1.4 The Internal and External Environments

The internal environment and external environment are foundational concepts for understanding strategy. At first, the distinctions between these environments seem trivial - one is about factors outside the firm, the other about the factors within. Yet many of the most influential tools in business strategy are rooted in this distinction. A clear understanding of and distinction between the internal and external environment will guide strategic actions because the organization can focus on what it can control, instead of becoming frustrated with external factors. Throughout this book, many of the tools and ideas will build upon this foundation.

Strategic fit is one such idea. It would be difficult to understand strategic fit without an understanding of the internal and external environments. Strategic fit is the degree to which an organization can match its internal resources and capabilities with opportunities in the external environment.

The External Environment

There are, obviously, many events and circumstances outside of a given organization. The external environment focuses on a subset of these events and circumstances - the factors that will impact the organization. Some difficulty arises in considering a broad enough range of factors that impact the organization without considering unnecessary factors. Some strategic tools, such as the STEEPLE Analysis, help broaden the manager's perspective on what impacts the firm. Other tools, such as the Weighted Comparative Strengths assessment, narrow the manager's view to focus on certain important factors. Organizations cannot directly change the external environment. However, they can respond to changes in the external environment. An incorrect response could spell disaster for the company, while a spectacularly good response could create a temporary comparative advantage.

Factors in the External Environment

• Legal oversight and regulation

• Macroeconomic trends

  • Interest Rates

  • Labor market constraints

  • Industry growth or decline

• Competition

  • New Market Entrants

  • Relative strength of competitors

• Political Factors

Tools to Analyze the External Environment

• Porter's 5 Forces - provides a broad perspective on competition.

• STEEPLE Analysis - a comprehensive analysis of the external environment.

• SWOT Analysis - an integrated top-level analysis of both the internal an external environments.

The Internal Environment

The internal environment refers to the conditions, events, entities, and factors that occur within (or internal to) the organization. As companies define their internal environment, they can align their resources to compete most effectively. An effective internal environment can provide a firm with the competitive advantage it needs to succeed in its industry.

Factors in the Internal Environment

• Employee skills and experience

• Technology

• Organizational structure

• Trademarks, patents, and trade secrets

• Management

• Production capabilities

• Team cohesion

Tools to Analyze the Internal Environment

• SWOT Analysis - - an integrated top-level analysis of both the internal an external environments.

• Pareto Analysis - an analysis based on the 80 - 20 rule.

• Organizational Resources - the resources available to an organization

• Measuring Productivity