THE EXTERNAL ASSESSMENT

Chapter 2

Two types of factors influencing business decision:

1. Internal Factors — are elements that come from within or are under a company's
control.
2. External Factors — are elements that come from outside.

EXTERNAL ANALYSIS
A business can’t operate on its own. Outside the office walls, there are multiple factors
that can dictate its performance. Some examples include new technology and changes in taxes,
interest rates, or minimum wages. In business terms, these are called external factors.
A firm’s external environment consists of all factors outside the firm that can affect its
potential to gain and sustain a competitive advantage. By analyzing the factors in the firm’s
external environment, strategic leaders can mitigate threats and leverage opportunities. One
common approach to understanding how external factors impinge upon a firm is to consider the
source or proximity of these factors.
We will now look at each of these environmental layers in detail, moving from a firm’s
general environment to its task environment. We will be looking from the outer ring to the inner
ring.
The PESTEL Model groups the factors in the firm’s general environment into six
segment
 The PESTEL model provides a relatively straightforward way to SCAN, MONITOR,
AND EVALUATE the important external factors and trends that might impinge upon a firm.
Such factors create both opportunities and threats.
Definition:
External factors are elements from outside the company that affect business
performance, such as competition, economic climate, political and legal environment,
technological advances, or major global events.
External Factors Affecting Business
Five main types of external factors affecting business
 Political
 Economic
 Sociocultural
 Technological
 Ecological
 Legal.
External factors can have both positive and negative impacts on business operations. To
sustain profitable growth, companies need to constantly monitor environmental changes to
adapt and minimize their negative consequences.

Political factors – result from the processes and actions of government bodies that can
influence the decisions and behaviors of firms
 Political influence on business refers to new legislation that affects consumers,
employees, and businesses rights.

Some examples of business-related legislation include:

o Anti-discrimination
o Intellectual property
o Minimum wage
o Health and safety
o Consumer protection.

Generally, these are grouped into three categories:

 Consumer laws – These are laws that ensure businesses will provide consumers with
quality goods and services.
 Employment laws – These are laws that protect employee rights and regulate the
relationship between employees and consumers.
 Intellectual property law – These are laws that protect creative work within the
business world, e.g. copyrights of music, books, films, and software.

Economic factors
Businesses and the economy have a mutual relationship. The success of businesses
results in a healthier economy, whereas a strong economy allows businesses to grow faster.
Thus, any changes in the economy will have a significant impact on business development.
 Economic factors in a firm’s external environment are largely macroeconomic, affecting
economy-wide phenomena. Strategic leaders need to consider how the following five
macroeconomic factors can affect firm strategy;
Economic activities can deeply be affected by changes in:

1. Growth rates
An economic growth rate is the percentage change in the value of all of
the goods and services produced in a nation during a specific period of time, as
compared to an earlier period. The economic growth rate is used to measure the
comparative health of an economy over time. The numbers are usually compiled
and reported quarterly and annually.

In most cases, the economic growth rate measures the change in a

nation's gross domestic product (GDP). In nations with economies that are
heavily dependant on foreign earnings, gross national product (GNP) may be
used. The latter takes into account net income from foreign investments.

2. Levels of Employment
Growth rates affect the level of employment. In boom times,
unemployment tends to be low, and skilled human capital becomes a scarce
and more expensive resource. As the price of labor rises, firms have an
incentive to invest more in capital goods such as cutting-edge equipment or
artificial intelligence (AI). In economic downturns, unemployement rises. As
more people search for employment, skilled human capital is more abundant
and wages usually fall.
3. Tax rates - A tax rate is a percentage at which an individual or corporation is
taxed. The United States, both the federal government and many of the states,
uses a progressive tax rate system, in which the percentage of tax charged
increases as the amount of the person's or entity's taxable income increases. A
progressive tax rate collects more from taxpayers with greater incomes.
4. Interest rates - An interest rate is the amount a borrower pays a lender to
use the lender’s capital. It is typically given as an annual value or annual
percentage rate (APR). The actual amount the borrower pays is determined by
the amount of the loan, which is called the principal.
5. Inflation - Inflation is the rate of increase in prices over a given period of
time. Inflation is typically a broad measure, such as the overall increase in prices
or the increase in the cost of living in a country.
One measure of economic performance is aggregate demand. Aggregate demand is the total
demand for goods and services within an economy (including consumer and government
spending, investing, and exports, minus imports). The higher the aggregate demand, the more
robust an economy is. However, too much demand can lead to high inflation, resulting in higher
prices for consumers.
Sociocultural -Socio-cultural factors include consumers' lifestyles, buying
habits, education, religion, beliefs, values, demographics, social classes,
sexuality and attitudes. These factors determine the suitability of an organisation's
products and services for its customers' needs.
Social influence also includes the ethical side of a business, such as how a company
treats its employees, consumers, and suppliers.
An ethical business is one that considers the needs of all shareholders, not just owners.
Typically, business ethics comprise three main aspects:
o Employees – Ensure work-life balance as well as the physical and emotional well-being
of the employees.
o Suppliers – Stick to the agreed contract and pay suppliers in a timely fashion.
o Customers – Provide quality products at a fair price. Businesses should not lie to
consumers or sell products that do serious harm to consumers

Technological factors
Technological factors capture then application of knowledge to create new processes
and products. Major innovations in process technology include lean manufacturing.
 Technology is used extensively in modern business, from production to product selling
and customer support.
 Technology allows a company to save time and labour costs while achieving more
efficiency, which, in the long run, can result in a competitive advantage.
Three key areas of technology:
Automation - the use of robots to perform repetitive tasks formerly done by humans.
o Automation is applied throughout the supply chain of many industries, including
electronics manufacturing, automotive, retail, online services, banks, etc.
o E-commerce - the buying and selling of goods and services on the internet.

Some examples of e-commerce include:

o An online bookstore
o Buying and selling through Amazon or eBay
o An online retailer.
The key incentive for businesses to move online is to reduce fixed costs.
While physical businesses have to pay healthy monthly fees for rent, warehousing, and
electricity on-site, an online business pays little to no fixed costs.

digital media - are online channels that get businesses in contact with their customers.
Some examples include
• websites,
• blogs,
• videos,
• Google and Facebook ads,
 • emails,
• social media, etc.
While traditional marketing methods like billboards and banners are restricted to local areas,
online channels allow companies to communicate their marketing messages across the globe in
a matter of seconds.

Environmental/Ecological Factors
Organizations and the natural environment coexist in an interdependent relationship.
Managing these relationships in a responsible and sustainable way directly influences the
continued existence of human societies and the organizations we create.
 Environmental influence refers to changes in the natural world, such as weather
conditions, that might affect business operations.
The production of goods and services is the major cause of climate change, pollution, and
waste. For example, the generation of electricity in coal-fired plants releases a tremendous
amount of carbon dioxide into the atmosphere, which causes global warming and acid rain. The
fashion industry is another CO2 emitter, contributing to around 8-10% of the total greenhouse
gas emission each year.
The good news is that many companies nowadays have been adopting eco-friendly solutions to
mitigate their impacts on the environment.
Some examples include:
 Recycling packaging
 Offsetting carbon footprint
 Introducing energy-saving plans
 Adopting more energy-efficient equipment
 Switching to fair-trade suppliers.

Competitive factors
 Competitive influence refers to the impact of competition in the business environment.
The impact can come from changes in price, product, or business strategy.
For example, if a company selling similar products at a similar price to your business suddenly
drops its price to attract more customers, you may have to reduce the price as well or risk losing
customers.
To avoid the impact of competitive influence, a company can develop competitive advantages.
These are attributes that allow the company to outperform its rivals. A business can gain a
competitive advantage by investing in a high-quality labour force, exceptional customer support,
stellar products, extra services, or a reputable brand image.

HOW DO CHANGES IN THE EXTERNAL ENVIRONMENT AFFECT BUSINESS?

In the modern world, external factors are changing at a rapid rate, causing competition to
become more intense than ever. Businesses that underestimate competition or are too slow to
adapt will get replaced by more innovative firms.
Changes in the external environment are often caused by:
 A shift in consumer behavior
 Introduction of new technology
 Entry of new competition
 An unpredictable event such as war, economic crisis, global pandemic, etc.
 Adoption of new legislation, e.g. tax policy, minimum wage.
 Changes in the external environment bring both opportunities and challenges for
businesses.

For example, the emergence of online marketing channels such as Facebook and Google ads
allows businesses to market and sell their products more effectively. However, their competitors
will also have access to the exact same tools and customer base.
To gain a competitive advantage, businesses cannot rely solely on external technology. They
need to invest in their own assets such as internal databases, human resources, and intellectual
property.
Another way to gain this advantage is to become more socially responsible.
With the external environment changing and the business landscape being taken over by
technology, businesses stand a better chance if they are seen in a positive light. This does not
mean companies should put on a show. Instead, they should put in a genuine effort to better
society.

PORTER’S FIVE FORCES

 Porter’s Five Forces is a model that identifies and analyzes five competitive forces that
shape every industry and helps determine an industry’s weaknesses and strengths. Five
 Forces analysis is frequently used to identify an industry’s structure to determine
corporate strategy.
 Porter’s model can be applied to any segment of the economy to understand the level of
competition within the industry and enhance a company’s long-term profitability. The
Five Forces model is named after Harvard Business School professor, Michael E.
Porter.
Porter’s 5 forces are:
 Competition in the industry
 Potential of new entrants into the industry
 Power of suppliers
 Power of customers
 Threat of substitute products

Porter’s Five Forces is a business analysis model that helps to explain why various industries
are able to sustain different levels of profitability.
1. Competition in the Industry
 The first of the Five Forces refers to the number of competitors and their ability to
undercut a company. The larger the number of competitors, along with the number of
equivalent products and services they offer, the lesser the power of a company.
 Suppliers and buyers seek out a company’s competition if they are able to offer a better
deal or lower prices. Conversely, when competitive rivalry is low, a company has greater
power to charge higher prices and set the terms of deals to achieve higher sales and
profits.
2. Potential of New Entrants Into an Industry
 A company’s power is also affected by the force of new entrants into its market. The less
time and money it costs for a competitor to enter a company’s market and be an
effective competitor, the more an established company’s position could be significantly
weakened.
 An Industry with strong barriers to entry is ideal for existing companies within that
industry since the company would be able to charge higher prices and negotiate better
terms.
3. Power of Suppliers
 The next factor in the Porter model addresses how easily suppliers can drive up the cost
of inputs. It is affected by the number of suppliers of key inputs of a good or service, how
unique these inputs are, and how much it would cost a company to switch to another
supplier. The fewer suppliers to an industry, the more a company would depend on a
supplier.
 As a result, the supplier has more power and can drive up input costs and push for other
advantages in trade. On the other hand, when there are many suppliers or low switching
costs between rival suppliers, a company can keep its input costs lower and enhance its
profits.
1. Power of Customers
  The ability that customers have to drive prices lower or their level of power is one of the
Five Forces. It is affected by how many buyers or customers a company has, how
significant each customer is, and how much it would cost a company to find new
customers or markets for its output.
 A smaller and more powerful client base means that each customer has more power to
negotiate for lower prices and better deals. A company that has many, smaller,
independent customers will have an easier time charging higher prices to increase
profitability.
2. Threat of Substitutes
 The last of the Five Forces focuses on substitutes. Substitute goods or services that can
be used in place of a company’s products or services pose a threat. Companies that
produce goods or services for which there are no close substitutes will have more power
to increase prices and lock in favorable terms. When close substitutes are available,
customers will have the option to forgo buying a company’s product, and a company’s
power can be weakened.

THE EXTERNAL FACTOR EVALUATION MATRIX

External Factor Evaluation (EFE) Matrix is a strategy tool used to examine company’s external
environment and to identify the available opportunities and threats.
External Factor Evaluation (EFE) Matrix is a strategic analysis tool used to evaluate firm’s
external environment and to reveal its strengths as well as weaknesses. The external and
internal factor analyses have been introduced by Fred R. David in his book, Strategic
Management[1]. According to the author, both tools are used to summarise the information
gained from company’s external and internal environment analyses.

External Factor Analysis

Key External Factors

When using the EFE matrix we identify the key external opportunities and threats that are
affecting or might affect a company. By analysing the external environment with the tools like
PESTLE analysis, Porter’s Five Forces or Profile Matrix, the key external factors can be
identified. The general rule is to identify as many key external and internal factors as possible.

Weights
Each key factor should be assigned a weight ranging from 0.0 (low importance) to 1.0 (high
importance). The number indicates how important the factor is if a company wants to succeed in
an industry. If there were no weights assigned, all the factors would be equally important, which
is an impossible scenario in the real world. The sum of all the weights must equal 1.0. Separate
factors should not be given too much emphasis (assigning a weight of 0.30 or more) because
the success in an industry is rarely determined by one or few factors.

Ratings
The ratings in external matrix refer to how effectively company’s current strategy responds to
the opportunities and threats. The numbers range from 4 to 1, where 4 means a superior
response, 3 – above average response, 2 – average response and 1 – poor response. Ratings,
as well as weights, are assigned subjectively to each factor. In our example, we can see that the
company’s response to the opportunities is rather poor, because only one opportunity has
received a rating of 3, while the rest have received the rating of 1. The company is better
prepared to meet the threats, especially the first threat.

Weighted Score
The score is the result of weight multiplied by rating. Each key factor must receive a score. Total
weighted score is simply the sum of all individual weighted scores. The firm can receive the
same total score from 1 to 4 in both matrices. The total score of 2.5 is an average score. In
external evaluation a low total score indicates that company’s strategies aren’t well designed to
meet the opportunities and defend against threats. In internal evaluation a low score indicates
that the company is weak against its competitors.

Note that EFE analyses only help identify and evaluate the factors, but do not directly help
formulate a strategy or the next best strategic move.

The letters EFE are an acronym for External Factor Evaluations, which shows how effectively
the company’s current strategy responds to external opportunities and threats.

It’s viewed as a strategy tool that’s used to investigate a company’s external environment and to
identify the available opportunities and threats.

It must always be combined with the IFE matrix, which stands for Internal Factor Evaluations.
This strategy tool is used to evaluate the internal environment of companies and discover both
the strengths and weaknesses.

The EFE matrix and IFE matrix were introduced by American strategic planning scholar and
consultant Fred R. David in his book ‘Strategic Management‘ in 1997. According to him, both
tools can be used to gather information obtained from external and internal environmental
analyses of companies. The summarised information can be evaluated and used for further
purposes such as building a SWOT analysis.

An External Factor Evaluation (EFE) Matrix allows strategists to summarize and evaluate
economic, social, cultural, demographic, environmental, political, governmental, legal,
technological, and competitive information. EFE Matrix indicates whether the firm is able to
effectively take advantage of existing opportunities along with minimizing the external threats.
Similarly, it will help the strategists to formulate new strategies and policies on the basis of
existing position of the company.
External factors are extracted after deep internal analysis of external environment. Obviously
there are some good and some bad for the company in the external environment. That’s the
reason external factors are divided into two categories opportunities and threats. Opportunities
are the chances exist in the external environment, it depends firm whether the firm is willing to
exploit the opportunities or may be they ignore the opportunities due to lack of resources.
Threats are always evil for the firm, minimum no of threats in the external environment open
many doors for the firm. Maximum number of threats for the firm reduce their power in the
industry.
Developing an EFE matrix is an intuitive process which works conceptually very much the same
way like creating the IFE matrix. An External Factor Evaluation (EFE) Matrix can be developed
in five steps:
1.) List key external factors as identified in the external €‘audit process. Include a total of
from ten to twenty factors, including both opportunities and threats affecting 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.
2.) 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
too 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.
3.) Assign a 1 to 4 rating 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.
4.) Multiply each factor’s weight by its rating to determine a weighted score.
5.) 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 External Factor
Evaluation (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 effect of external
threats. A total score of 1.0 indicates that the firm’s strategies are not capitalizing on
opportunities or avoiding external threats.
The External Factor Evaluation (EFE) Matrix is similar to Internal Factor Evaluation (EFE)
Matrix. The major difference between the EFE matrix and the IFE matrix is the type of factors
that are included in the model. While the IFE matrix deals with internal factors, the EFE matrix is
concerned solely with external factors.