Chapter 3

Strategy Management: Performing External Assessment Environmental Scanning is the monitoring, evaluating, and disseminating of information from the external and internal environments to key people within the corporation.

The nature and degree of competition in an industry hinge on five forces: 1) 2) 3) 4) 5)

the the the the the

threat of new entrants bargaining power of customers bargaining power of suppliers threat of substitute products pr services jockeying among current contestants.

To establish a strategic agenda for dealing with these contending currents and to grow despite them, a company must understand how they work in its industry and how they affect the company in its particular situation. Hence, environmental scanning or external assessment is a step where a firm identifies opportunities that could benefit it and threats that it should avoid.

The factors that could influence a firm and its strategy cold be broadly divided into the following categories: The industrial organization (I/O) view 1) 2) 3) 4) 5)

Economic Forces Social, Cultural, Demographic, and environmental forces Political, governmental, and legal forces Technological forces Competitive Forces.

These external forces may threaten the attainment of the entity’s objectives or, conversely, present opportunities that could benefit the entity. External forces affect the types of products/services an entity develops and offers, the nature of its market positioning and marketing strategies, its relationships with vendors and suppliers, the nature of alliances it forms, and its relationships with customers. Identifying and :evaluating opportunities and risks posed by external forces allows the entity to develop

• A clear vision and an explicit statement of mission; • Detailed objectives and effective strategies for achieving those objectives; • Effective and efficient policies and procedures to implement strategic plans and to achieve detailed objectives. Table 1 provides examples of factors that one might consider when specifying and analyzing each of these broad external force categories. Analysis of the external forces confronting an entity should not seek to develop an exhaustive listing of every possible factor. Rather, such analysis should seek to identify those factors that pose the greatest risks to, and offer the greatest opportunities for, the entity achieving its objectives. These key external factors should be such that the entity has the potential of responding, either offensively or defensively, through appropriate strategic planning and management of business processes to the risks and opportunities that the factors pose.

The industrial organization (I/O) view

External (industry) factors are more important than internal factors in a firm achieving competitive advantage. The industry has a stronger influence on the firm’s performance than do the internal functional decisions managers make in marketing, finance, and the like.

Economic forces

Economic forces have a direct impact on the potential attractiveness of various strategies. For example, when interest rates rise, funds needed for capital expansion become more costly or unavailable.

Social, cultural, demographic, and environmental forces

They have a major impact upon virtually all products, services, markets, and customers. Social, cultural, demographic, and environmental trends are shaping the way people live, wok, produce, and consume. New trends are creating a different type of consumer and, consequently, a need for different products, different services, and different strategies.

Political governmental and legal forces

National, state, and local governments are major regulators, deregulators, subsidizers, employers, and customers of organizations. Political, governmental and legal factors, therefore, can represent key opportunities or threats for both small and large organizations. Laws, regulatory agencies, and special interest groups can have a major impact on the strategies of small, large, for profit, and nonprofit organizations.

Technological forces

Revolutionary technological changes and discoveries are having a dramatic impact on organizations. Technological forces influence organizations in several ways. A technological innovation can have a sudden and dramatic effect on the environment of a firm. Technological developments can significantly alter the demand for an organization's or industry's products or services.

The Internet is acting as a national and global economic engine that is spurring productivity, a critical factor in a country’s ability to improve living standards. The Internet is changing the very nature of opportunities and threats by altering the life cycle of products, increasing the 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.

Competitive forces All firms compete for consumers dollars. It is not only important to focus on your direct competitors but also all marketers that target your customers and therefore compete with you for their income. Collecting and evaluating information on competitors is essential for successful strategy formulation. Competition in virtually all industries can be described as intense –and sometimes as cutthroat.

Competitive Intelligence  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 Sources of Competitive Intelligence            

Internet Employees Managers Suppliers Distributors Customers Creditors Consultants Trade journals Want ads Newspaper articles Government filings

 Competitors Objectives of Competitive Intelligence The objective of good competitive intelligence is to understand your industry, and your competition, so well that you can predict their next moves, exploit their weaknesses, counter their strengths and gain control of new opportunities before they are widely recognized. It is not enough to track competitors’ press releases (though sometimes this would be a good start). Real competitive intelligence is both a data-gathering and an analytic program. It must identify and understand established vendors and emerging sources of competition. But to gain a competitive edge requires tracking many other elements of the competitive landscape, including emerging technologies, new substitute products, leading executives, sales and R&D talent, potential legal & regulatory changes, new buying trends, M&A activity among competitors and suppliers, and so on. Out of this information, it must systematically generate actionable information -- information that can be used to improve your company's sales, profits and performance.  Provide a general understanding of industry and competitors  Identify areas where competitors are vulnerable and assess impact of actions on competitors  Identify potential moves that a competitor might make

Process of Performing an External Assessment The process of conducting external environment assessment starts with collating information and intelligence on factors affecting the external environment as highlighted above: economic, social, political, technological factors etc. Designated individuals will then monitor these factors though various sources like magazines, trade journal, publications, newspapers etc. They will then submit periodic report to the top management which provides them with continuous strategic information about the environment.

Once information is gathered, there will be series of meetings which will assess and evaluate the opportunities and threats that are present in the market. This assessment will help firm’s align its future strategies with the result of this assessment.

How Does the External Audit Affect Other Components of the Strategic Management Process? Strategic management takes account of factors in the external business environment. The strategic management process is an approach to making major decisions on your company’s future direction and strategy. You identify internal strengths and weaknesses, and external threats and opportunities, using the information to establish long-term objectives and choose which strategies to pursue. An external audit provides information on the threats and opportunities in the business environment that could impact your strategic decisions on issues such as new product development, market entry or exit, mergers and acquisitions, and resource allocation.

Audit: An external audit provides information on many different elements of the business environment, including competitive activity, economic conditions, social and cultural trends, demographic changes, political attitudes to business, and regulatory changes. You can carry out the audit by monitoring websites and industry publications, as well as general business magazines. Alternatively, you can hire a research firm to carry out an independent audit.

Product Development: Product development is an integral part of the strategic management process. The external audit affects product development by highlighting market opportunities and competitive threats. Use the information to focus on developing products that will enable you to enter attractive new markets. External audit results also indicate the need to improve or upgrade existing products so that they meet or exceed competitors’ performance levels.

Markets:

Your marketing strategy is a key element of strategic management. Information from the external audit indicates threats and opportunities that could impact your success in existing markets. Changes in the regulatory environment, for example, may open the market to new competitors, while changing economic conditions may reduce overall demand for a particular sector. Use the external audit results to select market sectors that offer you the most profitable growth opportunities.

Resources: An internal audit of strengths and weaknesses balances the external audit. The internal audit indicates whether you have the skills and resources needed to meet the external threats and opportunities. The results will affect your recruitment and training strategy. You may want to add new external skills and resources to improve your current capability. A mergers and acquisitions strategy is therefore an important element of strategic management. If the external audit indicates market opportunities that you could not exploit with current resources, consider a merger or acquisition.

Flexibility: Strategic management is a dynamic process that enables your company to adapt quickly to changing business and market conditions. But in order to be effective, your external audit results need to be integrated seamlessly into your overall strategic management process. Because the people who implement the plan are typically not the same people who do the external audit, it is crucial to communicate any goals formed through the external audit process, and to clearly communicate the reasons for forming them, as those who do not understand the basis for a goal can't effectively execute it. In addition, it is important to attach specific measures to each of the goals the company forms in its strategic management process -- particularly if the goals are driven by external audits that will force significant change on the company's existing culture or structure. Setting large goals is fine, but successful attainment of those goals will be much more likely if a big goal is broken into small, measurable steps to mark progress -- or lack of progress -- along the way. The external environment in which a business operates can create opportunities which a business can exploit, as well as threats which

could damage a business. However, to be in a position to exploit opportunities or respond to threats, a business needs to have the right resources and capabilities in place. An important part of business strategy is concerned with ensuring that these resources and competencies are understood and evaluated - a process that is often known as a "Strategic Audit".

The process of conducting a strategic audit can be summarized into the following stages: (1) Resource Audit: The resource audit identifies the resources available to a business. Some of these can be owned (e.g. plant and machinery, trademarks, retail outlets) whereas other resources can be obtained through partnerships, joint ventures or simply supplier arrangements with other businesses. You can read more about resources here.

(2) Value Chain Analysis: Value Chain Analysis describes the activities that take place in a business and relates them to an analysis of the competitive strength of the business. Influential work by Michael Porter suggested that the activities of a business could be grouped under two headings: (1) Primary Activities - those that are directly concerned with creating and delivering a product (e.g. component assembly); and (2) Support Activities, which whilst they are not directly involved in production, may increase effectiveness or efficiency (e.g. human resource management). It is rare for a business to undertake all primary and support activities. Value Chain Analysis is one way of identifying which activities are best undertaken by a business and which are best provided by others ("outsourced"). You can read more about Value Chain Analysis here.

(3) Core Competence Analysis: Core competencies are those capabilities that are critical to a business achieving competitive advantage. The starting point for analysing core competencies is recognising that competition between businesses is as

much a race for competence mastery as it is for market position and market power. Senior management cannot focus on all activities of a business and the competencies required to undertake them. So the goal is for management to focus attention on competencies that really affect competitive advantage. You can read more about the concept of Core Competencies here.

(4) Performance Analysis The resource audit, value chain analysis and core competence analysis help to define the strategic capabilities of a business. After completing such analysis, questions that can be asked that evaluate the overall performance of the business. These questions include:

- How have the resources deployed in the business changed over time; this is "historical analysis" - How do the resources and capabilities of the business compare with others in the industry - "industry norm analysis" - How do the resources and capabilities of the business compare with "best-in-class" - wherever that is to be found- "benchmarking" - How has the financial performance of the business changed over time and how does it compare with key competitors and the industry as a whole? - "ratio analysis"

(5) Portfolio Analysis: Portfolio Analysis analyses the overall balance of the strategic business units of a business. Most large businesses have operations in more than one market segment, and often in different geographical markets. Larger, diversified groups often have several divisions (each containing many business units) operating in quite distinct industries. An important objective of a strategic audit is to ensure that the business portfolio is strong and that business units requiring investment and management attention are highlighted. This is important - a business should always consider which markets are most attractive and which business units have the potential to achieve advantage in the most attractive markets.

Traditionally, two analytical models have been widely used to undertake portfolio analysis: - The Boston Consulting Group Portfolio Matrix (the "Boston Box"); - The McKinsey/General Electric Growth Share Matrix

(6) SWOT Analysis: SWOT is an abbreviation for Strengths, Weaknesses, Opportunities and Threats. SWOT analysis is an important tool for auditing the overall strategic position of a business and its environment.

Purposes of an External Audit External auditors review a firm's operations, internal controls and financial reporting.

An external audit is an evaluation of an entity's operations, governance, internal controls and financial reporting. It is usually conducted by external auditors from public accounting firms, government agencies or consulting companies. The primary purpose of an external audit is to provide an independent and unbiased assessment of an organization's internal governance and financial health.

Increasing Investor Confidence Investors read audit reports prepared by external auditors to make investment decisions--for instance, to buy, hold or sell a security. They rely on the external auditor--or examiner--to verify internal procedures in place, verify the methodologies used in preparing financial statements and provide an objective view of the entity's operations. Investors might also review audit reports to assess how the firm's senior managers perform and how their actions affect its reputation, competitiveness and profitability.

Reassuring Industry Regulators Industry regulators review external audit reports to evaluate an entity's adherence to industry standards and principles. For instance,

many companies listed on stock exchanges must file audited financial information with exchange regulators at the end of the quarter or year--this is the case for all firms listed on the New York Stock Exchange (NYSE) or the NASDAQ. Similarly, financial institutions operating in some capital markets--for instance, commodities futures markets--must file quarterly or annual reports with the Commodities Futures Trading Commission.

Helping Government Agencies Regulate Government agencies use reports prepared by external auditors to increase their knowledge of an organization's operations and adherence to laws applicable in their jurisdictions. They also use audit information as a basis for their enquiries or investigations. For example, the U.S. Securities and Exchange Commission might use audit report information to start an insider-trading enquiry at a company. Similarly, insurance commissioners might use audit information to enquire about a firm's practices and adherence to state insurance laws.

Supplementing Internal Audits

External audit reports help an entity's senior management evaluate the adequacy and effectiveness of existing internal controls. The internal audit department also relies on external audit reports to plan, review and execute annual audit programs. For instance, internal audits might allocate more resources on areas highlighted as risky by external auditors in prior examinations. Similarly, the entity's compliance department might use audit information prepared by outsiders to focus on areas where ethical issues have been raised. External audit reports are also incorporated in the firm's audit committee report presented to the board of directors. The primary objective of Starting a Competitive Intelligence Function is to provide an introduction to the necessary elements that provide the groundwork for creating an effective competitive intelligence function in your organization. This publication provides guidance and information on all aspects of starting a competitive intelligence function, from organizational issues to required resources to internal processes.

Contents include the processes, best practices, and operating procedures that chart the path to competitive intelligence success. It provides a checklist on what needs to be done before you actually start producing competitive intelligence (the groundwork – what you do before you put the nameplate on the door). The publication will also include case studies of successful (and unsuccessful) efforts.

Market Commonality  The number and significance of markets that a firm competes in with rivals

Resource Similarity  Extent to which the type and amount of a firm’s internal resources are comparable to a rival Competitive Analysis: Porter’s Five-Forces Model As illustrated, Porter’s five-forces model of competitive analysis is a widely used approach for developing strategies in many industries.

The nature of competitiveness in a given industry can be viewed as a composite of five forces:

1. 2. 3. 4. 5.

Rivalry among competing firms Potential entry of new competitors Potential development of substitute products Bargaining power of suppliers Bargaining power of consumers

Porter explains that there are five forces that determine industry attractiveness and long-run industry profitability. These five "competitive forces" are - The threat of entry of new competitors (new entrants) - The threat of substitutes - The bargaining power of buyers - The bargaining power of suppliers - The degree of rivalry between existing competitors

Threat of New Entrants New entrants to an industry can raise the level of competition, thereby reducing its attractiveness. The threat of new entrants largely depends on the barriers to entry. High entry barriers exist in some industries (e.g. shipbuilding) whereas other industries are very easy to enter (e.g. estate agency, restaurants). Key barriers to entry include - Economies of scale - Capital / investment requirements - Customer switching costs - Access to industry distribution channels - The likelihood of retaliation from existing industry players.

Threat of Substitutes The presence of substitute products can lower industry attractiveness and profitability because they limit price levels. The threat of substitute products depends on: - Buyers' willingness to substitute - The relative price and performance of substitutes - The costs of switching to substitutes

Bargaining Power of Suppliers Suppliers are the businesses that supply materials & other products into the industry. The cost of items bought from suppliers (e.g. raw materials, components) can have a significant impact on a company's profitability. If suppliers have high bargaining power over a company, then in theory the company's industry is less attractive. The bargaining power of suppliers will be high when: - There are many buyers and few dominant suppliers - There are undifferentiated, highly valued products - Suppliers threaten to integrate forward into the industry (e.g. brand manufacturers threatening to set up their own retail outlets) - Buyers do not threaten to integrate backwards into supply - The industry is not a key customer group to the suppliers

Bargaining Power of Buyers Buyers are the people / organisations who create demand in an industry The bargaining power of buyers is greater when - There are few dominant buyers and many sellers in the industry - Products are standardised - Buyers threaten to integrate backward into the industry - Suppliers do not threaten to integrate forward into the buyer's industry - The industry is not a key supplying group for buyers

Intensity of Rivalry The intensity of rivalry between competitors in an industry will depend on: - The structure of competition - for example, rivalry is more intense where there are many small or equally sized competitors; rivalry is less when an industry has a clear market leader

- The structure of industry costs - for example, industries with high fixed costs encourage competitors to fill unused capacity by price cutting - Degree of differentiation - industries where products are commodities (e.g. steel, coal) have greater rivalry; industries where competitors can differentiate their products have less rivalry - Switching costs - rivalry is reduced where buyers have high switching costs - i.e. there is a significant cost associated with the decision to buy a product from an alternative supplier - Strategic objectives - when competitors are pursuing aggressive growth strategies, rivalry is more intense. Where competitors are "milking" profits in a mature industry, the degree of rivalry is less - Exit barriers - when barriers to leaving an industry are high (e.g. the cost of closing down factories) - then competitors tend to exhibit greater rivalry.

Forecasting Tools and Techniques 

Forecasts are educated assumptions about future trends and events  Quantitative techniques – most appropriate when historical data is available and there is a constant relationship  Qualitative techniques

Assumptions 

Estimates of future events based upon the best available information in the present

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.

The EFE matrix is very similar to the IFE matrix. The major difference between the EFE matrix and the IFE matrix is the type of factors that are included in the model. While the IFE matrix deals with internal factors, the EFE matrix is concerned solely with external factors. External factors assessed in the EFE matrix are the ones that are subjected to the will of social, economic, political, legal, and other external forces.

How do I create the EFE matrix? Developing an EFE matrix is an intuitive process which works conceptually very much the same way like creating the IFE matrix. The EFE matrix process uses the same five steps as the IFE matrix. List factors: The first step is to gather a list of external factors. Divide factors into two groups: opportunities and threats. Assign weights: Assign a weight to each factor. The value of each weight should be between 0 and 1 (or alternatively between 10 and 100 if you use the 10 to 100 scale). Zero means the factor is not important. One or hundred means that the factor is the most influential and critical one. The total value of all weights together should equal 1 or 100. Rate factors: Assign a rating to each factor. Rating should be between 1 and 4. Rating indicates how effective the firm’s current strategies respond to the factor. 1 = the response is poor. 2 = the response is below average. 3 = above average. 4 = superior. Weights are industryspecific. Ratings are company-specific. Multiply weights by ratings: Multiply each factor weight with its rating. This will calculate the weighted score for each factor. Total all weighted scores: Add all weighted scores for each factor. This will calculate the total weighted score for the company. You can find more details about this approach as well as about possible values that the EFE matrix can take on the IFE matrix page.

What should I include in the EFE matrix?

Now that we know how to construct or create the EFE matrix, let's focus on factors. External factors can be grouped into the following groups: • • •

Social, cultural, demographic, and environmental variables: Economic variables Political, government, business trends, and legal variables

Below you can find examples of some factors that capture aspects external to your business. These factors may not all apply to your business, but you can use this listing as a starting point.

Social, cultural, demographic, and environmental factors... -

Aging population Percentage or one race to other races Per-capita income Number and type of special interest groups Widening gap between rich & poor Number of marriages and/or divorces Ethnic or racial minorities Education Trends in housing, shopping, careers, business Number of births and/or deaths Immigration & emigration rates

Economic factors...

-

Growth of the economy Level of savings, investments, and capital spending Inflation Foreign exchange rates Stock market trends Level of disposable income Import and export factors and barriers Product life cycle (see the Product life cycle page) Government spending

-

Industry properties Economies of scale Barriers to market entry Product differentiation Level of competitiveness (see the Michael Porter's Five Forces model)

Political, government, business trends & legal factors...

-

Globalization trends Government regulations and policies Worldwide trend toward similar consumption patterns Internet and communication technologies (e-commerce) Protection of rights (patents, trade marks, antitrust legislation) Level of government subsidies International trade regulations Taxation Terrorism Elections and political situation home and abroad

What is Competitive profile Matrix – CPM Competitive profile matrix is essential tool used in strategic management process, it contain all the important critical success factors of industry. Success factor can vary form industry to industry, every industry consider different success factor, all the companies in CPM are measured on same scale by considering the same success factor. In IFE we only consider internal strengths and weakness and EFE constraint is to consider only internal factor from PLEST (Political, legal, environmental, social and technological) but Competitive profile matrix is not bound by any constraint, all the success depends upon the importance it can be external or internal doesn’t matter. Competitive Profile Matrix (CPM) is a strategic management tool which is used to identify the major strengths and weaknesses of a firm in relation to the rival’s firm strategic position. On the basis of this comparison, the firm can design wise offensive or defensive strategies.

Two types of systems can be used for the construction of competitive profile matrix i.e. weighted rating system (each measure of critical success factor is assigned a weight based on its perceived importance) and unweighted (each critical success factor measured is assumed to be equally important) rating system. It is important to note that the meaning of weights and total weighted scores is same in both EFE (external factor evaluation) and CPM (competitive profile matrix).

Differences between EFE and CPM

Following are some of the important differences between EFE (external factor evaluation) and CPM (competitive profile matrix). In competitive profile matrix, critical success factors include both internal and external issues. In external factor evaluation, critical success factors are grouped into opportunities and threats whereas such grouping does not exist in competitive profile matrix. In external factor evaluation, total weighted scores of a firm can not be compared to the total weighted scores of rival firms whereas such comparison is possible in competitive profile matrix.

Steps in the Construction of CPM Here we will be using weighted rating system for the construction of competitive profile matrix. Some of the important steps involved in the construction of competitive profile matrix are given below. In the first column, lists down all the key success factors of Industry (usually from 6 to 10). In the second column, assign weights to each factor ranging from 0.0 (not important to 1 (most important). Greater weights should be given

to those factors which have grater influence on the organizational performance. The sum of all weights must equal 1. Now rate each factor ranging from 1 to 4 for all the firms in analysis. Here, rating 1 represents major weakness, rating 2 shows minor weakness. Similarly, rating 3 indicates minor strength whereas rating 4 shows major strength. It means that weakness must receive 1 or 2 rating while strength must get 3 or 4 rating. Calculate weighted score by multiplying each factor’s score by its rating. Find the total weighted score of all the firms by adding the weighted scores for each variable.