MAKING AN INTERNAL ASSESSMENT_1st Part

CHAPTER IV

Making an Internal Assessment

OVERVIEW OF CLASS MODULE

In this module, we will focus on identifying and evaluating a firm’s strengths and weaknesses in the
functional areas of business, including management, marketing, finance/accounting,
production/operations, research and development, and management information systems.
Relationships among these areas of business will be examined. Strategic implications of important
functional area concepts will also be discussed. The process of performing an internal audit will be
described. The Resource-Based View (RBV) of strategic management will be introduced as is the Value
Chain Analysis (VCA) concept.

LEARNING OBJECTIVES

By the end of this module, the students should be able to:

1. Describe how to perform an internal strategic-management audit;
2. Discuss the Resource-Based View (RBV) in strategic management;
3. Discuss key interrelationships among the functional areas of business; and
4. Identify the basic functions or activities that make up management, marketing, finance/
accounting, production/ operations, research and development, and management information
systems.

LEARNING CONTEXT
THE NATURE OF INTERNAL AUDIT
“Like a product or a service, the
All organizations have strengths and weaknesses in the planning process itself must be
functional areas of business. No enterprise is equally strong or managed and shaped, if it is to serve
weak in all areas. Maytag, for example, is known for excellent executives as a vehicle for strategic
decision-making.”
production and product design, whereas Procter & Gamble is
known for superb marketing. Internal strengths/weaknesses, -Robert Lenz
coupled with external opportunities/threats and a clear
statement of mission, provide the basis for establishing objectives and strategies. Objectives
and strategies are established with the intention of capitalizing upon internal strengths and
overcoming weaknesses.

Key Internal Forces

It is not possible in a strategic-management text to review in depth all the material

presented in courses such as marketing, finance, accounting, management, management
information systems, and production/operations; there are many subareas within these functions, such
as customer service, warranties, advertising, packaging, and pricing under marketing.

For different types of organizations, such as hospitals, universities, and government agencies, the
functional business areas, of course, differ. In a hospital, for example, functional areas may include
cardiology, hematology, nursing, maintenance, physician support, and receivables. Functional areas of
a university can include athletic programs, placement services, housing, fund-raising, academic
research, counseling, and intramural programs. Within large organizations, each division has certain
strengths and weaknesses.

A firm’s strengths that cannot be easily matched or imitated by competitors are called
distinctive competencies. Building competitive advantages involves taking advantage of distinctive
competencies. For example, 3M exploits its distinctive competence in research and development by
producing a wide range of innovative products. 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 Performing an Internal Audit

The process of performing an internal audit closely parallels the process of performing an external
audit. Representative Managers and employees from throughout the firm need to be involved in

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determining a firm’s strengths and weaknesses. The internal 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 the 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. This is a great benefit because managers and employees perform better when they
understand how their work affects other areas and activities of the firm. For example, when marketing
and manufacturing managers jointly discuss issues related to internal strengths and weaknesses, they
gain a better appreciation of the issues, problems, concerns, and needs of all the functional areas.

In organizations that do not use strategic management, marketing, finance, and manufacturing
managers often do not interact with each other in significant ways. Performing an internal audit thus is
an excellent vehicle or forum for improving the process of communication in the organization.
Communication may be the most important word in management.

Performing an internal audit requires gathering, assimilating, and evaluating information about
the firm’s operations. Strategic management is a highly interactive process that requires effective
coordination among management, marketing, finance/accounting, production/operations, R&D, and
management information systems managers. Although the strategic-management process is overseen
by strategists, success requires that managers and employees from all functional areas work together
to provide ideas and information. Financial managers, for example, may need to restrict the number of
feasible options available to operations managers, or R&D managers may develop products for which
marketing managers need to set higher objectives.

A key to organizational success is effective coordination and understanding among managers

from all functional business areas. Through involvement in performing an internal strategic-
management audit, managers from different departments and divisions of the firm come to understand
the nature and effect of decisions in other functional business areas in their firm. Knowledge of these
relationships is critical for effectively establishing objectives and strategies.

Financial ratio analysis exemplifies the complexity of relationships among the functional areas
of business. A declining return on investment or profit margin ratio could be the result of ineffective
marketing, poor management policies, research and development errors, or a weak management
information system. The effectiveness of strategy formulation, implementation, and evaluation
activities hinges upon a clear understanding of how major business functions affect one another.

RESOURCE-BASED VIEW

The Resource-Based View (RBV) approach to competitive advantage contends that internal
resources are more important for a firm than external factors in achieving and sustaining competitive
advantage. In contrast to the I/O theory presented in the previous chapter, proponents of the RBV view
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. Physical resources include all plant and equipment, location, technology, raw
materials, machines; human resources include all employees, training, experience, intelligence,
knowledge, skills, abilities; and organizational resources include firm structure, planning processes,
information systems, patents, trademarks, copyrights, databases, and so on. RBV theory asserts that
resources are actually what helps a firm exploit opportunities and neutralize threats.

The basic premise of the RBV is that the mix, type, amount, and nature of a firm’s internal
resources should be considered first and foremost in devising strategies that can lead to sustainable
competitive advantage. Managing strategically according to the RBV involves developing and
exploiting a firm’s unique resources and capabilities, and continually maintaining and strengthening
those resources. The theory asserts that it is advantageous for a firm to pursue a strategy that is not
currently being implemented by any competing firm. When other firms are unable to duplicate a
particular strategy, then the focal firm has a sustainable competitive advantage, according to RBV
theorists.

For a resource to be valuable, it must be either (1) rare, (2) hard to imitate, or (3) not easily
substitutable. Often called empirical indicators, these three characteristics of resources enable a
firm to implement strategies that improve its efficiency and effectiveness and lead to a sustainable
competitive advantage. The more a resource(s) is rare, non-imitable, and non-substitutable, the
stronger a firm’s competitive advantage will be and the longer it will last.

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Rare resources are resources that other competing firms do not possess. If many firms have the
same resource, then those firms will likely implement similar strategies, thus giving no one firm a
sustainable competitive advantage. This is not to say that resources that are common are not valuable;
they do indeed aid the firm in its chance for economic prosperity. However, to sustain a competitive
advantage, it is more advantageous if the resource(s) is also rare.

It is also important that these same resources be difficult to imitate. If firms cannot easily gain the
resources, say RBV theorists, then those resources will lead to a competitive advantage more so than
resources easily imitable. Even if a firm employs resources that are rare, a sustainable competitive
advantage may be achieved only if other firms cannot easily obtain these resources.

The third empirical indicator that can make resources a source of competitive advantage is
substitutability. Borrowing from Porter’s Five-Forces Model, to the degree that there are no viable
substitutes, a firm will be able to sustain its competitive advantage. However, even if a competing firm
cannot perfectly imitate a firm’s resource, it can still obtain a sustainable competitive advantage of its
own by obtaining resource substitutes.

INTEGRATING STRATEGY AND CULTURE

Organizational culture can be defined as “a pattern of behavior that has been developed by an
organization as it learns to cope with its problem of external adaptation and internal integration, and
that has worked well enough to be considered valid and to be taught to new members as the correct
way to perceive, think, and feel.” This definition emphasizes the importance of matching external with
internal factors in making strategic decisions.

Organizational culture captures the subtle, elusive, and largely unconscious forces that shape a
workplace. Remarkably resistant to change, culture can represent a major strength or weakness for the
firm. It can be an underlying reason for strengths or weaknesses in any of the major business
functions.

Defined in Table 4-1, cultural products include values, beliefs, rites, rituals, ceremonies, myths,
stories, legends, sagas, language, metaphors, symbols, heroes, and heroines. These products or
dimensions are levers that strategists can use to influence and direct strategy formulation,
implementation, and evaluation activities. An organization’s culture compares to an individual’s
personality in the sense that no two organizations have the same culture and no two individuals have
the same personality. Both culture and personality are enduring and can be warm, aggressive, friendly,
open, innovative, conservative, liberal, harsh, or likable.

Table 4.1 Example Cultural Products

Defined

Culture provides an explanation for the insuperable difficulties a firm encounters

when it attempts to shift its strategic direction. Not only has the “right” culture
become the essence and foundation of corporate excellence, it is also claimed that
success or failure of reforms hinges on management’s sagacity and ability to change
the firm’s driving culture in time and in time with required changes in strategies.

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MANAGEMENT

The functions of management consist of five basic activities: planning, organizing, motivating,
staffing, and controlling. An overview of these activities is provided in Table 4.2.

Table 4.2 Basic Functions of

Management

 Planning

The only thing certain about the future of any organization is change, and planning is the
essential bridge between the present and the future that increases the likelihood of achieving desired
results. Planning is the process by which one determines whether to attempt a task, works out the
most effective way of reaching desired objectives, and prepares to overcome unexpected difficulties
with adequate resources. Planning is the start of the process by which an individual or business may
turn empty dreams into achievements. Planning enables one to avoid the trap of working extremely
hard but achieving little.

 Organizing

The purpose of organizing is to achieve coordinated effort by defining task and authority
relationships. Organizing means determining who does what and who reports to whom. There are
countless examples in history of well-organized enterprises successfully competing against—and in
some cases defeating—much stronger but less-organized firms. A well-organized firm generally has
motivated managers and employees who are committed to seeing the organization succeed.
Resources are allocated more effectively and used more efficiently in a well-organized firm than in a
disorganized firm.

 Motivating

Motivating can be defined as the process of influencing people to accomplish specific objectives.
Motivation explains why some people work hard and others do not. Objectives, strategies, and policies
have little chance of succeeding if employees and managers are not motivated to implement strategies
once they are formulated. The motivating function of management includes at least four major
components: leadership, group dynamics, communication, and organizational change.

 Staffing

The management function of staffing, also called personnel management or human resource
management, includes activities such as recruiting, interviewing, testing, selecting, orienting,
training, developing, caring for, evaluating, rewarding, disciplining, promoting, transferring, demoting,
and dismissing employees, as well as managing union relations. Staffing activities play a major role in
strategy-implementation efforts, and for this reason, human resource managers are becoming more

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actively involved in the strategic management process. It is important to identify strengths and
weaknesses in the staffing area.

 Controlling

The controlling function of management includes all of those activities undertaken to ensure that
actual operations conform to planned operations. All managers in an organization have controlling
responsibilities, such as conducting performance evaluations and taking necessary action to minimize
inefficiencies. The controlling function of management is particularly important for effective strategy
evaluation. Controlling consists of four basic steps:

1. Establishing performance standards

2. Measuring individual and organizational performance
3. Comparing actual performance to planned performance standards
4. Taking corrective actions

Management Audit Checklist of Questions

The following checklist of questions can help determine specific strengths and weaknesses in the
functional area of business. An answer of no to any question could indicate a potential weakness,
although the strategic significance and implications of negative answers, of course, will vary by
organization, industry, and severity of the weakness. Positive or yes answers to the checklist questions
suggest potential areas of strength.

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 can be described as the process of defining, anticipating, creating, and fulfilling
customers’ needs and wants for products and services. There are seven basic functions of marketing:
(1) customer analysis, (2) selling products/services, (3) product and service planning, (4) pricing, (5)
distribution, (6) marketing research, and (7) opportunity analysis. Understanding these functions helps
strategists identify and evaluate marketing strengths and weaknesses.

 Customer Analysis

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. Customer profiles can reveal the demographic characteristics of an organization’s
customers.

 Selling Products/Services

Successful strategy implementation generally rests upon the ability of an organization to sell
some product or service. 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.
The effectiveness of various selling tools for consumer and industrial products varies. Personal selling is
most important for industrial goods companies, and advertising is most important for consumer goods
companies.

 Product and Service Planning

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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. Product and service planning is particularly
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. Governments can impose constraints on price
fixing, price discrimination, minimum prices, unit pricing, price advertising, and price controls.

Competing organizations must be careful not to coordinate discounts, credit terms, or condition of
sale; not to discuss prices, markups, and costs at trade association meetings; and not to arrange to
issue new price lists on the same date, to rotate low bids on contracts, or to uniformly restrict
production to maintain high prices. Strategists should view price from both a short-run and a long-run
perspective, because competitors can copy price changes with relative ease. Often a dominant firm will
aggressively match all price cuts by competitors.

 Distribution

Distribution includes warehousing, distribution channels, distribution coverage, retail site

locations, sales territories, inventory levels and location, transportation carriers, wholesaling, and
retailing. Most producers today do not sell their goods directly to consumers. Various marketing
entities act as intermediaries; they bear a variety of names such as wholesalers, retailers, brokers,
facilitators, agents, vendors—or simply distributors.

 Marketing Research

Marketing research is 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. Marketing research activities support all of the major business
functions of an organization. Organizations that possess excellent marketing research skills have a
definite strength in pursuing generic strategies.

 Opportunity Analysis

Cost/benefit analysis 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, and (3) compare the
total costs with the total benefits. When 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.
One key factor to be considered is risk. Cost/benefit analysis should also be performed when a
company is evaluating alternative ways to be socially responsible.

Marketing Audit Checklist of Questions

The following questions about marketing must be examined in strategic planning:

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 AND ACCOUNTING

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Financial condition is often considered the single best measure of a firm’s competitive position
and overall attractiveness to investors. Determining an organization’s financial strengths and
weaknesses is essential to effectively formulating strategies. A firm’s liquidity, leverage, working
capital, profitability, asset utilization, cash flow, and equity can eliminate some strategies as being
feasible alternatives. Financial factors often alter existing strategies and change implementation plans.

According to James Van Horne, the functions of finance/accounting comprise three decisions: the
investment decision, the financing decision, and the dividend decision. Financial ratio analysis is the
most widely used method for determining an organization’s strengths and weaknesses in the
investment, financing, and dividend areas.

 Investment Decision

Also called capital budgeting, is the allocation and reallocation of capital and resources to
projects, products, assets, and divisions of an organization. Once strategies are formulated, capital
budgeting decisions are required to successfully implement strategies.

 Financing Decision

It determines the best capital structure for the firm and includes examining various methods by
which the firm can raise capital (for example, by issuing stock, increasing debt, selling assets, or using
a combination of these approaches). The financing decision must consider both short-term and long-
term needs for working capital. Two key financial ratios that indicate whether a firm’s financing
decisions have been effective are the debt-to-equity ratio and the debt-to-total-assets ratio.

 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. Dividend decisions determine the amount of
funds that are retained in a firm compared to the amount paid out to stockholders. Three financial
ratios that are helpful in evaluating a firm’s dividend decisions are the earnings-per-share ratio, the
dividends-per-share ratio, and the price-earnings ratio

Basic Types of Financial Ratios

Financial ratios are computed from an organization’s income statement and balance sheet.
Computing financial ratios is like taking a picture because the results reflect a situation at just one
point in time. Comparing ratios over time and to industry averages is more likely to result in
meaningful statistics that can be used to identify and evaluate strengths and weaknesses.

Key financial ratios can be classified into the following five types:

 Liquidity ratios measure a firm’s ability to meet maturing short-term obligations.

Current ratio
Quick (or acid-test) ratio

 Leverage ratios measure the extent to which a firm has been financed by debt.

Debt-to-total-assets ratio
Debt-to-equity ratio
Long-term debt-to-equity ratio
Times-interest-earned (or coverage) ratio

 Activity ratios measure how effectively a firm is using its resources.

Inventory turnover
Fixed assets turnover
Total assets turnover
Accounts receivable turnover
Average collection period

 Profitability ratios measure management’s overall effectiveness as shown by the returns

generated on sales and investment.

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Gross profit margin
Operating profit margin
Net profit margin
Return on total assets (ROA)
Return on stockholders’ equity (ROE)
Earnings per share (EPS)
Price-earnings ratio

 Growth ratios measure the firm’s ability to maintain its economic position in the growth of the
economy and industry.

Sales
Net income
Earnings per share
Dividends per share

Finance/Accounting Audit Checklist

The following finance/accounting questions, like the similar questions about marketing and
management earlier, should be examined:

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?

SOURCE:

 David, Fred R. (2011). “Strategic Management: Concepts and Cases.” 13th Edition. Pearson
Education, Inc.

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