The Purpose and Nature of an External Audit

The purpose of an external audit is to develop a finite list of opportunities that could benefit a firm as well as threats that should be avoided. As the term finite suggests, the external audit is not aimed at developing an exhaustive list of every possible factor that could influence the business; rather, it 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. Figure 3-1 illustrates with white shading how the external audit fits into the strategic-management process.

1. 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; and (5) competitive forces. Relationships among these forces and an organization are depicted in Figure 3-2. External trends and events, such as rising food prices and people in African countries learning about online services, significantly affect products, services, markets, and organizations worldwide.

Important Note: When identifying and prioritizing key external factors in strategic planning, make sure the factors selected are (1) specific (i.e., quantified to the extent possible); (2) action­able (i.e., meaningful in terms of having strategic implications) and (3) stated as external trends, events, or facts rather than as strategies the firm could pursue. For example, regarding action­able, “the stock market is volatile” is not actionable because there is no apparent strategy that the firm could formulate to capitalize on that factor. In contrast, a factor such as “the GDP of Brazil is 6.8 percent” is actionable because the firm should perhaps open 100 new stores in Brazil. In other words, select factors that will be helpful in deciding what to recommend the firm should do, rather than selecting nebulous factors too vague for an actionable response. Similarly, “to expand into Europe” is not an appropriate opportunity, because it is both vague and is a strategy; the better opportunity statement would be “the value of the euro has increased 5 percent versus the U.S. dollar in the last twelve months.”

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 nature of positioning and market segmentation strategies, the type of services offered, and the choice of businesses to acquire or sell. External forces have a direct impact on both suppliers and distributors. Identifying and evaluating external opportunities and threats enables organizations to develop a clear mission, to design strategies to achieve long-term objectives, and to develop policies to achieve annual objectives.

The increasing complexity of business today is evidenced by more countries developing the capacity and will to compete aggressively in world markets. Foreign businesses and countries are willing to learn, adapt, innovate, and invent to compete successfully in the marketplace. Fast growth worldwide, recently reported by Alibaba and Samsung, are examples.

2. The Process of Performing an External Audit

The process of performing an external audit must involve as many managers and employees as possible. As emphasized in previous chapters, involvement in the strategic-management process can lead to understanding and commitment from organizational members. Individuals appreci­ate having the opportunity to contribute ideas and to gain a better understanding of their firm’s industry, competitors, and markets. Key external factors can vary over time and by industry.

To perform an external audit, a company first must gather competitive intelligence and infor­mation about economic, social, cultural, demographic, environmental, political, governmental, legal, and technological trends. Individuals can be asked to monitor various sources of infor­mation, such as key magazines, trade journals, and newspapers—and use online sources such as those listed later in this chapter in Table 3-8. These persons can submit periodic scanning reports to the person(s) who coordinate the external audit. This approach provides a continuous stream of timely strategic information and involves many individuals in the external-audit pro­cess. Suppliers, distributors, salespersons, customers, and competitors represent other sources of vital information.

After information is gathered, it should be assimilated and evaluated. A meeting or series of meetings of managers is needed to collectively identify the most important opportunities and threats facing the firm. A prioritized list of these factors must be obtained by requesting that all managers individually rank the factors identified, from 1 (for the most important opportunity/ threat) to 20 (for the least important opportunity/threat). Instead of ranking factors, managers could simply place a checkmark by their most important “top 10 factors.” Then, by summing the rankings, or the number of checkmarks, a prioritized list of factors is revealed. Prioritization is absolutely essential in strategic planning because no organization can do everything that would benefit the firm; tough choices among good choices have to be made.

3. The Industrial Organization (I/O) View

The Industrial Organization view of strategic planning advocates that external (industry) fac­tors are more important than internal ones for gaining and sustaining competitive advantage. Proponents of the I/O view, such as Michael Porter, contend that organizational performance will be primarily determined by industry forces, such as falling gas prices that no single firm can control. Porter’s Five-Forces Model, presented later in this chapter, is an example of the I/O per­spective, which focuses on analyzing external forces and industry variables as a basis for getting and keeping competitive advantage.

Competitive advantage is determined largely by competitive positioning within an indus­try, according to I/O advocates. Managing strategically from the I/O perspective entails firms striving to compete in attractive industries, avoiding weak or faltering industries, and gaining a full understanding of key external factor relationships within that attractive industry. I/O theo­rists contend that external factors—such as economies of scale, barriers to market entry, product differentiation, the economy, and level of competitiveness—are more important than internal resources, capabilities, structure, and operations.

The I/O view has enhanced the understanding of strategic management. However, the authors contend that it is not a question of whether external or internal factors are more important in gaining and maintaining competitive advantage. In contrast, effective integration and under­standing of both external and internal factors is the key to securing and keeping a competitive advantage. In fact, as discussed in Chapter 6, matching key external opportunities and threats with key internal strengths and weaknesses provides the basis for successful strategy formulation.

Source: David Fred, David Forest (2016), Strategic Management: A Competitive Advantage Approach, Concepts and Cases, Pearson (16th Edition).

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