Chapter 3: The External Assessment
Stephanie Rose Capule
Divine Grace Jasa
Mark Angelo Santiago
Mr. Jamilton Esguerra
After studying this chapter, you should be able to do the following: 1. Describe how to conduct an external strategic-management audit. 2. Discuss 10 major external forces that affect organizations: economic, social, cultural, demographic, environmental, political, governmental, legal, technological, and competitive. 3. Describe key sources of external information, including the Internet. 4. Discuss important forecasting tools used in strategic management. 5. Discuss the importance of monitoring external trends and events. 6. Explain how to develop an EFE Matrix.
7. Explain how to develop a Competitive Profile Matrix.
8. Discuss the importance of gathering competitive intelligence. 9. Describe the trend toward cooperation among competitors. 10. Discuss market commonality and resource similarity in relation to competitive analysis.
The Nature of an External Audit
External strategic business audits are essential for finding hidden opportunities and reducing the impact of future threats in a rapidly changing business environment. It is essential for the company to conduct external audit in order to evaluate and assess situations or trends that is beyond the control of the firm such as economic forces, social, cultural, demographic, and natural environment forces, political, governmental and legal, technological and competitive advantages. This chapter 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 Sunbelt, an aging society, consumer fear of travelling, and stock market volatility. An external audit 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. This chapter presents a practical framework for gathering, assimilating, and analyzing external information. The Industrial Organization (I/O) view of strategic management is introduced. 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. As the 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. Figure 3-1 illustrates how the external audit fits into the strategic-management process.
FIGURE 3-1. A Comprehensive Strategic-Management Model
Key External Forces
Most successful business start-ups are owned by believers and proponents of good strategic management, a regimented 7-stage discipline involving vision and mission development, external assessment, internal assessment, long-term objective setting, strategy identification and selection, strategy implementation, and performance evaluation. Well-meaning strategic management practitioners consider five (5) key external forces in doing the external assessment exercise: (1) economic forces; (2) social, cultural, demographic, and natural environment forces; (3) political, governmental, and legal forces; (4) technological forces; and (5) competitive forces. Relationships among these forces and an organization are depicted in Figure 3-2. External trends and events, such as the global economic recession, significantly affect products, services, markets, and organizations worldwide. Changes in external forces translate into changes in consumer demand for both industrial and consumer products and services. External forces affect the types of products developed, the nature of positioning and market segmentation strategies, the type of services offered, and the choice of businesses to acquire or sell. External forces directly affect both suppliers and distributors. The increasing complexity of business today is evidenced by more countries developing the capacity and will to complete aggressively in world markets. Foreign businesses and countries are willing to learn, adapt, innovate, and invent to compete successfully in the marketplace.
The Process of Performing an External Audit
Relationships between Key external Forces and an organization are shown in the figure above. Changes in the external forces translate into changes in consumer demand for both industrial and consumer products and services. External forces affect the types of products developed, the nature of positioning and market segmentation strategies, the types of services offered, and the choice of businesses to acquire or sell. External forces directly affect both suppliers and distributors. Identifying and evaluating external opportunities and threats enables organizations to develop a clear mission, to design strategies to achieve long-term objectives, and to develop policies to achieve annual objectives.
The process of performing an external audit must involve as many managers and employee as possible. As emphasized in earlier chapters, involvement in the strategic-management process can lead to understanding and commitment from organizational members. Individuals appreciate having the opportunity to contribute ideas and to gain a better understanding of their firm’s industry, competitors and markets.
To perform an external audit must gather competitive intelligence and information about economic, social, cultural, demographic, environmental, political, governmental, legal, and technological trends. Individuals can be asked to monitor various sources of information, such as key magazines, trade journals, and newspapers. These persons can submit periodic scanning reports to a committee of managers charged with performing the external audit.
Once information is gathered, it should be assimilated and evaluated. A meeting or series of meetings of managers is needed to collectively identify the most important opportunities and threats facing the firm. These key external factors should be listed on flip charts or a chalk board. A prioritized list of these factors should be obtained by requesting that all managers rank important opportunity/threat. These key external factors can vary over time and by industry.
Freund emphasized that these 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 of divisional areas. A final list of the most important key external factors should be communicated and distributed widely in the organization.
Industrial Organization (I/O) View
The competitive forces developed by Michael Porter are examples of the view of strategy that places primary importance on external conditions faced by the firm. In this view, strategy is about the firm creating for itself a ‘market position’ whereby it can defend itself from competitive forces that analyzes determinants of firm and market organization as between competition and monopoly, including from government actions. At Milka Krem, their external audit is performed by identifying such forces and assessing how these forces will affect their business.
Legal factor has an impact on Milka Krem since it is necessary for a business to acquire a business permit from the government and registration at Security and Exchange Commission and BIR that certify that Milka Krem is operating legally in Science City of Munoz to avoid queries and ethical issues that might affect it. Pricing strategy of this firm is affected by tax and advertising expenses in distributing the products that’s why most of the products they offer are relatively high. Environmental Issues
Since Milka Krem offers fresh and natural products they are making sure that the carabaos are well taken care of. Milka Krem provides clean and good quality products that are approved by ISO an integrated management system which is implemented by the firm to satisfy customers and to give them the best quality service. Another proof that the firm is an environmental friendly is their concern to CSR(Corporate Social Responsibility) by properly segregating their waste, Milka Krem have their own waste management process by disposing and dividing garbage into non biodegradable and biodegradable.
Milka Krem can’t stand alone hence it’s not an independent firm. Some of the funds came from the PCC and government that serve as their financial support in buying the raw materials of their product, especially the payment for smallholder dairy farmers in exchange for the buffalo’s milk. In addition there’s a fund worth of P 200 million 2kr grant from Japan government for the establishment of the Milka Krem. Milka Krem at the near future will not be under the governance of PCC. It will be a quasi-company partly own by the private sector and the government. The private sectors will have forty percent share in managing the firm and the sixty percent will be for the government. The control is still in the government since they have a larger percentage share in the ownership of the firm. Economic Forces
Home economy situation
Presently, our country imports 99% of our milk and other dairy product requirements. For this, our country spends around US $460 million annually, making milk the top 4th agricultural import. Supporting the local dairy industry will help our country in saving precious foreign exchange being spent for milk and dairy product importations. There are now provinces and towns in our country which are into buffalo raising and producing regular supply of buffalo milk as a health alternative. One of these is the province of Nueva Ecija. At present, the dairy cooperatives in the province produce 1,200 to 1,400 liters of buffalo milk daily. The Philippine President signed an agreement regarding the ASEAN free trade this coming 2015. Josef Yap, the president of state-owned think tank Philippine Institute for Development Studies (PIDS), said that without a strategy in place, the Philippines was not ready for many things, including its membership to the World Trade Organization (WTO) in 1995 or various free trade agreements (FTAs) undertaken in recent years. The Philippines will become a free trade area which means that other countries can operate their own business here in our country without tariffs that will surely affect our economy since new entrants of firms will come within our country. Milka Krem is bothered regarding this issue because there’s an information that New Zealand and Austraila are planning to sell their dairy products here in the Philippines which surely be more cheaper than others. Social Factors
The Science City of Muñoz wherein Milka Krem was located is a 4th class city, hence, people were able to survive, can provide their personal needs and sometimes can also buy add on products.
Since cow’s milk is usually more popular than carabao’s milk, the market finds it hard at first to accept products made from carabao’s milk. The conventional stereotype is that the carabao is only used in plowing rice fields. Demographic
The population of buffalos is decreasing every year that it consequently affects the supply of milk since the primary producer of fresh milk is the animal itself. The decrease in population of buffalos is very alarming to the business because it will highly affect its production. Consumer attitudes and opinions
Acceptance of foods with specific health characteristics, and price of the product depends largely on the consumers’ attitude and opinions in particularly with the type of product that is new to the market and not well known. Others opinions regarding the price, quality and service provided by the firm can significantly influence other consumers purchase decisions so it’s important for marketers to understand the mindset of their target audience. Although some customers do not agree and hesitant to buy at Milka Krem because some of its products offered were relatively high price, the manager still didn’t get affected by those negative comments instead she takes that consumer’s opinion as a motivation to prove that what customers pay is worth the price. Regarding the taste some says that they couldn’t even differentiate if cow’s milk or carabao’s milk is used. One thing is certain though, you can identify the freshness of the pastries – it is chewy, milky, and the flavor is strong (a good indication that they are not cutting down the ingredients). And others were well informed because all products have expiration date printed on the packaging to guarantee freshness. The regular customers appreciate the whole place exudes warmth and quite ambiance. It is a good place to have a long chat with business partners as few people goes inside the place because it has free wifi connection. Technological Factors
Milka Krem’s dairy products production seems to be the best because its machieneries and facilities are well installed and maintained by the Thailanders who were professional in that kind of production. The machine that were used in making Milka Krem’s dairy products are very sensitive in such case that they have to use mineral water instead of usual water because of its hardness can ruin the effective capacity of the machine . Milka Krem has the largest dairy processing plant in Central Luzon. It has a state-of-the-art processing facilities that produce a highly quality products. Because of the technological advancement of Milka Krem other firms also have their products processed there. The technology that they have is an advantage for the firm since they can be more competitive and flexible with their products. Fresh and natural products are the characteristics of Milka Krem products so the milk should be processed promptly to maintain its freshness thus its technological force is very helpful and advantageous to the firm. Competitive forces
Milka Krem has indirect competitor which is Macky’s Café that was also located at Science City of Munoz. It has its sister company called the PCC Product Outlet, which has been in the business of selling end products for years now. Since buffalo’s milk is the primary product of the business, the competition is not high enough compared to the cow’s milk industry because milk products from buffalos have not yet penetrated markets as of now. For Milka Krem, there are no other businesses offering products made of carabao’s milk in the near vicinity.
Competitive Intelligence Programs
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. Competitive intelligence is not corporate espionage because 95 percent of the information a company needs to make strategic decisions is available and accessible to the public. The sources of competitive information include trade journals, want ads, newspaper articles, and government filings, as well as customers, suppliers, distributors, competitors themselves, and the Internet. Information gathering from these sources can also make the difference between having superior or just average intelligence and overall competitiveness of an organization over its rival firm. The Internet has become an excellent medium for gathering competitive intelligence. An easier way to gather information on your competitor can be obtain through this. This is why firms’ find a way to secure their information wherein it cannot be easily gathered and not available for public view for the organizations own good, not to be copied by rival firms. Hiring top executives from rival firms is also a way companies obtain competitive intelligence. These top executives are the one who are aware of the things that are happening to the firm. They know the strength and weaknesses of the organization where they are currently employed. If they were hired by the rival firm, their ideas about the former organization, where they have worked, can help the firm to develop strategies that can exceed the strategies of their rival firm. For example, if an organization hired the current marketing manager of Milka Krem, who knows the operation and current standing of the business, then that organization will benefit from the information that will come from the marketing manager. Unethical tactics such as bribery, wiretapping, and computer break-ins should never be used to obtain information. An organization can be sued if this unethical tactics are used. Competitive information is equally applicable for strategy formulation, implementation, and evaluation decisions. An effective competitive information program allows all areas of a firm to access consistent and verifiable information in making decisions. The more information and knowledge a firm can obtain about its competitors, the more likely it is that it can formulate and implement effective strategies. Major competitors’ weaknesses can represent external opportunities; major competitors’ strengths may represent key threats. The gathered data of the director of competitive analysis can help the organization to develop strategies that can be used to strengthen the organization. If the organization is aware about the strengths and weaknesses of its rival firm, then it can develop the weakness of their rival firm to be their competitive advantage and they can implement strategies that can exceed the strength of their rival firm. For example, if a firm wants to develop a product made out of buffalo’s milk, and it will be based on Science City of Munoz or San Jose, then its nearest competitor would be Milka Krem. For the firm to be able to exceed the current operation or standing of Milka Krem then it will gather information about its rival firm. The firm must know the strengths and weaknesses of its rival firm, then that organization will benefit from the information that will be the basis of their decisions on making their rival firms weakness to be their strength and to implement ways to exceed the strengths of their rival firm. Some of the firm extended their function on their organizational charts under job titles such as Director of Competitive Analysis, Competitive Strategy Manager, Director of Information Services, or Associate Director of Competitive Assessment. The responsibilities of a director of competitive analysis include planning, collecting data, analyzing data, facilitating the process of gathering and analyzing data,
disseminating intelligence on a timely basis, researching special issues, and recognizing what information is important and who needs to know.
Competitive Analysis: Porter’s Five-Force Model
According to Porter, the nature of competitiveness in a given industry can be viewed as a composite of five forces; (a) rivalry among competing firms, (b) potential entry of new competitors, (c) potential development of substitute products, (d) bargaining power of suppliers, and (e) bargaining power of consumers.
Rivalry among Competing Firms
Rivalry among competing firms is usually the most powerful of the five competitive forces. The strategies pursued by one firm can be successful only to the extent that they provide competitive advantage over the strategies pursued by rival firms. Changes in strategy by one firm may be met such as lowering prices, enhancing quality, adding features, providing services, extending warranties, and increasing advertising.
The intensity of rivalry among competing firms tends to increase as the number of competitors increases, as competitors become more equal in size and capability, as demand for the industry’s products declines and as price cutting becomes common.
As rivalry among competing firms intensifies, industry profits decline, in some cases to the point where an industry becomes inherently unattractive.
Potential Entry of New Competitors
When new firms enter a particular industry, the intensity of competitiveness among firms will increase. Despite numerous barriers to entry, new firms sometimes enter industries with higher-quality products, lower prices, and substantial marketing resources.
Potential Development of Substitute Products
The presence of substitute products puts a ceiling on the price that can be charged before consumers will switch to the substitute product. Producers of sugar, for example, face similar pressures from artificial sweeteners. The magnitude of competitive pressure derived from development of substitute products is generally evidenced by rivals’ plans for expanding production capacity as well as by their sales and profit growth numbers.
The competitive strength of substitute products is best measured by the inroads into the market share those products obtain, as well as those firms’ plans for increased capacity and market penetration.
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, few good substitute raw materials, or when the cost of switching raw materials is costly. It is often the best interest of both suppliers and producers to assist each other with reasonable prices, improved quality, and development of new services, just-in-time deliveries, and reduced inventory costs, thus enhancing long-term profitability for all concerned.
Backward integration strategy can be used to gain control or ownership of suppliers. This strategy is especially effective when suppliers are unreliable, too costly, or not capable of meeting a firm’s needs on a consistent basis.
In more industries, sellers are forging strategic partnerships with select suppliers in efforts to (1) reduce inventory and logistics costs (2) speed the availability of next-generation components, (3) enhance the quality of the parts and components being supplied and reduced defect rates, and (4) squeeze out important costs savings for both themselves and their suppliers.
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. The bargaining power of consumers can be the most important force affecting competitive advantage.
Rivalry among Competing Firms
Potential Entry of New Competitors
Milka Krem may see the entry of new competition in the market as its Opportunity or Threat to their business. Milka Krem may consider supplying their products on retailers teaming up newly established entrepreneurs. Milka Krem will benefit from this action in general and new entrepreneurs may in turn treat such action as opportunities to diversify and enhance their knowledge about product management and risk taking. Potential Development of Substitute Products
One of the emerging milk products in the market today is buffalo’s milk. It is being introduced as a substitute product for cow’s milk. Since Milka Krem uses buffalo’s milk, they consider themselves as the first mover in the market to offer products such as coffees, pastillas, cheese, etc. that is made from buffalo’s milk. Bargaining Power of Suppliers
The overall raw milk supply of Milka Krem comes from the small cooperatives in the area of Munoz and Nueva Ecija, which aligns to the objectives of Milka Krem to help them increase their level of profitability. Through the milk supplied by the dairy farmers the demand in the market for Milka Krem products are produced. Milka Krem may also communicate with dairy cooperatives so that projected product demand may be satisfied with sample raw milk supply. These cooperatives gives the best quality of milk with reasonable prices. Milka Krem would take actions in increasing the number of suppliers in the market by offering dairy cooperatives with assistance programs and modules thereby increasing the number of buffalo kept for dairy procedures. This action would then potentially aid Milka Krem in complying with its target raw milk supply. This action is still subject to constraints of keeping and maintaining the buffalo healthy for production purposes. Bargaining Power of Consumers
The company may closely monitor preferences of customers. If it proves that the customers tend to purchase imported dairy products, they should change strategies and shift into differentiation strategies that would at least balance competition. Strong product differentiation can lead to enhanced product recognition that consumers would then prefer.
Industry Analysis: The External Factor Evaluation (EFE) Matrix External Factor Evaluation (EFE) matrix method is a strategic-management tool often used for assessment of current business conditions. The EFE matrix is a good tool to visualize and prioritize the opportunities and threats that a business is facing. It is one way to organize the external factors into generally accepted categories of opportunities and threats as well as to analyzed how well a particular company’s management (rating) is responding to these specific factors in light of the perceived importance (weight) of the factors to the company. An External Factor Evaluation (EFE) Matrix allows strategists to summarize and evaluate economic, social, cultural, demographic, environment, political, governmental, legal, technological, and competitive information. Illustrated in table 3-12, the EFE Matrix can be developed in five 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. Recall that Edward Deming said, “In God we trust. Everyone bring data.” 2. Assign 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 high weights if they are especially severe or threatening. Appropriate weights can be determined by comparing successful by unsuccessful competitors or by discussing the factor and reaching a group consensus. The sum of all weights assigned to the factor must equal to 1.0. 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 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 the total weighted score. 5. Sum the weighted scores for each variable to determine the total weighted score for the organization. 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 was to existing opportunities and threats in its industry. In other words, the firm’s strategies effectively take advantage of existing opportunities and minimize the potential adverse effects of external threats. A total score of 1.0 indicated that the firm’s strategies are not capitalizing on opportunities or avoiding external threats.
An example of an EFE Matrix is provided in Table 3-12 for Milka Krem. Note that the most important factor to being successful in this business is “Increasing milk demand in the market.” as indicated by the 0.14 weight. Note that you may have 1, 2, 3, or 4 anywhere down the rating column. Note also that the factors are stated in quantitative terms to extent possible, rather than being stated in vague terms. Qualify the factors as much as possible in constructing an EFE Matrix. Finally, note that the total weighted score of 2.69 is above the average (midpoint) of 2.5, so this milk business is doing pretty well, talking advantage of the external opportunities and avoiding the threats facing the firm. There is definitely room for improvement, though, because the highest total weighted score would be 4.0.
TABLE 3-12 EFE Matrix for Milka Krem
Key External Factors| Weight| Rating| Score|
External Opportunities| | | |
1. Increasing milk demand in the market.| 0.14| 3| 0.42| 2. Established dairy cooperatives as source of milk.| 0.08| 4| 0.32| 3. Development of imported-like dairy products processed locally.| 0.11| 4| 0.44| 4. Increase market acceptance and awareness.| 0.09| 1| 0.09| 5. New entrepreneurs creating further demand for milk.| 0.05| 2| 0.10| 6. Growing number of health conscious individual.| 0.06| 4| 0.24| External Threats| | | |
7. Slow development of new products.| 0.07| 1| 0.07| 8. Customer complaints on the products and service offered.| 0.06| 2| 0.12| 9. Possible spoilage or affected quality of dairy products if travelled.| 0.05| 2| 0.10| 10. Decreasing number of buffalo and pregnant animals.| 0.04| 2| 0.08| 11. Backyard selling of milk produced by farmers.| 0.10| 4| 0.40| 12. Superior quality imported products.| 0.07| 1| 0.07| 13. Limited promotional support from the government| 0.08| 3| 0.24| Total| 1| | 2.69|
The Competitive Profile Matrix (CPM)
CPM allows the strategists to identify the company’s major competitors and its particular strengths and weaknesses in relation to a sample form’s strategic position. EFE and CPM have the same meaning in both the weights and total weighted scores. However, CPM covers both the internal and external issues. CPM does not rely on opportunities and threats only. But this comparative analysis provides important internal strategic information. The rating of the table is as follows; 4 = major strength, 3 = minor strength, 2 = minor weakness, and 1 = major weakness.
An Example Competitive Profile Matrix|
| | Company 1| Company 2| Company 3|
Critical Success Factor| 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| 4| 0.40| Management| 0.10| 4| 0.40| 3| 0.20| 3| 0.30|
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| | 2.5| | 2.70|
*rating multiply by weight=score.
Company 1 is higher than Company 2 and Company 3 by 0.65 and 0.45 respectively. Not because the Company 1 is higher than Company 2 to by 0.65 means that Company 1 is better than Company 2. It only shows where the company excels and where it lacks for better decision making. Competitive Profile Matrix- Milka Krem|
| | Milka Krem| Macky’s Cafe| |
Critical Success Factor| Weight| Rating| Score| Rating| Score| | | Product Quality| 0.2| 4| 0.8| 2| 0.4| | |
Location Of Business| 0.1| 3| 0.3| 1| 0.1| | |
Advertisement| 0.05| 2| 0.1| 2| 0.1| | |
Customer Loyalty| 0.2| 3| 0.6| 2| 0.4| | |
Management Experience| 0.1| 4| 0.4| 2| 0.2| | |
Price Competitiveness | 0.2| 2| 0.4| 4| 0.8| | |
Technological Advantages| 0.15| 4| 0.6| 2| 0.3| | | Total| 1.00| | 3.2| | 2.3| | |