CHAPTER 2
EXTERNAL ANALYSIS
What is external analysis?
The external analysis is the first stage of the auditing process. It creates the information and analysis
necessary for an organisation to begin to identify the key issues it will need to address in order to
develop a successful strategy.
Introduction
An analysis of the external environment is undertaken in order to discover the opportunities and
threats that are evolving and that need to be addressed by the organisation. A study by Diffenbach
(1983) identified a number of positive consequences that stem from carrying out organised
environmental analysis (see Figure 2.1).
Scanning
There are four forms of scanning according to Aguilar (1967). They are as follows:
1. Undirected viewing: This activity concerns the viewer exploring information in general without
carrying a specific agenda. The viewer is exposed to a large amount of varied information but
this is not an active search looking for particular issues, just a broad attempt to be aware of
factors or areas that may have changed.
2. Conditional viewing: Again this is not an organised search but the viewer is sensitive to
information that identifies changes in specific areas of activity.
3. Informal search: This is an organised but limited search for information to support a specific
goal.
4. Formal search: This type of search is actively pursued and specifically designed to seek
particular information.
Managers search for information in five broad areas (Aguilar, 1967) (see Figure 2.2):
Macro Environmental Analysis
The macro-environment audit examines the broad range of environmental issues that may affect the
organisation. This is normally referred to as a PEST (Political, Economic, Social and
Technological) analysis. The aim of this analysis is to identify the critical issues in the external
environment that may affect the organisation.
● Political/legal issues.
The structure of a political system defines the centres of political influence.Therefore when
considering this area of the environment a much wider view has to be taken than just the domestic
national government or the legal process.
● Economic factors
Economics is concerned with the allocation of resources. Therefore issues such as conservation of
natural resources, costs of pollution, energy consumption and the whole area of the management of
natural resources should be considered under this heading.
● Social/cultural issues
Demographic changes are important and can be used as lead indicators in certain areas. However
other critical areas such as social/cultural values and beliefs that are central to changes in consumer
behaviour are harder to predict and can be subject to more dramatic shifts.
● Technological developments
Identifying new technologies that can service that consumer’s needs more completely or
economically is the critical part of this area of the analysis.
Industry Analysis
An organisation has to understand the nature of the relationship within its industry, in order to allow
the enterprise to develop strategies. Porter identified five factors that affect the level of competition
within an industry :
Supplier
The power of suppliers is liable to be strong where:
● Control over supplies is concentrated into the hands of a few players.
● Costs of switching to a new source of supply are high.
● If the supplier has a strong brand.
● The supplier is in an industry with a large number of smaller disparate customers.
Buyer
● Afew buyers control a large percentage of a volume market.
● There are a large number of small suppliers.
● The costs of switching to a new supplier are low.
● The supplier’s product is relatively undifferentiated, effectively lowering barriers to alternative
sources of supply.
Potential entrants
● The capital investment necessary to enter the industry can be very high
● A well-entrenched competitor who moved into the industry early may have established cost
advantages irrespective of the size of their operation.
● Achieving economies of scale in production, distribution or marketing can be a necessity in
certain industries.
● Gaining access to appropriate distribution channels can be difficult.
● Government legislation and policies such as patent protection, trade relations with other states
and state owned monopolies can all act to restrict the entry of competitors.
● The prospect of a well-established company’s hostile reactions to a new competitor’s entry to the
market may be enough to act as a deterrent.
Substitutes
● A new product or service may eradicate the need for a previous process.
● A new product replaces an existing product or service.
● All products and services, to some extent, suffer from generic substitution
Competitive rivalry
● The stage of the industry life cycle will have an effect.
● The relative size of competitors is an important factor.
● In industries that suffer from high-fixed costs, companies will try to gain as much volume
throughput as possible, this may create competition based on price discounting.
● There may be barriers that prevent companies withdrawing from an industry. This may be plant
and machinery that is specialist in nature and therefore cannot be transferred to other uses.
This model allows an organisation to identify the major forces that are present in the industry
sector.
Competitor Analysis
Strategic groups
• Size of the company • Choice of distribution channel
• Breadth of the product range • Relative product quality
• Scope of the operation • Brand image
• Assets and skills
Strategic groups are made up of organisations within the same industry that are pursuing equivalent
strategies targeting groups of customers that have similar profiles. There is a range of attributes that
can be used to identify strategic groups. Some examples are as follows:
For each competitor in their strategic group an organisation needs, as far as possible, to establish:
1. Competitors objectives:
- Whether the competitor’s current performance is likely to be fulfilling their objectives.
- How likely the competitor is to commit further investment to the business.
- The likely future direction of the competitor’s strategy.
2. Competitor’s current and past strategies:
- Identification of the current markets, or market segments, within which the competitor
currently operates
- Identification of the way the competitor has chosen to compete in those markets.
- Comparison between the current strategy and past strategies can be instructive.
3. Competitor’s capabilities:
- Management capabilities: The background and previous approaches of leading managers in
a competitor company can give clues as to their likely future strategy.
- Marketing capabilities: An analysis of the competitor’s actions, with the marketing mix,
uncovers the areas where their marketing skills are high and also areas of vulnerability.
- Innovation capabilities: Evaluating a competitor’s ability to innovate allows an organisation
to judge how likely the rival is to introduce new products and services or even new technology.
- Production capabilities: The configuration of a competitor’s production infrastructure can
highlight areas that may place them at an advantage or conversely point out areas that are
problematic to a competitor.
- Financial capabilities: The ability to finance developments is a critical area.
4. Competitors future strategies and reactions:
- Certain retaliation: The competitor is guaranteed to react in an aggressive manner to any
challenge.
- Failure to react: Competitors can be lulled into a false sense of security in an industry that,
over a long period of time, has seen very little change.
- Specific reactions: Some competitors may react, but only to competitive moves in certain
areas.
- Inconsistent reactions: These companies’ reactions are simply not predictable.
Problems in Identifying Competitors
There are risks in the process of identifying an organization’s competitors and a number of errors
should be avoided:
• Overlooking smaller competitors by placing too much emphasizing on large visible
competitors,
• Focusing on established competitors and ignoring potential new entrants,
• Concentrating on current domestic competitors and disregarding international competitors
who could possibly enter the market.
The Market Analysis
A market analysis consist of various factors that are relevant to the particular situation.
• Actual & potential market size ─ estimating the total sales, identifying the key sub-markets
of the market and potential areas of growth.
• Trends ─ analyzing general trends in the market.
• Customers ─ who is the customers and what criteria they use to judge a product offering?
• Customer segments ─ identifying current market segments and establishing the benefits
each group.
• Distribution channels ─ identifying the changes of importance between channels of
distribution, based on growth, cost or effectiveness.
