External Analysis

External analysis refers to the process conducted by companies to evaluate without bias all the changes taking place in different areas of their industry that can impact business operations. This procedure enables businesses to adjust to the changes and stay successful within the industry.

The aspects within an industry environment that might be subject to change include the competitive position, dynamics, competitive structure, and history. On a macro level, this type of analysis includes political, global, macroeconomic, social, technological, and demographic analysis. Companies can determine the threats and opportunities within an industry or a market segment that can drive volatility, growth, and profitability.

Key Takeaways                                                               

• External analysis refers to a procedure that a business conducts to analyze the alterations taking place in a business’s external environment. Businesses get to know the threats and opportunities within the market segment or industry they operate in if they carry out this process.
• Some elements or components of such an analysis are industry, economic trends, supply chain, and market demographics.
• A key difference between external analysis and internal analysis is that the latter involves assessing the changes taking place within a company.
• This type of analysis makes a company’s management team more proactive.

External analysis refers to a process that involves organizations objectively analyzing the alterations in their external environment or industry that can affect their operations. Businesses conduct such an analysis to keep all the changes occurring in their industry environment, understand the uncertainty, and continue to be successful. Moreover, businesses can stay aware of the potential opportunities and threats by carrying out this type of analysis.

Determining the opportunities and using the right strategies to make the most of them can offer great benefits. On the other hand, not identifying or mitigating the threats resulting from the external environment can lead to unfavorable results for an organization. This makes external analysis in strategic management essential for businesses.

As noted above, this form of analysis concentrates on the macro-environmental forces external to a company and indirectly impacting its performance or operations. Some of the factors that a company analyzes through this process are social, political, technological, global, ecological, and legal. With the help of the analysis, an organization can predict events that can occur in the future and impact its operations.

Since managers cannot control external environmental factors, they need to gain a competitive advantage to be ahead of their company’s industry peers and have the maximum market share. Companies that continuously analyze the external environment can compete in a competitive industry.

The components of external analysis are as follows:

#1 - Supply Chain

The supply chain focuses on these factors:

• The manufacturing or production procedure that converts raw materials into the organization’s products.
• Finished products’ transportation to the retail locations
• Sources of the business’s raw materials

The above factors are external, as they generally occur in an area that is not the organization’s headquarters. Hence, businesses need to track the process and seek ways in which they can improve it to maximize efficiency. Simultaneously, they must ensure to follow the laws and regulations.

#2 - Industry

Analyzing the industry helps understand a business’s position relative to different organizations offering similar services or products. Knowing and comprehending the forces within the industry is crucial for effective strategic planning. Businesses can identify their opportunities and threats and focus on utilizing the available resources to develop one-of-a-kind capabilities that can offer a competitive advantage by carrying out an industry analysis.

An industrial analysis has the following three crucial elements:

• The industry's attractiveness
• Critical factors determining the business’s success in its industry
• Underlying forces that are at work within the industry

Companies may take proactive measures to ensure their operations are carried out without hassle by reviewing factors like the industry’s estimated growth, current size, etc.

#3 - Market Demographics

This component helps organizations determine whether their market tactics and offerings fulfill the target audience’s requirements. Some factors included in market demographics are as follows:

• Economic or income status
• Age
• Interests and hobbies
• Location of residence

Considering the above factors enables organizations to revise their product or service portfolio and marketing campaigns.

#4 - Competitors

 It is another key component of this type of analysis. Let us look at some of its focus areas.

• The impact the goods of competitors will have on the exact kind of goods’ sale carried out by another organization
• Acceptable pricing organizations can assign to products encouraging sales while maintaining the same profit level as industry peers or competitors.
• Potential barriers to going into a new industry, for example, brand loyalty, government laws, or product saturation.
• The results of complementary services or products on the organization’s success

Reviewing such aspects helps organizations figure out the ideal price points, measures to enhance product quality, alternative industries they can pursue, and the necessary marketing tactics to ensure that the business remains successful.

#5 - Economic Trends

Looking for potential alterations in economic trends, for example, inflation, interest rates, recession levels, and trading laws, help organizations adapt. Precisely, it enables business owners to determine how the elements could impact the profit level during a certain timeframe.

#6 - PEST Analysis

This component offers a way for businesses to assess every external factor that can affect them. It includes the following factors:

• Economic: Interest rates, inflation, exchange rates, etc.
• Technological: Investments in research and development, new industry technology, etc.
• Political: Regulations, trade barriers, laws, etc.  
• Social: Population, age, etc.

Let us discuss some popular tools businesses use for external analysis.

#1 - Scenario Planning

In events where traditional forecasting techniques cannot predict the changes in the industry environment, a business can utilize scenario planning for environmental analysis. This method involves researching the possible environmental impact on a particular organization. It offers a believable and detailed analysis of possible future alterations to a company’s business environment.

#2 - PESTLEG Analysis

It involves analyzing the following factors:

• Legal
• Environmental
• Sociocultural
• Political
• Technological
• Economic

Since examples of political, economic, and technological factors are given above in the PEST analysis description, let us look at the examples for the other four factors.

• Sociocultural: Beliefs, values, views, traditions, preferences, habits, etc.
• Environmental: Changes in the physical climate
• Global Environment: Global competition, opportunities, threats, etc.  
• Legal: A nation’s laws, constitution, business laws, law administration, etc.

Firms cannot control such factors. They analyze these factors to spot environmental trends and evaluate potential threats or opportunities.

#3 - Competitive And Industry Analysis

Industries are formed by a number of organizations manufacturing goods that are close substitutes. It is considered that Porter’s five forces make up an industry environment. These forces are as follows:

• Buyers’ bargaining power
• Threats posed by product substitutes
• Competitive rivalry
• Threats posed by new entrants
• Suppliers’ bargaining power

Businesses can use this tool to assess all these forces in their industry environment effectively. Moreover, they can utilize it to determine a market’s potential profitability.

Let us look at a few external analysis examples to understand the concept better.

Example #1

Suppose a local clothing store named ABC utilized a business-to-customer (B2C) model to sell shirts, t-shirts, and trousers to consumers. After carrying out an external analysis, ABC identified a new trend in the market. Small-sized businesses expanded their customer base by selling products at wholesale prices to different organizations, allowing them to include those products in their list of offerings.

Hence, ABC decided to adapt and started to sell to both consumers and businesses directly. This was an excellent move as the organization made additional profits while expanding simultaneously.  

Example #2

Previously, Company XYZ, a business that sells beverages, identified that its target audience included individuals between the age of 18-30 years. However, the organization carried out an external analysis and found out that over 30% of its sales came from individuals aged between 30 and 35 years. Hence, they launched a new marketing campaign to appeal to customers aged 18-35.

One can understand the importance of external analysis in strategic management through the following points:

• It encourages organizations to be proactive with regard to how they carry out their operations and helps them grow.
• This analysis enables businesses to adapt to the changing industry environment. This can help organizations survive during tough conditions.
• It provides opportunities to organizations that can help them rise above industry peers.
• This type of analysis helps a company’s managers prepare well-informed strategic plans.

Individuals new to strategic management may find external analysis and internal analysis confusing. However, anyone can avoid confusion by understanding how they differ. In that regard, looking at their distinct features is imperative. Hence, this table shows the critical differences between the two concepts.