THE INTERNAL

ASSESSMENT

CHAPTER 4
 After studying this chapter, you should be able
to do the following:

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.
4. Identify the basic functions or activities that make up management, marketing,
finance/accounting, production/ operations, research and development, and management information
systems.
5. Explain how to determine and prioritize a firm’s internal strengths and weaknesses.
6. Explain the importance of financial ratio analysis.
7. Discuss the nature and role of management information systems in strategic management.
8. Develop an Internal Factor Evaluation (IFE) Matrix.
9. Explain benchmarking as a strategic management tool.

OBJECTIVES 2
"Weak leadership can wreck the soundest strategy."
—Sun Tzu

"Great spirits have always

encountered violent
opposition from mediocre
minds."
—Albert Einstein

3
Notable Quotes
 THE NATURE OF AN

1 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.
Objectives and strategies are established with the intention of
capitalizing upon internal strengths and overcoming weaknesses.
4
“ 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. Strategies are designed in part to
improve on a firm’s weaknesses, turning them into strengths
—and maybe even into distinctive competencies.

KEY INTERNAL FORCES

5
The Process of Performing an Internal Audit

▰ . Representative managers and employees from throughout

the firm need to be involved in 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.
▰ Assimilate and evaluate the information
▰ Strategy to address strengths and weaknesses

6
 The Process of Gaining Competitive
Advantage in a Firm

Weaknesses ⇒ Strengths ⇒ Distinctive Competencies ⇒ Competitive Advantage

7
 The Resource-Based View (RBV)

▰ The Resource-Based View Empirical indicators

(RBV) approach to competitive (1) rare,
advantage contends that internal
(2) hard to imitate, or
▰ resources are more important
(3) not easily substitutable
for a firm than external factors
in achieving and sustaining
▰ competitive advantage.

8
 Integrating Strategy and Culture

Organizational culture can be Dimensions of organizational The challenge of strategic

defined as “a pattern of behavior that culture permeate all the management today is to
has been developed by an functional areas of business. bring about the changes in
organization as it learns to cope with It is something of an art to organizational culture and
its problem of external adaptation uncover the basic values and individual mind-sets that
and internal integration, and that has beliefs that are deeply buried are needed to support the
worked well enough to be considered in an organization’s formulation,
valid and to be taught to new rich collection of stories, implementation, and
members as the correct way to language, heroes, and rituals, evaluation of strategies.
perceive, think, and feel.” but cultural products can
represent both important
strengths and weaknesses

9
 Management

The functions of management consist of five

basic activities: planning, organizing,
motivating, staffing, and controlling.

10
 Management

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?

11
Strength or Weakness????

12
MARKETING

Products Pricing
Distribu
&
Selling -tion
Services
Products & Marketing
Planning
Services Research

Opportunit
Customer
y Analysis
Analysis

BASIC FUNCTIONS OF MARKETING

13
 MARKETING
Customer
Analysis
Selling
Products
&
Marketing Audit Checklist of Questions Products Services
The following questions about marketing must be examined in strategic planning: &
1. Are markets segmented effectively? Services
Planning Pricing
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?
Distribution Marketing
5. Does the firm have an effective sales organization? Research
6. Does the firm conduct market research?
7. Are product quality and customer service good?
Opportunit
8. Are the firm’s products and services priced appropriately?
y Analysis
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?
BASIC FUNCTIONS OF
MARKETING
14
 FINANCE /ACCOUNTING

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

1. Liquidity ratios measure a firm’s ability to meet maturing short-term 4. Profitability ratios measure management’s overall effectiveness as shown by the
obligations. returns generated on sales and investment.
Current ratio Gross profit margin
Quick (or acid-test) ratio Operating profit margin
2. Leverage ratios measure the extent to which a firm has been financed by Net profit margin
debt. Return on total assets (ROA)
Debt-to-total-assets ratio Return on stockholders’ equity (ROE)
Debt-to-equity ratio Earnings per share (EPS)
Long-term debt-to-equity ratio Price-earnings ratio
Times-interest-earned (or coverage) ratio 5. Growth ratios measure the firm’s ability to maintain its economic position in the
3. Activity ratios measure how effectively a firm is using its resources. growth of the economy and industry.
Inventory turnover Sales
Fixed assets turnover Net income
Total assets turnover Earnings per share
Accounts receivable turnover Dividends per share
Average collection period
15
FINANCE /ACCOUNTING

Financial ratio analysis must go beyond the actual calculation and interpretation of
ratios. The analysis should be conducted on three separate fronts:
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?

16
FINANCE /ACCOUNTING

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?

17
 PRODUCTION/ OPERATIONS

The production/operations function of a business consists of all those

activities that transform inputs into goods and services. Production/operations
management deals with inputs, transformations, and outputs that vary across
industries and markets. A manufacturing
operation transforms or converts inputs such as raw materials, labor, capital,
machines, and facilities into finished goods and services.

18
 PRODUCTION/ OPERATIONS

Production/Operations Audit Checklist

Questions such as the following should be examined:
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?

19
RESEARCH & DEVELOPMENT

Research and development expenditures are directed at

developing new products before competitors do, at
improving product quality, or at improving manufacturing
processes to reduce costs.

Two forms: Internal R&D and Contract

R&D

20
RESEARCH & DEVELOPMENT

Research and Development Audit

Questions such as the following should be asked in performing an R&D 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?

21
MANAGEMENT INFORMATION SYSTEM

Information ties all business functions together and provides

the basis for all managerial decisions. It is the cornerstone of
all organizations. Information represents a major source of
competitive management advantage or disadvantage.

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.

Firms whose information-system skills are weak are at a competitive disadvantage.

In contrast, strengths in information systems allow firms to establish distinctive
competencies in other areas. Low-cost manufacturing and good customer service,
for example, can depend on a good information system.

22
MANAGEMENT INFORMATION SYSTEM

Management Information Systems Audit

Questions such as the following should be asked when conducting this 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?
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?

23
The Internal Factor Evaluation (IFE) Matrix
A summary step in conducting an internal strategic-management audit is to construct an
Internal Factor Evaluation (IFE) Matrix. This strategy-formulation tool summarizes and
evaluates the major strengths and weaknesses in the functional areas of a business, and it also
provides a basis for identifying and evaluating relationships among those areas. Intuitive
judgments are required in developing an IFE Matrix, so the appearance of a scientific
approach should not be interpreted to mean this is an all-powerful technique. A thorough
understanding of the factors included is more important than the actual numbers. Similar to
the EFE Matrix and Competitive Profile Matrix described in Chapter 3, an IFE Matrix can be
developed in five steps:
1. List key internal factors as identified in the internal-audit process. Use a total of
from 10 to 20 internal factors, including both strengths and weaknesses. List
strengths first and then weaknesses. Be as specific as possible, using percentages,
ratios, and comparative numbers. Recall that Edward Deming said, “In God we
trust. Everyone else bring data.”
2. Assign a weight that ranges from 0.0 (not important) to 1.0 (all-important) to each
factor. The weight assigned to a given factor indicates the relative importance of the
factor to being successful in the firm’s industry. Regardless of whether a key factor
is an internal strength or weakness, factors considered to have the greatest effect on
organizational performance should be assigned the highest weights. The sum of all
weights must equal 1.0.

24
3. Assign a 1-to-4 rating to each factor to indicate whether that factor represents a major
weakness (rating = 1), a minor weakness (rating = 2), a minor strength (rating = 3),
or a major strength (rating = 4). Note that strengths must receive a 3 or 4 rating and
weaknesses must receive a 1 or 2 rating. Ratings are thus company-based, whereas
the weights in step 2 are industry-based.
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.
Regardless of how many factors are included in an IFE Matrix, the total weighted
score can range from a low of 1.0 to a high of 4.0, with the average score being 2.5.
Total weighted scores well below 2.5 characterize organizations that are weak internally,
whereas scores significantly above 2.5 indicate a strong internal position. Like
the EFE Matrix, an IFE Matrix should include from 10 to 20 key factors. The number of
factors has no effect upon the range of total weighted scores because the weights
always sum to 1.0.
When a key internal factor is both a strength and a weakness, the factor should be
included twice in the IFE Matrix, and a weight and rating should be assigned to each statement.

25