Chapter Four

External Environmental Analysis

 External environment comprises all factors external to
the firm that can lead to opportunities and threats.
 A basic tenet of strategic management is that firms need
to formulate strategies to take advantage of opportunities
and to avoid the impact of threats.

 Opportunity is a condition that are helpful to attain the

objective of organization.

 Threat is a challenge posed by an unfavorable trend that would

lead to deterioration in profits.

Dr. Tizazu K. 1
 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
reduced.
 External environment of organization can be divided into the task
environment and general environment .
 Task environment constitute factors that are closer to organizational
boundary such as;
• competitors, suppliers, customers
• potential substitute and new entrants

 General environment includes

• political environment, economic environment, natural environment
• Social and cultural environment, & technological environment (PEST).
2
 Economic forces
 Economic forces affect the general health and well-being of a nation or
the regional economy of an organization, which in turn affect companies’
and industries’ abilities to earn an adequate rate of return.
 The four most important economic forces are
 the growth rate of the economy
 interest rates
 currency exchange rates, and
 inflation and deflation rates
 Economic growth leads to an expansion in customer expenditures,
tends to produce a general easing of competitive pressures within an
industry.
- This gives companies the opportunity to expand their operations and
earn higher profits.
3
 Cont….
 Conversely, recession leads to a reduction in customer
expenditures, it increases competitive pressures.
 Interest rates can determine the demand for a company’s
products.
 Currency exchange rates define the value of different national
currencies against each other.
- Movement in currency exchange rates has a direct impact on the
competitiveness of a company’s products in the global
marketplace.
For example,
When the value of the ETB is low compared with that of other currencies,
products made in the Ethiopia are relatively inexpensive, and products
made overseas are relatively expensive.
4
 Technological Forces

 Technological change can make established products

obsolete overnight and simultaneously create a host of new
product possibilities.
 Thus, technological change is both creative and
destructive- both an opportunity and a threat.
 One of the most important impacts of technological
change is that it can affect the height of barriers to entry and
therefore radically reshape industry structure.

5
 Social and Cultural Forces
Social forces refer to the way in which changing social traditions
and values affect an industry.
Like other macro-environmental forces discussed here, social
change creates opportunities and threats.
One major social movement of recent decades has been the
trend toward greater health consciousness.
Its impact has been immense, and companies that recognized
the opportunities early have often reaped significant gains.
For example,
•Pepsi was able to gain market share from its rival, Coca-Cola, by being the
first to introduce fruit-based soft drinks.
•The tobacco industry is in decline as a direct result of greater customer
awareness of the health implications of smoking.
6
 Political and Legal Forces
 Political and legal forces are outcomes of changes in laws and
regulations.

 Political processes shape a society’s laws, which constrain the

operations of organizations and thus create both opportunities
and threats.

 Firms must carefully analyze a new political administration’s

business-related policies and philosophies.
 Trade practice laws, taxation laws, industries chosen for
deregulation, labor laws, and the degree of commitment to
educational institutions are areas in which an administration’s
policies can affect the operations and profitability of industries.

7
 Natural Environment
The natural environment includes physical resources,
wildlife, and climate that are an inherent part of existence on
Earth.
• Global warming is a trend firms and nations should carefully
examine in efforts to predict any potential effects on the
global society as well as on their business operations.
• Energy consumption is another part of the physical
environment that concerns both organizations and nations.

8
 Sources of external information

a. Information is available to organizations from both

published and unpublished sources.
Unpublished sources include customer surveys, market
research, speeches at professional and shareholders’ meetings,
television programs, interviews, and conversations with
stakeholders.
Published sources include periodicals, journals, reports,
government documents, abstracts, books, directories, news
papers, and manuals.

b. The Internet has made it easier for firms to gather,

assimilate, and evaluate information using Web sites.
9
 Forecasting tools and techniques
 Forecasts are educated assumptions about future
trends and events.
 Forecasting tools can be broadly categorized into two groups:
quantitative techniques and qualitative techniques.

a. Quantitative forecasts
• An econometric model is one of the tools economists use to
forecast future developments in the economy.

- Econometricians measure past relationships among such variables

as consumer spending, household income, tax rates, employment,
and the like, and then try to forecast how changes in some
variables will affect the future course of others.

10
 Cont…
• Regression analysis
Example: Statistical approach to forecasting change in a
dependent variable (sales revenue) on the basis of change in one
or more independent variables(population and income).

• Trend extrapolation attempts to extend known data points to

regions beyond the timeframe of known data points, almost
always in an attempt to predict future values with some degree of
probability.

2. Qualitative forecasts
• Jury of Executive Opinion: when executives from various
corporate functions involved in forecasting sales (e.g., finance,
marketing, production) meet to generate forecasts.
11
 Cont…
• Delphi technique survey is also especially relevant when data
are lacking, quality of data is poor or when experts seem not to
agree on issues.

• Sales Force Composite uses the knowledge and experience of a

company’s salespeople, its sales management, and/or channel
members to produce sales forecasts.
• Scenario forecast: - Under this approach, the forecaster starts
with different sets of assumptions.

• Brainstorming sessions allows individuals participating in the

forecasting decision to arrive at a forecast based on their
subjective feelings and ideas.
12
 Competitive analysis: Porter’s five forces model
 According to Porter, the nature of competitiveness in a given
industry can be viewed as a composite of five 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
1. Rivalry among competing firms
This is the most obvious form of competition: the head –to-head rivalry
between firms making similar products and selling them in the same
market.

2. Potential Entry of New Competitors

New entrants are companies that are not currently competing in an
industry but have the capability to do so if they choose.
13
 Cont….

3. Pressure from Substitute Products

All firms in an industry are competing, in a broad sense, with
industries producing substitute products.

4. Bargaining Power of Buyers

A company's buyers may be the customers who ultimately
consume its products (its end users), but they may also be the
companies that distribute its products to end users, such as
retailers and wholesalers.

5. Bargaining Power of suppliers

In a similar vein to buyers, suppliers of vital resources to the
industry can exact high prices, leading to a squeeze on profits
through higher input costs.
14
 Porter’s Five Forces Model
Substitute Products
• Switching costs
• Buyer inclination to substitute
• Variety of substitutes
• Price-performance tradeoff of substitutes
• Necessity for product or service

Rivalry Among Bargaining power of Buyers

Bargaining power of Suppliers Competing • Buyer volume and
Key Inputs Firms
• Supplier concentration
information
• Exit barriers • Brand identity
• Differentiation of inputs • Industry concentration
• Switching costs • Fixed costs • Price sensitivity
• Threat of forward • Industry growth • Threat of backward
integration • Intermittent overcapacity integration
• Cost relative to total • Switching costs • Product differentiation
purchases in industry • Brand identity
• Diversity of rivals • Substitutes

Potential entry of New competitors

• Absolute cost advantages
• Access to inputs
• Economies of scale
• Brand identity
• Switching costs
• Access to distribution 15