Chapter Three

External Audit/Scan
 CHAPTER OBJECTIVE

 At the end of this chapter students able to know:

The nature of external audit/scan
Discuss the major external forces that affect organizations.

Describe key sources of external information, including internet.

Discuss important forecasting tools used in strategic management.
Discuss the importance of monitoring external trends and events.
Explain how to develop an EFE Matrix.
Explain how to develop a Competitive Profile Matrix.
Discuss the importance of gathering competitive intelligence.
 EXTERNAL AUDIT
The external assessment is also called environmental
scanning and industry analysis.

External environment consists all factors outside the organization

which provide opportunities or pose threats to the organization.

External audit is the process of identifying and evaluating

trends and events beyond the control of a single firm .

Such as increased foreign competition, population shifts,

aging society, information technology, computer revolution.

The purpose of an external audit is to develop a “finite”

list of opportunities that could benefit a firm and to minimize
the degree of threats.
 CONT'D
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.
 NEED FOR ENVIRONMENTAL SCANNING
 Environmental Scanning is essential because of following reasons:

1. Prime Influence – Environment is a prime influence on the

effectiveness of business strategies.

2. A tool to anticipate Changes – Environmental scanning is a

very useful tool not only to understand business surroundings,
but also as a good instrument to anticipate the changes and be
prepared to face the challenges of such changes.

3. Time for adjustment – A business unit cannot change the

business activities overnight. It needs time to adjust with the
changing environment.

4. Early Warning system - Environmental Scanning gives

advance warning or danger signals of the adverse changes in
environment.
 KEY EXTERNAL FORCES
 The external environment consists of two types of environment,
A. Micro environment and
B. Macro environment
 A. MICRO ENVIRONMENT
 The Micro environment consists of the factors in the company’s
immediate environments that affect the performance of the
company.

 Micro environment is also known as task environment /operating

environment.

 These includes: Suppliers, Competitors, Marketing intermediaries,

Customers, and Publics.

 Task environment is closer to the organization and includes the

sectors that conduct day-to-day transactions with the organization
and directly influence its basic operations and performance.
 SUPPLIERS
 Suppliers are those who supply the inputs like raw materials and
components to the company.

 The strategist has to consider the following factors:

 Source/Sources should be reliable.
 Uncertainty regarding the supply or other supply constraints
compel companies to maintain high inventories causing cost
increases.
 Very risky to depend on a single supplier.
 The purchasing department should “market” itself to suppliers, to
obtain favorable treatment during the periods of shortages.
 MARKETING INTERMEDIARIES:
Marketing intermediaries are the ‘firms that aid the company in
promoting, selling and distributing its goods to final buyers’.

This includes:
Middlemen and merchants who “help the company find customers
or close sales with them”

Physical distribution firms which “ assist the company in stocking

and moving goods from their origin to their destinations”

Marketing service agencies which “assist the company in targeting

and promoting its products to the right markets”

Financial intermediaries which “finance marketing activities and

insure business risks”
 COMPETITORS
Competitors are not only other firms of similar products but also all
those who compete for the discretionary income of the consumers.

The strategist has to consider what kind of the competition that

exists in the market, such as:
 Desire competition
 Generic competition
 Product form competition
 Brand competition
 CUSTOMERS
 Major task of a business is to create and sustain customers;
therefore monitoring the customer sensitivity is a prerequisite for the
business success.

Different categories of consumers are:

 Individuals
 Households
 Industries and other commercial establishments
 Government and other institutions
Depending on single customer is too risky.

Choice of customer should be done by considering

 Relative profitability
 dependability
 stability of demand
 growth prospectus
 extent of competition
 PUBLICS
 It is any group that has an actual or potential interest in or
impact on an organization’s ability to achieve its interests.

Some of examples are media publics, citizen’s action publics and

local publics.

 Media attack on any company can influence the
government decisions affecting the company.

 Environmental pollution is an issue often taken up by

number of local publics.

 Publics are not always threat to the business but fruitful

cooperation between a company and the local publics may
be established for the mutual benefit.
 B. MACRO ENVIRONMENT
 Macro environment consists of larger societal forces that affect all
the actors in company’s micro environment.

 Demographic, Economic, Social, Cultural, Political, Governmental

and Legal, and natural environmental changes have a major
impact on virtually all products, services, markets, and customers.

Also known as societal environment.

The societal environment includes general forces that do not directly

touch on short-run activities of the organization but that can, and often
does, influence its long-run decisions.
 1. DEMOGRAPHIC ENVIRONMENT
 The demographic environments consist of demographic factors
like population growth rate, age composition, sex composition,
education level, caste and creed, religion etc. which are relevant
to business.

 E.g. Decline in birth rates in USA has affected the demand for
baby products.

 So Johnson & Johnson repositioned their products like

baby shampoo and baby oil, to the adult segment,
particularly to females.
 2) ECONOMIC ENVIRONMENT
The important external factors that constitute the economic
environment of a business includes:
 Economic condition,
 Economic policies and
 Economic system.

Economic condition
 The economic conditions of a country for example, nature of
the economy, stage of development of the economy, economic
resources, level of income, distribution of income and assets,
etc. are among the very important determinants of business
strategies.

 In a developing country, the low income may be the reason

for the very low demand for the product.
 CONT'D
Economic policies
Some types or categories of business are favorably affected by
government policy, some adversely affected, while it is neutral to
some others.

E.g. a restrictive import policy may greatly help the import

competing industries, while a liberalization of the import
policy may create difficulties for such industries.

Economic System
The scope of the private business depends on the economic system.

The freedom of the private enterprise is the greatest in the free

market economy.
 3. NATURAL ENVIRONMENT
Geographical and ecological factors such as natural resources
endowments, weather and climatic conditions, topographic factors,
location aspects in the global context, port facilities, etc. are all
relevant to business.

Differences in geographical conditions between markets may

sometimes call for changes in the marketing mix.

Geographical and Ecological factors also influence the location of

certain industries.

E.g. industries with high material index tend to be located near

the raw material sources.
 CONT'D
Topographical factors may affect the demand pattern.

 E.g. In hilly areas with difficult terrain, jeeps may be in a

greater demand than cars.
 Ecological factors have recently assumed great importance.

 The depletion of natural resources, environmental pollution and

the disturbance of ecological balance have caused great concern.
 4. TECHNOLOGICAL
ENVIRONMENT
Business prospects demands availability of certain physical facilities.

 E.g. Demand for electrical appliances is affected by the extent of

electrification and the reliability of power supply.

The fast changing technologies also create problems for enterprises

as they render plants and products obsolete quickly.

 Differing technological environment of different markets may call for

product modifications.
 E.g. Many appliances are designed for 110 V in USA. They should
be converted for 240v in Asia and Africa
 Technological developments may increase or decrease the demand
for some existing products.
 E.g. Voltage stabilizers help increase in sale of electrical
appliances in markets characterised by frequent voltage
fluctuations.
 5. POLITICAL & GOVERNMENT ENVIRONMENT
 Political, governmental, and legal factors therefore can represent
key opportunities or threats for both small and large organizations.

In many countries regulations to protect consumer interests have

become stronger.

Some governments specify certain standards for the products to be

marketed in the country; some even prohibit the marketing of certain
products.

Promotional activities are subject to various types of controls.

Eg: In gulf countries and India advertisement of alcoholic and

tobacco products are prohibited and the packages must carry
“injurious to health” warnings.
 6. SOCIO - CULTURAL ENVIRONMENT
 Socio – cultural fabric is an important environment factor that
should be analyzed while formulating the business strategies.

 Major factors of socio- cultural environments are:

• Buying and consumption habits of people,
• Their language beliefs and values,
• Customs and traditions,
• Tastes and preferences,
• Education
Strategy should be appropriate in the socio-cultural environment.

 Eg: Nestle company makes a very large variety of instant

coffee to satisfy different national tastes.
 CONT'D
People of different cultures used the same product for different
purposes.

E.g: Vicks Vaporub, the popular pain balm is used as mosquito

repellent in some tropical countries.

 Language difference poses a serious problem.

 E.g. Tonic is popular drink in our county but it has different
meaning in Italy.

 Colour
 Blue: feminine and warm in Holland but masculine and cold in
Sweden.

 White: death and mourning in China and Korea; but it expresses

happiness in some countries and also the colour of bridal dress.
 COMPETITIVE (INDUSTRY)
ANALYSIS
The five forces framework developed by Michael porter is the most
widely known tool for analyzing the competitive environment, which
helps in explaining how forces in the competitive environment shape
strategies and affect performance.

According to Porter, the nature of competitiveness in a given industry

can be viewed as a composite of five forces.
A. Rivalry among competitive firms.
B. Potential entry of new competitors.
C. Potential development of substitute products
D. Bargaining power of suppliers.
E. Bargaining power of consumers.
THE FIVE-FORCES MODEL OF
COMPETITION
 RIVALRY AMONG EXISTING FIRMS
It is usually the most powerful of the five competitive forces.
Focus on competitive advantage of strategies over other firms.
Some of conditions that causes high rivalry among competing firms
include:
 High number of competing firms.
 Similar capability of firms competing.
 When barriers to leaving the market are high.
 Similar size of firms competing.
 When consumers can switch brands easily.
 When the product is perishable.
 When rivals have excess inventory.
 When consumer demand is falling.
 When rivals sell similar products/services etc.
 POTENTIAL ENTRY OF NEW COMPETITORS
 Barrier to entry is the condition that a firm must satisfy to enter an
industry.

New entrants to an industry bring new capacity, the desire to gain

market share and often substantial resources.

Whenever, new firms can easily enter a particular industry, the

intensity of competitiveness among firms increase.

 Sources of barrier to entry

 Need to gain economies of scale quickly.
 Need to gain technology and specialized know - how.
 Strong customer loyality.
 Strong brand preferences.
 Large capital requirements.
 Lack of adequate distribution channels.
 Lack of access to raw materials.
 Potential saturations of the market. etc
 POTENTIAL DEVELOPMENT OF SUBSTITUTES

An important force of competition is the power of substitutes.

“Substitutes limit the potential returns in an industry by placing a

ceiling on the price firms in the industry can profitability charge.

A firm that has a product which cannot be easily substituted, either

because it is unique or because it has some form of protection (e.g.
a patent), is in a strong position.

Pressure increases when:

 Prices of substitutes decrease.
 Consumers switching costs decrease.
 BARGAINING POWER OF CUNSUMERS/BUYERS
 Customers being concentrated or buying in volume affects intensity
of competition.

Consumers/Buyers are powerful if

a) They are concentrated or purchase in large volume
b) Products are standard or not differentiated.
c) Sellers are struggling in the face of falling consumer demand.
d) They are price sensitive ( inexpensively switch)
e) They are well informed about prevailing issues in the market
(Products, prices and costs)
f) There are large number of sellers/suppliers
 BARGAINING POWER OF
SUPPLIERS/SELLERS
Suppliers can exert bargaining power on participants in an industry
by raising price or reducing the quality of products or services.

E.g. If a major steel producer selling to a small metal fabricator,

the firm has a weak position and its ability to compete will to a
large extent depend on the steel producer. If, the supplier decided
to raise prices, the firm would have high switching costs and little
option but to accept the raise.

Suppliers are powerful if:

a) It is dominated by few companies/suppliers.
b) Large number of buyers and high product demand.
c) Its product is unique or at least differentiated.
d) Costs of switching raw materials is high.
e) Few substitutes.
 SOURCES OF EXTERNAL INFORMATION
A. Published and Unpublished Sources
 Information is available from both published and unpublished
Sources.

Unpublished sources include customer surveys, market

research, speeches at professional and shareholders’ meetings,
television programs, interviews, and conversations with
stakeholders.

Published sources of strategic information include periodicals,

journals, reports, government documents, abstracts, books,
directories, newspapers, and manuals.
B. Internet
Millions of people today use on-line services for both business and
personal purposes.

The Internet offers consumers and businesses a widening range of

services and information resources from all over the world.
 FORECASTING TOOLS AND TECHNIQUES
A. Forecasts
 Forecasts are educated assumptions about future trends and
events.

 Forecasting is a complex activity due to factors such as

technological innovation, cultural changes, new products,
improved services, stronger competitors, shifts in
government priorities, changing social values, unstable
economic conditions, and unforeseen events.

 Forecasting tools can be broadly categorized into two

groups:

a. Quantitative forecasts are most appropriate when historic

data are available and when the relationships among key
variables are expected to remain the same in the future.

 The three basic types of quantitative forecasting techniques

b) Qualitative forecasts.
 The six basic qualitative approaches to forecasting are:
(1) sales force estimates,
(2) juries of executive opinions,
(3) anticipatory surveys or market research,
(4) scenario forecasts,
(5) Delphi forecasts, and
(6) brainstorming.
B. Making 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 o the ability to achieve desired
results.
 INDUSTRY ANALYSIS: THE EXTERNAL
FACTOR EVALUATION (EFE) MATRIX
 An External Factor Evaluation (EFE) Matrix allows strategists to
summarize and evaluate economic, social, cultural, demographic,
environmental, political, governmental, legal, technological, and
competitive information.

 The EFE matrix consists of five steps process.

 EFE MATRIX STEPS

1. List key external factors (10-20)

 These factors should be two points to be kept in mind these are opportunities
and threats.
2. Assign weight for each from 0 to 1.0 then, Sum of all weights.
 The sum of the total of all the factors should always be one.

3. Assign 1-4 rating to each factor (Rate effectiveness of current strateies)

 How well Firm’s current strategies respond to these factors.

4. Multiply each factor’s weight by its rating. (Produces a weighted score)

 How the firm will respond to these external factors. Such criteria are known as
rating
 CONT'D
5. Sum the weighted scores for each. (Determines the total weighted
score for the organization)

 Highest possible weighted score for the organization is 4.0; the

lowest, 1.0. Average = 2.5

 Note: Understanding of the factors used in the EFE Matrix is more

important than the actual weights and ratings assigned.

 This is important to understand the factors for which you are

preparing the EFE matrix than the weight %age given to the
each factors.
EFE MATRIX FOR A LOCAL TEN-THEATER CINEMA
COMPLEX
 THE COMPETITIVE PROFILE MATRIX
(CPM)

The Competitive Profile Matrix (CPM) identifies a firm's major

competitors and their particular strengths and weaknesses in relation
to a sample firm's strategic position.

The weights and total weighted scores in both a CPM and EFE have
the same meaning.

However, the factors in a CPM include both internal and external

issues.

Therefore, the ratings refer to strengths and weaknesses, where 4.5

major strength, 3.5 minor strength, 2.5 minor weakness, and 1.5 major
weakness.
EXAMPLE COMPETITIVE PROFILE
MATRIX
 DIFFERENCES BETWEEN THE EFE AND
CPM
There are some important differences between the EFE and CPM.

1. Critical success factors in a CPM are broader; they do not include

specific or factual data and even may focus on internal issues.

2. The critical success factors in a CPM also are not grouped into
opportunities and threats as they are in an EFE.

3. In a CPM the ratings and total weighted scores for rival firms can
be compared to the sample firm.

 This comparative analysis provides important internal

strategic information.
 COMPETITIVE INTELLIGENCE(CI)
Competitive Intelligence
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.

The three basic objectives of a CI program are:

to provide a general understanding of an industry and its competitors.
to identify areas in which competitors are vulnerable and to assess the
impact strategic actions would have on competitors.
to identify potential moves that a competitor might make that would
endanger a firm's position in the market.
 Chapter Four
The Internal Assessment
 Chapter Objectives
1. Describe how to perform an 5. Explain how to determine and prioritize
internal strategic-management a firm’s internal strengths and
audit. weaknesses.

2. Discuss the Resource-Based View

(RBV) in strategic management. 6. Explain the importance of financial ratio
analysis.
3. Discuss key interrelationships
among the functional areas of
business. 7. Discuss the nature and role of
management information systems in
4. Identify the basic functions or strategic management.
activities that make up
 management, 8. Develop an Internal Factor Evaluation
 marketing, (IFE) Matrix.
 finance/accounting
 production/operations, 9. Explain cost/benefit analysis, value chain
 research and development, and analysis, and benchmarking as strategic-
management tools.
 management information systems.
 NATURE OF INTERNAL AUDIT
 All organizations have strengths and weaknesses in the functional
areas of business.

No enterprise is equally strong or weak in all areas.

Internal strengths/weaknesses, coupled with external

opportunities/threats and a clear statement of mission provide the
basis for establishing objectives and strategies.

Here of, Objectives and strategies are established with the

intention of capitalizing upon internal strengths and overcoming
weaknesses.

After understanding opportunities from external environment , the

firm requires internal capacity that enables to exploit opportunities
on time.
 CONT'D
 Hence, the internal environmental analysis process evaluates all
relevant factors within an organization in order to determine its
strengths and weaknesses.

 It starts with the identification of the organization’s resource

allocations, an enumeration of its strengths and their strategic
significance.
 THE PROCESS OF PERFORMING AN INTERNAL AUDIT

 The internal audit

 The process of performing an internal audit closely parallels the
process of performing an external audit.

 Requires gathering and assimilating information about the firm’s

management, marketing, finance/accounting, production/operations,
research and development (R&D), and management information
systems operations.

 Compared to external audit, the process of performing an internal

audit provides more opportunity for participants to understand how
their jobs, departments, and divisions fit into the whole organization.
 Key Internal Forces
 Distinctive competencies
A firm’s strengths that cannot be easily matched or imitated by
competitors.

 Building competitive advantages involves taking advantage of

distinctive competencies.

 Strategies are designed in part to improve on a firm’s weaknesses,

turning them into strengths and maybe even into distinctive
competencies.

 The process of gaining competitive advantage in a firm

 Weaknesses ⇒ Strengths ⇒ Distinctive Competencies ⇒ Competitive Advantage
 THE RESOURCE-BASED VIEW (RBV)
 The Resource-Based View (RBV) approach
 contends that internal resources are more important for a firm
than external factors in achieving and sustaining competitive
advantage.

 Proponents of the RBV contend that organizational performance will

primarily be determined by internal resources that can be grouped
into three all-encompassing categories:
Physical resources,
Human resources, and
Organizational resources.
 CONT'D
 For a resource to be valuable, it must be either
(1) rare,
(2) hard to imitate, or
(3) not easily substitutable

 These three characteristics of resources enable a firm

to implement strategies that improve its efficiency and
effectiveness and lead to a sustainable competitive
advantage.
 MANAGEMENT
 The functions of management consist of five basic activities: planning,
organizing, motivating, staffing, and controlling.

 These activities are important to assess in strategic planning because

an organization should continually capitalize on its management
strengths and improve on its management weaknesses.

 Functions of S. Management
 Planning Strategy Formulation
 Organizing Strategy Implementation
 Motivating Strategy Implementation
 Staffing Strategy Implementation
Controlling Strategy Evaluation
THE BASIC FUNCTIONS OF
MANAGEMENT
 MANAGEMENT AUDIT CHECKLIST OF
QUESTIONS
1. Does the firm use strategic-management concepts?
2. Are company objectives and goals measurable and
well communicated?
3. Do managers at all hierarchical levels plan
effectively?
4. Do managers delegate authority well?
5. Is the organization’s structure appropriate?
6. Are job descriptions and job specifications clear?
7. Is employee morale high?
8. Are employee turnover and absenteeism low?
9. Are organizational reward and control mechanisms
effective?
 MARKETING
 Marketing
 the process of defining, anticipating, creating, and fulfilling
customers’ needs and wants for products and services.
 There are seven basic Functions of Marketing:
Customer analysis
Selling products/services
Product and service planning
Pricing
Distribution
Marketing research
Opportunity analysis
 Understanding these functions helps strategists identify and
evaluate marketing strengths and weaknesses.
 MARKETING FUNCTIONS
 Customer analysis
 The examination and evaluation of consumer needs, desires, and
wants.

 Involves administering customer surveys, analyzing consumer

information, evaluating market positioning strategies,
developing customer profiles, and determining optimal market
segmentation strategies.

 The information generated by customer analysis can be essential

in developing an effective mission statement
 CONT'D
 Selling Products/Services
 Selling includes many marketing activities such as advertising,
sales promotion, publicity, personal selling, sales force
management, customer relations, and dealer relations.

 These activities are especially critical when a firm pursues a

market penetration strategy.
 Product and service planning
 includes activities such as test marketing; product and brand
positioning; devising warranties; packaging; determining product
options, features, style, and quality; deleting old products; and
providing for customer service.

 important when a company is pursuing product development or

diversification.
 PRICING

 Five major stakeholders affect pricing decisions:

consumers, governments, suppliers, distributors, and
competitors.

 Sometimes an organization will pursue a forward

integration strategy primarily to gain better control over
prices charged to consumers.

 Strategists should view price from both a short-run and a

long-run perspective, because competitors can copy price
changes with relative ease.
 DISTRIBUTION

 Distribution
 includes warehousing, distribution channels,
distribution coverage, retail site locations, sales
territories, inventory levels and location,
transportation carriers, wholesaling, and retailing.

 especially important when a firm is striving to

implement a market development or forward
integration strategy.
 MARKETING RESEARCH

 Marketing research
 the systematic gathering, recording, and analyzing of
data about problems relating to the marketing of
goods and services.

 Marketing research can uncover critical strengths and

weaknesses, and marketing researchers employ
numerous scales, instruments, procedures, concepts,
and techniques to gather information.

 Organizations that possess excellent marketing

research skills have a definite strength in pursuing
generic strategies.
 OPPORTUNITY OR COST/BENEFIT
ANALYSIS
The seventh function of marketing is opportunity analysis, which
involves assessing the costs, benefits, and risks associated with
marketing decisions.

Three steps are required to perform a cost/benefit analysis:

1. compute the total costs associated with a decision,
2. estimate the total benefits from the decision,
3. compare the total costs with the total benefits.
 As expected benefits exceed total costs, an opportunity becomes
more attractive.

 Sometimes the variables included in a cost/benefit analysis cannot

be quantified or even measured, but usually reasonable estimates
can be made to allow the analysis to be performed.
 MARKETING AUDIT CHECKLIST OF QUESTIONS
1. Are markets segmented effectively?
2. Is the organization positioned well among competitors?
3. Has the firm’s market share been increasing?
4. Are present channels of distribution reliable and cost effective?
5. Does the firm have an effective sales organization?
6. Does the firm conduct market research?
7. Are product quality and customer service good?
8. Are the firm’s products and services priced appropriately?
9. Does the firm have an effective promotion, advertising, and publicity
strategy?
10. Are marketing, planning, and budgeting effective?
11. Do the firm’s marketing managers have adequate experience and
training?
12. Is the firm’s Internet presence excellent as compared to rivals?
 FINANCE/ACCOUNTING FUNCTIONS
According to James Van Horne, the functions of finance/accounting
comprise three decisions:

1. the investment decision

2. the financing decision
3. the dividend decision

Investment decision/capital budgeting

 the allocation and reallocation of capital and resources to
projects, products, assets, and divisions of an organization.

Financing decision
 determines the best capital structure for the firm and includes
examining various methods by which the firm can raise capital.
 CONT'D

 Dividend decisions
 concern issues such as the percentage of
earnings paid to stockholders, the stability of
dividends paid over time, and the repurchase
or issuance of stock.
 determine the amount of funds that are
retained in a firm compared to the amount
paid out to stockholders.
A SUMMARY OF KEY FINANCIAL
RATIOS
A SUMMARY OF KEY FINANCIAL RATIOS
A SUMMARY OF KEY FINANCIAL RATIOS
A SUMMARY OF KEY FINANCIAL RATIOS
 FINANCE/ACCOUNTING FUNCTIONS

1. How has each ratio changed over time?

2. How does each ratio compare to industry norms?
3. How does each ratio compare with key competitors?
FINANCE/ACCOUNTING AUDIT CHECKLIST

1. Where is the firm financially strong and weak as

indicated by financial ratio analyses?
2. Can the firm raise needed short-term capital?
3. Can the firm raise needed long-term capital through
debt and/or equity?
4. Does the firm have sufficient working capital?
5. Are capital budgeting procedures effective?
6. Are dividend payout policies reasonable?
7. Does the firm have good relations with its investors and
stockholders?
8. Are the firm’s financial managers experienced and well
trained?
9. Is the firm’s debt situation excellent?
 PRODUCTION/OPERATIONS

 Production/operations function
 consists of all those activities that transforms inputs into goods
and services.
 Production/operations management deals with inputs,
transformations, and outputs that vary across industries and markets.
THE BASIC FUNCTIONS (DECISIONS) WITHIN
PRODUCTION/OPERATIONS
IMPLICATIONS OF VARIOUS STRATEGIES ON
PRODUCTION/OPERATIONS
 PRODUCTION/OPERATIONS AUDIT CHECKLIST

1. Are supplies of raw materials, parts, and subassemblies

reliable and reasonable?
2. Are facilities, equipment, machinery, and offices in good
condition?
3. Are inventory-control policies and procedures effective?
4. Are quality-control policies and procedures effective?
5. Are facilities, resources, and markets strategically
located?
6. Does the firm have technological competencies?
 RESEARCH AND DEVELOPMENT AUDIT
1. Does the firm have R&D facilities? Are they adequate?
2. If outside R&D firms are used, are they cost-effective?
3. Are the organization’s R&D personnel well qualified?
4. Are R&D resources allocated effectively?
5. Are management information and computer systems adequate?
6. Is communication between R&D and other organizational units
effective?
7. Are present products technologically competitive?
 MANAGEMENT INFORMATION SYSTEMS

 A management information system’s purpose is to improve the

performance of an enterprise by improving the quality of
managerial decisions.

 An effective information system thus collects, codes, stores,

synthesizes, and presents information in such a manner that it
answers important operating and strategic questions.
 MANAGEMENT INFORMATION SYSTEMS AUDIT
1. Do all managers in the firm use the information system to make
decisions?

2. Is there a chief information officer or director of information

systems position in the firm?
3. Are data in the information system updated regularly?

4. Do managers from all functional areas of the firm contribute

input to the information system?

5. Are there effective passwords for entry into the firm’s

information system?
 CONT'D

6. Are strategists of the firm familiar with the information

systems of rival firms?

7. Is the information system user-friendly?

8. Do all users of the information system understand the

competitive advantages that information can provide
firms?

9. Are computer training workshops provided for users of

the information system?

10. Is the firm’s information system continually being

improved in content- and user-friendliness?
 VALUE CHAIN ANALYSIS (VCA)
 Value chain analysis (VCA)
 The firm is viewed as a chain of value-creating activities starting
with procuring new materials or inputs and continuing through
design, component production, manufacturing and assembly,
distribution, sales, delivery, and support of the ultimate user of its
products or services.

 Therefore, a value chain is a set of interlinked value-creating

activities performed by an organization.

 aims to identify where low-cost advantages or disadvantages

exist anywhere along the value chain from raw material to
customer service activities.
 CONT'D
Assessing the strength and weakness of an organization based on
an understanding of the series of activities it performs.

 The value chain of a manufacturing organization can be divide into

 Primary activities and
 Supporting activities

 Primary activities: those involved in the physical creation of the

product, marketing and transfer to the buyer, and after-sale
support.

 Support activities: assist the primary activities by providing

infrastructure of inputs that allow them to take place on an ongoing
basis.
VALUE CHAIN ANALYSIS: DIAGRAM
 BENCHMARKING

 Benchmarking
 an analytical tool used to determine whether a firm’s
value chain activities are competitive compared to
rivals and thus conducive to winning in the
marketplace.

 entails measuring costs of value chain activities across

an industry to determine “best practices”
TRANSFORMING VALUE CHAIN ACTIVITIES INTO
SUSTAINED COMPETITIVE ADVANTAGE
 THE INTERNAL FACTOR EVALUATION (IFE)
MATRIX
1. List key internal factors as identified in the internal-audit process.
2. Assign a weight that ranges from 0.0 (not important) to 1.0 (all-important) to each factor.
3. Assign a 1-to-4 rating to each factor to indicate whether that factor represents a strength
or weakness.
4. Multiply each factor’s weight by its rating to determine a weighted score for each
variable.
5. Sum the weighted scores for each variable to determine the total weighted score for
the organization.
A SAMPLE INTERNAL FACTOR EVALUATION MATRIX
FOR A RETAIL COMPUTER STORE
STRATEGIES IN
ACTION
CHAPTER FIVE
5.1 Types of Strategies and Guidelines
for Pursuing Strategies
Types of Strategies: can be categorized into
six broad categories.
1. Vertical Integration Strategies
A. Forward Integration

B. Backward Integration

C. Horizontal Integration

2. Intensive Strategies
A. Market Penetration

B. Market Development

C. Product Development
3. Diversification Strategies
A. Concentric Diversification
B. Conglomerate Diversification
C. Horizontal Diversification
4. Defensive Strategies
D. Retrenchment
E. Divestiture
F. Liquidation
5. Michael Porter’s Generic
Strategies
A. Cost leadership

B. Differentiation

C. Focus
1. VERTICAL INTEGRATION /
INTEGRATION STRATEGIES:
 allow a firm to gain control over
distributors, suppliers, and/or competitors.
A. Forward Integration:
 Gaining ownership or increased control
over distributors or retailers.
 Guidelines for Forward Integration: when

 Present distributors are expensive,

unreliable, or incapable of meeting
firm’s needs
 Availability of quality distributors is
limited
  firm competes in an industry that is
expected to grow markedly
 Organization has both capital and
human resources needed to manage new
business of distribution
 Advantages of stable production are
high, i.e., if there is high mark-up inside
of retailers.
 Present distributors have high profit
margins
B. Backward Integration:
 Involves seeking ownership or increased
control of a firm’s suppliers.
 Guidelines for Backward Integration:
When
 present suppliers are expensive,
unreliable, or incapable of meeting needs
 Number of suppliers is small and
number of competitors large
 High growth in industry sector
 Firm has both capital and human
resources to manage new business
 Advantages of stable prices are
important
 Present supplies have high profit
margins
C. Horizontal Integration:
 Seeking ownership of or
increased control over a firm’s
competitors.
 Used as a growth strategy.
 Best examples: Mergers,
acquisitions, and takeovers.
They allow for:
 increased economies of scale

and
 enhanced transfer of resources
Merger:
 A transaction involving two or more
corporations in which stock is exchanged,
but from which only one corporation
survives:
 Usually occur between firms of somewhat
similar size and are usually “friendly”.
 The resulting firm is likely to have a name
derived from its composite firms.
 Example

 The merging of Allied Corporation &

Signal companies to form Allied Signal
 The merging of Matador Tire and Addis
Tire to form Matador Addis.
Acquisition
 Is the purchase of a company that is
completely absorbed as an operating
subsidiary or division of the acquiring
corporation.
 Example:
 Heineken’s purchase of Bedele.
 Hayat Real Estate’s purchase of Ras Hotel.
 Occurs between firms of different sizes and
can be friendly or hostile.
 Hostile acquisitions are often called
takeovers.
 Guidelines for Horizontal Integration
 Firm can gain monopolistic
characteristics without being challenged
by federal government
 When a firm competes in growing
industry
 When Increased economies of scale
provide major competitive advantages
 Faltering due to lack of managerial
expertise or need for particular
resources
 An organization has both the capital
and human talent needed to successfully
manage an expanded organization.
2. INTENSIVE STRATEGIES:
 require intensive efforts to improve a
firm’s competitive position with existing
products.
A. Market Penetration:
 seeks to increase market share for
present products or services in present
markets through greater marketing
efforts.
 includes :
 increasing the number of salespersons,
 increasing advertising expenditures,

 offering extensive sales promotion items,

or

 Guidelines for Market Penetration
 Current markets not saturated.
 Usage rate of present customers can be
increased significantly.
 Market shares of competitors declining
while total industry sales increasing.
 Increased economies of scale provide
major competitive advantages.
TWO TYPES OF MARKET PENETRATION

1.Rapid Market 2. Slow Market

Penetration: Penetration
Assumptions: Assumptions:
 Lowering the price  Lowering the price

 Increasing  Unchanged
promotional promotional
activities activities.
B. Market Development:
 involves introducing present products or
services into new geographic areas.
 Example: Ethiopian Airlines’ flights to new
states.
 Guidelines for Market Development

 When there is new channels of

distribution that are reliable, inexpensive,
and good quality
 Firm is very successful at what it does
 Untapped or unsaturated markets
 Capital and human resources necessary to
manage expanded operations
 Excess production capacity
 Basic industry rapidly becoming global
C. Product Development:
a strategy that seeks increased
sales by improving or modifying
present products or services.
usually entails large research and
development expenditures.

Example: Geely Automobile

 Guidelines for Product Development
 Products in maturity stage of life cycle
 Competes in industry characterized by
rapid technological developments
 Major competitors offer better-quality
products at comparable prices
 Compete in high-growth industry
 Strong research and development
capabilities
3. DIVERSIFICATION STRATEGIES:
When an industry consolidates
and becomes mature, most of the
surviving firms have reached the
limits of growth using vertical and
horizontal growth strategies.
Unless the competitors are able to
expand internationally into less
mature markets, they may have no
choice but to diversify into
different industries if they want to
continue growing.
A.Concentric
Diversification:
Adding new, but related
products or services.
Example: Coca Cola
Company; the recent add of
Fanta Apple to existing
product mix.
 Guidelines for Concentric Diversification
 Adding new & related products increases
sales of current products
 New & related products offered at
competitive prices
 Current products are in decline stage of
the product life cycle
 Strong management team

B.Conglomerate Diversification:
 Adding new, unrelated products or
services.
 E.g., If a Construction business enters
into Hotel business
 Guidelines for Conglomerate
Diversification
 Declining annual sales and profits
 Capital and managerial talent to compete
successfully in a new industry
 Financial synergy between the acquired
and acquiring firms
 Existing markets for present products
are saturated
C. Horizontal Diversification:
 Adding new, unrelated products or
services for present customers.
 E.g., Zemen Bank and Access Real Estate
 Guidelines for Horizontal
Diversification
Revenues from current
products/services would increase
significantly by adding the new
unrelated products
Highly competitive and/or no-
growth industry with low margins
and returns
Present distribution channels can
be used to market new products to
current customers.
4. DEFENSIVE STRATEGIES:
 aim to lower the probability of attack,

 divert attacks to less threatening

avenues, or lessen the intensity of
attack.
 deliberately reduce short term
profitability to ensure long-term
profitability.
A. Retrenchment:
 Occurs when an organization
regroups through cost and asset
reduction to reverse declining sales
and profits.
 Guidelines for using retrenchment
Firm is one of the weaker
competitors
Firm has failed to meet its
objectives and goals consistently
over time but has distinctive
competencies
Inefficiency, low profitability, poor
employee morale and pressure from
stockholders to improve
performance.
When an organization’s strategic
managers have failed
B. Divestiture:
 Selling a division or part of an
organization, which is unprofitable.
 Guidelines for Divestiture
 When firm has pursued retrenchment but
failed to attain needed improvements
 When a division needs more resources
than the firm can provide
 When a division is responsible for the
firm’s overall poor performance
 When a division is a misfit with the
organization
 When a large amount of cash is needed
and cannot be obtained from other
C. Liquidation:
 Selling of all of a company’s assets, in
parts, for their tangible worth.
 Guidelines for Liquidation
 When both retrenchment and
divestiture have been pursued
unsuccessfully
 If the only alternative is bankruptcy,
liquidation is an orderly alternative
 When stockholders can minimize their
losses by selling the firm’s assets
6. MICHAEL PORTER’S GENERIC
STRATEGIES
 According to Porter, strategies allow
organizations to gain competitive advantage

from three different bases: cost leadership,

differentiation, and focus.

 Porter calls those bases generic strategies.

A. Cost Leadership Strategy:

 Emphasizes producing standardized products
at very low per-unit cost for consumers who
are price sensitive.
B. Differentiation Strategy:
A strategy aimed at producing products
and services considered unique industry-
wide and directed at consumers who are
relatively price - insensitive.
C. Focus/Niche Strategy
 Producing products and services that
fulfill the needs of small/particular groups
(segment) of consumers.
 A firm can form a competitive advantage
for the particular market segment (niche)
by pursuing either;
 Cost focus - low cost of production or

 Differentiation focus - providing unique

product features.
Figure: Porter’s Generic Strategies
End of
Chapter
Five