Strategic Management

Copyright 2005 Prentice Hall 1

Chapter 3
The External Assessment

"It is not the strongest of the species that survive,

nor the most intelligent, but the one most
responsive to change.“

—Charles Darwin

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The External Assessment
 An external audit reveals key opportunities and threats
confronting an organization so that managers can
formulate strategies to take advantage of the opportunities
and avoid or reduce the impact of threats.

 This chapter presents a practical framework for gathering,

assimilating, and analyzing external information.

 The Industrial Organization (I/O) view of strategic

management is introduced (we should focus on external
matters more)

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 External Strategic Management Audit

Identify & evaluate factors beyond the

control of a single firm
 Increased foreign competition
 Population shifts to and from a country
 Aging society (age more than 65 are more
in USA)
 Fear of traveling (through air/railway)
 Stock market volatility (constant fluctuations
may effect our company shares as well)
(impact on our company)

Ch 3 -5
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External Strategic
Management Audit

Purpose of an External Audit

 Develop a finite (limited) list of

 opportunities that could benefit a firm

and
 threats that should be avoided

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Techniques for conducting external
audit

– Environmental Scanning

– Industry Analysis

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 Key External Forces
 External forces can be divided into five broad
categories:
 (1) economic forces; (per capita income)
 (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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 The Process of Performing an
External Audit
 Process should involve as many managers and employees
as possible. (more employee more info)
 To perform an external audit, a company first must gather
competitive intelligence and information about economic,
social, cultural, demographic, environmental, political,
governmental, legal, and technological trends.
 Individuals (our employees) can be asked to monitor various
sources of information, such as key magazines, trade
journals, and newspapers. These persons can submit
periodic scanning reports to a committee of managers
charged with performing the external audit.

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 The Process of Performing
an External Audit
 Internet provides another source for gathering strategic
information, as do corporate university, and public libraries.
Suppliers, distributors, salespersons, customers, and
competitors
 Once information is gathered, it should be integrated and
evaluated. A meeting or series of meetings of managers is
needed to collectively identify the most important
opportunities and threats facing the firm.
 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.
Ch 3 -11
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 The Process of Performing
an External Audit
 A final list of the most important key external factors should
be communicated and distributed widely in the
organization. Both opportunities and threats can be key
external factors.

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The Industrial Organization (I/O) View
 The Industrial Organization (I/O) approach to competitive
advantage advocates that external (industry) factors are more
important than internal factors in a firm for achieving
competitive advantage.
 Competitive advantage according to I/O is determined largely
by competitive positioning within an industry
 So
1. you need to choose an attractive industry
2. You need to gain full understanding of key external factors
within that industry for getting competitive positioning
 Porter’s Five-Forces Model is an example of the I/O perspective, which
focuses on analyzing external forces and industry variables as a basis
for getting and keeping competitive advantage.
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 The Industrial Organization (I/O) View
 I/O theorists contend that 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.

 Firm’s performance, they argue, is primarily based more on industry

properties, such as economies of scale, barriers to market entry, product
differentiation (unique products), the economy, and level of
competitiveness than on internal resources, capabilities, structure, and
operations.

 The global economic recession’s impact on both strong and weak firms
has added credence to the notion that external forces are more
important than internal. Many thousands of internally strong firms in
2006–2007 disappeared in 2008–2009.

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 The Industrial Organization
(I/O) View
 The I/O view has enhanced our understanding of strategic
management.
 However, it is not a question of whether external or internal
factors are more important in gaining and maintaining
competitive advantage.
 Effective integration and understanding of both external and
internal factors is the key to securing and keeping a
competitive advantage.
 In fact, matching key external opportunities/threats with key
internal strengths/weaknesses provides the basis for
successful strategy formulation.
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Economic Forces
 Economic factors have a direct impact on the potential
attractiveness of various strategies.
 For example, when interest rates rise, funds become
more costly or unavailable
 Also, when interest rates rise, discretionary income
declines, and the demand for discretionary goods falls.
 When stock prices increase, the desirability of equity as
a source of capital for market development increases.

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Social, Cultural, Demographic, and
Natural Environmental Forces
 US Facts
 Aging population
 Widening gap between rich & poor
 2025 = 18.5% population > 65 years
 2075 = no ethnic or racial majority
 More American households with people
living alone
 Aging Americans – affects all

organizations
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Ch 3 -18
Political, Governmental, and
Legal Forces
Government Regulation

Key opportunities & threat

 Tax rates
 Lobbying activities

 Patent laws

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Political, Governmental, and
Legal Forces

 Protectionist policies

 Governments taking equity stakes

in companies

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Technological Forces

Major Impact –
•Internet
•Softwares
•E-products

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Competitive Forces

Collection & evaluation of data on

competitors is essential for successful
strategy formulation

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Competitive Forces
Identify Rival Firms’
•Strengths
•Weaknesses
•Capabilities
•Opportunities
•Threats
•Objectives
•Strategies

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Key Questions Concerning
Competitors
 Their strengths
 Their weaknesses
 Their objectives and strategies
 Their responses to external variables
 Their vulnerability to our alternative
strategies
 Our vulnerability to strategic counterattack

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Key Questions Concerning
Competitors
 Our product/service positioning
 Entry and exit of firms in the industry
 Key factors for our current position in industry
 Sales/profit ranking of competitors over time
 Nature of supplier and distributor
relationships
 The threat of substitute products/services

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Competitive Intelligence

 A systematic and ethical process for

gathering and analyzing information
about the competitor’s activities and
general business trends to further a
business’s own goals

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Sources of Competitive Intelligence

 Internet  Consultants
 Employees  Trade journals
 Managers  Want ads
 Suppliers  Newspaper articles
 Distributors  Government filings
 Customers  Competitors
 Creditors

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Objectives of Competitive
Intelligence
 Provide a general understanding of industry
and competitors
 Identify areas where competitors are
vulnerable and assess impact of actions of
competitors
 Identify potential moves that a competitor
might make

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The Five-Forces Model of Competition

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Steps to Determine if an Acceptable
Profit Can Be Earned
1. Identify key aspects or elements of each
competitive force
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

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 The Five-Forces Model
 Rivalry among competing firms
 Most powerful of the five forces
 Strategies pursued by one firm can be successful
only to the extent that they provide competitive
advantage over the strategies pursued by others.
 Change in strategy by one firm may be met with
retaliatory countermoves, such as lowering price,
enhancing quality, adding features, providing
service etc.
 Internet enables consumers to make all the
comparisons easily
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Conditions that Cause High Rivalry Among
Competing Firms
 High number of competing firms
 Similar size of firms competing
 Similar capability of firms competing
 Falling demand for the industry’s products
 Falling product/service prices in the industry
 Consumers can switch brands easily
 Barriers to leaving the market are high
 Barriers to entering the market are low
 Fixed costs are high among firms competing
 The product is perishable
 Rivals have excess capacity
 Consumer demand is falling
 Rivals have excess inventory
 Rivals sell similar products/services

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The Five-Forces Model

 Potential development of substitute

products
 Pressure increases when:

 Prices of substitutes decrease

 Consumers’ switching costs

decrease
 New substitutes emerge

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The Five-Forces Model

 Bargaining Power of Suppliers affects

intensity of competition when there are:
 Large numbers of suppliers

 Few substitute raw materials

 Costs of switching raw materials is high

 Backward integration is gaining control or

ownership of suppliers

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The Five-Forces Model

 Bargaining power of consumers

 Customers being concentrated or

large and buying in volume affects

intensity of competition
 Consumer power is higher where

products are standard or

undifferentiated
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Conditions Where Consumers Gain
Bargaining Power
 If buyers can inexpensively switch
 If buyers are particularly important to the seller
 If sellers are struggling in the face of falling
consumer demand
 If buyers are informed about sellers’ products,
prices, and costs
 If buyers have discretion in whether and when
they purchase the product

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 The Five-Forces Model

 Potential Entry of New Competitors

Whenever new firms can easily enter a particular industry,
the intensity of competitiveness among firms increases.
 Barriers to entry of competitor:
 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,

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Barriers to entry of competitor (cont.)

 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

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Sources of External Information:
Unpublished Sources
 Customer surveys
 Market research
 Speeches at professional or shareholder
meetings
 Television programs
 Interviews and conversations with
stakeholders

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Sources of External Information:
Published Sources
 Periodicals
 Journals
 Reports
 Government documents
 Abstracts
 Books
 Directories
 Newspapers
 Manuals
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Sources of External Information:
Web Sites
 [Link]
 [Link]
 [Link]
 [Link]
 [Link]
 [Link]

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Industry Analysis: The External
Factor Evaluation (EFE) Matrix
An External Factor Evaluation
Political


(EFE) Matrix allows strategists to
summarize and evaluate the
following factors
 Governmental
 Economic  Technological
 Social  Competitive
 Cultural  Legal
 Demographic
 Environmental
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 EFE Matrix 5 Steps
1. List key external factors
• Opportunities and threats (10 to 20)
2. Weight from 0 to 1
• Sum of all weights = 1.0
3. Rate effectiveness of current strategies (how well firm is
responding)
• Assign 1-4 rating to each factor
4. Multiply weight * rating
5. Sum weighted scores (highest score is 4 and lowest is 1,
average score 2.5)
6. If a firm get 2.5 score it is said that the firm is in an average position
to respond to external factors.
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Industry Analysis EFE

Total weighted score of 4.0

 Organization response is outstanding to threats
and weaknesses

Total weighted score of 1.0

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

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Industry Analysis: Competitive Profile
Matrix (CPM)
 Identifies firm’s major competitors and
their strengths & weaknesses in
relation to a sample firm’s strategic
positions

 Critical success factors include

internal and external issues

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