Chapter 8 - Strategic Management: External and Internal Analysis

Overview:

This chapter explains (1) external analysis of the competitive environment, including Porter's five forces, and (2) internal analysis of the farm's operating environment with an assessment of the farm's strengths, weaknesses, opportunities, and threats.

Objectives:

After completing this chapter, you will be able to:

• Perform an external analysis for a farm
• Perform an internal analysis for a farm

Key Points:

• The answers to eight key questions provide a comprehensive external analysis.
• Porter's five forces describing competition are risk of entry by potential competitors, rivalry among established farms, bargaining power of buyers, bargaining power of suppliers, and substitute products. Two other forces affecting competition are the role of technology and drivers of change.
• Key success factors (KSFs) are measures and performance standards that must be met to be competitive. They are “key” because other results will follow if the KSFs are met.
• The answers to five key questions provide a comprehensive internal analysis.
• A farm has a sustained competitive advantage when its profit rate has been higher than the industry average for several years running.
• Four building blocks of competitive advantage are efficiency, quality, innovation, and customer responsiveness.
• SWOT analysis identifies a farm's strengths, weaknesses, opportunities, and threats.

Key Terms:

• Benchmarking: identifying the best and then comparing costs and physical efficiencies between farms.
• Competitive advantage: having a profit rate higher than the industry average.
• Competitive forces: the forces that affect the level of competition within an industry.
• Dominant economic traits: those economic traits or characteristics which drive and affect an industry and the firms within that industry.
• External analysis: looking outside the firm; studying the forces operating in the general economy and in the industry which the firm belongs to.
• Financial condition and performance: an evaluation of a farm’s profitability, solvency, liquidity, repayment capacity, and efficiencies.
• Internal analysis: looking inside the firm; evaluating a farm’s strengths, weaknesses, competitive capabilities, and its past and potential condition and performance.
• Key Success Factors (KSFs): Performance measures or conditions that are critical for success and, if not met, indicate the farm will not perform adequately and its viability will be threatened.
• Macro environment: the four dimensions of macroeconomics, social, demographic and the political and legal environments.
• Porter’s Five Forces: Five forces that shape the competitiveness within an industry. The five forces are risk of entry by potential competitors, rivalry among established farms, bargaining power of buyers, bargaining power of suppliers, and substitute products.
• Structural Change: changes in the makeup of an industry: the number, size, and geographical location of buyers, suppliers, processors, producers, and all other firms as well as the physical, legal, and social network of connections between the firms in an industry.
• SWOT analysis: developing and analyzing a firm’s strengths, weaknesses, opportunities and threats.

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Study Notes:

This chapter focuses on two critical pieces of strategic planning: external and internal analyses. External analysis is looking outside the farm to study and understand the forces operating in the farm’s industry and in the general economy. Internal analysis is looking inside the farm to evaluate how well it is achieving its objectives; its strengths, weaknesses, opportunities, and threats; and how it is positioned for success in its chosen industry.

EXTERNAL ANALYSIS

What is happening outside the farm? Not just at the next neighbor’s farm, but in neighboring states and countries, in the offices of suppliers and processors, in national and local legislatures, and in many other institutions that can affect farming. As the text discusses, by answering eight key questions thoroughly, a farmer can perform an external analysis and gain a significant understanding of his or her chosen industry.

1. What are the conditions and trends in the macro environment?
   The farm and the agricultural industry operate within a larger business environment. Understanding the changes in the larger environment is important for crafting strategy for the farm. A common method to study the macro environment is identified as PESTEL: political, economic, social, technological, environmental and legal. An extension of PESTEL is LoNGPESTEL which reminds us to look at the local, national, and global aspects.
   
   
2. What are the industry's dominant economic traits?
   To better understand an industry (such as dairy, hogs, feed grains, food grains, vegetables, and so on) and its economic traits, we need to consider many factors such as market size and growth rate, number of rivals and buyers, ease of entry and exit, technological change, economies of scale, capital requirements, and others described in the text.
   
   
3. What is competition like and how strong is each of the competitive forces?
   Today’s farmer needs to understand the competitive forces in their own industry as well as understanding the forces affecting their product processors and input suppliers. Porter describes competition in an industry as a composite of five forces: (1) threat of entry by potential competitors, (2) bargaining power of suppliers, (3) bargaining power of buyers, (4) substitute products and services, and (5) rivalry among established farms. Two other forces affecting competition are (6) role of technology and (7) other drivers of change.
   
   
4. What is causing the industry's structure and business environment to change?
   The forces of structural change can be divided into major and minor forces. Usually, only three or four forces qualify as major driving forces of change. These can include changes in the long-term industry growth rate, product innovation, technological change, entry or exit of major firms (or countries), and others described in the text.
   
   
5. Which farms are in the strongest/weakest competitive positions?
   At least seven points need to be considered: size, location, production methods, age of equipment and/or workforce, specialization, diversification, and vertical integration.
   
   
6. What strategic moves are others likely to make next?
   What moves are competitors likely to make? Which farms, companies, regions, or countries may change? What are the makers of substitute products doing or might they be doing? Will these potential changes make a large impact?
   
   
7. What are the key factors for competitive success?
   Farms must identify the key success factors (KSFs) and keep them at performance levels required by the industry. A KSF can be identified by what would complete this sentence for a farmer: “If we ________, we will be successful.”
   
   
8. Is the industry attractive and what are the prospects for above average profitability?
   This is an overall assessment of the industry's attractiveness or unattractiveness, special issues and problems, and its profit outlook.

After reviewing external analysis in the text, perform an external analysis by completing Worksheet 8.1 for a farm in an industry of your choice.

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INTERNAL ANALYSIS

After looking outside the farm, the next questions are internal. What’s happening inside the farm? How well is it doing? What could it do better? By answering the following five questions well, a farmer can perform an internal analysis and gain a significant understanding of his or her own farm.

1. How well is the present strategy working?
   At this point we are interested in the results of past strategic and operational decisions. What is the financial condition and performance of the farm and has it met both strategic and financial objectives?
   
   
2. What are the farm's strengths, weaknesses, opportunities, and threats?
   This is referred to as a SWOT analysis. A strength is something a business is good at doing or a characteristic that gives it an important capability. A weakness is something a company lacks or does poorly or a condition that puts it at a disadvantage. Strengths and weaknesses are internal conditions. Opportunities and threats are, simply put, good and bad things that could be taken advantage of or could happen to a business. Opportunities and threats are external conditions in the marketplace.
   To improve your understanding the strengths and weaknesses of your own management skills for your farm, try this: work through the lists of management skills listed in “Checking Your Farm Business Management Skills” from Purdue University and decide which are your strengths and weaknesses.
   
   
3. Are the farm's costs competitive with rivals?
   Does a specific farm has lower costs of production and delivery than other farms producing the same product for the same market? Costs per unit need to be estimated and compared to other farms. For agriculture, this information is often available from government sources. It may also be available through farm record associations. Benchmarking is a major part of this comparison.
   
   
4. How strong is the farm's competitive position?
   The ability of a farm to improve and(or) maintain competitiveness depends not just on the farm’s past record but also on the strength of the position the firm is in. Based on the internal and external analyzes, a farm can be evaluated for the signs of competitive strengths and weaknesses as described in the text.
   
   
5. What strategic issues need to be addressed?
   At this point, the external and internal analyses are reviewed and put together to assess how well the farm is placed in the industry situation and what strategic issues or points need to be studied, improved, changed, etc. This identification of issues is the beginning of crafting strategy which is described in the next section.

After reviewing internal analysis in the text, perform an internal analysis for your farm by completing Worksheet 8.2. Also, working through the questions on Worksheet 8.3 for the Kinney Farm will give you a better understanding of what internal analysis involves.

Worksheets:

8.1 External analysis.pdf

8.2 Internal analysis.pdf

8.3 Internal analysis of the Kinney farm.pdf (Resource needed: The Kinney Farm.pdf)

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