Lecture Five

External Audit
(Chapter 7)

Ch 6 -1
 Learning Objectives
7-1. Describe the nature and purpose of an external assessment in
formulating strategies.
7-2. Identify and discuss 10 external forces that must be examined in
formulating strategies: economic, social, cultural, demographic,
environmental, political, governmental, legal, technological, and
competitive.
7-3. Explain Porter’s Five Forces Model and its relevance in
formulating strategies.
7-4. Describe key sources of information used for locating vital external
information.
7-5. Discuss forecasting tools and techniques.
7-6. Explain how to develop and use an External Factor Evaluation
(EFE) Matrix.
7-7. Explain how to develop and use a Competitive Profile Matrix.

Ch 6 -2
External Audit
 External audit
 focuses on identifying and evaluating trends and
events beyond the control of a single firm,
e.g. increased foreign competition, population
shifts to urban areas, an aging society, and
taxing Internet sales.
 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
External strategic management audit (sometimes also called environmental
scanning or industry analysis)

7-3
The Nature of an External Audit
 The external audit is aimed at identifying key variables
(but finite) that offer actionable responses.
 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
 Firms should be able to respond either offensively or
defensively to the factors by formulating strategies that
take advantage of external opportunities or that minimize
the impact of potential threats.

7-4
A Comprehensive Strategic-
Management Model

7-5
Key External Forces
External forces can be divided into five broad
categories (10 specific forces):
1. economic forces
2. social, cultural, demographic, and natural
environment forces
3. political, governmental, and legal forces
4. technological forces
5. competitive forces

7-6
Relationships Between Key External
Forces and an Organization

7-7
The Process of Performing an
External Audit
 First, gather competitive intelligence and
information about economic, social, cultural,
demographic, environmental, political,
governmental, legal, and technological
trends.
 Information should be assimilated and
evaluated
 A final list of the most important key external
factors should be communicated

7-8
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, and
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
In other must be Specific (i.e., quantified to the extent possible); Actionable
(i.e., meaningful in terms of having strategic implications) and Stated as
external trends, events, or facts rather than as strategies the firm could
pursue.

7-9
The Process of Performing an External Audit
 For example, regarding actionable, “the stock market is volatile” is
not actionable because there is no apparent strategy that the firm
could formulate to capitalize on that factor. In contrast, a factor such
as “the GDP of Brazil is 6.8 percent” is actionable because the firm
should perhaps open 100 new stores in Brazil.
 Select factors that will be helpful in deciding what to recommend the
firm should do, rather than selecting nebulous factors too vague for
an actionable response.
 Similarly, “to expand into Europe” is not an appropriate opportunity,
because it is both vague and is a strategy; the better opportunity
statement would be “the value of the euro has increased 5 percent
versus the U.S. dollar in the last twelve months.”

7-10
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.

7-11
The Industrial Organization
(I/O) View
 Firm performance is based more on industry
properties

7-12
Economic Forces

7-13
Advantages and Disadvantages of a
Weak Dollar

7-14
Social, Cultural, Demographic, and
Natural Environmental Forces
 U.S. Facts
 Aging population
 Less white
 Widening gap between rich & poor
 2025 = 18.5% population > 65 years
 2075 = no ethnic or racial majority

7-15
Social, Cultural, Demographic, and
Natural Environmental Forces
 Facts
 World population 7 billion
 World population = 8 billion by 2028
 World population = 9 billion by 2054
 U.S. population > 310 million

7-16
Key Social, Cultural, Demographic, and
Natural Environment Variables

7-17
Political, Governmental, and Legal
Forces
 The increasing global interdependence
among economies, markets, governments,
and organizations makes it imperative that
firms consider the possible impact of political
variables on the formulation and
implementation of competitive strategies.

7-18
Political, Government, and
Legal Variables

7-19
Technological Forces
The Internet has changed the very nature of
opportunities and threats by:
alteringthe life cycles of products,
increasing the speed of distribution,

creating new products and services,

erasing limitations of traditional geographic markets,

changing the historical trade-off between production

standardization and flexibility.

The Internet has lowered entry barriers, and redefined the

relationship between industries and various suppliers,
creditors, customers, and competitors.

7-20
Technological Forces

 Many firms now have a Chief Information

Officer (CIO) and a Chief Technology
Officer (CTO) who work together to ensure
that information needed to formulate,
implement, and evaluate strategies is
available where and when it is needed

7-21
Technological Forces
Technological advancements can:
 Create new markets
 Result in a proliferation of new and improved
products
 Change the relative competitive cost positions
in an industry
 Render existing products and services obsolete

7-22
Competitive Forces

 An important part of an external audit is

identifying rival firms and determining their
strengths, weaknesses, capabilities,
opportunities, threats, objectives, and
strategies

7-23
Competitive Forces
Characteristics of the most competitive
companies:
1. Market share matters
2. Use the vision/mission as a guide for all decisions
3. Whether it’s broke or not, fix it–make it better
4. Continually adapt, innovate, improve
5. Acquisition is essential to growth
6. People make a difference
7. Strive to stay cost-competitive on a global basis

7-24
Key Questions About Competitors

7-25
Competitive Intelligence Programs

 Competitive intelligence (CI)

 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

7-26
Competitive Intelligence Programs
The three basic objectives of a CI program are:
1. to provide a general understanding of an
industry and its competitors

2. to identify areas in which competitors are

vulnerable and to assess the impact strategic
actions would have on competitors

3. to identify potential moves that a competitor

might make that would endanger a firm’s
position in the market

7-27
The Five-Forces Model of
Competition

7-28
The Five-Forces Model of
Competition
1. Identify key aspects or elements of each
competitive force that impact the firm.

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.

7-29
The Five-Forces Model

 Rivalry among competing firms

 Most powerful of the five forces
 Focus on competitive advantage of strategies
over other firms

7-30
The Five-Forces Model

7-31
The Five-Forces Model

 Potential Entry of New Competitors

 Barriers to entry are important
 Quality, pricing, and marketing can overcome
barriers

7-32
Barriers to Entry

 Need to gain economies of scale quickly

 Need to gain technology and specialized know-
how
 Lack of experience
 Strong customer loyalty
 Strong brand preferences
 Large capital requirements
 Lack of adequate distribution channels

7-33
Barriers to Entry

 Government regulatory policies

 Tariffs
 Lack of access to raw materials
 Possession of patents
 Undesirable locations
 Counterattack by entrenched firms
 Potential saturation of the market

7-34
The Five-Forces Model

 Potential development of substitute

products
 Pressure increases when:
 Prices of substitutes decrease
 Consumers’ switching costs decrease

7-35
The Five-Forces Model

 Bargaining Power of Suppliers is increased

when there are:
 Large numbers of suppliers
 Few substitutes
 Costs of switching raw materials is high
 Backward integration is gaining control or
ownership of suppliers

7-36
The Five-Forces Model

 Bargaining power of consumers

 Customers being concentrated or buying in
volume affects intensity of competition
 Consumer power is higher where products are
standard or undifferentiated

7-37
 Conditions Where Consumers Gain
Bargaining Power
1. If buyers can inexpensively switch
2. If buyers are particularly important
3. If sellers are struggling in the face of falling
consumer demand
4. If buyers are informed about sellers’ products,
prices, and costs
5. If buyers have discretion in whether and when
they purchase the product

7-38
Sources of External Information

 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.

739
Sources of External Information

 www.money.msn.com
 http://finance.yahoo.com
 www.hoovers.com
 http://globaledge.msu.edu/industries/
 www.monrningstar.com

7-40
Forecasting Tools and Techniques

 Forecasts
 educated assumptions about future trends and
events
 quantitative, qualitative techniques

7-41
Making Assumptions

 Assumptions
 Best present estimates of the impact of major
external factors, over which the manager has little
if any control, but which may exert a significant
impact on performance or the ability to achieve
desired results.

7-42
Industry Analysis: The External Factor
Evaluation (EFE) Matrix

 Economic  Political
 Social  Governmental
 Cultural  Technological
 Demographic  Competitive
 Environmental  Legal

7-43
EFE Matrix Steps

1. List key external factors

2. Weight from 0 to 1
3. Rate effectiveness of current strategies
4. Multiply weight * rating
5. Sum weighted scores

7-44
EFE Matrix for a Local Ten-Theater
Cinema Complex

7-45
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

7-46
An Example Competitive
Profile Matrix

7-47