THE EXTERNAL

AUDIT
Chapter 07
External Audit
◦ External audit
◦ focuses on identifying and evaluating trends and events beyond the control of a single firm
◦ reveals key opportunities and threats confronting an organization so that managers can formulate strategies to take advantage of
the opportunities and avoid or reduce the impact of threats

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The Nature of an External Audit
◦ The external audit is aimed at identifying key variables that offer actionable responses

◦Firms should be able to respond either offensively or

defensively to the factors by formulating strategies that
take advantage of external opportunities or that minimize
the impact of potential threats.

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A Comprehensive Strategic-Management
Model

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Key External Forces
External forces can be divided into five broad categories:

1. economic forces
2. social, cultural, demographic, and natural
environment forces
3. political, governmental, and legal forces
4. technological forces
5. competitive forces
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Relationships Between Key External
Forces and an Organization

3-6
The Process of Performing an External
Audit
◦ First, gather competitive intelligence and information about economic, social, cultural, demographic,
environmental, political, governmental, legal, and technological trends.
◦ Information should be assimilated and evaluated
◦ A final list of the most important key external factors should be communicated

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The Process of Performing an External
Audit
Key external factors should be:

1. important to achieving long-term and annual

objectives
2. measurable
3. applicable to all competing firms, and
4. hierarchical in the sense that some will pertain to
the overall company and others will be more
narrowly focused on functional or divisional areas

3-8
The Industrial Organization
(I/O) View
◦ The Industrial Organization (I/O) approach to competitive advantage advocates that external (industry) factors are
more important than internal factors in a firm for achieving competitive advantage.

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The Industrial Organization
(I/O) View
◦ Firm performance is based more on industry properties

Economies of scale
Barriers to market
entry
Product
differentiation
The economy
Level of
competitiveness 3-10
Economic Forces

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Key Social, Cultural, Demographic, and
Natural Environment Variables

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Political, Governmental, and Legal Forces
◦ The increasing global interdependence among economies, markets, governments, and organizations makes it
imperative that firms consider the possible impact of political variables on the formulation and implementation of
competitive strategies.

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Political, Government, and
Legal Variables
TABLE 3-4 Some Political, Governmental, and Legal Variables
▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬
Government regulations or deregulations Sino American relationships
Changes in tax laws Russian American relationships
Special tariffs European American relationships
Political action committees African American relationships
Voter participation rates Import–export regulations
Number, severity, and location of Government fiscal and monetary policy
changes
government protests Political conditions in foreign countries
Number of patents Special local, state, and federal laws
Changes in patent laws Lobbying activities
Environmental protection laws Size of government budgets
Level of defense expenditures World oil, currency, and labor markets
Legislation on equal employment Location and severity of terrorist activities
Level of government subsidies Local, state, and national elections
Antitrust legislation 3-14
Technological Forces
The Internet has changed 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,
◦changing the historical trade-off between production
standardization and flexibility.
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Technological Forces
The Internet has lowered entry barriers, and redefined the relationship between industries and various suppliers,
creditors, customers, and competitors.

Technological advancements can:

◦ Create new markets

◦ Result in a proliferation of new and improved
products
◦ Change the relative competitive cost positions in
an industry
◦ Render existing products and services obsolete
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Competitive Forces
An important part of an external audit is identifying rival firms and determining their strengths, weaknesses, capabilities, opportunities, threats,
objectives, and strategies

Characteristics of the most competitive companies:

1. Market share matters

2. Use the vision/mission as a guide for all decisions
3. Whether it’s broke or not, fix it–make it better
4. Continually adapt, innovate, improve
5. Acquisition is essential to growth
6. People make a difference
7. Strive to stay cost-competitive on a global basis
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Key Questions About Competitors
TABLE 3-5 Key Questions About Competitors
▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬

1. What are the major competitors’ strengths?

2. What are the major competitors’ weaknesses?
3. What are the major competitors’ objectives and strategies?
4. How will the major competitors most likely respond to current economic, social, cultural,
demographic, environmental, political, governmental, legal, technological, and competitive trends
affecting our industry?
5. How vulnerable are the major competitors to our alternative company strategies?
6. How vulnerable are our alternative strategies to successful counterattack by our major competitors?
7. How are our products or services positioned relative to major competitors?
8. To what extent are new firms entering and old firms leaving this industry?
9. What key factors have resulted in our present competitive position in this industry?
10. How have the sales and profit rankings of major competitors in the industry changed over recent
years? Why have these rankings changed that way?
11. What is the nature of supplier and distributor relationships in this industry?
12. To what extent could substitute products or services be a threat to competitors in this industry?
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Competitive Intelligence Programs
◦ Competitive intelligence (CI)
◦ a systematic and ethical process for gathering and analyzing information about the competition’s activities and
general business trends to further a business’s own goals

The three basic objectives of a CI program are:

1. to provide a general understanding of an industry and its competitors

2. to identify areas in which competitors are vulnerable and to assess the impact strategic actions would have on
competitors
3. 3.to identify potential moves that a competitor might make that would endanger a firm’s position in the market

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The Five-Forces Model of Competition

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The Five-Forces Model of Competition
1. Identify key aspects or elements of each
competitive force that impact the firm.

2. Evaluate how strong and important each

element is for the firm.

3. Decide whether the collective strength of the

elements is worth the firm entering or
staying in the industry.

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Sources of External Information

◦Unpublished sources include customer surveys, market

research, speeches at professional and shareholders’
meetings, television programs, interviews, and conversations
with stakeholders.
◦Published sources of strategic information include
periodicals, journals, reports, government documents,
abstracts, books, directories, newspapers, and manuals.

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Sources of External Information
◦ www.money.msn.com
◦ http://finance.yahoo.com
◦ www.hoovers.com
◦ http://globaledge.msu.edu/industries/
◦ www.monrningstar.com

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Forecasting Tools and Techniques
◦ Forecasts
◦ educated assumptions about future trends and events
◦ quantitative, qualitative techniques

◦ Assumptions
◦ Best present estimates of the impact of major external factors, over which the manager has little if any control, but which may
exert a significant impact on performance or the ability to achieve desired results.

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Industry Analysis: The External Factor
Evaluation (EFE) Matrix
◦ Economic ◦ Political
◦ Social ◦ Governmental
◦ Cultural ◦ Technological
◦ Demographic ◦ Competitive
◦ Environmental ◦ Legal

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EFE Matrix Steps
1. List key external factors
2. Weight from 0 to 1
3. Rate effectiveness of current strategies
4. Multiply weight * rating
5. Sum weighted scores

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EFE Matrix for a Local Ten-Theater Cinema
Complex
TABLE 3-8 EFE Matrix for a Local 10-Theater Cinema Complex
▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬
Key External Factors Weight Rating Weighted Score

Opportunities___________________________________________________________________________
1. Rowan County is growing 8 percent annually in population 0.05 3 0.15
2. TDB University is expanding 6 percent annually 0.08 4 0.32
3. Major competitor across town recently ceased operations 0.08 3 0.24
4. Demand for going to cinema growing 10 percent annually 0.07 2 0.14
5. Two new neighborhoods being developed within 3 miles 0.09 1 0.09
6. Disposable income among citizens grew 5 percent in prior year 0.06 3 0.18
7. Unemployment rate in county declined to 3.1 percent 0.03 2 0.06
Threats________________________________________________________________________________
8. Trend toward healthy eating eroding concession sales 0.12 4 0.48
9. Demand for online movies and DVDs growing 10 percent annually 0.06 2 0.12
10. Commercial property adjacent to cinemas for sale 0.06 3 0.18
11. TDB University installing an on-campus movie theater 0.04 3 0.12
12. County and city property taxes increasing 25 percent this year 0.08 2 0.16
13. Local religious groups object to R-rated movies being shown 0.04 3 0.12
14. Movies rented from local Blockbuster store up 12 percent 0.08 2 0.16
15. Movies rented last quarter from Time Warner up 15 percent 0.06 1 0.06
Total 1.00 2.58 3-27
Industry Analysis: Competitive Profile
Matrix (CPM)
◦ Identifies firm’s major competitors and their strengths & weaknesses in relation to a sample firm’s strategic
positions
◦ Critical success factors include internal and external issues

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An Example Competitive
Profile Matrix
An Example Competitive Profile Matrix
TABLE 3-10
▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬
Company 1 Company 2 Company 3____________
Critical Success
Factors_ ___ _ Weight Rating Score Rating Score Rating Score____ ____
Advertising 0.20 1 0.20 4 0.80 3 0.60
Product Quality 0.10 4 0.40 3 0.30 2 0.20
Price Competitiveness 0.10 3 0.30 2 0.20 1 0.10
Management 0.10 4 0.40 3 0.20 1 0.10
Financial Position 0.15 4 0.60 2 0.30 3 0.45
Customer Loyalty 0.10 4 0.40 3 0.30 2 0.20
Global Expansion 0.20 4 0.80 1 0.20 2 0.40
Market Share 0.05 1 0.05 4 0.20 3 0.15
Total 1.00 3.15 2.50 2.20

Note: The ratings values are as follows: 1 = major weakness, 2 = minor weakness, 3 = minor strength, 4 =
major strength. As indicated by the total weighted score of 2.50, Competitor 2 is weakest. Only eight
critical success factors are included for simplicity; this is too few in actuality.
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