THE EXTERNAL AUDIT A meeting or series of meetings of managers is needed to
collectively identify the most important opportunities and
This chapter examines the tools and concepts needed to threats facing the firm.
conduct an external strategic management audit These key external factors should be listed on flip charts
(sometimes called environmental scanning or industry or a chalkboard. A prioritized list of these factors could
analysis). be obtained by requesting that all managers rank the
An external audit focuses on identifying and evaluating factors identifies, from 1 for the most important
trends and events beyond the control of a single firm. opportunity/threat to 20 for the least important
The company showcased here for practicing exemplary opportunity/threat.
strategic management is Chipotle Mexican Grill.
Chipotle is a rapidly growing firm with highly motivated The Industrial Organization (I/O) View
employees who execute daily a company strategy to The Industrial Organization (IO) approach to
capitalize on the public’s increasing concern for animal competitive advantage advocates that external (industry)
welfare and preference for organic foods. factors are more important than internal factors in a firm
achieving competitive advantage.
The Nature of an Internal Audit Proponents of the I/O view, such as Michael Porter,
The purpose of an external audit is to develop a finite list contend that organizational performance will be
of opportunities that could benefit a firm as well as primarily determined by industry forces.
threats that should be avoided. Competitive advantage is determined largely by
As the term finite suggests, the external audit is not competitive positioning within an industry, according to
aimed at developing an exhaustive list of every possible I/O advocates.
factor that could influence the business; rather, it is Managing strategically from the I/O perspective entails
aimed at identifying key variables that offer actionable firms striving to compete in attractive industries,
responses. avoiding weak or faltering industries, and gaining a full
Firms should be able to respond either offensively or understanding of key external factor relationships within
defensively to the factors by formulating strategies that that attractive industry.
take advantage of external opportunities or that minimize
the impact of potential threats. Economic Forces
Key economic variables to be monitored:
Key External Factors Inflation rates Propensity of people to spend
External forces can be divided into five broad categories: Gross domestic product trend Interest rates
1. Economic forces Unemployment trends Value of dollar in world markets
2. Social, cultural, demographic, and natural environment
Import/export factors
forces
An economic variable of significant importance in
3. Political, governmental, and legal forces
strategic planning is gross domestic product (GDP),
4. Technological forces
especially across countries.
5. Competitive forces.
Trends in the dollar’s value have significant and unequal
effects on companies in different industries and in
A Comprehensive Strategic-Management Model
different locations.
Fluctuations in the dollar’s value have uneven impacts on
industries. A weaker dollar benefits exports-oriented
sectors like pharmaceuticals, tourism, and motor vehicles
because their products become cheaper for international
buyers.
Tourism is particularly sensitive; a weaker dollar
discourages Americans from traveling abroad because
their money buys less in foreign currencies, while
simultaneously attracting more foreign visitors to the
The Process of Performing an External Audit
U.S. due to the increased purchasing power of their
The process of performing an external audit must involve
currencies.
as many managers and employees as possible.
Involvement in the strategic-management process can
Social, Cultural, Demographic, and Natural Environment
lead to understanding and commitment from
Forces
organizational members.
Social, cultural, demographic, and natural environmental
A company first must gather competitive intelligence and
changes have a major impact on virtually all products,
information about economic, social, cultural,
services, markets, and customers.
demographic, environmental, political, governmental,
Small, large, for-profit, and nonprofit organizations in all
legal, and technological trends.
industries are being staggered and challenged by the
Individuals can be asked to monitor various sources of
opportunities and threats arising from changes in social,
information, such as key magazines, trade journals, and
cultural, demographic, and environmental variables.
newspapers.
Key social, cultural, demographic, and natural
After information is gathered, it should be assimilated
environment variables:
and evaluated.
Number of marriages Immigration and emigration rates
Number of divorces Life expectancy rates Many multidivisional firms do not provide sales and
Number of births Attitudes toward government profit information on a divisional basis for competitive
reasons.
Number of deaths Ethical concerns
Also, privately held firms do not publish any financial or
marketing information.
Political, Government, and Legal Forces
Addressing questions about competitors such as those
Federal, state, local, and foreign governments are major
presented in Table 3-5 is important in performing an
regulators, deregulators, subsidizers, employers, and
external audit.
customers of organizations.
Characteristics of the most competitive companies:
Political, governmental, and legal factors, therefore, can
1. Strive to continually increase market share.
represent key opportunities or threats for both small and
2. Use the vision/mission as a guide for all decisions.
large organizations.
3. Continually strive to improve everything about the
Changes in patent laws, antitrust legislation, tax rates,
firm.
and lobbying activities can affect firms significantly.
4. Continually adapt, innovate, improve especially
For industries and firms that depend heavily on
when the firm is successful.
government contracts or subsidies, political forecasts can
5. Strive to grow through acquisition whenever
be the most important part of an external audit.
possible.
Some political, governmental, and legal variables:
6. Hire and retain the best employees and managers
Government regulations or Political conditions in foreign possible.
deregulations countries 7. Strive to stay cost-competitive on a global basis.
Changes in tax laws Environmental protection laws
Special tariffs Legislation on equal employment Competitive Intelligence Program
Number of patents Changes in patent laws What is competitive intelligence? Competitive
intelligence (CI), as formally defined by the Society of
Lobbying activities
Competitive Intelligence Professionals (SCIP), is a
systematic and ethical process for gathering and
Technological Forces
analyzing information about the competition’s activities
Revolutionary technological changes and discoveries are
and general business trends.
having a dramatic impact on organizations.
Good competitive intelligence in business, as in the
The internet has changed the nature of opportunities and
military, is one of the keys to success.
threats by altering the life cycles of products, increasing
The more information and knowledge a firm can obtain
the speed of distribution, creating new products and
about its competitors, the more likely it is that it can
services.
formulate and implement effective strategies.
To effectively capitalize on e-commerce, a number of
Major competitors’ weaknesses can represent external
organizations are establishing two positions in their
opportunities; major competitors’ strengths may
firms: chief information officer (CIO) and chief
represent key threats.
technology officer (CTO), reflecting the growing
importance of information technology (IT) in strategic
Competitive Analysis: Porter’s Five-Forces Model
management.
Porter’s Five-Forces Model of competitive analysis is a
Examples of the impact of wireless technology:
widely used approach for developing strategies in many
Many airlines now offer wireless technology in industries. The intensity of competition among firms
Airlines
flight. varies widely across industries.
Automotive Vehicles are becoming wireless. The Five-Forces Model of Competition:
Banking Sends text message alerts after unusual transactions.
Many secondary (and even college) students may
Education use smart phones for math because research shows
this to be greatly helpful.
Patients use mobile devices to monitor their own
Healthcare
health, such as calories consumed.
President Obama won the election partly by
mobilizing Facebook and Myspace users,
Politics revolutionizing political campaigns. Obama
announced his vice presidential selection of Joe
Biden by a text message.
Publishing E-books are increasingly available.
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. 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 competitors, shifts in government priorities, and
that they provide competitive advantage over the changing social values.
strategies pursued by rival firms.
Potential Entry of New Competitors Making Assumptions
Whenever new firms can easily enter a particular Planning would be impossible without assumptions.
industry, the intensity of competitiveness among firms McConkey defines assumptions as the “best present
increases. estimates of the impact of major external factors, over
Despite numerous barriers to entry, new firms sometimes which the manager has little if any control, but which
enter industries with higher-quality products, lower may exert a significant impact on performance or the
prices, and substantial marketing resources. ability to achieve desired results.”
Potential Development of Substitute Products Business Analytics
Competitive pressures arising from substitute products Business analytics is an MIS technique that involves
increase as the relative price of substitute products using software to mine huge volumes of data to help
declines and as consumers’ costs of switching decrease. executives make decisions. Sometimes called predictive
analytics, machine learning, or data mining, this
Bargaining Power of Suppliers software enables a researcher to assess and use the
The bargaining power of suppliers affects the intensity of aggregate experience of an organization, which is a
competition in an industry, especially when there are few priceless strategic asset for a firm.
suppliers, when there are few good substitute raw
materials, or when the cost of switching raw materials is The External Factor Evaluation Matrix
especially high. An External Factor Evaluation (EFE) Matrix allows
strategists to summarize and evaluate economic, social,
Bargaining Power of Consumers cultural, demographic, environmental, political,
The bargaining power of consumers can be the most governmental, legal, technological, and competitive
important force affecting competitive advantage. information.
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.
Sources of External Information
A wealth of strategic information is available to
organizations from both published and unpublished
sources. Unpublished sources include customer surveys,
market research, speeches at professional and
shareholders’ meetings, television programs, interviews, The Competitive Profile Matrix
and conversations with stakeholders. The Competitive Profile Matrix (CPM) identifies a
firm’s major competitors and its particular strengths and
Forecasting Tools and Techniques weaknesses in relation to a sample firm’s strategic
Forecasts are educated assumptions about future trends position. The weights and total weighted scores in both a
and events. Forecasting is a complex activity because of CPM and an EFE have the same meaning.
factors such as technological innovation, cultural
changes, new products, improved services, stronger
Chapter Summary
Increasing turbulence in markets and industries around
the world means the external audit has become an
explicit and vital part of the strategic-management
process. This chapter provided a framework for
collecting and evaluating economic, social, cultural,
demographic, environmental, political, governmental,
legal, technological, and competitive information. Firms
that do not mobilize and empower their managers and
employees to identify, monitor, forecast, and evaluate key
external forces may fail to anticipate emerging
opportunities and threats and, consequently, may pursue
ineffective strategies, miss opportunities, and invite
organizational demise.
