Assessing Opportunities and Threats : Doing an External Analysis

Chapter 3 Assessing Opportunities and Threats: Doing an External Analysis


LEARNING OUTCOMESUse this Learning Outline as you read and study the chapter:

3.1 Describe an external analysis.3.2 Explain how to do an external analysis of an organization’s specific and general

environments.3.3 Discuss the benefits and challenges of doing an external analysis.

TEXT OUTLINE

Strategic Management in Action Case #1: Not Sold OutMovie theaters’ ticket sales rebounded in 2006 and dropped with the economy of 2008, however, getting people to come watch movies in theaters is dependent upon the following factors: continuing uncertainty over how people want their movies delivered; the impression consumers want of the movie-going experience; and being more proactive in warding off potential competition from unexpected sources. The theater industry is considering the following to try to make the movie-going experience something special: offering variable pricing, using an all-digital approach; offering more and better amenities.

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Active Learning HintHand out an “empty” outline or one with key information missing for the students to use for note taking. This incomplete outline will help the students to organize the information, but keep them actively listening for the information needed to complete the outline.

I. LEARNING OUTCOME 3.1 DESCRIBE AN EXTERNAL ANALYSIS

WHAT IS AN EXTERNAL ANALYSIS?An external analysis is the process of scanning and evaluating an organization's external environment to determine the opportunities and threats facing their organizations.

Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall1


1. Opportunities are positive external trends or changes that may help an organization improve its performance.

2. Threats are negative external trends or changes that may hinder an organization's performance.

3. It’s important to know what’s happening in the external environment so new strategies can be formulated or current strategies changed in response to the opportunities or threats. (Figure 3.1)

A. Organizations as Open Systems1. Open systems interact with and respond to its external environment.

a) Chester Barnard, an early management theorist, first suggested in 1938 that organizations functioned as systems.

b) Organizations have interrelated and interdependent parts that function as a whole. Any change in any part (or subsystem) can affect the other parts.

c) As an open system, an organization is affected by the environment and can also impact that environment. (see Figure 3.2)

[NOTE: It may help to discuss the concept of "closed systems" at this point and point out that early organizations often neglected their external environments, as many start-up businesses do today, and as a result, made decisions based on incomplete information. In short—they failed.]

B. Perspectives on Organizational EnvironmentsThe various studies of organizational environments can be summarized from two different perspectives:1. Environment as Information Perspective—the environment is viewed as a source of

information for decision making.a) A key aspect is the idea of environmental uncertainty, which is defined as the amount

of change and complexity in an organization's environment.(1) Environmental stability (Dynamic vs. Stable)—if the organization's environment is

changing rapidly, it's classified as more dynamic. If changes are minimal or slow in occurring, the environment is a more stable.

(2) Environmental complexity (Complex vs. Simple)—if decision makers must monitor a number of components in the environment, the environment is complex. If the number of environmental components is few, it's a simple environment.

(3) The more complex and dynamic the environment, the more uncertain it is and the more information that decision makers need about the environment to make appropriate decisions.

(4) The perceived uncertainty of the environment (amount of change and complexity) dictates the amount and types of information that managers need about that environment.

Strategic Management in Action: Indra Nooyi , PepsiCo What other types of external information might you want to look at? The answers to this question

might vary. PepsiCo might consider seeking information on consumer buying patterns, consumer purchasing patterns and television viewing patterns,

How would you classify PepsiCo’s environmental uncertainty (i.e., its amount of change and complexity? PepsiCo has high levels of environmental uncertainty as the organization’s environment is changing rapidly (dynamic) and the decision makers must monitor numerous components in the environment (complex).

2. Environment as Source of Resources PerspectiveThe environment is viewed as a source of scarce and necessary resources that are sought by competing organizations. These organizations may be from entirely different industries,



(i.e., all organizations compete for secretaries, clerks, and many for water or transportation); they may not be making or selling competing products.a) As the environment becomes more “hostile” (i.e., resources become harder to obtain

and control), organizations are subjected to greater uncertainty.b) Managers look for ways to acquire and control those critical resources. Do so by

monitoring the environment and making appropriate decisions based on what they see happening, keeping in mind that the environment is the source of those scarce resources.

3. Table 3.1: Summary of Two Perspectives on the EnvironmentC. Environmental Scanning and External Analysis

1. Environmental scanning allows strategic decision makers to know what's happening in the external environment so they can identify and anticipate environmental changes. This means scanning the environment and evaluating what the various data and trends mean to the organization.

2. Note that it's not enough just to know what's happening in an organization's environment—the informational needs of an organization also need to be assessed. In other words, an external analysis is needed to determine the opportunities and threats facing the organization.

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Learning Review: Learning Outcome 3.1 What is an external analysis and what does it show managers?

• The process of scanning and evaluating an organization's various external environmental sectors to determine positive and negative trends that could impact organizational performance.

How does the concept of an organization as an open system relate to external analysis?• An organization that interacts with and responds to its external environment.• As an open system, an organization is affected by the environment and can also impact that

environment. For this reason, strategic decision makers must understanding the environment and its potential impact on the organizations; hence, the need for external analysis.

What does each of the perspectives on organizational environments say?• Environment as information perspective. In this approach to organizational environments, the

environment is viewed as a source of information for decision making. Information that may reduce the level of uncertainty in decision making.

• Environment as source of resources perspective. The environment is viewed as a source of scarce and necessary resources, sought by competing organizations. The scarcer a resource, the harder it is to maintain control over resources—the more uncertainty decision makers face.

What role does environmental uncertainty play in external analysis?



• The amount of change and complexity in an organization's environment.• The more complex and dynamic the environment, the more uncertain it is and the more

information that decision makers need about the environment to be able to make appropriate decisions. The degrees of complexity and stability of the environment and the availability of resources all contribute to the level of uncertainty that strategic decision makers face.

Why do managers need to do more than just scan the environment?• It's not enough for a manager just to know what's happening in your organization's environment—

you also need to assess what this information means for your organization.

II. LEARNING OUTCOME 3.2 EXPLAIN HOW TO DO AN EXTERNAL ANALYSIS OFAN ORGANIZATION’S SPECIFIC AND GENERALENVIRONMENTS

A. External Environmental SectorsExternal vs. Internal environment: [NOTE: Some students may have difficulty separating the two operating environments at this point. This is often the case when doing a situation analysis where students list opportunities vs. strengths and weaknesses vs. threats. Therefore, though this is not discussed in the textbook, it may be necessary to take a few moments to identify the differences.]1. External: affects all competitors, not just one organization2. Internal: (studied in the next chapter) affects only the decision maker's organization3. Figure 3.3: An Organization’s External Environment

a) Specific environment describes those external environmental sectors that directly impact the organization's decisions and actions by opening up opportunities or threats. (e.g., customers, competitors, suppliers and other industry-competitive variables).

b) General environment refers to those external environmental sectors that indirectly affect the organization’s strategic decisions and actions and may pose opportunities or threats (e.g., economic, demographic, sociocultural, political-legal and technological sectors).

B. Specific EnvironmentThe specific environment consists of those external sectors with which the organization directly interacts. In other words, the specific environment includes industry and competitive variables.

Industry is a group(s) of organizations producing similar or identical products. These organizations compete for customers to purchase their products and must secure the necessary resources that are converted into products.

The strategic manager can use Porter’s model to determine external opportunities and threats by evaluating the five forces.

Porter's Five Forces Model (Figure 3.4):

Some industries are inherently more attractive than others (i.e., the profit potential for companies in those industries is greater).The strength and interaction of the five forces are what influence profit potential.

1. Current Rivalry Among Existing FirmsThe existing firms in an industry are an organization's current competitors. The more intense the rivalry among existing firms, the more profitability will suffer.a) Porter lists eight conditions that contribute to intense rivalry among existing

competitors:(1) Numerous or equally balanced competitors

(a) Constant competitive turmoil , constantly jockeying for position(2) Slow industry growth



(a) Battle for the limited market share(3) High fixed or storage costs

(a) e.g., Price cutting strategy keeps profits low(4) Lack of differentiation or switching costs

(a) Commodity-like product leads to differentiation by price and service(5) Addition of capacity in large increments

(a) Adding capacity is costly so competitors will cut prices to attract customers(6) Diverse competitors

(a) Differing philosophies or circumstances between competitors make it difficult to predict strategies in the market, which increases rivalry.

(7) High strategic stakes(a) Short run profitability may be sacrificed to succeed

(8) High exit barriers(a) Factors that keep companies competing even though they may be earning low

or negative returns on investment. Extreme tactics may be used to compete.

Strategic Management in Action: E-books and readers Using the eight conditions, assess the level of current rivalry in this industry.

Competitors: Several major competitors and numerous smaller onesIndustry growth: The industry growth remains very rapidFixed or storage costs: Relatively inexpensive fixed/storage costsDifferentiation: Though some elements of e-readers are consistent, each product has its own unique features and benefitsCapacity: If one considers such aspects as e-reader memory, variations in software, compatibility with other products, etc. as part of the capacity condition, then it is varied among competitorsDiverse competitors: Major competition has included a traditional brick-and-mortar store (Barnes & Noble), a dot-com retailer (Amazon), and computer company (Apple), thereby providing a relatively diverse set of competitorsStrategic stakes: Rivalry is high among the leading competitors as each strives to become the number one e-reader providerExit barriers: Exit barriers are relatively low for the big three in this industry, but are probably much higher for smaller or newer competitors

Which of these eight conditions do you think are the most important to the level of current rivalry in this industry? Competitors, industry growth, and strategic stakes are most likely the most important, although a case could be made for several of the others. The reason is the newness of this industry, the number and type of competitors, and the rapid advances in the evolution of the technology.

As the industry matures, do you think the intensity of rivalry will change? Explain. Most likely, the intensity will continue in the near term until a clear “winner” emerges. At that point, the intensity will probably wane.

b) Organizations’ direct competitors are the competitors that are most appropriate to evaluate. A strategic group is a set of firms competing within an industry that have similar strategies, resources, and customers. Analyzing firms within the strategic group will help to identify the level of current rivalry.

For Your Information – The Benefits of Competition Force organizations to be more innovative in products and work processes to make and deliver

products



Compels companies to be effective and efficient at what they do

2. Potential EntrantsIn addition to current competitors, organizations should also be on the lookout for organizations moving into their industry.a) Why?:

(1) Bring new capacity to the industry(2) Want to gain customers (market share)(3) May possess substantial resources that can be used to launch attacks against current

competitors(4) Threat of potential entrants depends on the barriers to entry and the reaction by

current competitors to entrants.b) Barriers to entry are obstacles to entering an industry. When barriers are high or

current competitors can be expected to take significant actions to keep newcomers out, then the threat of entry is low. A low threat of potential entrants is positive for an industry because profitability won’t be divided up among more competitors. What are the major entry barriers? Porter described seven:(1) Economies of scale(2) Cost disadvantages from other than scale (e.g., favorable access to raw materials,

favorable location; government subsidies, human resource advantages from cumulative knowledge, learning and experience).

(3) Product differentiation (e.g., brand loyalty with customers creates a high barrier).(4) Capital requirements: high initial investment will discourage newcomers.(5) Switching costs: One-time cost facing the buyer who switches from one supplier’s

product to another’s, may be monetary or psychological (e.g., cell phone or Internet service providers; new software).

(6) Access to distribution channels: costs associated with distributing the product such as price breaks to distributors.

(7) Government policy: Licensing and other standards can be costly in time and money. The more government regulations, the higher the barrier.

Strategic Management in Action: Coke and Pepsi’s Bottled Water Analyze the situation using the seven barriers to entry from the perspective of the current

competitors and from the perspective of the potential entrants.The seven barriers to entry in the bottled water business are:1) Economies of scale: Coke and Pepsi would be able to maximize economies given their current ability to market, produce, research. 2) Cost disadvantages from other than scale: Bottled water from “preferred” sources would create a disadvantage to newcomers.3) Product differentiation: Name brand “Perrier” may create a barrier for certain customer types. Also, to find a unique niche may be costly to newcomers.4) Capital Requirements: Little barriers for Coke and Pepsi as bottling capabilities are in place.5) Switching costs: Low costs for customers to switch brands.6) Access to distribution channels: Low barrier: Coke and Pepsi would have distribution in place.7) Government policy: Some barriers, for labeling, bottling regulations imposed…Coke and Pepsi would be able to meet this requirement fairly easily.

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3. Bargaining Power of BuyersBuyers are the seller's customers. If they have a lot of bargaining power, they can force prices down, bargain for higher quality or more services, or even play competitors against each other trying to see who will give them the best deal.a) The factors of buyer power are:

(1) Large volume purchases—customer is more important to the seller than seller is to the customer.

(2) Products purchased represent a significant portion of the buyer's costs or purchases—customer is more likely to bargain hunt.

(3) Products are standard or undifferentiated—the customer sees little difference in the sellers’ (competitors’) products with customer likely to play one supplier against another to find the best deal.

(4) Buyer faces few switching costs—this does not encourage brand loyalty.(5) Buyer has low profits (or has low income levels)—if the customer is earning low

profits, the customers will be looking for ways to reduce costs, hence reduce purchasing costs.

(6) Buyer's ability and resources to produce the products themselves—if customer can make the product it’s buying, then it’s in a powerful position to ask for concessions from the supplier.

(7) Product's quality isn’t important to the quality of the buyer's products or services.If buyers don’t need the industry’s products to get desired levels in their products or services, they have the power to bargain with the industry over prices and services offered.

(8) Buyer has full information/knowledge about product demand, market prices, and supplier costs—gives the customer good ammunition to get the best possible prices from suppliers.

The Grey Zone What are the ethical implications of the discussed apps? Do businesses have a responsibility to

protect their consumers? Why or why not?Ask your students if they have seen other apps that may be harmful to the population. Ask your students to name and discuss companies who are warning their consumers about the consequences of using their products on the consumer (e.g., tobacco, alcohol, and products made with olestra). Would the students have any personal ethical concerns about working for a company that may not have the consumer’s best interests at heart?

4. Bargaining Power of SuppliersIf an industry's suppliers have bargaining power, they can raise prices or reduce the quality of products that an industry purchases. An industry's suppliers include any of the providers of resources or inputs: raw materials sources, equipment manufacturers, financial institutions and even labor sources. [NOTE: Consider selecting an industry and asking the students to evaluate each factor as you discuss them.]



a) The factors of supplier power are:(1) Domination by a few suppliers and more concentration than the industry(2) Availability of substitute products (inputs)(3) Multiple industries demanding the products of suppliers(4) Importance of the product (input) to the industry(5) Supplier’s products are differentiated or if customer has switching costs—

availability of substitute or undifferentiated products(6) Ability of the supplier to enter the customer's industry and start making the product

that the customer makes

Strategic Management in Action: Apple Analyze this situation using the five competitive factors approach. Where do the opportunities and

threats appear to be for publishers?Look at Figure 3.4 and Table 3.2 to help evaluate this industry.

5. Substitute ProductsThe best way to evaluate the threat of substitute products is to ask whether other industries can satisfy the consumer need that our industry is satisfying.

[NOTE: Call attention to Table 3.2 and point out a few of the competitive evaluation factors.]Teaching Notes:

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C. General EnvironmentThe general environment includes those external environmental sectors that indirectly affect the organization's strategic decisions and actions and may pose opportunities or threats. The five main general environment sectors:1. Economic

a) The economic sector encompasses all the macroeconomic data (i.e., current statistics, forecasted trends and changes) that reflect what’s happening with the economy. It doesn't include the economic statistics of an organization’s industry. For instance, industry sales forecasts and trends aren't part of the general economic sector. However, you would look at those statistics in evaluating the industry and competitive environment. The economic sector includes:(1) Interest rates(2) Exchange rates and the value of the dollar(3) Budget deficit or surplus(4) Trade deficit or surplus(5) Inflation rates



(6) Gross National Product (GNP) or Gross Domestic Product (GDP) levels and resulting stage of the economic cycle

(7) Consumer income, spending and debt levels(8) Employment-unemployment levels(9) Consumer confidence levels(10) Workforce productivity rates

b) Evaluating the effect on the organization: Look at current information as well as forecasted trends, and determine how the change may or may not affect your organization.

c) International considerations:(1) An additional challenge is to find convenient and reliable information.(2) Most critical economic information may be the inflation rates, interest rates,

currency exchange rates, and consumer-income-spending-debt levels because these tend to be the most volatile economic factors.

Strategic Management — The Global Perspective — Increased Transportation Costs Find and graph the cost of a barrel of oil over the last 3 years. Why are transportation costs

particularly challenging for manufacturers of lower-value goods and for heavier and bulkier products? Which industries, in addition to the oil industry, might benefit from higher transportation costs?

2. Demographicsa) The demographic sector evaluates current statistical data and trends in population

characteristics. It includes the kind of information that the U.S. Census Bureau gathers:(1) Gender(2) Age(3) Income levels(4) Ethnic makeup(5) Education(6) Family composition(7) Geographic location(8) Birthrates(9) Employment status

For Your Information — The Hourglass Phenomenon Is the “hourglass” society description accurate? How do you think strategic decision makers

might be able to use this information?

b) Evaluate changes and trends, and how the trends would affect the organization. Also consider the interaction of these variables, e.g., What is the trend of the geographic location of baby boomers? Will this affect marketing?

c) International considerations: Demographics on current or target customers is relevant regardless of location. It may be difficult to find this information in some of the semi-industrialized countries, but industrialized and most larger semi-industrialized countries collect census data.

Strategic Management in Action: Walmart’s Pollo Campero Restaurant



● What are the drawbacks to Walmart partnering with the Pollo Campero restaurant? What happens if a Pollo Campero restaurant is located in all the Walmarts?

3. Socioculturala) What the country's culture is like and is it changing? What are society's traditions,

values, attitudes, beliefs, tastes, patterns of behavior and how are these changing?b) Evaluating shifts in beliefs, opinions, values, etc. to determine how these values may

influence people’s behavior in shop, work, family rearing, etc. (e.g., How has the fear of terrorism influenced buyers? What about “low carb” diet fads?)

c) International Considerations: Important to understand each country’s culture, and try to uncover any trends or changes within the culture.

Strategic Management in Action: Hallmark Cards● Go to www.hallmark.com and click on “About Hallmark” and then the “Newsroom”and then type in the word “trends.” What trends and countertrends are described there? How will these trends affect strategies at Hallmark? What could other companies learn from these descriptions?

4. Political-Legala) The various laws, regulations, judicial decisions, and political forces that are currently

in effect at the federal, state, and local levels of government.(1) It might also include regulations enacted by professional associations (e.g., FASB

—the Financial Accounting Standards Board).(2) Potential legal, regulatory, and political changes, or pending judicial decisions that

might take place and could impact your organization.(3) Table 3.3: Examples of Significant Legislation Affecting Organizations

b) Evaluate the impact regulations may have on the organization and the industry. Also consider how consumer attitudes may change toward the industry/organization due to regulation (e.g., “vices” [tobacco, alcoholic beverages, gambling]).

c) International Considerations: If operating in another country, your organization needs to know the relevant laws and regulations, and abide by them. It is also important to be aware of political changes.

d) Various trade alliances among countries are easing political and economic restrictions on trade and creating numerous opportunities and threats. Trade alliances among countries include: the North American Free Trade Agreement (NAFTA), the European Union, the Central America Free Trade Agreement, the Association of Southeast Asian Nations (ASEAN) and the African Union.

Strategic Management — The Global PerspectiveStudents will most likely oppose any taxes on e-waste. How might laws/regulations impact strategies of organizations (not the e-waste recyclers)?

5. Technologicala) Scientific or technological improvements, advancements and innovations create

opportunities and threats for an organization, such as:(1) Communications (2) Computing (3) Transportation(4) Manufacturing (5) Robotics (6) Biotechnology (7) Medicine and medical (8) Telecommunications


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(9) Consumer electronics b) Two organizational areas impacted most by technological innovations concern the

product research and development and organizational work processes. In evaluating this sector, consider how technological changes will affect your organizations products (positively or negatively) or how the changes will affect how you produce your product (the process) (e.g., computerization of an organization’s activities).

c) International Considerations: a country’s level of technological advancement is going to affect the assessment (e.g., Infrastructure required for telecommunications).

Active Learning HintHave the student read through “YOU as a Strategic Decision Maker: Building Your Skills #6,” break into groups of 4-5 students to discuss the exercise for 5 minutes. Take a poll of the student groups to see which fast food organization they think is better positioned. Ask the students to support their position.

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D. Finding Information on the External Environment and Evaluating It1. Look for specific data, statistics, analyses, trends, predictions, forecasts, inferences, or

statements made by experts, or other types of evidence of what's happening or predicted to happen in those sectors.

2. Evaluate whether or not this specific information is good or bad for your organization (i.e., does the external environment provide opportunities or threats to your organization?)

For Your Information—Spotting Trends Focus groups (i.e., moderated discussions with consumers discussing products and their attributes)

do not appear to work with teens. Teens do not articulate their opinions but will interact in observable ways with products. By observing their actions marketers can learn about product attributes that older consumers would have told them about…but older consumers have different needs and tastes. Teens do not like to be marketed to, but they do like to try new things so product demonstrators appear to be a way to introduce teens to new products without alienating them with advertising.

This informational box may be more relevant to older readers than to the typical class of college seniors. However, it may be used as starting point for discussion of why standard marketing research



doesn’t work with this group of consumers. An extension of the discussion could involve alternative methods that could be pursued in teenage marketing research.

3. Methods for collecting information:a) Informal:

(1) Customer comments(2) Reading trade journals and general news media(3) Talking with suppliers' sales representatives

b) Formal:(1) External information system (EIS) is an information system that provides

managers with needed external information on a regular basis. A more dynamic environment will require information updates more often than a less complex environment.

4. Approaching external analysisa) Identify what specific information is needed, keeping in mind that industries differ in

terms of the potential impact of these external trends.b) Study each external sector carefully and identify what information is needed to make

intelligent strategic decisions.c) Table 3.4 lists some information sources on each of the external sectors.

5. Responsibilities for External Analysis at Different Managerial Levels(remove space below)

a) The size of the organization will affect who does what type of external analysis.b) Lower Level Managers/Supervisors—encourage workers to observe and interact with

external parties such as customers and supplier representatives. Lower-level managers collect and consolidate information from their workers.

c) Middle managers—coordinate any external information provided from the different functional departments or divisional units and share this information with other organizational units that might benefit. The role of the middle manager in external analysis is to act more as an information gatherer and disseminator. Also, middle managers might monitor changes in general environmental sectors that are particularly important to their specific circumstances and use this information to make any needed strategic changes.

d) Upper management—top-level managers should evaluate external opportunities and threats.

e) Larger organizations may have a strategic planning department responsible for doing the external analysis.

For Your Information—Competitor Intelligence After visiting the www.fuld.com Web site and reviewing the Intelligence Index and CI Tools, have the

students discuss the information. Do the students think competitor intelligence has a place in external analysis? Why or why not?The Fuld site provides one consultant’s view of competitive intelligence. Have the students discussin class some of the ideas, links, and how strategists might use competitive intelligence in strategyformulation. Student teams might conduct a search to locate information about a competitor to theirfocal company if the teams are doing a strategy project. How much can the students learn about thefocal company just by looking online? This exercise will help dispel the notion that companies haveto spy on a company to really learn anything.


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Learning Review: Learning Outcome 3.2 What does the five forces model look at and how is it used?

Porter’s five forces model looks at the strength and interaction of the following five forces that influence profit potential: Current rivalry among existing firms, potential entrants, bargaining power of buyers, bargaining power of suppliers, substitute products. Porter’s five forces model determines external opportunities and threats by evaluating the five forces to determine which industries are more attractive than others (i.e., the profit potential for companies in those industries are greater).

What is examined in each of the five components of the general environment?• The five components of the general environment are: economic, demographic, socio-cultural,

political-legal, technological.• The economic environment examines: interest rates; exchange rates and the value of the dollar;

budget deficit-surplus; trade deficit-surplus; inflation rates; Gross National Product (GNP) or Gross Domestic Product (GDP) levels and resulting stage of the economic cycle; consumer income, spending, and debt levels; employment-unemployment levels; and workforce productivity rates.

• The demographics sector examines: gender, age, income levels, ethnic makeup, education, family composition, geographic location, birthrates and employment status.

• The sociocultural sector examines: a society's traditions, values, attitudes, beliefs, tastes, patterns of behavior and how are these changing.

• The political-legal sector examines: various laws, regulations, judicial decisions, and political forces that are currently in effect at the federal, state, and local levels of government (Table 3.3); regulations enacted by professional associations (such as FASB—the Financial Accounting Standards Board); and potential legal, regulatory, and political changes or pending judicial decisions that might take place and could impact your organization.

• The technological sector examines: scientific or technological improvements, advancements, and innovations create opportunities and threats for your organization including: communications, computing, transportation, manufacturing, robotics, biotechnology, medicine and medical, telecommunications and consumer electronics.

How is an external analysis done for a company that’s doing business globally?[NOTE: This question requires application of the materials presented in this section. Therefore, answers and opinions may vary widely.]

• One might wish to identify first how the information will be used. Perhaps the information will be used to support a decision for locating a facility, maybe for introducing a new product, or expanding current market coverage or penetration.

• Second, identification of sources of information will be needed.• Third, some form of comparative measures should be developed.• Finally, a method or process for interpretation of the findings will be needed.

How is information on the external environment found and evaluated?• Basically, there are two ways of obtaining environmental information:

1. Make—expend the resources to collect the data.2. Buy—hire an external source to do the research or subscribe to a service that provides general

or tailored reports.• There are two methods for collecting data:

1. Informal—customer comments, reading relevant literature and talking with suppliers and distributors.

2. Formal—develop an EIS that provides needed external information on a regular basis and conduct market or customer surveys.

• Determining which approach often comes down to a choice between time and resources—how critical is the information (time), does the organization have the expertise in-house (skill), and what are the costs (dollars).

Describe the different responsibilities for doing an external analysis.



• At the lower levels of the organization, collection of information and data and identifying trends is the primary effort.

• At mid-level management, the effort is on consolidation of information from the lower organizational levels and collection of information in their respective functional areas.

• At the upper level, the information sought focuses on the organization as a whole, the industry, competition and the marketplace.

LEARNING OUTCOME 3.3 DISCUSS THE BENEFITS AND CHALLENGES OF DOINGAN EXTERNAL ANALYSIS

III. WHY DO AN EXTERNAL ANALYSIS?

A. Benefits of Doing an External Analysis

1. It allows the manager to pinpoint opportunities and threats.2. The manager can anticipate and plan for change rather than just react to change. A

proactive manager is a manager who anticipates changes and plans for those changes accordingly. For example, lobbying is just one way managers can proactively manage their external environment.

3. The external analysis provides the information that strategic managers use in planning, decision making and strategy formulation.

4. The organization's ability to acquire and control needed resources depends on having strategies that take advantage of the environment's abundant resources and strategies that cope with the environment's limited resources.

5. The realization that today's external environment is increasingly dynamic. Turbulent market conditions, fragmented markets, less brand loyalty, more demanding customers, rapid changes in technology and intense global competition—these are just a few of the images used to describe today's business environments.

6. An external analysis does appear to make a difference. Various research studies generally have shown that in organizations where strategic decision makers did external analyses, performance (return on assets or growth in profitability) was higher.

B. Challenges of Doing an External Analysis1. The environment might be changing more rapidly than one realistically can keep up with.2. The amount of time that can be consumed.3. Forecasts and trend analyses are not actual fact. They’re the best predictions that experts

have about what they believe is going to happen.

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Learning Review: Learning Outcome 3.3 List some benefits of doing an external analysis.

• Provides the information that strategic managers use in planning, decision making and strategy formulation.

• Allows the manager to be proactive, rather than reactive, to changing market and industry conditions.

Discuss the challenges associated with doing an external analysis.• Rapid change, Time consuming, Identifying accurate forecasts and trends and Availability of data

and information.

QUESTIONS?

THE BOTTOM LINE

Learning Outcome 3.1: Describe what an external analysis is. External analysis: process of scanning and evaluating the external environment in order to

identify opportunities and threats. Opportunities: positive external trends or changes that may help improve the organization’s

performance; threats: negative trends or changes that may hinder the organization’s performance.

Based on the idea that organizations are open systems, which means they interact with and respond to their environment.

Two perspectives on organizational environments: (1) environment as information is based on the idea of environmental uncertainty: amount of change and complexity in organization’s environment; the more dynamic and complex the environment, the more uncertainty there is and the greater the need for information; (2) environment as source of resources is based on the idea that as environments become more hostile, the more difficult it is to obtain and control resources; managers monitor environment in order to acquire and control those needed resources.

Important to scan and evaluate external environment.Learning Outcome 3.2: Explain how to do an external analysis of an organization’s specific and general environments.

External sectors are classified as specific (customers, competitors, suppliers and other industry-competitive variables) and general (economic, demographic, sociocultural, political-legal, and technological).

Specific environment is analyzed using Porter’s five forces model: (1) Current rivalry is evaluated by 8 factors: number of competitors and how balanced their market shares are, rate of industry growth, level of fixed or storage costs, amount of differentiation and switching costs, capacity increments required, diversity of competitors, extent of strategic stakes, and extent of exit barriers (those factors that keep companies competing in an industry); current competitors may be determined by strategic group (a group of industry firms that have similar strategies, resources, and customers); (2) potential entrants is determined by 7 factors: barriers to entry (obstacles to entering an industry) including economies of scale, cost disadvantages from other than scale, product differentiation, capital requirements, switching costs (one-time costs a buyer faces when switching from one competitor’s product to another), access to distribution channels, and government policy protection; (3) bargaining power of buyers is determined by



8 factors: how much the buyer purchases, whether those purchases represent a significant portion of buyer’s costs, how much standardization or differentiation products have, whether buyer faces switching costs, level of buyer’s profits or income, buyer’s ability to manufacture products being purchased, how important products are to buyer, and how much information buyer has; (4) bargaining power of suppliers is determined by 7 factors: how many suppliers there are and how concentrated they are, whether there are substitute products, how important industry is to supplier, how important supplier’s products are to industry, level of differentiation and switching costs, and can industry do what supplier provides; and (5) threat of substitute products, which is determined by whether there is another industry that can satisfy customers’ needs.

The general environment includes 5 sectors that are evaluated. (1) economic, which looks at all the macroeconomic data that reflect what’s happening with the overall economy; (2) demographics, which looks at current data and trends in population characteristics—census-type information; (3) sociocultural, which looks at current data and trends in society and culture—values, attitudes, behavior patterns, and so forth; (4) political-legal, which looks at laws, regulations, judicial decisions, and political forces; and (5) technological, which looks at scientific or technological innovations.

When looking for external information, look for data, statistics, analyses, trends, predictions, forecasts, inferences, or statements made by experts.

External analysis can be informal and unscientific or more formal using an external information system (EIS), an information system that provides managers with needed external information on a regular basis.

In smaller and medium-sized organizations, external analysis needs to be done by all employees, especially those on the front-line. In larger organizations, external analysis is usually the responsibility of managers.

Learning Outcome 3.3: Discuss the benefits and challenges of doing an external analysis. The benefits include: (1) proactive managers: managers who anticipate changes and plan for

those changes instead of simply reacting; (2) provides information used in planning, decision making, and formulating strategy; (3) helps organizations get needed resources – environment as source of resources; (4) helps organizations cope with uncertain environments – environment as source of information; and (5) makes a difference in organization’s performance.

The challenges include: (1) rapidly changing environment can be hard to keep up with; (2) time-consuming; and (3) forecasts and trend analyses aren’t perfect.

Suggestions for using YOU as Strategic Decision Maker: Building Your Skills exercises

1. Assign as an out-of-class group exercise to further discuss the impact of external economic conditions on the strategic planning process. This might be an excellent assignment to ask the students to predict what industries might be able to develop and sustain a competitive advantage. [Learning Outcome 3.1: Describe an external analysis; Course Level Objectives: Explain how to evaluate a firm’s external environment; AACSB: Use of information technology]

2. Good exercise to bring out the impact of changing culture on strategic planning. This exercise could be expanded to include some examples (e.g., current events or from the students’ experiences) of fads or fashion for six- to ten-year-olds. This exercise might also be a good discussion starter about whether a less complex external analysis is better than a more thorough and complex external analysis. [Learning Outcome 3.2: Explain how to do an external analysis of an organization’s specific and general environments; Course Level Objectives: Explain how to evaluate a firm’s external environment; AACSB: Reflective thinking skills]

3. Discuss in small student groups and ask each group to report its findings to the class. You may consider focusing the class by selecting a given industry for the purpose of discussion. You might also ask the students the downside of businesses making decisions based on the less-than-current



economic data provided by the government. [Learning Outcome 3.1: Describe an external analysis; Course Level Objectives: Explain how to evaluate a firm’s external environment; AACSB: Analytic skills, Use of information technology]

4. Provides an opportunity to discuss “demographics” as a source of external influence on the organization. The impact of demographic change on both sides of the transformation process (e.g., the changing labor market and on customers and markets) might make for a good class discussion. [Learning Outcome 3.3: Discuss the benefits and challenges of doing an external analysis; Course Level Objectives: Explain how to evaluate a firm’s external environment]

5. This could be assigned as an out of class assignment. The students might do well to interview baby boomers, namely their parents, to see if their parents might be able to identify the opportunities and threats for different industries. [Learning Outcome 3.3: Discuss the benefits and challenges of doing an external analysis; Course Level Objectives: Explain how to evaluate a firm’s external environment]

6. Students are generally very familiar with these two fast-food chains. If your area does not have one of these, you might consider, as an alternative, other national restaurants such as Burger King, Taco Bell, or Pizza Hut. Use these familiar companies to press the students’ understanding of organizational strategy and positioning. [Learning Outcome 3.3: Discuss the benefits and challenges of doing an external analysis; Course Level Objectives: Explain how to evaluate a firm’s external environment; AACSB: Reflective thinking skills]

7. Additionally, you may wish to include how these values may vary in different cultures in other parts of the world. Ask the students if they feel they have seen a change or sense a change in the United States’ cultural values during their lifetimes. [Learning Outcome 3.3: Discuss the benefits and challenges of doing an external analysis; Course Level Objectives: Explain how to evaluate a firm’s external environment; AACSB: Reflective thinking skills]

8. Discuss in small student groups in-class and ask each group to report its findings to the class. You might also ask the students the downsides and upsides of communicating honestly and openly with employees. [Learning Outcome 3.3: Discuss the benefits and challenges of doing an external analysis; Course Level Objectives: Explain how to evaluate a firm’s external environment; AACSB: Reflective thinking skills]

Strategic Management in Action Cases

Case #1 Not Sold Out

1. External trends, part of the general environment, movie theater chains’ strategic managers have to deal with are: continuing uncertainty over how people want their movies delivered; the impression consumers want of the movie-going experience; and being more proactive in warding off potential competition from unexpected sources. Ask the students whether or not these trends are of equal importance to the movie theater chains. [Learning Outcome 3.3: Discuss the benefits and challenges of doing an external analysis; Course Level Objectives: Explain how to evaluate a firm’s external environment]

2. Opportunities in this situation include: trying to make the movie-going experience something special through offering variable pricing, using an all-digital approach; offering more and better amenities.



Threats in this situation include: the popular video web site YouTube owned by Google as well as the consumers’ perception of the movies’ cost, noise, inconvenience, uncomfortable seats, overcrowding and too many reviews/commercials before the movie. [Learning Outcome 3.2: Explain how to do an external analysis of an organization’s specific and general environments; Course Level Objectives: Explain how to evaluate a firm’s external environment; AACSB: Reflective thinking skills]

3. Movie theater chains’ corporate headquarters strategic decision makers will be interested in entertainment costs, real estate costs, wages in the area in which the theater operates and income level data for area to be served by a store. In addition, knowing the plans that entertainment competitors have for new location openings, discounting plans, sourcing capabilities and cost structure would all help movie theater chains’ corporate headquarters strategic decision makers decide how they should respond or how high the level of competitive rivalry will be in any given market.

Local movie theater managers would be most interested in employment statistics, wage rates and competitor promotional sales plans. These managers will also want to understand what their local consumers’ entertainment tastes are (e.g., tastes in the cosmopolitan New York City will be different than that of the hip west coast). [Learning Outcome 3.2: Explain how to do an external analysis of an organization’s specific and general environments; Course Level Objectives: Explain how to evaluate a firm’s external environment; AACSB: Reflective thinking skills]

4. The external trends should help formulate the strategies used by the movie theater chains. For example, if the trend is for a really comfortable theater experience, then the movie theater chains may remodel and upgrade their theater seating. [Learning Outcome 3.1: Describe an external analysis; Course Level Objectives: Explain how to evaluate a firm’s external environment; AACSB: Reflective thinking skills]

Case #2 Being the Best

1. He did not scan; he experimented out of necessity and found a formula that appeared to work. He does see what is happening to his stores. Best Buy is large and successful but that also means that making a bad choice can have wide-ranging and expensive consequences, (i.e., economies of scale in reverse as errors are multiplied across many chain stores and larger quantities of merchandise, bigger ad budgets and more employees). Best Buy can withstand some experimentation but will need to scan to ensure that rivals and trends do not lead to major gaps in its product or service offerings thereby opening the door to competitors. [Learning Outcome 3.2: Explain how to do an external analysis of an organization’s specific and general environments; Course Level Objectives: Explain how to evaluate a firm’s external environment; AACSB: Reflective thinking skills]

2. Buyer power: Best Buy is the largest customer for many products giving it significant buyer power. There are many brands and most are hard to differentiate so they can be traded-off against each other further increasing buyer power and a corresponding decline in supplier power due to commoditization of most products. Best Buy will also be able to use its own house brand to further lever concessions from suppliers. If supplier margins drop too low, there might be pressure for suppliers to move toward acquiring distribution capacity and capture distributors’ profits creating new competition for Best Buy.

Rivalry is high with Circuit City and a number of regional electronics discounters trying to keep ahead of Best Buy. These competitors provide legitimate alternatives to Best Buy for consumers and aggressively discount and/or price match.



New entrants on a national or international scale are unlikely as the territory gets saturated with existing retailers. It becomes very hard to achieve scale economies because most markets are competitive. Virgin might be a company to watch out for as it could tie in its entertainment stores with selling electronics but they would be less likely to go into home appliances.

Substitutes are unlikely to emerge in the short-run. In the long-run, Best Buy can probably retail the substitute as part of its product line. Relocation of buyers to the Internet can also be tapped by all of the players in the industry so it is unlikely that a substitute will emerge in a form in which Best Buy cannot participate. [Learning Outcome 3.2: Explain how to do an external analysis of an organization’s specific and general environments; Course Level Objectives: Explain how to evaluate a firm’s external environment; AACSB: Analytic skills]

3. Economic: Growth rate in disposable income and the level of new home sales and remodeling trends drive demand for many major appliances and entertainment devices (e.g., home theatre technology).

Demographics: Changes in the United States’ population’s gender, age, income levels, ethnic makeup, education, family composition, geographic location, birthrates and employment status.

Sociocultural: Changes in the United States’ society’s traditions, values, attitudes, beliefs, tastes and patterns of behavior.

Technology: New devices entering the market quickly with shorter time from development to market drive product selection decisions and employee training needs. MP3 is likely to replace CD media and DVD will put pressure on CD sales as it expands.

Political-Legal: Internet sales remain tax free but there might be an advantage to Best Buy to encourage sales tax on the Internet to drive more customers to the stores. If Best Buy becomes too dominant the Federal Trade Commission may prohibit further acquisitions. [Learning Outcome 3.2: Explain how to do an external analysis of an organization’s specific and general environments; Course Level Objectives: Explain how to evaluate a firm’s external environment; AACSB: Analytic skills]

4. Wifi and related wireless technologies may make it so we can be connected continuously to the Internet creating a situation for people that Sirius and other satellite broadcast services do for cars. This could reduce demand for retail CDs or their replacement products as people opt to listen to music via wireless connections. Best Buy and its rivals could sell the devices needed to do this but would lose sales of the music media.

The trend toward home theatres and for building new homes with theatres in them appears to be accelerating making an opportunity to sell more expensive and elaborate systems as people budget more for home entertainment. More luxurious kitchens and baths may put Best Buy and other discounters on the defensive as high-end products are more in demand (e.g., fancy baths and sinks from Kohler Co.). [Learning Outcome 3.2: Explain how to do an external analysis of an organization’s specific and general environments; Course Level Objectives: Explain how to evaluate a firm’s external environment]

5. Where are competitors that are similar to Best Buy located? Can they gain access to market sites for big stores…in Europe, large sites are expensive and hard to find. Best Buy would need to understand how suppliers will reach new countries with large volumes of products and at what price. Distribution may be too expensive to keep Best Buy as a discounter…they may have to shift emphasis from discounting to being a provider of many brands at reasonable prices to sustain profit margins if costs shift. Demographic trends in home ownership and in appliance buying: Will



Europeans buy CDs and washing machines from the same store? How will design trends for appliances in Europe and elsewhere affect purchasing by European consumers? [Learning Outcome 3.2: Explain how to do an external analysis of an organization’s specific and general environments; Course Level Objectives: Explain how to evaluate a firm’s external environment, Explain how strategies are implemented in international business; AACSB: Reflective thinking skills]

6. Visit the Web site. [AACSB: Analytic skills]

Case #3 Dressing Up

1. Convenience and time constraints on Moms. Price conscious shoppers. Malls are trendy…clothing sold in many mall stores is not accepted by Moms due to its extreme style or its extremeprice. Location and living preferences…movement to new subdivisions…movement to revitalizeddowntown areas. To keep track of these changes, managers can go visit the coasts. New York Cityand Southern California tend to lead the trends in “lifestyle” products and entertainment (famousactors help drive style choices). Focus groups made up of customers that they want to target or ofcustomers who will soon enter the customer type that Kohl’s wants to target (try to anticipate futurecustomer needs). [Learning Outcome 3.2: Explain how to do an external analysis of an organization’s specific and general environments; Course Level Objectives: Explain how to evaluate a firm’s external environment; AACSB: Reflective thinking skills]

2. Managers will be interested in clothing costs, real estate costs, wages in the area in which the store operates, locations available for store construction, income level data for area to be served by a store. In addition, knowing the plans that competitors have for new store openings, discounting plans, sourcing capabilities and cost structure would all help Kohl’s managers decide how they should respond or how high the level of competitive rivalry will be in any given market.

Local managers would be most interested in employment statistics, wage rates and competitor promotional sales plans. They will also want to understand what their local consumers’ tastes are…for example fashion demand in the beach areas of south L.A. (surfer-wear) will be different than that of coastal communities in Maine (L.L. Bean). [Learning Outcome 3.2: Explain how to do an external analysis of an organization’s specific and general environments; Course Level Objectives: Explain how to evaluate a firm’s external environment]

3. Kohl’s saw a market that was changing as women had families later giving them more money to spend but also making them less trendy and more value conscious. Also, mothers wanted good value and selection in a location that was easy to get in and out of with children in tow. By making their stores convenient and value-priced in locations near where Moms shop they came up with a winning recipe for clothing sales. [Learning Outcome 3.3: Discuss the benefits and challenges of doing an external analysis; Course Level Objectives: Explain how to evaluate a firm’s external environment; AACSB: Use of information technology]

4. Kohl’s saw an opportunity to move shoppers from traditional mall stores to their closely located, but more convenient and more value oriented stores. By sensing the needs of young mothers Kohl’s was able to take advantage of the growing demographic trend of women with young children who valued shopping convenience, price and selection of fashionable but not overly trendy clothing. Kohl’s managers need to be aware that the young children will grow to be the trendy teens of tomorrow and who may resist shopping where their moms shopped. This will lead to a drop in demand for Kohl’s unless it can somehow recapture these former customers. But to do this might risk making Kohl’s too trendy for its best customers—Moms. To reach the next generation will Kohl’s have to change its formula? See if the students have some thoughts on this issue…do they shop now where they shopped as kids? [Learning Outcome 3.2: Explain how to do an external



analysis of an organization’s specific and general environments; Course Level Objectives: Explain how to evaluate a firm’s external environment]


Assessing Opportunities and Threats : Doing an External Analysis

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