The External

Audit

Lecture 4

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 Learning Objectives
1. Describe the nature and purpose of an external
assessment in formulating strategies.
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.
3. Explain Porter’s Five Forces Model and its
relevance in formulating strategies.

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 External Audit

 External audit
 focuses on identifying and evaluating trends and
events beyond the control of a single firm
 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
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 The Nature of an External Audit

 The external audit 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.
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 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

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 Key External Forces
External forces can be divided into five broad
categories:
1. Economic forces
2. Social, cultural, demographic, and natural
3. Environmental forces
4. Political, governmental, and legal forces
5. Technological forces
6. Competitive forces

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Relationships Between Key External
Forces and an Organization

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 1. Economic Forces
 Shift to service economy  Income differences by region and
 Availability of credit consumer group
 Level of disposable income  Price fluctuations
 Propensity of people to spend  Foreign countries’ economic
 conditions
Interest rates
 Monetary and Fiscal policy
 Inflation rates
 Stock market trends
 GDP trends
 Tax rate variation by country and
 Consumption patterns
state
 Unemployment trends  European Economic Community
 Value of the dollar (EEC) policies
 Import/Export factors  Organization of Petroleum
 Demand shifts for different goods Exporting Countries (OPEC)
and services policies
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 2. Social, Cultural, Demographic, and
Natural Environmental Forces
 Social, cultural, demographic, and environmental trends
are shaping the way customers live, work, produce, and
consume.
 New trends are creating a different type of consumer and,
consequently, a need for different products, new services,
and updated strategies.
 Example :U.S. Facts
 Aging population
 Less white
 2050 = 20% population > 65 years
 2075 = no ethnic
Copyrightor racial
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 Key Social, Cultural, Demographic, and
Natural Environmental Variables
 Population changes by race, age,  Attitudes toward retirement
and geographic area  Energy conservation
 Regional changes in tastes and  Attitudes toward product quality
preferences  Attitudes toward customer
 Number of marriages
service
 Number of divorces
 Pollution control
 Number of births
 Attitudes toward foreign peoples
 Number of deaths
 Energy conservation
 Immigration and emigration rates
 Social programs
 Social Security programs
 Number of churches
 Life expectancy rates
 Per capita income  Number of church members
 Social media pervasiveness  Social responsibility issues

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 3. 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.
 Federal, state, local, and foreign governments are major
regulators, deregulators, subsidizers, employers, and
customers of organizations.
 Political, governmental, and legal factors, therefore, can
represent major opportunities or threats for both small
and large organizations.
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 3. Key Political, Government, and
Legal Variables

 Environmental regulations  USA vs. other country

relationships
 Number of patents  Political conditions in
 Changes in patent laws foreign countries
 Equal employment laws  Global price of oil changes
  Local, state, and federal
Level of defense
laws
expenditures  Import–export regulations
 Unionization trends  Tariffs
 Antitrust legislation  Local, state, and national
elections

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 4. Technological Forces
New technologies such as:
 the Internet of Things
 3D printing
 the cloud
 mobile devices
 biotech
 analytics
 autotech
 robotics and artificial intelligence
 are fueling innovation in many industries, and impacting
strategic-planning decisions.
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 4. 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.
 These individuals are responsible for developing,
maintaining, and updating a company’s information
database.
 The CIO is more a manager, managing the firm’s
relationship with stakeholders.
 the CTO is more a technician, focusing on technical
issues such as data acquisition, data processing, decision-
support systems, Copyright
and software andLimited
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Results of Technological Advances
1. Major opportunities and threats that must be considered in
formulating strategies.
2. Can affect organizations’ products, services, markets, suppliers,
distributors, competitors, customers, manufacturing processes,
marketing practices, and competitive position.
3. Can create new markets, result in new and improved products,
change the relative competitive cost positions, and render
existing products and services obsolete.
4. Can reduce or eliminate cost barriers between businesses, create
shorter production runs, create shortages in technical skills, and
result in changing values and expectations of employees,
managers, and customers.
5. Can create new competitive advantages that are more powerful
than existing advantages.
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 5. Competitive Forces
 An important part of an external audit is
identifying rival firms and determining their
strengths, weaknesses, capabilities,
opportunities, threats, objectives, and
strategies

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 5. Competitive Forces
Characteristics of the most competitive
companies:
1. Strive to continually increase market share
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. Hire and retain the best employees and managers possible
7. Strive to stay cost-competitive on a global basis

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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

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 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
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The Five-Forces Model of Competition

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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.
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 The Five-Forces Model
Rivalry among competing firms
 Most powerful of the five forces
 Focus on competitive advantage of strategies over other firms
 Conditions That Cause High Rivalry Among Competing
Firms:
1. When the number of competing firms is high
2. When competing firms are of similar size
3. When competing firms have similar capabilities
4. When the demand for an industry’s products is falling
5. When the product or service prices in the industry are
falling
6. When consumers can
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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 are
important in this case.
 Barriers to entry can include:
1. Need to gain economies of scale quickly
2. Need to gain technology and specialized know-how
3. Lack of experience
4. Strong customer loyalty
5. Strong brand preferences
6. Large capital requirements
7. Lack of adequate distribution channels
 The strategist’s job is to identify potential new firms entering the
market, to monitor the new rival firms’ strategies, to counterattack as
 The Five-Forces Model
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.
 Competitive pressures arising from substitute
products increase as the relative price of substitute
products declines and as consumers’ costs of
switching decrease.
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 The Five-Forces Model
Bargaining Power of Suppliers
The bargaining power of suppliers affects the
intensity of competition in an industry,
especially when there are:
 Few suppliers
 Few substitutes
 Costs of switching raw materials is high

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 The Five-Forces Model
Bargaining power of consumers
 When customers are concentrated or large in number or buy in volume,
their bargaining power represents a major force affecting the intensity of
competition in an industry.
 Consumer power is higher where products are standard or undifferentiated.
 Consumers gain increasing bargaining power under the following
circumstances:
1. If they can inexpensively switch to competing brands or substitutes
2. If they are particularly important to the seller
3. If sellers are struggling in the face of falling consumer demand
4. If they are informed about sellers’ products, prices, and costs
5. If they have discretion in whether and when they purchase the
product
 Industry Analysis: The External Factor
Evaluation (EFE) Matrix
 An External Factor Evaluation (EFE) Matrix allows
strategists to summarize and evaluate economic,
social, cultural, demographic, environmental,
political, governmental, legal, technological, and
competitive information.
 EFE Matrix Steps
1. List key external factors as identified in the external-audit process. Include a
total of 15 to 20 factors, including both opportunities and threats, that affect
the firm and its industry:
 List the opportunities first and then the threats. Be as specific as
possible, using percentages, ratios, and comparative numbers whenever
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.
 Opportunities often receive higher weights than threats, but threats can
receive high weights if they are especially severe or threatening.
 Appropriate weights can be determined by comparing successful with
unsuccessful competitors or by discussing the factor and reaching a
group consensus.
 The sum of all weights assigned to the factors must equal 1.0.
 EFE Matrix Steps
3. Assign a rating between 1 and 4 to each key external 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, and 1 = the response is poor.
 Ratings are based on effectiveness of the firm’s strategies.
 Ratings are thus company-based, whereas the weights in Step 2
are industry-based.
 It is important to note that 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.
 EFE Matrix Steps
Important remarks:
 Regardless of the number of key opportunities and threats
included in an EFE Matrix, the highest possible total weighted
score for an organization is 4.0 and the lowest possible total
weighted score is 1.0.
 The average total weighted score is 2.5. A total weighted score
of 4.0 indicates that an organization is responding in an
outstanding way to existing opportunities and threats in its
industry.
 A total score of 1.0 indicates that the firm’s strategies are not
capitalizing on opportunities or avoiding external threats.
EFE Matrix for a Local Ten-Theater
Cinema Complex

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 Industry Analysis: Competitive Profile
Matrix (CPM)
 The Competitive Profile Matrix (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 a CPM and an EFE have
the same meaning. However, critical success factors in a CPM include
both internal and external issues.
 Therefore, the ratings refer to strengths and weaknesses, where 4 =
major strength, 3 = minor strength, 2 = minor weakness, and 1 = major
weakness.
 The critical success factors in a CPM are not grouped into opportunities
and threats as they are in an EFE.
 In a CPM, the ratings and total weighted scores for rival firms can be
compared to the sample firm.
 This comparative analysis provides important internal strategic
information
 An Example Competitive
Profile Matrix
TABLE 7-12 An Example Competitive Profile Matrix
▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬
Company 1 Company 2 Company 3____________
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 3 0.30 2 0.20
Price Competitiveness 0.10 3 0.30 2 0.20 1 0.10
Management 0.10 4 0.40 3 0.20 1 0.10
Financial Position 0.15 4 0.60 2 0.30 3 0.45
Customer Loyalty 0.10 4 0.40 3 0.30 2 0.20
Global Expansion 0.20 4 0.80 1 0.20 2 0.40
Market Share 0.05 1 0.05 4 0.20 3 0.15
Total 1.00 3.15 2.50 2.20

Note: The ratings values are as follows: 1 = major weakness, 2 = minor weakness, 3 = minor strength, 4 =
major strength. As indicated by the total weighted score of 2.50, Competitor 2 is weakest. Only eight
critical success factors are included for simplicity; this is too few in actuality.

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