The External Assessment

STRATEGIC MANAGEMENT

Chapter 3

The External Assessment

          This chapter examines the tools and concepts needed to conduct an external strategic management audit (sometimes called environmental scanning or industry analysis).

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 avoided. 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. 

The Process of Performing the External Audit

-          It must involve as many managers and employees as possible.

-          Individual appreciate having the opportunity to contribute and be involved.

The Process

1.       Gather competitive intelligence and information on the various eternal forces.

2.       Assimilate and evaluate the information gathered. A meeting or series of meeting of managers is needed to collectively identify the most important opportunities and threats facing the firm.

Key External Forces

1.       Economic Forces

These have a direct impact on the potential attractiveness of various strategies.

Some Economic Variables:

1.       Interest Rates

2.       Unemployment Trends

3.       Inflation Rates

4.       Price Fluctuations

5.       Foreign Countries’ Economic Condition

2.       Social, Cultural, Demographic, and Environmental Forces

Changes in these forces have major impact virtually on all products, services, markets, and customer.

Some Social, Cultural, Demographic, and Environmental Variables:

1.       Life Expectancy

2.       Sex Roles

3.       Ozone Depletion

4.       Buying Habits

5.       Energy Conservation

3.       Political, Governmental, and Legal Forces

Federal, state, local and foreign governments are major regulators, deregulators, subsidizers, employer, and customers of organizations.

Political forecasts can be the most important part of the external audit.

Some Political, Governmental, and Legal Forces:

1.       Changes in Laws

2.       Lobbying Activities

3.       Import-Export Regulations

4.       Political Conditions in Foreign Countries

5.       Government Fiscal and Monetary Policy

4.       Technological forces

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 life cycles of products, increasing 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.

5.       Competitive forces

An important part of the external audit is identifying rival firms and determining their strengths, weaknesses, capabilities, opportunities, threats, objectives, and strategies.

In  business competition, rivals consider the following:

a.       Market Commonality – the number and significance of markets that a firm competes with a rival.

b.      Resource Similarity – extent to which the type and amount of a firm’s internal resources are comparable to a rival.

Competitive Intelligence – is 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.

The more information and knowledge a firm can obtain about its competitors; the more likely it can formulate and implement effective strategies.

Firms need an effective Competitive Intelligence Program (CIP). The three basic missions of CIP 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.

Cooperation Among Competitors

Strategies that stress cooperation among competitors are being used more. Cooperative agreements between competitors are even becoming popular.

For  collaboration between competitors to succeed, both firms must contribute something distinctive, such as technology, distribution, basic research, or manufacturing capacity. But a major risk is that unintended transfers of important skills or technology may occur at organizational levels below where the deal was signed. Information not covered in the formal agreement often gets traded in the day-to-day interactions and dealings of engineers, marketers, and product developers. Firms often give away too much information to rival firms when operating under cooperative agreements. Tighter agreements are needed.

For example, Boeing and Lockheed are working together to modernize the U.S. overburdened air-traffic-control system. Fierce competitors America Online, Microsoft, and Yahoo! For the first time joined forces in 2003 to form a united front against spam.

Competitive Analysis: Porter’s Five-Forces Model of Competition

The Composite Five Forces:

11.  Rivalry Among Competing Firms

          Rivalry among competing firms is the most powerful of the five forces. The strategies pursued by one firm can be successful only to them extent that they provide competitive advantage over the strategies pursued by rival firms.

          Changes in strategy of one firm may be met with retaliatory countermoves, such as lowering prices, enhancing quality, providing services, extending warranties, and increasing advertising.

          In the Internet world, competitiveness is fierce. Price comparison Web sites allow consumers to efficiently find the lowest-priced seller on the Internet. And the costs of setting up a great e-commerce site are nothing compared to the cost of acquiring real estate for building retail stores – or even printing and mailing catalogs. Free flowing information on the Internet is driving down prices and inflation worldwide.

          The intensity of rivalry among competing firms tends to increase as the number of competitors increases, as competitor become more equal in size and capability, as demand for the industry’s products declines, and as price cutting becomes common.

22.   Potential Entry of New Competitors

          Whenever new firms can easily enter a particular industry, the intensity of competition among forms increases.

          Despite numerous barriers to entry, new firms sometimes enter industries with higher quality products, lower prices, and substantial marketing resources.

          The strategist’s job therefore, is to identify potential new firms entering the market, to monitor the new rival firm’s strategies, to counterattack as needed, and to capitalize on existing strengths and opportunities.

33. Potential Development of Substitute Products

          In many industries, firms are in close competition with producers of substitute products in other industries. Examples are plastic container producers competing with glass, paperboard, and aluminum can producers.

          The presence of substitute products puts a ceiling on the price that can be charged before consumers will switch to the substitute product.

          Competitive pressures arising from substitute products increase as the relative price of the substitute products declines and as consumers’ switching costs decrease.

          The competitive strength of substitute products is best measured by the inroads into the market share those products obtain, as well as those firm’s plans for increased capacity and market penetration.

44.   Bargaining Power of Suppliers

          The bargaining power of suppliers affects the intensity of competition in an industry, especially when there is a large number of suppliers, when there are only a few good substitute raw materials, or when cost of switching raw materials is especially costly.

          It is often in the best interest of both suppliers and producers to assist each other with reasonable prices, improved quality, development of new services, just- in- time deliveries, and reduced inventory costs, thus enhancing long-term profitability for all concerned.

          Firms may pursue backward integration strategy to gain control or ownership of suppliers. This strategy is effective when suppliers are unreliable, too costly, or not capable of meeting a firm’s needs on a constant basis. Firms generally can negotiate more favorable terms with suppliers when backward integration is a commonly used strategy among rival firms in the industry.

  

55. Bargaining Power of Consumers

          When customers are concentrated or large, or buy in volume, their bargaining power represents a major force affecting the intensity of competition in an industry.

          Rival firms may offer extended warranties or special services to gain customer loyalty whenever the bargaining power of consumers is substantial.

          Bargaining power of consumers also is higher when the products being purchased are standard or undifferentiated. When in this case, consumers often can negotiate selling price, warranty coverage, and accessory packages to a greater extent. Even huge companies, the drastic increase in bargaining power of consumers caused by Internet usage is a major external threat.  

Sources of External Information

          A wealth of strategic information is available to organizations from:

·         Published Sources – include periodicals, journals, reports, government documents, abstracts, books, directories, newspapers, and manuals.

·         Unpublished Sources – include customer surveys, market research, speeches at professional and shareholder’s meetings, television programs, interviews, and conversation with stakeholders.

·         The Internet  - offer consumers and businesses a widening range of services and information resources from all over the world.

Forecasting  and Making Assumptions

          Managers often must rely upon published forecasts to identify key external opportunities and threats effectively.

          Forecasts are educated assumptions about future trends and events.  A sense of the future permeates all action and underlies every decision a person makes. Accurate forecasts can provide major competitive advantage for organizations. Forecasts are vital to the strategic-management process and to the success of the organization.

          Assumptions are the 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. Strategists are faced with countless variables that can neither be controlled nor predicted with 100% accuracy.

          Without reasonable assumptions, the strategy-formulation process could not proceed effectively. Firms that have best information generally make the most accurate assumptions, which can lead to major advantages.

Globalization

          Globalization is the process of worldwide integration of strategy formulation, implementation, and evaluation activities. Strategic decisions are made based on their impact upon global profitability of the firm, rather than just on domestic or other individual country considerations. A global strategy integrates actions against competitors into a worldwide plan.

Industry Analysis: The External Factor Evaluation (EFE) Matrix

          The EFE matrix allows strategists to summarize and evaluate external factors. EFE matrix can be developed in five steps:

1.       List key external factors as identified in the external-audit process. Include both opportunities and threats that affect the firm and its industry. Be specific as possible, using percentages, ratios, and comparative numbers if possible.

2.       Assign to each factor a weight that ranges from 0.0 (not important) to 1.0 (very important). The weight indicates the relative importance of that factor to being successful in the firm’s industry.

3.       Assign a 1-to-4 rating to each key internal factor to indicate how effectively the firm’s current strategies respond to the factor, where 4 = the response is superior; 3 = the response is above average; 2 = the response is average; 1= the response is poor. Ratings are based on effectiveness of the firm’s strategies, thus, company based, whereas the weights in step 2 are industry based. It is important to note both threats and opportunities can receive a 1,2,3, or 4.

4.       Multiply each factor’s weight by its rating to determine a weighted score.

5.       Sum the weighted scores for each variable to determine the total weighted score for the organization.

An Example of External Factor Evaluation Matrix (EFE)

KEY EXTERNAL FACTORS	WIEIGHT	RATING	WEIGHTED SCORE
Opportunities
1.       Global Markets are practically untapped by smokeless tobacco market	.15	1	.15
2.       Increased demand caused by public banning of smoking	.05	3	.15
3.       Astronomical Internet advertising growth	.05	1	.05
4.       Pinkerton is leader in discount tobacco market	.15	4	.60
5.       More social pressure to quit smoking, thus leading users to switch to alternatives	.10	3	.30
Threats
1.       Legislation against the tobacco industry	.10	2	.20
2.       Production limits on tobacco increases competition for production	.05	3	.15
3.       Smokeless tobacco market is concentrated in southeast region of US	.05	2	.10
4.       Bad media exposure from FDA	.10	2	.20
5.       Clinton administration	.20	1	.20
TOTAL	1.00		2.10

The Competitive Profile Matrix (CPM)

          The CPM identifies a firm’s major competitors and its particular strengths and weaknesses in relation to a sample firm’s strategic position. The weights and total weighted scores in both CPM and EFE have the same meaning. 

An Example Competitive Profile Matrix (CPM)

			AVON		L’OREAL		PROCTER & GAMBLE
Critical Success Factors	Weight	Rating	Score	Rating	Score	Rating	Score
Advertising	0.20	1	0.20	4	0.80	3	0.60
Product Quality	0.10	4	0.40	4	0.40	3	0.30
Price Competitiveness	0.10	3	0.30	3	0.30	4	0.40
Management	0.10	4	0.40	3	0.30	3	0.30
Financial Position	0.15	4	0.60	3	0.45	3	0.45
Customer Loyalty	0.10	4	0.40	4	0.40	2	0.20
Global Expansion	0.20	4	0.80	2	0.40	2	0.40
Market Share	0.05	1	0.05	4	0.20	3	0.15
TOTAL	1.00		3.15		3.25		2.80

Note:  (1) The rating values are as follows: 1 = major weakness, 2 = minor weakness, 3 = minor strength,       4 = major strength. (2) As indicated by the total weighted scores of 2.8, Competitor 3 is weakest.(3) Only eight critical success factors are included for simplicity, this is too few in actuality.