Final answer:
External analysis helps a firm understand its competitive environment, influencing business decisions such as product choice, production methods, output, pricing, and labor requirements. It becomes vital as the firm's strategy leads to potential profitability, making the firm more attractive to outside investors.
Step-by-step explanation:
External analysis is a critical component of strategic management, allowing a firm to understand its competitive environment and identify strategic opportunities and threats.
Performing an external analysis, firms can determine factors like market structure, market power of competitors, the uniqueness of their own products in comparison to others, and the barriers to entry for new firms. This knowledge then informs several aspects of business decision-making, including:
What products the firm should produce
How the firm should produce the products (choice of production process)
The appropriate level of output to meet market demand
The pricing strategy for the firm's products
The amount of labor the firm should employ
Such analysis takes into account the production and cost conditions that the firm faces, and is particularly important as a firm becomes established and strategies lead towards profitability.
At this stage, widely available information about the company's products, revenues, costs, and profits makes personal knowledge of individual managers less critical, attracting outside investors like bondholders and shareholders who are willing to provide financial capital without personal connections to the firm's management.