Strategic Management

Dr. Karim Kobeissi

Chapter 3: The External Audit

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. 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. The

external audit stage of the strategic management process is

revealed in the next slide.

A Comprehensive Strategic-Management Model

The Process of Performing an External Audit

The process of performing an external audit must involve as

many managers and employees as possible.

To perform an external audit, a company must first (1) gather

competitive information about economic, social, cultural,

demographic, environmental, political, governmental,

legal, and technological trends. Individuals can be asked to

monitor various sources of vital information, such as the

internet, suppliers, distributors, salespersons, customers,

and competitors.

The Process of Performing an External Audit (con)

Once information is gathered, it should be assimilated and evaluated to (2) collectively identify the most important opportunities and threats facing the firm. These key external factors – forces- should be:

a) Important to achieving long-term and annual objectives

b) Measurablec) Applicable to all competing firmsd) Hierarchical in the sense that some will affect the

overall company while others will narrowly be focused on divisional or functional areas.

The Process of Performing an External Audit

key External

Forces

Measurable

Important to achieving long-term and annual objectives

Applicable to all competing firms

Hierarchical

Major External Forces

External forces can be broken down into five broad

categories:

1) Economic forces

2) Social, cultural, and demographic forces

3) Political, governmental and legal forces

4) Technological forces

5) Competitive forces

Economic Forces

An important part of the external audit is the identification and

interpretation of the main economic forces:

- Economic cycles

- Evolution of the Gross Domestic Product (the total value of goods

produced and services provided in a country during one year)

- Interest rate

- Monetary policy

- Unemployment rate

- Inflation rate

- Disposable income (income remaining after deduction of taxes and

social security charges, available to be spent or saved as one wishes)

Social, Cultural, and Demographic Forces

An important part of the external audit is the identification and interpretation of the main social cultural, and demographic forces:

- World population (7.2 billion in 2013 8 billion in 2028 9 billion in 2054)

- Life time (older population)- Distribution of revenues (growing gap between rich

and poor)- Changing lifestyles- Consumerism- Education levels

Political, Governmental and Legal Forces

The increasing global interdependence between

economies, markets, governments and

organizations, makes it imperative that companies

consider the possible impact of the political,

governmental and legal (laws on monopolies,

government stability, fiscal policy, labor law , safety

standards ...) forces on the formulation and

implementation of competitive strategies.

Technological Forces

Technological forces represent major opportunities and threats that must be considered in formulating strategies. In fact, technological advancements have changed the very nature of opportunities and threats by:

- Changing manufacturing and distribution processes- Changing marketing practices- Creating new markets- Result in a proliferation of new and improved products- Changing the relative competitive cost positions in an industry- Rendering existing products obsolete- Reducing or eliminating cost barriers between businesses - Changing values and expectations of customers. - creating new competitive advantages that are more powerful than

existing advantages changing competitive positions

Technological Forces

The main technological forces that have dramatic impacts on business:

- Public and private investments in technology

- Rate of obsolescence of technological products

- Transfer of information through information technology

- Usage rate of technological products (mobile, internet ...).

Example of the Impact of Wireless Technology on Different Industries

• Airlines—Many airlines now offer wireless technology in flight.• Automotive—Vehicles are becoming wireless.• Banking—Visa sends text message alerts after unusual transactions.• Education—Many secondary (and even college) students may use smart

phones for math because research shows this to be greatly helpful.• Energy—Smart meters now provide power on demand in your home or

business.• Health Care—Patients use mobile devices to monitor their own health, such

as calories consumed.• Hotels—Days Inn sends daily specials and coupons to hotel guests via text

messages.• Market Research—Cell phone respondents provide more honest answers,

perhaps because they are away from eavesdropping ears.• Politics—President Obama won the election partly by mobilizing Facebook

and MySpace users, revolutionizing political campaigns. Obama announced his vice presidential selection of Joe Biden by a text message.

• Publishing—eBooks are increasingly available.

Competitive Forces

An important part of the external audit is to identify

the competitors and determine their:

• Strengths & Weaknesses

• Capacities

• Riposte to all external variables

• Goals

• Strategies

• Vulnerability to our alternative strategies

Competitive Forces - Competitive Intelligence Programs

Competitive intelligence is a systematic process for gathering and analyzing information about the competition’s activities and general business trends to further a business’s own goals. Good competitive intelligence in business, as in the military, is one of the keys to success. 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.

Competitive Forces- Porter’s Five-Forces Model

Porter’s Five-Forces Model of competitive analysis is a widely used

approach for developing strategies in many industries (Strategic

Business Unit strategy). The intensity of competition among firms

varies widely across industries. In fact, according to Porter, the

nature of competitiveness in a given industry can be viewed as a

composite of five forces:1) Rivalry among competing firms2) Potential entry of new competitors3) Potential development of substitute products4) Bargaining power of suppliers5) Bargaining power of consumers

Porter’s Five-Forces Model of Competition

The Industrial Enterprises Approach

Industrial companies assume that their

performance is primarily affected by the external

factors (of the industry) more than their internal

factors (of the firm); hence the exceptional

importance they attach to the external audit

when formulating their strategies.

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. The EFE Matrix can be developed in five steps:

Step 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.

The External Factor Evaluation (EFE) Matrix

Step 2- Assign to each factor a weight that ranges from 0.0 (not important) to 1 (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.

The External Factor Evaluation (EFE) Matrix

Step 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.

The External Factor Evaluation (EFE) Matrix

Step 4- Multiply each factor’s weight by its rating to

determine a weighted score.

Step 5- Sum the weighted scores for each variable to

determine the total weighted score for the

organization.

The External Factor Evaluation (EFE) MatrixRegardless 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. 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 indicates that the firm’s strategies are not capitalizing on opportunities or avoiding external threats.

EFE Matrix for a Local Ten-Theatre Cinema Complex

C O M M E N T SNote that the most important factor to being successful in this business is

“Trend toward healthy eating eroding concession sales” as indicated by the 0.12 weight. Also note that the local cinema is doing excellent in regard to handling two factors, “TDB University is expanding 6 percent annually” and “Trend toward healthy eating eroding concession sales.” Perhaps the cinema is placing flyers on campus and also adding yogurt and healthy drinks to its concession menu. Note that you may have a 1, 2, 3, or 4 anywhere down the Rating column. Note also that the factors are stated in quantitative terms to the extent possible, rather than being stated in vague terms. Quantify the factors as much as possible in constructing an EFE Matrix. Finally, note that the total weighted score of 2.58 is above the average (midpoint) of 2.5, so this cinema business is doing pretty well, taking 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. As indicated by ratings of 1, this business needs to capitalize more on the “two new neighbourhoods nearby” opportunity and the “movies rented from Time Warner” threat.