CHAPTER 2
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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.
External trends and events
significantly affect all products,
services, markets, and organizations in
the world.
2
contd
Not only must managers be aware of
environmental forces and environmental change,
they must manage the organization’s resources to
take advantage of opportunities and counter
threats.
The strategic leader should ensure that this
happens and that the values and culture of the
organization are appropriate for satisfying the key
success factors.
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complexity and dynamism
Quite often complexity and dynamism
occur together. Technology-based industries
and Internet-based businesses are excellent
examples of this.
Managers will need to be open and
responsive to the need for change and
flexible in their approach if they are to
handle complexity successfully.
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THE INDUSTRIAL ORGANIZATION (I/O) VIEW
The Industrial Organization (I/O): advocates
that external (industry) factors are more
important than internal factors in a firm
achieving competitive advantage.
Proponents of the I/O view, such as Michael
Porter, contend that organizational
performance will be primarily determined by
industry forces.
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I/O theorists deal with that external factors
in general and the type of industry in which
a firm chooses to compete has a stronger
influence on the firm’s performance.
Effective integration and understanding of
both external and internal factors is the key
to securing and keeping a competitive
advantage.
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7
contd
Changes in external forces translate into
changes in consumer demand for both
industrial and consumer products and
services.
External forces affect:
the types of products developed,
the type of services offered
the nature of market segmentation,
targeting and positioning strategies, and
the choice of businesses to acquire or sell.
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Ansoff’s model
Ansoff (1987) contends that ‘to survive and succeed in
an industry, the firm must match the aggressiveness of
its operating and strategic behaviors to the
changeability of demands and opportunities in the
marketplace’.
Ansoff suggests that the more turbulent the
environment is, the more aggressive the firm must be
in terms of competitive strategies and
entrepreneurialism or change orientation if it is to
succeed.
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.
The extent to which the environment is
changeable or turbulent depends on factors:
changeability of the market environment
speed of change
intensity of competition
pressures from governments and influence groups.
10
contd
Ansoff suggests that the environment
should be analyzed in terms of competition
and entrepreneurship or change.
Ansoff is really arguing that the resources
of the organization and the values must be
congruent with the needs of the
environment.
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12
Key External Forces
External forces can be divided into five broad
categories:
(1) Economic forces;
(2) Social, cultural, demographic, and
environmental forces;
(3) Political, governmental, and legal forces;
(4) Technological forces; and
(5) competitive forces.
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1. ECONOMIC FORCES
Economic factors have a direct impact
For example, if interest rates rise, then funds
needed for capital expansion become more
costly or unavailable.
The key economic variables that a firm should
monitor are: (1) availability of credit; (2) level
of disposable income; (3) propensity of people
to spend; (4) interest rates; (5) inflation rate;
(6) unemployment trends; and so on.
14
Trends in the dollar’s value have significant
and unequal effects on companies in
different industries and in different
locations.
A low value of the dollar means lower
imports and higher exports; it helps U.S.
companies’ competitiveness in world
markets.
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2. SOCIAL, CULTURAL, DEMOGRAPHIC, AND
ENVIRONMENTAL FORCES
Social, cultural, demographic, and environmental
changes have a major impact on virtually all products,
services, markets, and customers.
Small, large, for-profit, and nonprofit organizations in
all industries are being staggered and challenged by
the opportunities and threats arising from changes in
social, cultural, demographic, and environmental
variables.
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Key Social, Cultural, Demographic, and Natural
Environment Variables are:
Childbirth rates
Number of special-interest groups
Number of marriages
Number of divorces
Attitudes toward retirement
Attitudes toward leisure time
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3. POLITICAL, GOVERNMENTAL, AND LEGAL
FORCES
For industries and firms that depend heavily
on government 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.
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Local, state, and federal laws, regulatory
agencies, and special interest groups can have
a major impact on the strategies of
organizations.
Increasing global competition accents the
need for accurate political, governmental, and
legal forecasts.
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.
key political, governmental, and legal variables
are:
Government regulations or deregulations
Changes in tax laws, infrastructure, power, transport
Special tariffs
Changes in patent laws
Environmental protection laws
Political conditions in foreign countries
Special local, state, and federal laws
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4. TECHNOLOGICAL FORCES
The Internet is changing the very nature of
opportunities and threats by
- altering the life cycles of products,
- increasing the speed of distribution,
- creating new products and services,
- erasing limitations of traditional geographic
markets etc.
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Science and technology have enabled:
man to conquer distances;
control birth rate;
saving lives;
discover new materials and substitutes to existing
ones;
introduce machine to do the world of human beings;
substitute mental work with computers
It increases the productivity in terms of both quality
and quantity.
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Unfavorable effects of technology on business
A new technology may destroy the industry
Introduction of new technology dislocates
some workers unless they are well equipped
to work on new machines.
Air pollution, acid rain, industrial waste
disposal, toxic waste, noise and vibrations
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5. Competitive Forces
Collecting and evaluating information about
competitors is essential for successful strategy
formulation.
Identifying major competitors is not always easy
because many firms have divisions that compete in
different industries.
Many multidivisional firms do not provide sales and
profit information on a divisional basis for competitive
reasons.
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.
PORTER’S FIVE-FORCES MODEL
According to Porter, the nature of competitiveness in a
given industry can be viewed as a composite of five
forces.
a. Rivalry among competitive firms.
b. Potential entry of new competitors.
c. Potential development of substitute products.
d. Bargaining power of suppliers.
e. Bargaining power of consumers.
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26
a. Rivalry among competing firms:
It is usually the most powerful of the five
competitive forces.
Changes in strategy by one firm may be met with
retaliatory countermoves, such as:
lowering prices,
enhancing quality,
adding features,
providing services, extending warranties, and
increasing advertising.
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The intensity of rivalry among competing
firms tends to increase:
As the number of competitors increases
When competitors become more equal in size and
capability,
When demand declines for the industry’s
products, and
When price cutting becomes common.
28
contd
If customers are loyal to brand then there will be
low competition.
If there is a little brand loyalty then competition
will be high.
If buyers are strong and there are close substitutes
available for the product then the degree of
competition rivalry will be more.
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b. Potential entry of new competitors:
Low barriers generally mean that responses will be
slower
Whenever new firms can easily enter a particular
industry, the intensity of competitiveness among firm’s
increases.
Despite numerous barriers to entry, new firms
sometimes enter industries with higher-quality
products, lower prices, and substantial marketing
resources.
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When the threat of new firms entering the market
is strong, incumbent firms generally strengthen
their positions and take actions to deter new
entrants,
such as lowering prices,
extending warranties, and
adding features
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A number of factors can create barriers to enter:
Economies of scale: if a newcomer enters the market with only
limited investment and is not able to achieve comparable economies
of scale.
Economies of scale exist in industries in which large firms can
produce goods at lower cost than small firms.
Product differentiation: If consumers perceive rival products or
services to be clearly differentiated then newcomers must also seek
to establish a distinct identity.
Newcomers will therefore have to invest in advertising and
promotion to establish their new brand, and this may be expensive.
32
contd
Capital requirements: Any requirement for
substantial investment capital in order to enter a
market is a barrier to entry.
The investment may be on capital equipment,
research and development, or advertising to establish a
market presence, and it may deter many aspiring
competitors.
Switching costs: These are not costs incurred by the
company wishing to enter the market but by the
existing customers.
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c. The threat of substitute products:
If the prices and performance of existing
product rise above that of the substitute
product, customer tends to switch to the
substitute.
Newspapers and magazines face substitute-
product competitive pressures from the
Internet and 24-hour cable television.
- Buyer will be more willing to change
substitute if switching costs are low. 34
.
d. Bargaining power of suppliers:
Suppliers affect an industry through their ability to control
prices and product quality, supplier can affect an industry’s
profit potentials,
either by increasing their prices or by reducing the
quality of good and services they provide to the
industry.
The bargaining power of suppliers affects the intensity of
competition in an industry, especially when there are a
large number of suppliers
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The conditions under which suppliers will be
powerful include:-
1. The uniqueness and scarcity of
resources that supplier provide or
dominance by few suppliers.
2. If resources are supplied to more
industries, the greater will be their
bargaining power.
36
contd
3. If the numbers of resource suppliers are
small and buyers are large then greater will
be the bargaining power of suppliers.
4. Cost of switching over to another
sources.
If the resource can’t be easily
substituted the bargaining power of
supplier will be more.
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e. Bargaining power of buyers:
Buyer’s of an industry product can exert bargaining
power over that industry by forcing prices down, by
reducing the amount of good they purchased from the
industry, by demanding better quality for the same
price.
When customers are concentrated, large, or buy in
volume, their bargaining power represents a major
force affecting intensity of competition in an industry.
Rival firms may offer extended warranties or special
services to gain customer loyalty whenever the
bargaining power of consumers is substantial.
38
contd
The other factors that lead to greater buyer power
include the following:-
- The fewer the buyers and greater the volume of
purchase, the greater will be their bargaining
power.
- If the suppliers of products are large in
comparison to the buyers, then buying power will
tend to increase.
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End of Chapter Three
Questions
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