EXTERNAL ENVIRONMENT

LESSON 3
Learning Objectives
1. Describe the nature and purpose of an external assessment in
formulating strategies.
2. Identify and discuss the PESTEL external forces that impact
organizations.
3. Explain Porter’s Five-Forces Model and competitive forces that impact
organizations.
4. Describe key sources of information for identifying opportunities and
threats.
5. Discuss forecasting tools and techniques.
6. Explain how to develop and use an External Factor Evaluation (E F E)
Matrix.
7. Explain how to develop and use a Competitive Profile Matrix (C P M).
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.
• Sometimes called industry analysis.
The Purpose 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.
Key External Forces
External forces can be divided into six groups:
1. Political.
2. Economic.
3. Sociocultural.
4. Technological.
5. Environmental.
6. Legal.

PESTEL is the acronym for these six forces.

Five-Forces Analysis
The five-forces analysis focuses on:
1. Current competitors.
2. Potential new competitors.
3. Suppliers.
4. Buyers.
5. Substitute products.
Five-Forces Analysis and P E S T E L
1. Five-Forces is more refined than the PESTEL analysis.
2. Five-Forces focuses on key industry stakeholders.
3. Combined with PESTEL it helps the firm discover key opportunities and
threats.
4. PESTEL can account for up to 25% of a firm’s performance.
1. PESTEL can include Black Swan events such as the COVID-19
pandemic.
5. Five-Forces Model can explain another 20% of the firm’s performance.
Figure 3.2
How Are Key External Factors Identified in Performing Strategic Planning in
a Firm?
The A Q C D Test
• When identifying and prioritizing essential PESTEL and Five-Forces
external factors in strategic planning, the following 4 criteria are important:
• Actionable.
• Quantitative.
• Comparative.
• Divisional.
• The AQCD is a measure of the quality of an external factor.
P E S T E L: Political External Forces that
Impact Organizations (1 of 3)
Local, state, and federal laws, as well as regulatory agencies and special-interest
groups, can have a major impact on the strategies of small, large, for-profit, and
nonprofit organizations.
• A few examples include:
• Seven U.S. states have zero state income taxes which makes it attractive to
locate facilities.
• Between 2016 and 2020 FedEx invested $71 million on campaign
contributions and lobbying, and the company received tax credits of $877
million between 2018 and 2020.
• Dubai’s political and social reforms such as zero tax rates, allowing the
consumption of alcohol without a license, and others have made it one of the
most booming economies in the world.
P E S T E L: Political External Forces that
Impact Organizations (2 of 3)
Table 3.1 contains some examples of political variables to be monitored that
include:
• Natural environmental regulations.
• Protectionist actions by countries.
• Changes in patent laws.
• Equal employment opportunity laws.
• Level of defense expenditures.
• Unionization trends.
• Antitrust legislation.
P E S T E L: Political External Forces that
Impact Organizations (3 of 3)
Additional political variables to be monitored include:
• USA versus other country relationships.
• Political conditions in countries.
• Global price of oil changes.
• Local, state, and federal laws.
• Import-export regulations.
• Tariffs, particularly on steel and aluminum.
• Local, state, and national elections.
P E S T E L: Economic Forces (1 of 3)
Economic factors have a direct impact on the potential attractiveness of
various strategies. Examples include:
• Current strong U.S. dollar can boost profits of importers but harms large
multinational firms since it makes U.S. goods more expensive to foreign
buyers.
• In the first four months of 2022, the U.S. dollar rose 10 percent against the
Japanese yen and more than 5 percent against the euro.
P E S T E L: Economic Forces (2 of 3)
• Shift to a service economy.
• Availability of credit.
• Level of disposable income.
• Propensity of people to spend.
• Interest rates.
• Inflation rates.
• Gross domestic product (GDP) trends.
• Import/export factors.
• Unemployment trends.
• Value of the dollar in world markets.
P E S T E L: Economic Forces (3 of 3)
• Demand shifts for different goods and services.
• Income differences by region and consumer groups.
• Price fluctuations.
• Foreign countries’ economic conditions.
• Monetary and fiscal policies.
• Stock market trends.
• Tax rate variation by country and state.
• European Economic Community (EEC) policies.
• Organization of Petroleum Exporting Countries (OPEC) policies.
P E S T E L: Sociocultural Forces (1 of 3)
• Sociocultural forces impact strategic decisions on virtually all products,
services, markets, and customers.
• These forces are shaping the way people live, work, produce, and
consume.
• Examples include:
• The decline in demand for packaged foods as people demand healthier
and fresher food options.
• The ongoing shift to online shopping.
• Aging U.S. population.
P E S T E L: Sociocultural Forces (2 of 3)
• Population changes by race, age, and geographic area.
• Regional changes in tastes and preferences.
• Number of marriages.
• Number of divorces.
• Number of births.
• Number of deaths.
• Immigration and emigration rates.
• Social Security programs.
P E S T E L: Sociocultural Forces (3 of 3)
• Life expectancy rates.
• Per capita income.
• Social media pervasiveness.
• Attitudes toward retirement.
• Attitudes toward product quality.
• Attitudes toward customer service.
• Social programs.
• Social responsibility issues.
P E S T E L: Technological Forces (1 of 4)
A variety of new technologies impact strategic planning decisions. Some of
these include:
• The Internet of Things (IoT).
• Three-dimensional (3D) printing.
• Predictive analytics.
• Quantum computing.
• Robotics.
• Artificial intelligence (AI).
• Increase in the amount of data.
P E S T E L: Technological Forces (2 of 4)
Technology forces can impact the firm in the following ways:
• They can dramatically affect organizations’ products, services, markets, suppliers,
distributors, competitors, customers, manufacturing processes, marketing practices, and
competitive position.
• They can create new markets, result in a proliferation of new and improved products,
change the relative competitive cost positions in an industry, and render existing products
and services obsolete.
• They can reduce or eliminate cost barriers between businesses, create shorter production
runs, create shortages in technical skills, and result in changing values and expectations
of employees, managers, and customers.
• They can create new competitive advantages that are more powerful than existing
advantages.
P E S T E L: Technological Forces (3 of 4)
One major technological force emerging is the metaverse:
• Metaverse - online 3D, virtual or augmented reality (AR) world where
individuals, companies, and organizations can interact and share quality
time with others and spend money as avatars on products and services.
• Avatars are digital objects that can become “you” or “anyone” or
“anything” and interact with you as if you and the entity are actually
together.
• Consumers can access the metaverse through a wide range of mobile
devices.
P E S T E L: Technological Forces (4 of 4)
• Many firms now have a Chief Information Officer (CIO) and a Chief
Technology Officer (CTO) who work together to ensure that information
needed to formulate, implement, and evaluate strategies is available
where and when it is needed.
P E S T E L: Environmental Forces
The second E in the PESTEL category of external variables that represent
key opportunities and threats for companies stands for environmental
forces. Examples include:
• Climate change.
• Carbon dioxide ( CO2 )
• Pollution abatement.
• Water quality.
• Air quality.
• Ecological factors.
• Weather.
P E S T E L: Environmental Forces (continued)
Environmental forces and trends shaping business include:
• Rapid electrification of vehicles.
• Growing pollution problem around the world.
• Shift from AC power to DC power that can be stored.
• Solar, wind, and hydrogen power sources expanding.
• Compensation for many executives becoming tied to ESG metrics.
P E S T E L: Legal Forces
The L in the PESTEL category of external variables that impact companies’
strategic planning includes all the regulations and laws imposed on various
businesses globally. These forces include:
• Mandatory minimum wage.
• Labor laws.
• Consumer laws.
• Antitrust laws.
• Changing tax and accounting regulations.
Competitive Forces
• An important part of an external audit is identifying rival firms and
determining their strengths, weaknesses, capabilities, opportunities,
threats, objectives, and strategies.
Key Questions About Competitors (1 of 3)
1. What are the strengths and weaknesses of our major competitors?
2. What products and services do we offer that are unique in the industry?
3. What are the objectives and strategies of our major competitors?
4. How will our major competitors most likely respond to current political,
economic, sociocultural, technological, environmental, and legal trends
affecting our industry?
Key Questions About Competitors (2 of 3)
5. How vulnerable are our major competitors to our new strategies,
products, and services?
6. How vulnerable is our firm to successful counterattack by our major
competitors?
7. How does our firm compare to rivals in mastering the social media
conversation in this industry?
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?
Key Questions About Competitors (3 of 3)
10. How are supplier and distributor relationships changing in this industry?
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.
Obtaining Competitive Intelligence
Legal and ethical ways to obtain competitive intelligence:
1. Reverse-engineer rival firms’ products.
2. Use surveys and interviews of customers, suppliers, and distributors of
rival firms.
3. Analyze rival firm’s Form 10-K.
4. Conduct fly-over and drive-by visits to rival firm operations.
5. Search online databases.
6. Contact government agencies for public information about rival firms.
Obtaining Competitive Intelligence
(continued)
7. Monitor relevant trade publications, magazines, and newspapers.
8. Purchase social-media data about customers of all firms in the industry.
9. Hire top executives from rival firms.
Figure 3.3
The Five-Forces Model of Competition
Porter’s Five-Forces Model of Competition
According to Porter, the nature of competitiveness in a given industry can be
viewed as a composite of five forces:
1. Rivalry among competing firms.
2. Bargaining power of suppliers.
3. Bargaining power of consumers.
4. Potential entry of new competitors.
5. Potential development of substitute products.
The Five-Forces Model (1 of 5)
• Rivalry among competing firms
• Most powerful of the five forces.
• Focus on competitive advantage of strategies over other firms.
Table 3.5
Conditions that Cause High Rivalry Among Competing Firms
1. When the number of competing firms is high.
2. When competing firms are of similar size.
3. When competing firms have similar capabilities.
4. When demand for the industry’s products is changing rapidly.
5. When price cuts are common in the industry.
6. When consumers can switch brands easily.
7. When barriers to leaving the market are high.
8. When barriers to entering the market are low.
9. When fixed costs are high among competing firms.
10. When products are perishable or have short product life cycles.
The Five-Forces Model (2 of 5)
• Bargaining Power of Suppliers is increased when (there are):
• Few suppliers.
• Few substitutes.
• Costs of switching raw materials is high.
• Backward integration is gaining control or ownership of suppliers.
The Five-Forces Model (3 of 5)
Bargaining power of consumers
Consumers gain bargaining power:
1. If they can inexpensively switch to competing brands or substitutes.
2. If they are particularly important to the seller.
3. If sellers are struggling in the face of falling consumer demand.
4. If they are informed about sellers’ products, prices, and costs.
5. If they have discretion in whether and when they purchase the product.
The Five-Forces Model (4 of 5)
• Potential Entry of New Competitors
• Barriers to entry are important.
• Quality, pricing, and marketing can overcome barriers.
Barriers to Entry
• Need to gain economies of scale quickly.
• Need to gain technology and specialized know-how.
• Lack of experience.
• Strong customer loyalty.
• Strong brand preferences.
• Large capital requirements.
• Lack of adequate distribution channels.
Forecasting Tools and Techniques
• Forecasts
• Educated assumptions about future trends and events.
• No forecast is perfect.
Making Assumptions
• 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.
Industry Analysis: The External Factor
Evaluation (E F E) Matrix
Summarize and evaluate these factors:
E F E Matrix Steps
Industry Analysis: Competitive Profile Matrix
(C P M)
• 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.