External factors are considered to be extrinsic to an organization, those over which it has limited or no control. These affect the industry in which the organization is operating. Such as the technological environment in the case of Microsoft which would affect the entire information technology sector. At the same time very powerful and leveraged players in a sector such as Microsoft would be able to shape the external environment to a certain degree by exercising leverages of control such as monopoly over software codes. Despite this it is not possible for companies to affect other major external factors such as the social and political environment. An increasingly important external factor emerging today is environmental protection including laws, policies and stipulations which have to meet international standards.
Frequently the most significant external factor is competition. In the embryonic stage of growth of an industry, a company may not encounter competition and would not feel the impact of the same. However an industry which is reaching maturity will be posed greater threat from competition and this factor would have to be considered by the management as it would impinge on growth or even survival.
Toyota Motor Co is a salient example wherein its entry into the American as well as the global market has become a major external consideration for all automobile manufacturers in the World, particularly legacy brands as General Motors and Ford in the United States. The political environment of a country also has a major role to play in the growth of any industry. China is the most prominent example of the same. Opening of the Chinese markets to external players has been one of the greatest factors which have contributed to Chinese growth in the past two decades.
Internal factors on the other hand can be shaped by the management by providing it positive or negative inputs. These factors could include diverse issues ranging from human resources, branding, financial resources, product development, research, information technology and labor relations. There is a frequent conflict between the inter se priorities of the internal factors. Human resources assume a significant factorial value in many companies today and when linked with research and development will determine on how the company operates in a knowledge economy.
IBM thus focuses its attention on a strong human resource base which can contribute to normal operations as well as research and development. Management of financial resources is an important facet which has to be considered deliberately by any company. This will determine a company’s financial viability at a given time. Mismanagement can ruin a company as indicated by the example of Enron which had to go into liquidity due to unethical financial practices of its management.
Traditionally it is felt that the management has an overriding control over the internal factors as opposed to external factors, though at times there is a powerful influence of issues such as the social environment on say branding. Many multi nationals find this quite difficult to absorb and even retail giants as Wal-Mart had to adapt their brand to conditions obtained in an external market as France before they could develop their chain in Europe.
Information technology absorption has become a powerful internal factor which is affecting expansion of many companies. With development of concepts such as e commerce or e business and enterprise resource planning, it has become increasingly important for an organization to place all its operations on line. While this is clearly an internal factor, its external linkage cannot be ignored.
The primary difference as would be seen from the examples above is the degree of control that a management has on factors affecting business. Where the controlling factors are located externally, these are considered as external factors and need to be evaluated accordingly. However where based internally these will be considered within the ambit of internal factors.
b. Discuss an example where an organization might be able to increase its control/influence over an external factor.
To increase its control over an external factor, management would have to take into consideration a number of factors including at times reviewing the core product profile of the company without sacrificing its overall brand image. Companies as Coca Cola and Pepsi have through their deep penetration in developing countries created conditions where they are able to control the entire soft drinks market in many locations in South and South East Asia altering social preferences and tastes of people.
McDonald has been the most leveraged player in altering food and social habits which are external factors in developing countries. It has achieved this by a judicious mix of local products even introducing vegetarian burgers in India along with its traditional Burgers. Having changed its product profile, the company has been able to penetrate many traditionally hostile markets to American food industry.
c. Since external factors can impact the profitability of an organization, why do we have financial performance as an internal factor?
In determining whether a factor is to be considered as an internal or an external one, the key attribute to be considered is the ability of an organization to develop strategies and responses for growth and the control it has over the same. Applying this parameter would indicate that financial performance is an internal factor. Profitability is just one aspect of financial performance of a company. Profitability not only depends on the external environment including competition, economic factors, money markets and currencies but has greater linkage with internal factors such as liquidity, activity and growth of capital.
Profitability of a company is determined by gross and net profit margins, returns on assets and equity which are all considered as a part of internal factors. The structuring of the company finances to include debt and equity ratio which is a purely internal function also has an important role to play in profitability thereby leading to its consideration as an internal factor.
d. How does misclassifying an internal factor as an external factor in the EFE impact the analysis?
The EFE is a comparative analysis of various factors which affect the external environment of an organization. The evaluation is based on weight age given to each factor based on relative importance. Generally 10 opportunities or threats are considered in an EFE Matrix with each provided a weight age between 0 and 1 out of a sum total of 1 based on impact on profitability. There after ratings are also provided to each factor based on a scale of 1 to 4 with 4 being the best. The weight distribution will be balanced between threats and opportunities and will finally represent the strengths and opportunities in an organization. By including an internal factor the entire evaluation matrix is likely to be skewed by a minimum of 5 to 10 % which would emerge as a major flaw in the EFE, thereby resulting in neglect of other more important external factors.
Based on the EFE the management will determine that the internal factor placed in EFE matrix can be controlled only in a limited way through internal inputs, thereby neglecting it to a large extent, resulting in a drop in performance in the particular field. Thus if labor relations has been placed wrongly in the EFE, the management will only consider external inputs that are likely to affect it such as legal statutes and central memorandums and neglect internal management possibly resulting in poor labor relations in the company.
David, Fred R. (1999) STRATEGIC MANAGEMENT. Electronically reproduced