External Analysis 1 Why Does Firm Performance Differ?
Updated: 2 Sept. 2009 ©Scott Gallagher 2006
Economics predicts that all firms should obtain similar results after adjusting for their
costs of capital. Yet clearly firm performance varies tremendously. Why?
Naturally, firms do not exist in isolation and their performance can vary because of their
external environment. For analysis purposes we'll break the external environment up into
the broad macro environment and a more narrow industry environment. As their names
suggest, both of these environments are outside the firm and generally beyond the firm’s
control, at least in the near term.
The macro environment consists of the broad trends and patterns in the nation and world
beyond the firm. These patterns and trends highly influence customer needs and firm
options. For purpose of analysis, the use of five aspects of the environment will provide
The five-macro environments are economic, political/legal,
technological, socio-cultural, and demographic. Each environment’s impact on a firm
can range from favorable to unfavorable. Generally, these environments are analyzed at
the level of the nation; however, it may be advisable to look at them more broadly or
more narrowly depending on the scope of the firm's business. For example if you are
examining a single restaurant then the local conditions are probably far more important
than what's going on in the nation as a whole.
The economic environment refers to the broad economic conditions inside a country.
Items such as changes in per capita income, interest rates, foreign exchange and inflation
are all common measures of the economic environment. For most (but not all) firms a
growing economy is favorable for business.
The political/legal environment refers to a society’s formal rules (i.e. enforced by state
sanction) for determining...