BUAD 453 Midterm Slide Notes

Risks and limitations of financial analysis...

1. Financial data reflects historical information on company performance •Assesses decisions made in the past •Limited in predicting the probability of success for future 2. Market conditions are in constant state of change •Factors that led to economic gain in past may not accurately predict future gains •Benchmarking against industry peers •Overly focused on competitive parity NOT innovations/sources of sustainable competitive advantage

Process of financial analysis...

1. Select Peer Companies for Comparison • Research companies in same SIC code OR •*Use Industry/Historical Averages *what we use in BUAD 453 2. Calculate Key Financial Ratios •Compare peer companies •Compare against industry/historical averages •Compare over time 3. Analyze Ratios -Identify sources of advantage/disadvantage -What are the ratios telling us...

Segmentation insight...

1."Where to play" & "How to win" 2.Which subsections of market are most attractive 3.What to do to pursue those subsections 4.Leverage limited resources to create value for market

Case Analysis Components

1.Identify problem statement 2.Identify options being considered 3.External/industry analysis (Five Forces) 4.Internal analysis (VRIO) 5.Financial analysis (ratio analysis) 6.Recommendation (one or more of options) & justification (from analysis) 7.Next steps

How to Stay Ahead of Disruptive Change?

1.Spend time at the periphery 2.Focus on changing customer behaviors 3.Make sure your strategy isn't trapped by yesterday's assumptions 4.Embrace dual transformation 5.Assess the cost of inaction

Travel & Tourism

AirBnB and Uber impact from the move to "asset-lite" business models of companies like Airbnb and Uber which don't own real estate or vehicles. Starwood Hotels & Resorts - owned a higher percentage of its properties than most other hotel companies, drag on its market value, helping to force its $13.6 billion merger with Marriott divesting real estate moving toward a more asset-lite approach investing heavily in digital to improve the customer experience versus new rivals

Market Entry Modes

Company wants to enter a new market •Control vs Cost o going it alone ("greenfield") o acquiring existing firm o entering into joint venture with foreign partner •control over international entry •BUT are costly entry modes

Leverage of Coke vs. Pepsi via debt to assets ratio...

Debt to assets calculation...

Leverage of Coke vs. Pepsi via debt to equity ratio...

Debt to equity calculation...

Strategies

Define corporate mission, vision, values, and goals (MOST: Mission & Objectives) Diagnose External understand the macro-environment and the competitive/industry environment Internal identify resources/capabilities and unique strengths (core capabilities) - competitive advantage source Decide Generate alternatives and decide among them (MOST: Strategic actions) Deliver Implement decisions and track process using balanced scorecard (MOST: Tactics) Feedback Iterate If something isn't working and competitive advantage is not achieved, return to the process

Strategy Process

Diagnose Identify & describe challenge or opportunity confronting business Decide Make decision about what will be done to deal with & overcome central challenge or capture key opportunity Deliver Devise & implement coherent set of actions to deliver on key decisions

Root Cause (5 Whys)

Eradicate problems by addressing their root cause •addressing symptoms is easier but does not solve problem •Permanently resolve problem •Prevent recurrence

KEY FINANCIAL RATIOS CONTINUED

Focus on debt to assets, debt to equity, gross margin, and return on equity...

Comparison of Coke vs. Pepsi in regard to KEY FINANCIAL ratios...

Focus on differences in debt to assets, debt to equity, gross margin, & return on equity...

KEY FINANCIAL RATIOS

Focus on quick, current, inventory turnover, and fixed asset turnover...

Vertical Integration: Make or Buy?

Forward Vertical Integration • manufacturer decides to perform distribution/retail functions •Examples?

Profitability of Coke vs. Pepsi via gross profit margin...

Gross Profit Margin calculation

Hypothesis Testing (5 Hows)

How do we know a recommendation is good? •validate specific conditions related to proposed solution • direct research/analysis efforts • targeted data gathering

Staples vs Amazon: Dual Transformation?

Many brick-and-mortar retailers have adapted- own digital channels transformed by integrating physical and digital commerce around customer experiences Is this enough A: repositioning its core business of selling office supplies - 2016, e-commerce accounted for more than 60% of its $18.2 billion in sales. B: new growth plan that could leverage its strengths - Amazon Web Services venture into a $10 billion new growth business, Staples had not ventured much beyond its core

SWOT analysis

Organize conclusions from DIAGNOSIS •Internal oVRIO, Financial, others (SW) •External oSTEEP, Five Forces, others (OT)

Strategy

Process the way that strategic direction and actions are formed over time Content resulting decisions and choices that can been seen in how to compete in an industry (and strategic choices within the firm to support this position) as well as decisions about what different industries to enter

Profitability of Coke vs. Pepsi via return on equity...

ROE calculation

Firms are bundles of resources...

Resources are defined as "those (tangible and intangible) assets which are tied semi-permanently to the firm" •firms may be heterogeneous with respect to strategic resources they control •resources are sticky, that is, not perfectly mobile across firms •possession of certain types of resources (those that are valuable, rare, difficult to imitate, non-substitutable) can lead to sustained competitive advantage •firm's competitive position is defined by unique bundle of resources and relationships firm possesses across these categories

Root Cause on running out of gas/backing into another car/getting speeding ticket...

Root Cause (5 Whys)

Performance Outcomes: Balanced Scorecard

Stakeholders of a Firm •have stake in success of business o sustaining their jobs (employees/supplier) o providing needed products at good price (customers/suppliers) o giving back to community/environment o providing financial returns (financial shareholders)

TOWS (SWOT)

Strategic Options (W1, O3): Create new original programming with an independent studio (S2,T2): customizing the customer experience using data making customers want to stay (S1,O1) create a new streaming platform leveraging the Netflix brand name

Resources

Tangible •Plant and equipment •Property •People or employees •Access to capital Intangible •Exceptional and stable leadership •Loyalty of employees •Investment in employees •Positive and well-recognized brand •Ability to manage relationships with other organizations Patents/Copyrights

Competitive Advantage

What is competitive advantage? •Why some organizations outperform others over time •Greater profitability •More customer value •Lower cost •Premium price

Hypothesis Testing (5 Hows)

When have you seen an idea presented as fact that's disproven later after being tested?

Vertical Integration: Make or Buy?

When these are present, don't buy from another company, do it in-house (contracts will be difficult to write): 1. specific assets involved in transaction 2. uncertainty about quality or reliability of delivery 3. frequent interactions with supplier *mismanagement will have big effect on competitive advantage

Primary activities

activities directly tied to initial taking of inputs, subsequent converting of products, and ultimate delivery of outputs to customers include: • Inbound logistics—inventory management, warehousing, & handling • Operations—actual transformation of inputs into outputs • Outbound logistics—distribution channels, shipping, & delivery • Marketing & sales—marketing communications & pricing • Service—pre- & post-sale support

Value chain analysis

aids in understanding a firm's (potential) sources of competitive advantage primary + support activities that support higher profit margins

Support activities...

auxiliary role to primary activities...not directly tied to transformation of core product/service include: • Technology—R&D, ICTs, & engineering • Human resource management—hiring, promotion, incentive systems, & training • Infrastructure—administrative support, physical infrastructure, & stakeholder relations

PayPal

company that sells specific products and services to secure platform for commerce—physical, online, and mobile— former foes such as MasterCard and Visa into partners better compete against newer rivals Apple and Square PayPal's market value has risen to nearly $100 billion, more than double eBay

Activity of Coke vs. Pepsi via current ratio...

current equation

What is Strategy?

diagnosis that defines or explains business challenge or opportunity, decision or set of decisions for dealing w/ challenge/opportunity, and coherent set of actions to deliver on decisions so as to create sustainable advantage/superior returns.

Activity of Coke vs. Pepsi via fixed asset turnover ratio...

fixed asset turnover equation

Competitive strategy

how a firm decides to compete

Competitor analysis can be used by managers or practitioners to...

inform business decisions and strategic choices 1. clear picture of competitive landscape 2.ID under/over served areas in market 3.Market Opportunities/threats become more evident 4.Create competitor-conscious culture within organization

Other Key Financial Ratios for Coke and Pepsi...

inventory turnover and fixed asset turnover

Activity of Coke vs. Pepsi via inventory turnover ratio...

inventory turnover equation

Backward Vertical Integration

manufacturer buys another company that supplies products or services needed for production

Energy Sector

massive shift of investment to renewables has finally reached critical mass, w/ investment in solar, wind & related grid capacity now surpassing total investment in new fossil fuel resources for the first time, according to the International Energy Agency. Solar and wind are now either the same price or cheaper than new fossil fuel capacity in more than 30 countries, according to the World Economic Forum. In the U.S., jobs in solar are growing at 17X the rate of the economy and are more than double the number of coal jobs. S&P Global Clean energy index posted an 18% rise in 2017 (roughly in line with the 19.5% gain of the S&P 500 index for the year fossil-fuel based S&P Global Energy Index posted performance of about 7%, and the domestic S&P Energy Index was at 3% lagging performance of traditional energy companies is a direct result of extreme downward pressure on the prices of fossil fuels, crippling many of the profit models of leading players, leading to bankruptcies and consolidation. why many incumbent energy companies are massively investing in renewables requires new business models, new growth strategies, and new organizational capabilities.

explosion of private "decacorn" companies

private valuations now above $10 billion startups will continually disrupt incumbent leaders across industries for years to come. Those industries range from transportation (Uber and Lyft), financial services (ANT Financial and SoFi), aerospace (Space-X), real estate (We Work), healthcare (Outcome Health), energy (Bloom Energy) as well as everything in the technology space.

Liquity of Coke vs. Pepsi via quick ratio...

quick equation

Resources and capabilities are assessed...

resource or capability may serve as significant strength for firm—something around which it can build sustainable, competitive strategy

STEEP

stands for social, technical, economic, ecological, and political & does not prioritize one environmental factor over another structured way to account for trends, forces, & changes beyond boundaries of firm, which may impact operations & markets of firm

VRIO analysis

systematically identify resources/capabilities that may serve as key source of competitive advantage. resource or capability to be basis of sustainable competitive advantage, it must be valuable (V), rare (R), & costly to imitate (I), and firm must be organized (O) to capture value from resource or capability allow managers/practitioners to assess resource or capability to evaluate whether it may constitute sustainable competitive advantage for firm

Porter's Five Forces...

the threat of new entrants, the bargaining power of customers, the bargaining power of suppliers, the threat of substitute products or services, and the jockeying among current contestants determines industry's long-run profit potential because it determines how economic value created by industry is divided— how much is retained by companies in industry versus bargained away by customers & suppliers, limited by substitutes, or constrained by potential new entrants. considering all five forces, strategist keeps overall structure in mind instead of gravitating to any one element. In addition, strategist's attention remains focused on structural conditions rather than on fleeting factors. It is especially important to avoid common pitfall of mistaking certain visible attributes of an industry for its underlying structure.

S-CURVE ANALYSIS

understand & interpret evolution of market, product, or technology... •understand & interpret evolution of market, product, or technology so as to make informed strategic decisions about where value may be created now & in the future •s-curves map out evolution of market, product, or technology •we can expect cycle to repeat itself with current & future markets, products, or technologies. This means that we can use S-curve concept to assess current markets, products, or technologies & make strategic decisions that factor in such assessments.

Inimitable?

•Can other companies easily duplicate resource/capability? •Can competitors easily develop substitute resource? •Do patents/other laws protect it? •Is resource/capability socially complex? •Is it hard to identify particular processes, tasks, or other factors that form resource?

The following questions may help to assess whether valuable and rare resources and capabilities are also costly to imitate:

•Can other companies easily duplicate the resource or capability? •Can competitors easily develop a substitute resource? •Do patents or other laws protect it? •Is a resource or capability socially complex? •Is it hard to identify the particular processes, tasks, or other factors that form the resource?

Five Forces Overview - Fast Food Industry

•Competitive rivalry or competition - Strong Force (High) •Bargaining power of buyers or customers - Strong Force (High) •Bargaining power of suppliers - Weak Force (Low) •Threat of substitutes or substitution - Strong Force (High) •Threat of new entrants or new entry - Moderate-Strong Force (Medium-High)

Risks and Limitations of VRIO

•Creates inward-looking perspective of strategy •Creates backward looking, or static, perspective of strategy •Overlooks firm weaknesses/threats

(Firm is) Organized (to capture value)?

•Does company have effective strategic management process in place? •Are there effective motivation/reward systems in place? •Is organizational structure designed to use resource? •Are there effective management/control systems?

The following questions might be helpful to assess whether a firm is organized to capture value from a resource or capability:

•Does the company have an effective strategic management process in place? •Are there effective motivation and reward systems in place? •Is the organizational structure designed to use a resource? •Are there effective management and control systems?

Return on Sales = Net Income/Total Sales

•Evaluate operational efficiency-how much profit is produced per dollar of sales. •Net income margin or net profit margin/sales = revenue •Second-best ratio to assess company or industry performance •Average global public & private firm ROS: 5% •high quality firms in S&P 500: 10% •$1 sales = average earns $0.05 net profit/best $0.10

One of key roles of managers is to invest resources in manner that produces new S-Curves...

•Eventually new market, product, or technology may emerge to challenge & replace the old one, thereby potentially jumpstarting new S-curve. •This is natural evolution process. It cannot be avoided/reversed. •One of key roles of managers is to invest resources in manner that produces new S-curves to replace declining ones so as to keep firm viable for longer time.

Competitive Rivalry - High

•High number of firms •High aggressiveness of firms •Low switching costs

Threat of Substitutes - High

•High substitute availability - fulfilling need with resource from a different industry •Low switching costs •High performance-to-cost ratio of substitutes

The following questions may help to assess whether valuable resources and capabilities are also rare:

•How many other companies own a resource or deliver this capability in the same way in your industry? •Can the resource or capability be acquired in the market by rivals?

Rare?

•How many other companies own resource/deliver this capability in same way in your industry? •Can resource or capability be acquired in market by rivals?

Introduction through Shakeout...

•Introduction: new product/service is introduced in market/innovators & early adopting customers who are initially unfamiliar with product make initial purchases. •Growth: sales explode as mainstream customers become familiar with product or service & buy it, prices fall as firms manage to attain experience/economies of scale/distribution channels are established •Shakeout: initial success of product or service attracted competitors, yet growth starts to taper off as demand reaches saturation levels...focus on differentiation or cost leadership relative to competitors rather than push category as whole; rivalry intensifies w/ number of losing firms backing out

Why do financial analysis?

•Knowing current company position - making profit? •Using assets effectively? •Compare self to rivals •Check sustainability - over time •Facts backing up decisions •Assessment of stability - compared to competitors, see where company going as a whole - longevity

Bargaining power of suppliers - Low

•Large number of suppliers •Low forward vertical integration of suppliers •High overall supply •Suppliers can not easily exert power by raising prices, lowering quality, or reducing availability of products

Which Decision Tools to Use?

•Let problem faced by company define which diagnosis/decision tools to use. •Combine tools that offer complementary insights to look issues from different but complementary perspectives. •Usually you use (least) one external/internal analysis tool together.

Bargaining power of buyers

•Low switching costs •Large number of providers •High availability of substitutes

Threat of New Entrants - Medium-High

•Low switching costs (High) •Highly variable capital cost (Medium) •High cost of brand development (Low) •Easy access to necessary inputs (High)

Maturity and Decline...

•Maturity: demand mainly takes form of replacement purchases, growth slows to halt, & those having survived shakeout compete for market share, often leading to price war. •Decline: growth becomes negative as market is completely saturated; threat of substitution is real & can set off new PLCs for superior novel products or services, excess capacity leads to inventory being sold at discounted prices, & firms come up w/ exit strategies & end-game strategies

Charles Chocolates Problem Statement

•The BOD has instructed Steve Parkland to expand company size 2-3 time in 10 years while maintaining corporate culture/tradition

Following questions may help to identify valuable resource capabilities:

•Which activities lower the cost of production without decreasing perceived customer value? •Which activities increase product or service differentiation and perceived customer value? •Has your company won an award or been recognized as the best in class (e.g., most innovative, best employer, highest customer retention, best exporter)? •Do you have access to scarce raw materials or hard-to-access distribution channels? •Do you have a special relationship with your suppliers, such as a tightly integrated order and distribution system powered by unique software? •Do you have employees with unique skills and capabilities? •Do you have brand reputation for quality, innovation, and/or customer service? •Do you perform any tasks better than your competitors do? •Does your company have any other strengths compared to rivals?

Valuable?

•Which activities lower the cost of production without decreasing perceived customer value? •Which activities increase product or service differentiation and perceived customer value? •Has your company won an award or been recognized as the best in class? •Do you have access to scarce raw materials or hard-to-access distribution channels? •Do you have a special relationship with your suppliers, such as a tightly integrated order and distribution system powered by unique software? •Do you have employees with unique skills and capabilities? •Do you have brand reputation for quality, innovation, and/or customer service? •Do you perform any tasks better than your competitors do? •Does your company have any other strengths compared to rivals?

Return on Assets = Net Income/Total Assets

•best gauge of company's or industry's profitability •average global public & private firm ROA: 4% •$100 in assets = generate $4 in returns

(S-Curve) Early research studied the diffusion of new technologies like household appliances and color televisions...

•characteristic initial slow growth when technology is first introduced •followed by rapidly accelerating growth •much steeper rate of diffusion when larger share of market warms up to technology, followed by maturity when growth slows again & eventually stops

Competitor analysis should be central component of strategy b/c...

•customer value is always defined relative to rival offerings •Superior competitive positions can only be obtained/maintained if one has detailed knowledge of one's competitors. •One underlying idea behind competitor analysis is the concept of proactive competitor profiling—series of detailed questions that reveal: •(1) reveals strategic weaknesses in competitors that firm can exploit, •(2) reveals insights about likely strategic responses by competitors to planned initiatives •(3) greater agility in terms of anticipation of future strategic moves by competitors

Risks and Limitations of Segmentation...

•difficult to manage balance between becoming too niche (not having a big enough market to serve)/being too broad (not clearly identifying narrow enough segments to make exercise meaningful). •segments are almost never static...tend to change over time. •for some undifferentiated products, economies of scale & scope may render mass market to be most attractive segment.

SEGMENTATION ANALYSIS

•first phase: identify market & then to establish basis for segmenting market •find basis for segmentation, market manager should •look for means of achieving internal homogeneity (similarity within segments) •external heterogeneity (differences between segments) •searching for process that minimizes differences between members of segment & maximizes differences between each segment

Return on Equity = Net Income/Total Equity

•how efficiently company (its management team) is handling money that shareholders have contributed •total equity includes ALL features of equity (retained earnings, common stock, paid in capital, preferred stock, treasury stock). •average global ROE for public & private firms: 11.5% •$100 in equity = $11.5 in profits

Segmentation analysis provides...

•means to understand/partition broad consumer/business market into subgroups of consumers/businesses (called segments), such that firm can effectively target specific segments rather than the market as whole. •Segmenting market allows firm's managers to understand/target segments that are most attractive for firm. •Targeting attractive segment allows firm to more effectively utilize its limited resources to focus on those areas of market where it can be most successful.

Root Cause (5 Whys) & Hypothesis Testing (5 Hows)

•underlying reasons for organizational problems (or potential problems) •assumptions/conditions for potential strategic move

Porter's Five Forces: Assessing Industry Attractiveness

•understand an industry •identify opportunities & risks •anticipate how profits within industry will be distributed •recognize industry trends & anticipate changing trends •overall INDUSTRY profitability, NOT company's profitability •framework to guide strategic choices