External Assessment in Strategic Management

Understanding the external environment is crucial for any organization aiming for sustained success. This article delves into the concept of external assessment in strategic management, providing a comprehensive overview for students and professionals alike. An effective external audit helps firms identify key opportunities to leverage and threats to mitigate, shaping their strategic direction.

What is External Assessment in Strategic Management?

An external assessment, also known as an external audit, environmental scanning, or industry analysis, is a fundamental step in the strategic management process. Its primary purpose is to develop a finite list of external opportunities that could benefit a firm and external threats that should be avoided. This isn't about creating an exhaustive list, but rather identifying key variables that demand actionable responses from the organization.

Firms must be able to react strategically, either offensively to capitalize on opportunities or defensively to minimize the impact of potential threats. This process involves identifying and evaluating trends and events beyond a single firm's control, such as increased foreign competition, population shifts, an aging society, and the rise of Internet sales.

The Industrial Organization (I/O) View

The Industrial Organization (I/O) view of strategic planning emphasizes the paramount importance of external (industry) factors over internal ones for achieving and sustaining competitive advantage. Proponents of this view, like Michael Porter, argue that organizational performance is primarily dictated by industry forces. Porter's Five-Forces Model is a prime example of this perspective, focusing on analyzing external forces and industry variables to gain and maintain a competitive edge. According to I/O advocates, competitive advantage largely stems from a firm's competitive positioning within its industry.

Key External Forces Affecting Organizations

External forces can be categorized into five broad areas that significantly influence an organization's products, services, markets, and strategic decisions:

1. Economic Forces

Economic factors are crucial in determining the competitiveness of a firm's operating environment and directly impact the attractiveness of various strategies. Key economic variables to monitor include:

• Availability of credit
• Level of disposable income
• Propensity of people to spend
• Interest rates and inflation rates
• Consumption patterns and unemployment trends
• Import/export factors and price fluctuations
• Monetary and fiscal policies
• Tax rates and international economic community policies (e.g., European Economic Community policies)

These variables must be quantified and actionable to be useful in strategic planning, often representing significant opportunities or threats.

2. Social, Cultural, Demographic, and Natural Environment Forces

These forces have a major impact on products, services, markets, and customers worldwide. Global markets are constantly evolving due to these trends, shaping consumer behavior and creating demand for new products and strategies. Examples of important variables include:

• Population changes (by race, age, geographic area)
• Regional changes in tastes and preferences
• Number of marriages, divorces, births, and deaths
• Per capita income and attitudes toward retirement
• Attitudes toward product quality, customer service, and social responsibility
• Issues like recycling, waste management, air pollution, and changing lifestyles

The rise of online purchases and mobile technology also falls under this category, impacting retail traffic and consumer behavior.

3. Political, Governmental, and Legal Forces

Political conditions and legal frameworks significantly affect business and strategic decisions. For industries relying on government contracts or subsidies, political forecasts are critical. Key variables include:

• Environmental regulations
• Changes in patent laws and antitrust legislation
• Political conditions in foreign countries and import-export regulations
• Government regulations or deregulations
• Government fiscal and monetary policy changes
• Lobbying activities and the size of government budgets

These factors can present major opportunities or threats, especially given increasing global interdependence.

4. Technological Forces

Technology is a powerful driver of innovation, impacting strategic planning in many industries. New technologies like the Internet of Things, 3D printing, cloud computing, mobile devices, biotech, analytics, robotics, and artificial intelligence are altering product life cycles, distribution speeds, and market dynamics. The Internet, for instance, has changed economies of scale, entry barriers, and relationships with stakeholders.

Key aspects of technological forces include:

• Online Reputation: Monitoring online reviews and social media (e.g., Facebook, Instagram) is essential, as benign neglect can hurt sales.
• Information Technology (IT): The growing importance of IT is reflected in new positions like Chief Information Officer (CIO) and Chief Technology Officer (CTO). A CIO is more managerial, handling stakeholder relations, while a CTO is more technical, focusing on data acquisition and systems.
• Impact: Technological advancements create major opportunities and threats, affecting products, services, markets, suppliers, competitors, manufacturing, marketing, and competitive position. They can create new markets, products, change cost positions, render existing products obsolete, and create new competitive advantages.

5. Competitive Forces

Identifying and evaluating rival firms is a vital part of the external audit. This involves understanding their strengths, weaknesses, capabilities, objectives, and strategies. Analyzing competitors helps in successful strategy formulation. Important questions to ask include:

• What are competitors' strengths, weaknesses, objectives, and strategies?
• How will competitors respond to current external trends?
• How vulnerable are competitors to our strategies, and vice versa?
• How are our products/services positioned against competitors?
• What is the rate of entry/exit of firms in the industry?
• What key factors have shaped the current competitive position?
• What is the nature of supplier and distributor relationships?
• How much could substitute products threaten competitors?

Porter’s Five-Forces Model of Competition

Michael Porter's Five-Forces Model is a widely used framework for analyzing industry competitiveness and developing strategies. It posits that the nature of competitiveness in any industry is a composite of five forces:

1. Rivalry Among Competing Firms

This is often the most powerful competitive force. Intensity of rivalry increases with more competitors, similar size/capability, declining demand, price cutting, easy brand switching, high exit barriers, high fixed costs, perishable products, slow demand growth leading to excess capacity, commoditized products, diverse rival strategies, and frequent mergers/acquisitions. Intense rivalry typically leads to declining industry profits.

2. Potential Entry of New Competitors

Easy entry by new firms increases competitive intensity. Barriers to entry can include the need for economies of scale, specialized know-how, lack of experience, strong customer loyalty, brand preferences, large capital requirements, distribution channel access issues, government regulations, tariffs, raw material access, patents, undesirable locations, or counterattacks by entrenched firms. Strategists must monitor potential new entrants and fortify their positions.

3. Potential Development of Substitute Products

Substitute products from other industries (e.g., plastics versus glass containers) place a ceiling on prices firms can charge, equating to profit ceilings and more intense competition. Competitive pressure from substitutes increases as their relative price declines and consumer switching costs decrease. Their competitive strength is measured by market share inroads and capacity expansion plans.

4. Bargaining Power of Suppliers

Supplier power affects competition intensity, especially when there are few good substitute raw materials or high switching costs. Suppliers and producers often benefit from mutual assistance in pricing, quality, service development, and cost reduction. Firms might use backward integration to gain control over unreliable or costly suppliers. Strategic partnerships with suppliers are also common to reduce costs, speed component availability, and enhance quality.

5. Bargaining Power of Consumers

When customers are concentrated, large, or buy in volume, their bargaining power is significant. This leads rival firms to offer extended warranties or special services. Consumer power is also high with standard or undifferentiated products, allowing them to negotiate price, warranty, and accessory packages. Consumers gain bargaining power if they can switch brands easily, are important to the seller, if sellers face falling demand, if they are well-informed about products/prices, and if they have discretion on when to purchase.

The Process of Performing an External Audit

An effective external audit involves a systematic process:

1. Involve Managers and Employees: Maximize participation to foster understanding and commitment. This encourages individuals to contribute ideas and learn about the industry.
2. Gather Competitive Intelligence: Collect information on economic, social, cultural, demographic, environmental, political, governmental, legal, and technological trends. Assign individuals to monitor various sources (magazines, journals, newspapers, Internet, libraries, suppliers, distributors, customers, competitors).
3. Assimilate and Evaluate Information: Hold meetings to collectively identify the most important opportunities and threats. Prioritization is essential, as no organization can pursue every potential benefit.

Sources of External Information

Strategic information can come from both published and unpublished sources:

• Published Sources: Periodicals, journals, reports, government documents, abstracts, books, directories, newspapers, manuals. The Internet is a powerful tool for gathering up-to-date information.
• Unpublished Sources: Customer surveys, market research, speeches, television programs, interviews, conversations with stakeholders.
• Grey Literature: Primary source materials not available through traditional publication systems, such as conference proceedings, market research reports, online documents, and working papers.

Forecasting Tools and Techniques

Forecasts are educated assumptions about future trends and events. Forecasting is complex due to constant changes in technology, culture, products, services, competition, government priorities, social values, and economic conditions. Managers often rely on published forecasts but must also develop their own projections.

Forecasting tools are broadly categorized:

• Quantitative Techniques: Most appropriate when historical data is available and relationships between variables are expected to remain stable (e.g., linear regression). However, accuracy decreases with less stable historical relationships.
• Qualitative Techniques: Used when historical data is scarce or relationships are highly dynamic.

No forecast is perfect, emphasizing the need for strategists to thoroughly study published forecasts and develop internal ones. Accurate forecasts provide significant competitive advantages by enabling effective identification of key external opportunities and threats.

Making Assumptions

Planning would be impossible without making reasonable assumptions based on available information about future trends and events. These assumptions should focus on factors most likely to significantly affect the firm. They serve as checkpoints; if future occurrences deviate from assumptions, corrective actions may be needed. Firms with the best information generally make the most accurate assumptions, leading to competitive advantages.

Business Analytics

Business Analytics (also known as predictive analytics, machine learning, or data mining) is an MIS technique that uses software to process large volumes of data for decision-making. This technology helps firms leverage their aggregate experience, from interactions with customers, suppliers, and competitors, to generate predictive models. It enables companies to measure and manage risk, identify customer segments, understand competitive weaknesses, and make future decisions based on past information, thereby gaining proprietary business intelligence.

FAQ: External Assessment in Strategic Management

What is the primary goal of an external assessment in strategic management?

The primary goal is to identify and evaluate key external opportunities that a firm can leverage and external threats that it should mitigate or avoid. This information is then used to formulate strategies that provide a competitive advantage.

Why is Porter's Five-Forces Model important for external assessment?

Porter's Five-Forces Model is crucial because it provides a structured framework to analyze the intensity of competition within an industry. By understanding the forces of rivalry, potential new entrants, substitute products, and the bargaining power of suppliers and buyers, firms can better assess industry attractiveness and develop effective competitive strategies.

How do technological forces impact strategic management?

Technological forces profoundly impact strategic management by creating new markets, products, and services, changing cost structures, and rendering existing offerings obsolete. They necessitate continuous monitoring of trends like AI, IoT, and mobile technology, and often lead to new organizational roles (like CIO and CTO) to manage information technology strategically.

What are some common challenges in conducting an external audit?

Common challenges include the complexity of forecasting future trends accurately, the sheer volume of information to process, identifying truly actionable variables, and ensuring broad organizational involvement to gather diverse intelligence. Prioritizing the most significant opportunities and threats from a vast array of factors is also a key challenge.

Can small businesses benefit from external assessment as much as large corporations?

Absolutely. While the process might be more informal in smaller firms, the need to understand key external trends and events is no less important. Identifying opportunities and threats in their specific market environment allows small businesses to adapt, innovate, and compete effectively, ensuring their long-term survival and growth.