An External Factor Evaluation (EFE) Matrix allows strategists to summarize and evaluate economic, social, cultural, demographic, environmental, political, governmental, legal, technological, and competitive information, illustrated earlier in Figure 3-2. The EFE Matrix can be developed in five steps:
- List 20 key external factors as identified in the external-audit process, including both opportunities and threats that affect the firm and its industry. List the opportunities first and then the threats. Be as specific as possible, using percentages, ratios, and comparative numbers whenever possible. Recall that Edward Deming said, “In God we trust. Everyone else bring data.” In addition, utilize “actionable” factors as defined earlier in this chapter.
- Assign to each factor a weight that ranges from 0.0 (not important) to 1.0 (very important). The weight indicates the relative importance of that factor to being successful in the firm’s industry. Opportunities often receive higher weights than threats, but threats can receive high weights if they are especially severe or threatening. Appropriate weights can be determined by comparing successful with unsuccessful competitors or by discussing the factor and reaching a group consensus. The sum of all weights assigned to the factors must equal 1.0.
- Assign a rating between 1 and 4 to each key external factor to indicate how effectively the firm’s current strategies respond to the factor, where 4 = the response is superior, 3 = the response is above average, 2 = the response is average, and 1 = the response is poor. Ratings are based on effectiveness of the firm’s strategies. Ratings are thus company-based, whereas the weights in Step 2 are industry-based. It is important to note that both threats and opportunities can receive a 1, 2, 3, or 4.
- Multiply each factor’s weight by its rating to determine a weighted score.
- Sum the weighted scores for each variable to determine the total weighted score for the organization.
Regardless of the number of key opportunities and threats included in an EFE Matrix, the highest possible total weighted score for an organization is 4.0 and the lowest possible total weighted score is 1.0. The average total weighted score is 2.5. A total weighted score of 4.0 indicates that an organization is responding in an outstanding way to existing opportunities and threats in its industry. In other words, the firm’s strategies effectively take advantage of existing opportunities and minimize the potential adverse effects of external threats. A total score of 1.0 indicates that the firm’s strategies are not capitalizing on opportunities or avoiding external threats.
An example of an EFE Matrix is provided in Table 3-9 for a local 10-theater cinema complex. Observe in the table that the most important factor to being successful in this business is “Trend toward healthy eating eroding concession sales,” as indicated by the 0.12 weight. Also note that the local cinema is doing excellent in regard to handling two factors, “TDB University is expanding 6 percent annually” and “Trend toward healthy eating eroding concession sales.” Perhaps the cinema is placing flyers on campus and also adding yogurt and healthy drinks to its concession menu. Note that you may have a 1, 2, 3, or 4 anywhere down the Rating column. Observe also that the factors are stated in quantitative terms to the extent possible, rather than being stated in vague terms. Quantify the factors as much as possible in constructing an EFE Matrix. Note also that all the factors are “actionable” instead of being something like “The economy is bad.” Finally, note that the total weighted score of 2.58 is above the average (midpoint) of 2.5, so this cinema business is doing pretty well, taking advantage of the external opportunities and avoiding the threats facing the firm. There is definitely room for improvement, though, because the highest total weighted score would be 4.0. As indicated by ratings of 1, this business needs to capitalize more on the “Two new neighborhoods developing [nearby]” opportunity and the “movies rented from … Time Warner” threat. Notice also that there are many percentage- based factors among the group. Be quantitative to the extent possible! Note, too, that the ratings range from 1 to 4 on both the opportunities and threats.
An actual EFE Matrix for the largest U.S. homebuilder, D. R. Horton, is given in Table 3-10. Note that the most important external threat facing the company, as indicated by a weight of 0.10, deals with labor and supplier costs. The key factors are listed in order beginning with the most important (highest weight). Notice how specific the factors are stated—specificity is essential. Also note that following DRH’s EFE Matrix, an “author commentary” is given in Table 3-11, providing the rationale for each factor included.
Author commentary on each factor in the D. R. Horton EFE Matrix is given in Table 3-11 to provide insight on the thinking that needs to support not only inclusion of respective factors but also various weights and ratings assigned. Recall that mathematically, 0.04 is 33 percent more important than 0.03, and a rating of 3 is 50 percent higher than a rating of 2. Small judgments are helpful in moving forward toward larger decisions related to deployment of resources and money across regions and products.
Source: David Fred, David Forest (2016), Strategic Management: A Competitive Advantage Approach, Concepts and Cases, Pearson (16th Edition).