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The External Assessment

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 Process of Performing an External Audit


This process should include as many managers and employees as possible because
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, an organization must;

1. 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 and can submit
periodic scanning reports to a committee of managers charged with performing an
external audit.

This approach provides a continuous stream of timely strategic information and


involves many individuals in the external-audit process.

2. The information should be assimilated and evaluated. A meeting or a 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 and ranked
from the most to the least important opportunities or threats.

The key external factors can vary overtime and by industry. Freund emphasized
that these key external factors should be;
a) Important to achieving long-term and annual objectives;
b) Measurable;
c) Applicable to all competing firms and;
d) Hierarchical in the sense that some will pertain to the overall company and
others will be more narrowly focused on functional or divisional areas.

A final list of the most important key external factors should be communicated and
distributed widely in the organization. Both opportunities and threats can be key
external factors.

The Industrial Organization (I/O) View


The I/O view approach to competitive advantage advocates that external (industry)
factors are more important than internal factors in a firm achieving competitive advantage. Its
proponents such as Michael Porter, contends that organizational performance will be primarily
determined by industry forces. I/O theorists contend that the industry in which a firm chooses
to compete has a stronger influence on the firm’s performance than do the internal functional
decisions managers make in marketing, finance, and the like. According to these theorists, Firm
Performance is primarily based more on industry properties, such as economies of scale,
barriers to market entry, product differentiation and level of competitiveness than on internal
resources, capabilities, structure and operations. However, it is not a question of whether
external or internal factors are more important in gaining and maintaining a competitive
advantage. Effective integration and understanding of both external and internal factors is the
key to securing and keeping a competitive advantage.

Resources: Fred R. David Strategic Management An Integral Approach


The External Assessment

Key External Forces


1. Economic Forces

Economic factors have a direct impact on the potential attractiveness of various


strategies. For instance, when interest rates rise, funds for capital expansion become
more costly or unavailable. Also, when interest rates rise, discretionary income declines,
and the demand for discretionary goods falls. When stock prices increase, the
desirability of equity as a source of capital for market development increases. Also,
when market rises, consumer and business wealth expands. Some are Key Economic
Variables to be monitored;
 Availability of credit
 Level of disposable income
 Interest rates
 Inflation rates
 Money market rates
 Gross domestic product trend
 Consumption patterns
 Stock market trends
 Import/export factors
 Demand shifts for different categories of goods and services
 Price fluctuations
 Income differences by region and consumer groups

2. Social, Cultural, Demographic and Environmental Forces

Social, cultural, demographic and environmental changes have a major impact


upon virtually all products, services, markets and customers. New trends are creating a
different type of consumer and consequently a need for different products, different
services, and different strategies. Some are the Key Social, Cultural, Demographic and
Environmental Forces;
 Lifestyle
 Attitudes toward work
 Buying habits
 Ethical concerns
 Attitudes toward saving
 Pollution control
 Attitudes toward product quality
 Attitudes toward customer service
 Social programs
 Recycling
 Waste management
 Pollution

3. Political, Governmental and Legal Forces

State, local and foreign governments are major regulators, deregulators


subsidizers, employers and customers of organizations that can represent key
opportunities or threats to small or large organizations. For industries and firms that
depend heavily on governmental contracts or subsidies, political forecasts can be the
most important part of an external audit. Changes in patent laws, antitrust legislation,
tax rates and lobbying activities can affect firms significantly. 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.
Political forecasting can be especially critical and complex for multinational firms
that depend on foreign countries for natural resources, facilities, distribution of products,
special assistance, or customers. Strategists today must possess skills that enable them
to deal more legalistically and politically than previous strategists whose attention was

Resources: Fred R. David Strategic Management An Integral Approach


The External Assessment

directed more toward economic and technical affairs of the firm. Strategists today are
spending more time anticipating and influencing public policy actions. They spend more
time meeting with government officials, attending hearings and government-sponsored
conferences, giving public speeches and meeting with trade groups, industry
associations and government agency directors.
Increasing global competition accents the need for accurate political,
governmental, and legal forecasts. Many strategists will have to become familiar with
political systems in Europe, Africa and Asia and with trading currency features. A world
market has emerged from what previously was a multitude of distinct national markets
and the climate for international business today is much more favorable than yesterday.
Mass communication and high technology are creating similar patterns of consumption
in diverse cultures worldwide. This means that many companies may find it difficult to
survive by relying solely on domestic markets. Some are the key Political, Governmental
and Legal variables;
 Changes in tax laws
 Tariffs
 Government regulations and deregulations
 Environmental protection laws
 Size of government budgets
 World oil, currency and labor markets
 Import-export regulations

4. Technological Forces

Revolutionary technological changes and discoveries are having a dramatic


impact on organizations. The internet is acting as a national and even a global economic
engine that is spurring productivity, a critical factor in a country’s ability to improve
living standards; and it is saving companies billions of dollars in distribution and
transaction costs from direct sales to self-service systems.
The internet is changing the very nature of opportunities and threats by altering
life cycles of products, increasing the speed of distribution, creating new products and
services and the like. To effectively capitalize on e-commerce, a number of organizations
are establishing two new positions in their firms: chief information officer (CIO) and
chief technology officer (CTO). This trend reflects the growing importance of information
technology (IT) in strategic management. A CIO and a CTO work together to ensure
that information needed to formulate, implement and evaluate strategies are available
where and when it is needed. These individuals are responsible for developing,
maintaining and updating a firm’s database. The CIO is more a manager, managing the
overall external-audit process; the CTO is more a technician, focusing on technical
issues such as data acquisition, data processing and software and hardware acquisition.
Technological advancements can create new markets, proliferation of new and
improved products and even render existing products and services obsolete. The pacing
of technological change is increasing and literally wiping out business every day. An
emerging consensus holds that technology management is one of the key
responsibilities of strategists. Firms should pursue strategies that take advantage of
technological opportunities to achieve sustainable competitive advantage in the
marketplace.

5. Competitive Forces

Collecting and evaluating information on competitors is essential for successful


strategy formulation. Identifying major competitors is not always easy because many
firms have divisions that compete in different industries. Most multidivisional firms
generally do not provide sales and profit information on a divisional basis for competitive
reasons. Also, privately held firms do not publish any financial or marketing information.
However, many businesses use the internet to obtain most of their information on
competitors. Some are key questions about competitors;
 What are the major competitors’ strengths?
 What are the major competitors’ weaknesses?

Resources: Fred R. David Strategic Management An Integral Approach


The External Assessment

 What are the major competitors’ objectives and strategies?


 How vulnerable are the major competitors to our alternative company strategies?
 How are our products and services positioned relative to major competitors?

Resources: Fred R. David Strategic Management An Integral Approach

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