case study of sony

8/14/2019 Case Study of Sony

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INTRODUCTION

is considered asone of the most

leading multinationalcompanies in the world and isranked among the top tenU.S. Companies in patentsgranted. In the array ofthousands of products, 3M

products are considered to bethe most innovative. 3M produces more than 200innovative products eachyear. With a ticker symbol ofMMM, It is listed on the NewYork, Pacific, Chicago andSwiss stock Exchange.

3M, established in 1902, nowoperates in more than 60countries and is engaged inproducing more than 75,000products including adhesives,sand paper, post-it products,abrasives, pharmaceuticals,fluorochemicals, optics,coatings, ceramics, LCDs,cables and other industrialand office equipments. It issaid that a quarter of theworlds population uses oneor more 3M products dailyand its demand for theproducts is increasing day byday leading the company tomake solid sales growth andmake further prosperity infuture.

With referring to theorganizational growth andsuccess over the past few

years, the company continuesto invest in growth programsand brand buildingthroughout the portfolio. Itscapital budgeting decisionsregarding research anddevelopment and othercapital expenditures arehoped to increase in every

coming year which requiresthe challenges of meetinggrowing needs for finances,efficient allocation ofresources, making goodinvestment decisions andmost importantly maintaininga balance between theobjective of profit and

shareholders wealthmaximization. It has to havea competitive edge andmaintain itself financiallysound and stable inaccordance with the growingglobal demand of its productsand increasing innovation inthe world.

WHY CAPITALBUDGETING DECISIONS

ARE IMPORTANT?

CapitalBudgeting


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decisions are the mostimportant and criticaldecisions that directlyinfluence the companys performance in terms of profitability and liquidity.

These decisions can lead thecompany to reach the heightsof success and can even leadthe company to face disaster.So effective capital budgetingdecisions are key to theorganizations success

because they involve risk andunderstanding of uncertaintyabout each investment and project, which is usuallydifficult to analyze.

Case study

OVERVIEW / ANALYSIS

Since 3M makes almost 60% of itsrevenue from international marketsthats why its primary growth strategyis based on continuing internationalexpansion and producing moreinnovative products into new orexisting markets. Currently 3Mmanages its business operations in sixbusiness segments i.e. Health care,Industrial and Transportation, Display

and Graphics, Consumer and Office,Electro and communication, Safetysecurity and protection services.

3Ms FINANCIAL MANAGEMENTSTRUCTURE IN TERMS OF

CAPITAL BUDGETING DECISIONS

3Ms capital budgeting decisions aremostly related to its R&D,acquisitions, strategic alliances,mergers, investments in plant, property, equipment and usually in

available for sale securities.3Minvests more than $1 billion per yearin research and development andrelated activities, and is awardednearly 600 U.S. patents each year.3Ms capital expenditures totaled$943 million in 2005 and areexpected to increase up to $1.1 billion

in the year 2006. 1A brief overviewabout the companys capitalbudgeting activities over the past fewyears is given below:

In 2005, 3M spent about $26

million for capital projects relatedto protecting the environmentwhich are further expected toincrease to $35 million for new

programs to build pollutioncontrol devices, modern facilitiesand modify manufacturingprocesses to minimize waste andreduce emissions.

In 2005, 3M announced to

build an LCD optical filmmanufacturing facility in

1 Only few of the materialinvestments have been mentioned inthe analysis to give the readers ideaabout the companys capitalbudgeting activities.


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Poland in order to cater to theLCD-TV market in Europeand to better serve itscustomers.

In 2005, 3M (industrialbusiness segment) acquired aCUNO filtration plant for purification of fluid andgases for $1.36 billion ($1.27billion paid in cash and $80million of debt out of whichmostly has been paid) alongwith the intangible assets of$268 million.

In the years 2003, 2004 and

2005, 3M business segments

continued to buy 100% ofoutstanding shares fromvarious companies,manufacturing lines andsubsidiaries for the purpose

of expansion

and other activities.

In 2006,

companycombined itsindustrialand

transportation business

segment to increaseefficiency and lower down itsoperational costs.

In 2005, approximately $3.6

billion of cash was used torepurchase 3M commonstock under its repurchaseauthorization and for the payment of dividends andcontributed $788 million toits pension and

postretirement plans.

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3M paid its first dividend of 6cents per share in 1916 and sincefrom then, it believes indelivering sustainable and higher

returns to the companysshareholder. Its dividendexpenditures totaled $1.268billion in 2005 ($1.68 per share),$1.125 billion in 2004 ($1.44 per

share) and $1.034 billion in 2004($1.32 per share)2.

3M invests large amount of

expenditures in Research and product development. Its totalexpenditures regarding R&Dtotaled $1.242 billion in 2005,$1.194 billion in 2004 and$1.147 billion in 2003 including

2 Dividend per share over theyears have been shown in graphgiven at appendix 2


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the expenditures regarding thedevelopment of new andimproved products of $798million in 2005, $759 million in2004 and $749 million in 2003.Regarding product development,

3M uses six sigma3 to increasethe productivity and operationalefficiencies by reducing defectsto deliver high performance,reliable products to itscustomers.

The company strongly believesthat its ongoing cash flows provide great source of itsfunding for expectedinvestments and capital

expenditures. It has sufficientaccess to the capital markets tomeet its investment fundingneeds. The company allocates itsfunding needs from debt as wellas from equity. It obtainsfinances from operations as wellas from long-term debt andshort-term borrowings i.e. byissuing and trading commercial papers, medium term notes,floating rate note, convertible

notes, and marketable securities.

The company has entered intovarious indentures with thebanks (including Citi Bank) with

3 Six sigma is explained indetail in appendix 3

respect to short term and longterm senior debt securities.

The table 1.1 (given in theappendix 1) comprisesinformation about its short-termand long-term debts along withthe interest rates and theirmaturity dates. Its overall long-term debt has increased from $727 million to $1,309 million in

2005 but its short-term debt hasdecreased from $2,094 millionto $1,072 million in2005.

3M has contingentlyconvertible 30-yearzero-coupon senior noteswhich are redeemableinto 9.4602 shares of 3Mcommon stock aftersome conditions have been met. In 2005, theconversion price for thefourth quarter was $120 per share. In November

2005, 22,506 out of the 639,000outstanding bonds wereredeemed which resulted 3M to payout approximately $20million.


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3M has various pension and postretirement plans for itsemployees. 3Ms goal of thisinvestment strategy is to meetthe obligations and earn thehighest rate of return on

actuarial basis. The companydetermines discount rate for

measuring plan liabilities forthese plans and determines therate of return by analyzing thereturns on fixed incomeinvestment having similarduration liabilities (determined

by


recognized rating agencies).Table 1.2 (given in appendix 1)depicts the discount rate,expected rate of return estimated

over the past few years.

The company estimates its fairvalue of assets and investmentsusing discounted cash flowanalysis. It also uses discountrate to determine its fair value ofobligation and liabilities.Management makes estimationand assumptions while showingthe long term effects of assetsand investments in the financial

statements and adjust thoseassumptions according to thechanging circumstances andrequirements.

3M uses net present valuemethod to evaluate itsinvestment decisions. It uses 4

Mapping portfolio tools i.e. bubble diagram and ellipses to plot probability of successagainst Net Present Value.

3M invests heavily in intangibleassets including patents,goodwill, trademarks etc. In2005, 3M acquired goodwill of$3.5 billion (including $1.002

4 Explanation is given inAppendix 3.

billion of goodwillacquired fromacquisitions

primarilyrelated to theCUNOacquisition).The impairmenttesting of goodwill isdone atreporting levelto recognizeany impairmentloss5 over the

year.

3M has 18reporting unitsto whichgoodwill isdirectly assigned. The estimatedfair value of a reporting unit isdetermined by discounted cash-flow analysis or by multiplyingeach reporting units earningswith the price earning ratio for

comparable industry group.

The company also raises fundsthrough repurchase of commonstock to support the stock based

5 Impairment loss is recognizedwhen carrying value of assetexceeds the fair value of theasset.

3M Diamond Grade Reflective sh


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compensation plans and othercorporate purposes. Thecompany contributes treasuryshares, accounted at fair value toemployee savings plans to coverobligations.

It has many stock optionownership programsincluding Employee stockOwnership plan (ESOP),General Employee stockOwnership plan (GESPP)and Management Stock

Ownership Program(MSOP). 6Black-Scholesoption pricing model is usedfor calculating the weightedaverage fair value per optionat the date of grant for theseplans.

3M uses Discount DividendModel7 also known asGordon Model to evaluateits dividend decisions. This

model calculates the presentvalue of the future dividendsthat are expected to pay toits shareholders in future. Itrelates the market value ofthe firm to its dividend policy by calculatingexpected return, currentdividend yield and projecteddividend growth.

6 Black-Scholes option pricingmodel is discussed in detail inappendix 37 Dividend Discount Model isexplained in detail in appendix3


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CORPORATE STRATEGY

Innovation is the basiccorporate strategy that 3M isusing for driving itsorganization. It invests a largesum in its R&D and believes itsinnovation and patents to be thegreat sources of its competitiveadvantage. 3M's corporatestrategy is based on a paradigm

shift towards 21st centurycompetitiveness that requiresmovement towards long termsustainable growth withoutcompromise of financialsuccess. It has pursued thisgoal, in part, through itstechnical corporate culture witha workforce that is empoweredto innovate. In their annualreport for the year 2005 it isstated:

Every day, people at 3M find

ways to make life better and

easier for people around the

world. We increase and

efficiency by sharing

technologies, manufacturing

operations, brands and other

resources across our

businesses and geographies.

Our businesses produce

innovative products, hold

leading market positions andgenerate solid returns on

investment.

At 3M innovation is a dynamic process. All employees areencouraged to innovate andaccording to the 15% rule (theirmost famous management

principle),employees areallowed to spend15% of their working time ontheir owninnovative ideas.The company ismore than hundredyears old and has been throughvarious

circumstances.Shift towards aninnovativeorganization has been gradual. It had to facemany challenges and adapt tothem by changing itsorganizational structure.


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CHALLENGES ANDORGANIZATIONALCHANGES WITHREFERENCE TO

STRATEGICDEVELOPMENT

Some of the challenges faced by the organization in thetransformation into aninnovative organization arementioned in the table 1.3 inAppendix 1. At 3M, Managersare now engaging the staff formaximum innovation. Thistransformation required the

leaders to take responsibilityfor articulating the direction,for creating an environmentthat empowers the members of

the organization, to have a deepunderstanding of the changingneeds of the environment andenabled the individuals to becreative and to be driven bytheir own will by

communicating a clear visionof the future.

COMPETITORS

3M is the member of conglomerate industry. Noorganization competes with 3Mon all product platforms; it hasencountered strong competitionin specific business lines. In particular, Avery Dennison

Corporation AVY), Johnsonand Johnson (JNJ) and DuPont(DD) compete with 3M.


A comparison of 3M performance with itscompetitors is given in table1.4 in Appendix 1.

FINANCIALPERFORMANCE

3Ms corporate strategy hasgreat impact on its financial performance. Due to theincreasing demand for itsinnovative products andeffective decision making toreach operational excellenceenabled the company to

generate the highest salesrevenue8 of $21.2 billion in2005 with an increase of 5.4%

8 Graph representing thesales revenue, EPS,dividends per share over theyears have been given inAppendix 2


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over the previous year. Itreported a net income of $3.2 billion with an increase of7.0%.

Operating income grew up to $5

billion with an increase of9.4%. Earnings per sharereported $4.12, 9.9% higher ascompared to the year 2004.Dividends per share with anincrease of 16.7% reported to$1.68. However because ofheavy investments and paymentof some long term debts in2005, the company reported anet decrease in cash & cashequivalents of $1,685 million as

compared to the year 2004. Butthese outflows were because ofheavy investments which would benefit the company on thelong-term basis.

While talking about thecompanys ratios, there had been an improvement in itsprofitability ratios as comparedto the previous years. PretaxROA increased from 23.78% in

2004 to 24.18% in 2005. ROEincreased by 5.4%. Return onCommon Equity (ROCE)reported 31.04%. Gross ProfitMargin was 50.24% in 2004and increased up to 50.96% in2005, Operating Margin(22.88% in 2004, 23.66% in2005) and the Net Profit Marginwas increased from 14.94% in2004 to 15.11% in 2005.

The companys liquidity ratiosdeclined because of decrease incash and cash equivalents in2005 but these ratios are still

considered good as comparedwith the industry ratios and aresound according to the rule ofthumb. The company currentlyhas a rating of AA credit ratingfrom Standard & Poors and

Aa1 credit rating from MoodysInvestors Service.

In 2004, the current ratio for3M was 1.44 and it haddecreased to 1.36 in 2005. For2004, the quick ratio was 1.12and it decreased to 0.95 in2005. However decline in debtratio from 20.4% in 2004 to14.0% and debt to equity ratiofrom 0.27 to 0.24 in 2005 is a

positive sign.

Overall increased profitabilityratios, high amount of return oninvestments, increase in sales,and continuous payment ofdividends to its stockholdersover the years show the

companys financial soundnessand increase the shareholders

confidence to make thecompany attractive for theinvestors.

3M Diamond Grade Reflective sh


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Case study Page 1011/23/2008

RISK MANAGEMENT

To understand uncertainty

and risk is to understand the

key business problem and

the key business

opportunity David B.

Hertz, 1972.

Risk is the most importantfactor incorporated in thecapital budgeting decisions thatdirectly influences thecredibility of an investment.

When a company invests in a project, it always has somedegree of uncertainty involvedin it. Financial managers lookfor the projects whose expectedrate of return is higher with lessamount of risk involved in it toensure shareholders wealthmaximization and companysprofitability.

RISK FACTORS

3M deals with different types

of market and company risks.

Briefly, they are as follows:

The effects of, and

changes in, worldwide

economic conditions e.g.

recession, social, political,

labor conditions or

government policies in

which company operatesetc. can have an impact on

its results.

Change in consumer

preferences, introduction

and timings of competitive

products, changing

customer order patterns

can affect the demand for

3M products and hence

can affect the companys

revenue and profit

margins.

As company makes almost

60% of its revenue from

international markets

therefore its receivables,

and expected returns for

the investments, sales and

earnings can be affected

by exchange rate

fluctuations.

Developments of new

products may subject to

many risks and is largely

dependent on the timings

of their launch and

acceptance of that product

in the market. There is no

guarantee that all these

products will be

commercially successful.

Price fluctuations,

interruption in supply,

shortages of raw material,changing demand, naturaldisasters and other factorscan have a material effect onthe companys results. e.g. In2005, the company had toface many problemsregarding costs and supply ofoil-derived raw materials


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because of hurricanes hit inKatrina and Rita.

Its capital budgeting

decisions regardingacquisitions, strategicalliances, divestitures and

other events resulting from portfolio managementactions, possibleorganizational restructuringand any other change in its business strategy can affectthe future results.

The companys future results

can be affected if companygenerates less productivityimprovements thanestimated.

The Company and some of

its subsidiaries are facingmany claims, lawsuits, legaland regulatory proceedings

and litigation including thoseinvolving product liability, property and other matterscan result in the outcomesother than those of estimatedwhich can affect the future

results.

RISK MANAGEMENTSTRATEGY BEINGFOLLOWED BY 3M TOOFFSET RISKS

3M has a financial risk management committee,comprising senior management,to deal with the companysfinancial risk policies and provides guidelines andprocedures for risk managementand derivative instrumentutilization for control andvaluation.

Case study Page 1111/23/2008

Regarding the risk factorsmentioned above, the company isusing various techniques andstrategies to minimize these risks.The activities undertaken by themanagement to offset these risksare:

Hedging is the most

important activity which 3Muses to counter risk. The

company has variouscontractual derivativearrangements to manage risksassociated with foreignexchange rate, interest rateand commodity price risks.The company uses interestrate swaps, forward andoption contracts to manage

risk. It uses a mix of floatingand fixedinterest ratedebt anduses interestrate swapsto helpmanagingtheborrowingcosts. In2005, half of

the currencyimpactswerereduced byhedging.

The

company is engaged insupply contracts, price protection agreements and


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forward physical contracts toensure uninterrupted supplythroughout the year and tomanage commodity pricerisks.

The company is doing global

sourcing for coping with thecommodity price inflationwhich would help in reducingthe cost of raw material.

The company uses tools like

six sigma to improve itsoperational efficiency and productivity to reduce itsoperational costs in order toavoid risk regarding newproduct development.

3M uses variance/co-variance

statistical model namedthird-party bank dataset9 toassess interest rates, currencyfluctuations and the risksassociated with the loss inafter-tax earnings in financialinstruments and derivatives.

3Ms COMPLIANCE WITHLATEST REGULATORY

REQUIREMENTS

3M makes its financialstatements in accordancewith the Generally AcceptedAccounting Principles

9 Explanation is given inAppendix 3

(GAAP) and takes care ofadopting new regulatoryrequirements that areessential for the company toopt in order to come up to theinternational financial

reporting standards. Itsfinancial statements areaudited byPricewaterhouseCoopers LLPwhich, (in the financialstatements of 2005 under theReport of IndependentRegistered Public AccountingFirm), reports the 3Mmanagement to have aneffective internal control overthe financial reporting.

The company makes sure thatits financial reports aretransparent and reflect theinformation about estimates,transactions, records, policies, risks, assumptionsand other publicly available

information, fairly andproperly.


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face new challenges regardingits capital budgeting decisionsthat would directly impact theorganizations structure andcompanys financial performance. In this rapidly

changing global environment ofuncertainty, proper riskmanagement is necessary toacquire required efficiency inorder to have a good financialmanagement structure.

DISCUSSION QUESTIONS

What kind of

corporate strategy

does 3M follow?

And do you believe

that in the coming

years, that will

necessarily make

3M a market

leader?

How will the

companys capital

budgeting decisionsimpact their

financial

performance in the

coming years?

What further steps

should 3M take to

offset the risks that

they face? Do you

believe that the

strategies they are

currently following

are feasible or not?

Just because the

company discloses

in their financial

reports, the new

regulatory

requirements, does

that mean that the

company is clearly

transparent?

Explain your

answer.

How far the

company has been

able to pursue the

goal of having a

balance between

shareholders

wealthmaximization and

profit

maximization?

case study of sony

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