Presentation on

Chapter -3 THE EXTERNAL ASSESSMENT

• Chapter 3 examines the tools and concepts needed to conduct an external strategic-management audit (sometimes called environmental scanning or industry analysis).

• 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 to the Sun Belt, an aging society, consumer fear of traveling, and stock market volatility.

• An external audit reveals key opportunities and threats confronting an organization, so managers can formulate strategies to take advantage of the opportunities and avoid or reduce the impact of threats.

• This chapter presents a practical framework and guidelines for gathering, assimilating, and analyzing environmental information.

External Strategic Management Audit

– Environmental Scanning

– Industry Analysis

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 avoid threats.

A. Key External Forces

1. External forces can be divided into five broad categories: (1) Economic forces; (2) Social, cultural, demographic, and natural environment forces; (3) Political, governmental, and legal forces; (4) Technological forces; and (5) Competitive forces.

2 Relations among these forces and an organization are depicted in Figure 3-2. External trends and events significantly affect all products, services, markets, and organizations in the world.

3.Changes in external forces translate into changes in consumer demand for both industrial and consumer products and services.

1. The nature of an external auditcontd.

B. The Process of Performing an External Audit

1. The process of performing an external audit must involve as many managers and employees as possible.

2. To perform an external audit, a company first must gather competitive intelligence and information about social, cultural, demographic, environmental, economic, political, legal, governmental, and technological trends.

a. Individuals can be asked to monitor various sources of information such as key magazines, trade journals, and newspapers. b. The Internet is another source for gathering strategic information, as are corporate, university, and public libraries.c. Suppliers, distributors, salespersons, customers, and competitors represent other sources of vital information.

3. Once information is gathered, it should be assimilated, evaluated, and prioritized. 4. Key external factors should be important to achieving long term and annual objectives, measurable, applicable to all competing firms, and hierarchical in the sense that some will pertain to the overall company while others will be more narrowly focused.

Industrial Organization (I/O) View

Industry factors are more important than internal factors

Performance determined by industry forces

II. The industrial organization (i/o) view

External Factors versus Internal Factors– External factors are more important than internal factors in a firm achieving competitive

advantage. Organizational performance is primarily determined by industry forces.

– Managing strategically from the I/O perspective entails firms striving to compete in attractive industries, avoiding weak or faltering industries, and gaining a full understanding of key external factor relationships.

Factors Affecting Firm Performance

1. Firm performance is primarily based on industry properties such as economies of scale, barriers to market entry, product differentiation, and level of competitiveness.

2. 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.

Economies of Scale

Industry Properties

Barriers to Market Entry

Product Differentiation

The Economy

I/O Perspective Firm Performance

Level of Competitiveness

III. Economic forcesA. Economic Factors Have a Direct Impact

1. Economic factors have a direct impact on the potential attractiveness of various strategies. For example, if interest rates rise, then funds needed for capital expansion become more costly or unavailable. 2. The key economic variables that a firm should monitor are :-

(1) shifts to a service economy in the United States; (2) availability of credit; (3) level of disposable income; (4) propensity of people to spend; (5) interest rates; (6) inflation rate; (7) unemployment trends; and so on.

3. An economic variable of significant importance is gross domestic product, especially across countries

4. Trends in the dollar’s value have significant and unequal effects on companies in different industries and in different locations.

5. Rising unemployment rates across the United States has touched off a race among states to attract businesses with tax breaks and financial incentives.

IV. Social , Cultural, Demographic, and Natural Environment forces

• Major Impact –

• Products

• Services

• Markets

• Customers

V. POLITICAL, GOVERNMENTAL, AND LEGAL FORCES

• Federal, state, local, and foreign governments are major regulators, deregulators, subsidizers, employers, and customers of organizations. Political, governmental, and legal factors, therefore, can represent key opportunities or threats for both small and large organizations.

• For industries and firms that depend heavily on government contracts or subsidies, political forecasts can be the most important part of an external audit.

• Changes in patent laws, antitrust legislation, tax rates, and lobbying activities can affect firms significantly.

• In the face of a deepening global recession, countries worldwide are resorting to protectionism to safeguard their own industries. Many economists point out that the current rash of trade constraints will make it harder for global economic growth to recover from the global recession.

• Governments are taking control of more and more companies as the global economic recession cripples

firms considered vital to the nation’s financial stability. As more and more companies around the world accept government bailouts, those companies are being forced to march to priorities set by political leaders.

• Local, state, and federal laws, regulatory agencies, and special interest groups can have a major impact on the strategies of small, large, for-profit, and nonprofit organizations.

VI. Technological forces

A. Revolutionary technological changes and discoveries are having a dramatic impact on organizations.

– The Internet is changing 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.

– To effectively capitalize on information technology, a number of organizations are establishing two

new positions in their firms: chief information officer (CIO) and chief technology officer (CTO). This trend reflects the growing importance of information technology (IT) in strategic management.

B. Technological forces represent major opportunities and threats that must be considered in formulating strategies.

– Technological advancements can dramatically affect organizations’ product, services, markets, suppliers, distributors, competitors, customers, manufacturing practices, and competitive position.

– Technology management is one of the key responsibilities of strategists. Firms should pursue strategies that take advantage of technological opportunities to achieve sustainable, competitive advantages in the marketplace.

VII. Competitive Forces

Collection & evaluation of data on competitors is essential for successful strategy formulation

Competitive Forces

•Strengths

•Weaknesses

•Capabilities

•Opportunities

•Threats

•Objectives

•Strategies

Identify Rival Firms’

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

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

Competitive Forces

• 7 characteristics of most competitive firms– Market share matters– Understanding what business you are in– Broke or not, fix it– Innovate or evaporate– Acquisition is essential to growth– People make a difference– No substitute for quality

• Competitive Intelligence– 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

• Objectives of Competitive Intelligence– Provide a general understanding of industry and

competitors– Identify areas where competitors are vulnerable

and assess impact of actions on competitors– Identify potential moves that a competitor might

make

• Sources of Competitive Intelligence

• Internet• Employees• Managers• Suppliers• Distributors• Customers• Creditors

• Consultants• Trade journals• Want ads• Newspaper articles• Government filings• Competitors

• Market Commonality and Resource Similarity

– The number and significance of markets that a firm competes in with rivals

– Competitors are firms that offer similar products in the same market. – Markets can be geographic, product areas, or segments.

– Market commonality can be defined as the number and significance of

markets that a firm competes in with rivals.

– Resource similarity is the extent to which the type and amount of a firm’s

internal resources are comparable to a rival.

VIII. Competitive analysis:Porter’s five-forces model

• It is a framework for the analysis of the structural factors that shape competition within the industry.

• The five forces:– Determine the level of competition in an industry– Assess how attractive and potentially profitable is an

industry.

The Five-Forces Model

• Rivalry among competing firms– Most powerful of the five forces– Focus on competitive advantage of

strategies over other firms

Intensity of rivalry

within the industry

Threats of substitute products

Bargaining power of

Buyers (customers)

Threats of new entrants

Bargaining power of suppliers

The Five Force Model of Competition

The Five Force Model of Competition

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

1. 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

Conditions that Cause High Rivalry Among Competing Firms contd.

• 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

Conditions that Cause High Rivalry Among Competing Firms contd.

• Rivals have excess capacity• Consumer demand is falling• Rivals have excess inventory• Rivals sell similar products/services• Mergers are common in the industry

2. Threat of new entrants• If new entrant moves into an industry they will gain

market share, rivalry will accelerate and profits will decline.

• Impediments to the entry of new firms are known as barriers to the entry.

• If it is difficult to enter an industry the position of existing firms will be strengthened.

• If barriers to entry are low then the threat of new entrants will be high, and vice versa.

Barriers to entry

• Capital cost of entry– High cost will deter entry– High capital requirements might mean that only large firms

can compete.

• Economies of scale available to existing firms – If they enjoy absolute cost advantages based on large scale

then it will be difficult for smaller newcomers to break into the market and compete effectively.

• Regularity and legal restrictions– Each restriction act as a barrier to entry

What are the barriers to entry?

• Product differentiation ( including brands)– Will act to increase customer loyalty making it difficult for

newcomers to gain market share.

• Access to raw material and distribution channels– A lack of access will make it difficult for newcomers to enter

the market.

• Retaliation by established products– Eg. The threat of price war– Will act to discourage newcomers.

Threats of new entrants

• The main factors in determining this level are:– Absolute cost advantage– Access to inputs/ distribution– Government policy– Economies of scale– Capital requirements– Brand identity– Switching costs

3. Bargaining power of suppliers

• Suppliers are the businesses that supply materials & other products into the industry.

• The cost of items bought from suppliers (e.g. raw materials, components) can have a significant impact on a company's profitability.

• If suppliers have high bargaining power over a company, then in theory the company's industry is less attractive.

• The bargaining power of suppliers will be high when:- There are many buyers and few dominant suppliers.- There are undifferentiated, high valued products.- Suppliers threaten to integrate forward into the industry (e.g. brand manufacturers threatening to set up their own retail outlets).- Buyers do not threaten to integrate backwards into supply.

4. Bargaining Power of Buyers

• Buyers are the people / organizations who create demand in an industry.

• The bargaining power of buyers is greater when:– There are few dominant buyers and many sellers in the

industry.– Products are standardized.– Buyers threaten to integrate backward into the industry.– Suppliers do not threaten to integrate forward into the

buyer's industry.

Conditions Where Consumers GainBargaining Power

• If buyers can inexpensively switch• If buyers are particularly important• 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

5. Threat of substitute products

• The presence of substitute products can lower industry attractiveness and profitability because they limit price levels. The threat of substitute products depends on: - Buyers' willingness to substitute

- The relative price and performance of substitutes

Threat of substitute products contd.

• The substitute product can be regarded as something that meets the same need.

• Substitute products are produced in a different industry- but crucially satisfy the same customer needs.

IX. Sources of external information

1. A wealth of 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 of strategic information include periodicals, journals, reports, government documents, abstracts, books, directories, newspapers, and manuals

2. Web Sites for gathering strategic information:

1. http://marketwatch.multexinvestor.com2. http://moneycentral.msn.com3. http://finance.yahoo.com4. www.clearstation.com5. https://us.etrade.com/e/t/invest/markets6. www.hoovers.com

3. Standard & Poor’s (S&P) Industry Surveys include the following sections of information:

– Current environment– Industry trends– How the industry operates– Key industry ratios and statistics– How to analyze a company– Glossary of industry terms– Additional industry information– References– Comparative company financial analysis

X. Forecasting tools and techniquesA. Forecasts 1. Forecasts are educated assumptions about future trends and events.

2. Forecasting is a complex activity due to factors such as technological innovation, cultural changes, new products, improved services, stronger competitors, shifts in government priorities, changing social values, unstable economic conditions, and unforeseen events.

3. Forecasting tools can be broadly categorized into two groups: quantitative techniques and qualitative techniques. a. Quantitative forecasts are most appropriate when historic data are available and when the relationships among key

variables are expected to remain the same in the future. Linear regression, for example, is based on the assumption that the future will be just like the past.

b. Accurate forecasts can provide major competitive advantages for organizations. However, no forecast is perfect, and some are wildly inaccurate.

B. Making Assumptions 4. By identifying future occurrences that could have a major effect on the firm and making reasonable

assumptions about those factors, strategists can carry the strategic-management process forward.

5. Assumptions are needed only for future trends and events that are most likely to have a significant effect on the company’s business.

6. Firms that have the best information generally make the most accurate assumptions, which can lead to major competitive advantages.

7.

XI. Industry analysis: The external factor evaluation (EFE) matrix

An EFE Matrix allows strategists to summarize and evaluate economic, social, cultural, demographic, environmental, political, governmental, legal, technological, and competitive information. There are five steps in developing an EFE Matrix as : 1. List key external factors as identified in the external-audit process. Include a total of

10-20 factors from both the opportunities and threats. 2. Assign to each factor a weight from .0 (not important) to 1.0 (very important). These

weights show the relative importance. The total of all the weights should equal 1.0.3. Assign a 1-4 rating to each factor to indicate how effectively the firm’s current

response strategy is: 1 = the response is poor, 2 = the response is average, 3 = the response is above average, and 4 = the response is superior.

4. Multiply each factor’s weight by its rating to get a weighted score.5. Sum the weighted scores for each variable to determine the total weighted score for

the organization.

Total weighted score of 4.0• Organization response is outstanding to threats and

weaknesses

Industry Analysis EFE

Total weighted score of 1.0 Firm’s strategies not capitalizing on opportunities or

avoiding threats

XII. The competitive profile matrix (CPM)

A. The CPM Matrix The CPM identifies a firm’s major competitors and their particular strengths and weaknesses in relation to a sample firm’s strategic position. There are some important differences between the EFE and CPM.

First, the critical success factors in a CPM are broader. These factors are also not grouped into opportunities and threats as in the EFE.

In a CPM, the ratings and weighted scores can be compared to rival firms.

Industry Analysis CPM

Just because one firm receives a 3.2 rating and another receives a 2.8 rating, it does not follow that the first firm is 20 percent better than the second.

Important –

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