & commitment from
the organization members.
Individuals appreciate the opportunity to contribute
ideas and gain better understanding on firms industry,
competitors and market.
 The Process of Performing an External
Audit
Stage 1: Information Gathering
Company gather information:
Economic, social, culture, demographic, environmental, political, Other information
governmental, legal and technological trends. sources: Internet,
libraries (corporate,
universities & public),
Individuals can be asked to monitor these suppliers, salesperson,
customers & competitors.
information from various source:
Magazines, trade journals & newspapers.

These persons can submit periodic report to a

committee of managers in charged with
performing external audit.

This approach provide continuous stream of

timely strategic information & involved many
individuals.
 The Process of Performing an External
Audit
Stage 2: Evaluating Information

Conducting meetings with managers to

identify the most important opportunities and
threats facing the firm.

Other influencing
variables market
Obtaining a prioritized list of these factors. share, price
competitiveness,
Managers to rank from 1 to 20 (for most important to technology
least important opportunity/threat).
advancements,
population shifts,
interest rates.

These key external factors can vary over

time and by industry. Relationship with
suppliers are often critical success factor.
The Process of Performing an External
Audit
Key external factors should be:
1. Important to achieving long-term and annual
objectives
2. Measurable
3. Applicable to all competing firms
4. Hierarchical in the sense that some will pertain to the
overall company and others will be more narrowly
focused on functional or divisional areas
Key External Forces
External forces can be divided into 5 broad
categories:
Political,
governmental
Social, culture, and legal forces
demographic Technological
and forces
environmental
forces

Economic forces
External Competitive
Forces forces
Economic Forces
Economic factors have direct impact on the potential
attractiveness of various strategies:
When interest rates rise, funds needed for capital
expansion become more costly or unavailable.
When market rises, consumer and business wealth
expends.
Economic Forces

Key Economic Variables to be Monitored

Availability of credit
Level of disposal income
Propensity of people to spend
Interest rates
Inflation rates
Income differences by region and
consumer groups
Unemployment trends
Worker productivity levels
Stock market trends
Foreign countries economic conditions
Import/Export factors
Demand shifts for different categories of
goods and services

Federal government budget deficits Money market rates

GDP trends Price fluctuations
Consumption patterns Tax rates
Social, culture, demographic and
environmental forces
Have major impact on all products, services, markets
and customers.
Small, large, for-profit and nonprofit organization in
all industries are being challenged by the
opportunities & threats of these forces.
These forces are shaping the way people live, work,
produce and consume.
New trends creating different type of consumer and also
the need for different products, services & strategies.
Social, culture, demographic and
environmental forces
Key Social, Culture, Demographic and Environmental Variables
Childbearing rates, Number of births,
Number of deaths
Number of marriages and divorces
Immigration and emigration rates
Life expectancy rates
Per capita income
Attitude towards retirement
Attitude towards product quality,
customer service, foreign people.
Population changes
Waste management, pollution
Location of retailing, manufacturing and
service businesses
Attitude towards business
Lifestyle, Buying habit
Traffic congestion
Trust in government
Attitude towards work
Social responsibility
Average level of education
Government regulation
Political, governmental and legal forces

Federal, state, local and foreign government are

major regulators, deregulators, subsidizers, employers
and customers of organizations.
For industries & firms that depend on government
contracts and subsidies:
Political forecast can be the most important part in
external audit
Political, governmental and legal forces
Political, Governmental and Legal Variables
Government regulations or deregulations
Changes in tax laws
Political action committees
Voter participation rates
Environmental protection laws
Level of government subsidies
Legislation on equal employment
Government fiscal and monetary policy
change
Political conditions in foreign countries
Special local, state and federal laws
Lobbying activities
Size of government budgets
World oil, currency and labor markets
Local, state and national elections
Technological forces
Technological changes and discoveries are having
dramatic impact on organizations.
The Internet impact:
Altering life-cycle of the products
Increasing the speed of distribution

Creating new product and services

Erasing limitation of traditional geographic markets

Technological forces
Technological advancement affect organization:
Product,Service, Market, Suppliers, Distributors,
Competitors, Customers, manufacturing processes,
marketing practices and competitive position.
Create new and improved products.

Not all sectors are affected by technological

development textile, forestry, metal industries.
Competitive forces
Important to identifying rival firms and determining
their strength, weakness, opportunities, threat,
objectives and strategies.
Identifying major competitors is difficult as many firms
have divisions that compete in different industries.
Most firms do not provide information on sales, profit,
financial and marketing for competitiveness reason.
However, there is always the power of Internet
Competitive forces
Porters Five-Forces Model
A widely used approach for developing strategies in
many industries.
The nature of competitiveness in a given industry
consist of 5 forces:
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
Competitive forces
By using Porters model, there are 3 steps to reveal if
the firm can make acceptable profit in a competitive
industry:

Identify key aspects or Decide whether the

elements of each Evaluate how strong and collective strength of the
competitive force that important each element is elements is worth the firm
impact the firm. for the firm. entering or staying in the
industry.
 Porters Five-Forces Model

Potential
development
of substitute
products

Bargaining Rivalry among Bargaining

power of competing power of
suppliers firms consumers

Potential
entry of new
competitors
Competitive forces
1. Rivalry among competing firms
The most powerful of the 5 competitive forces.
Changes in strategy by one firm may be met with
countermoves:
i. Lowering price
ii. Enhancing quality
iii. Adding features
iv. Providing services
v. Extending warranties
vi. Increasing advertising
Competitive forces
1. Rivalry among competing firms
The intensity of rivalry among competing firms tends
to increase as:
1. The number of competitors increases
2. Competitors become more equal in size and
capability
3. Demand for the industrys products declines
4. Price cutting becomes common
5. Consumers can switch brands easily
6. Products sold are commodities (not easily
differentiated gasoline)
Competitive forces
2. Potential entry of new competitors
When new firms can enter easily to a particular industry,
the intensity of competitiveness among firm increases.
Barriers to entry:

The need to gain EOS quickly Lack of adequate distribution channels

The need to gain technology and
specialized knowledge
The lack of experience
Strong customer loyalty
Strong brand preferences
Large capital requirements
Government regulatory policies
Lack of access to raw materials
Undesirable location
Counter attack from competitors
Possession of patents
Competitive forces
2. Potential entry of new competitors
Despite barriers, new firm usually is equip with:
1. High-quality products
2. Lower prices
3. Substantial marketing resources
It is the job of the strategist to identify potential new
firms entering the market, monitor their strategies to
counter attack and strengthen existing strength and
opportunities.
Competitive forces
3. Potential development of substitute products
In many industries, firms are in close competition with
producers of substitute products in other industries.
Plastic container producers competing with glass,
paperboard and aluminum can producers.
Producers of eyeglasses and contact lenses VS laser eye
surgery
The presents of substitute products puts a celling price
that can be charged before consumers will switch to
substitute products.
Competitive forces
4. Bargaining power of suppliers
Occur when:
1. There is a large number of suppliers or
2. There are only a few good substitute raw materials
or
3. The cost of switching raw materials is costly.
It is best if both suppliers & producers assists each
other with:
Reasonable prices, improved quality, development of new
services, JIT deliveries, reduce inventory cost = Enhance long
term profitability of both parties
Competitive forces
5. Bargaining power of consumers
When customers are concentrated or large or buy in
volume.
Rival firms may offer extended warranties or special
service to gain customer loyalty when customers
bargaining power is strong.
Bargaining power is higher if the purchased products
are standard or undifferentiated.
Competitive forces
5. Bargaining power of consumers
Customers can negotiate price, warranty coverage
and accessory packages.
Consumers gain increasing bargaining power if:
1. They can inexpensively switch to competing brands and substitutes.

2. If they are particularly important to the seller.

3. If seller are struggling with failing consumer demand.

4. They are informed about sellers products, prices and costs.

5. They have the freedom in whether to purchase the product or not.

Sources of External Information
Sources available:
1. Published Sources
Journals, reports, government documents, abstracts, books,
directories, newspapers and manuals.
2. Unpublished Sources
Customer surveys, market research, speeches at
professional or shareholders meetings, television
programs, interviews and conversation with stakeholders.
Internet
Wide range of information from around the world.
Can even interact with the person who create the information.
Forecasting Tools & Techniques
Forecasts are educated assumptions about future
trends and events.
Forecasting is complex as (these are unforeseen
events):
Technologicalinnovation,
Culture changes,

New products,

Improved services,

Stronger competitors,

Unstable economic condition

Forecasting Tools & Techniques
Managers often rely on published forecasts to identify
key external opportunities & threat.
Sometimes firms need to develop their own projections.
Most firms forecast their own revenues and profits
annually.
Some firm forecast market share & customer loyalty.

In order to produce a reliable forecast, selection of

forecasting tools to use is important.
Forecasting Tools & Techniques
Forecasting Tools:
1. Quantitative Techniques
Uses historical data & assume the relationship between
variables will remain the same in future.
No forecast is perfect Depend on the strategists effort
to study historical trend.
2. Qualitative Techniques
Group Activity
Identify 2 industries experiencing rapid
technological changes and 3 industries that are
experiencing little technological change.
Use Porters Five-Forces Model to evaluate
competitiveness within a chosen industry.
Industry Analysis: The External Factor
Evaluation (EFE) Matrix
EFE Matrix allows strategists to summarize and
evaluate key external forces.
EFE Matrix can be developed in five steps:
Industry Analysis: The External Factor
Evaluation (EFE) Matrix
STEP 1
List key external factors (as identified in the external-
audit process).
Include a total of 15-20 factors, (both opportunities
& 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.
Industry Analysis: The External Factor
Evaluation (EFE) Matrix
STEP 2
Assign each factor a weight that ranges from 0.0 (not
important) to 1.0 (very important).
Opportunities usually weights higher than threats.
Weights are 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.
Industry Analysis: The External Factor
Evaluation (EFE) Matrix
STEP 3
Assign a rating between 1 & 4 to each key external
factor to indicate how effectively the firms current
strategies respond to the factor:
a. 4 = the response is superior
b. 3 = the response is above average
c. 2 = the response is average
d. 1 = the response is poor
Ratings are based on effectiveness of the firms
strategies.
Industry Analysis: The External Factor
Evaluation (EFE) Matrix
STEP 3
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.
Industry Analysis: The External Factor
Evaluation (EFE) Matrix
STEP 4
Multiply each factors weight by its rating to
determine a weighted score.

STEP 5
Sum the weighted scores for each variable to
determine the total weighted score for the
organization.
Example of EFE Matrix
Industry Analysis: The External Factor
Evaluation (EFE) Matrix
Regardless of the number of key opportunities and
threats included in an EFE Matrix:
i. The highest total weighted score is 4.0
ii. The lowest total weighted score is 1.0.
iii. The average total weighted score is 2.5.
A total weighted score of 4.0 -
The firms strategies effectively A total score of 1.0
take advantage of existing The firms strategies are not
opportunities and minimize the capitalizing on opportunities
potential effects of external or avoiding external threats.
threats.
The Competitive Profile Matrix (CPM)

CPM identifies a firms major competitors and its

particular strengths and weaknesses in relation to a
sample firms strategic position.
The weights and total weighted scores in both a CPM
and an EFE have the same meaning.
However, critical success factors in CPM include both
internal and external issues.
The Competitive Profile Matrix (CPM)

Therefore, the ratings refer to strengths and

weaknesses:
i. 4 = major strength
ii. 3 = minor strength
iii. 2 = minor weakness
iv. 1 = major weakness
The critical success factors in a CPM are not grouped
into opportunities and threats as they are in an EFE.
The Competitive Profile Matrix (CPM)

In CPM, the ratings & total weighted scores for rival

firms can be compared to the sample firm.
This comparative analysis provides important internal
strategic information.
Example of CPM
Example of CPM
END