dr. nancy mangold, csuh1 financial reporting and financial statement analysis dr. nancy mangold...
TRANSCRIPT
Dr. Nancy Mangold, CSUH 1
Financial Reporting and Financial Statement Analysis
Dr. Nancy MangoldCalifornia State University, East Bay
Dr. Nancy Mangold, CSUH 2
Financial Statement Analysis - Purposes
Making an investment (common or preferred stocks)
Extending credit– short-term (bank loan to finance receivables or
inventories)– long-term (bank loan or public bond to finance
acquisition of property, plant, or equipment)
Dr. Nancy Mangold, CSUH 3
Financial Statement Analysis - Purposes
Assessing the operating performance and financial health of a supplier, customer, or competitor.
Valuing a firm in settings such as– the initial public offering of its common stock– as an acquisition candidate– in court-directed bankruptcy hearings or– in liquidation actions
Dr. Nancy Mangold, CSUH 4
Financial Statement Analysis - Purposes
Forming a judgment about damages sustained in a lawsuit
Forming an opinion on a client’s financial statements with respect to whether the client is a “going concern”
Assessing whether combinations in an industry might generate monopoly returns, thus prompting antitrust action by government regulators
Dr. Nancy Mangold, CSUH 5
Steps in Financial Statement Analysis
1.Identify
Economic Characteristics
2. Identify CompanyStrategies
3. Understand and
Cleanse the Financial
Statements
4.Analyze
Profitability and Risk
5. Value the Firm
Dr. Nancy Mangold, CSUH 6
Overview of Financial Statement Analysis
Identify the economic characteristics of the particular industry
Identify the strategies that a particular firm pursues to gain competitive advantage
Understand the financial statements of the particular firm and cleanse them of nonrecurring and unusual items
Dr. Nancy Mangold, CSUH 7
Overview of Financial Statement Analysis
Assess the profitability and risk of the firm using information in the financial statements
Value the particular firm
Dr. Nancy Mangold, CSUH 8
Identify the Industry Economic Characteristics
A large number of firms selling similar products
Grocery stores– Similar (non-differentiated) products– Low barriers to entry (retail space & access to
food product distributors)– Extensive competition– Low assets invested and high asset turnover
Dr. Nancy Mangold, CSUH 9
Identify the Industry Economic Characteristics
A smaller number of competitors selling unique products
Pharmaceutical companies– High entry barrier
» High R&D to create new drugs
» Lengthy government approval process to receive a patent for a new drug
» Exclusive rights to manufacture and sell the product for a long time
Dr. Nancy Mangold, CSUH 10
Identify the Industry Economic Characteristics
Pharmaceutical companies– Higher profit margins– Unique product liability risks– Risk of competitor develop superior drugs that
make one firm’s drug obsolete– Small debt financing
Dr. Nancy Mangold, CSUH 11
Identify the Industry Economic Characteristics
Technological change critical to a firm’s maintaining a competitive advantage
Computer software
Dr. Nancy Mangold, CSUH 12
Identify the Industry Economic Characteristics
Rapid growth in Industry sales Internet search services
– Yahoo, Excite, Lycos Internet service providers
– AOL– Earthlink
E-commerce – Amazon.com– eBay
Dr. Nancy Mangold, CSUH 13
Identify the Industry Economic Characteristics
Capital intensive industry Electric utility
– Large investments in property, plant & equipment– Monopoly in a particular area– Regulators set the rates– High profit margins to offset low asset turnover– High proportion of debt– Deregulation and market rates will reduce profit
margins.
Dr. Nancy Mangold, CSUH 14
Identify the Industry Economic Characteristics
Commercial Bank Assets
– Investment in short-term financial securities– Loans to businesses and consumers
Financing– Customer deposits– Short-term borrowing
Dr. Nancy Mangold, CSUH 15
Identify the Industry Economic Characteristics
Commercial Banks Small profit margins on interest rate
difference between lending and borrowing Fee based financial service more profitable
– Arranging mergers and acquisitions– Structuring financing packages for businesses– Guaranteeing financial commitments of
business customers
Dr. Nancy Mangold, CSUH 16
Tools for Studying Industry Economics
Value Chain Analysis Porter’s five forces classification An Economic attributes framework
Dr. Nancy Mangold, CSUH 17
Value Chain Analysis
A value chain for an industry involves the creation. Manufacture, and distribution of its products and services
Dr. Nancy Mangold, CSUH 18
Value ChainPharmaceutical Industry
Research to DiscoverDrugs
Approval of Drugs by
Government Regulators
Manufactyre ofDrugs
Creation of Demand for
DrugsDistribution to
Customers
Dr. Nancy Mangold, CSUH 19
Value ChainPharmaceutical Industry
Where value gets added in an industry? Value of drug discovery
– Prices paid to acquire firms with promising or newly discovered drugs
Value to test and obtain approval of new drugs– prices paid to clinical research firms to test and
to obtain approval of new drugs
Dr. Nancy Mangold, CSUH 20
Value ChainPharmaceutical Industry
Identify the strategic positioning of a particular firm within the industry
Traditionally in– Research discovery– Manufacturing– Demand Creation
Not in– Distribution to customers to pharmacies– Contract out drug testing and approval phase
Dr. Nancy Mangold, CSUH 21
Value Chain Beverage Industry
Creation ofBeverageProduct
Manufacture ofConcentrate
Mixing of Concentrate,
Water, Sweetenerto Produce
Beverage or Syrup
Containerizing Beverage or Syrup in Bottles, Cans or
other Container
Distribution to Retail Outlets
Dr. Nancy Mangold, CSUH 22
Value Chain Beverage Industry
Coke engages in– New Product Development– Manufacture of Concentrate (secret ingredients and
formula) Contract out bottling operation
– 15% subsidiaries– 40% independent bottlers– 45% noncontrolled affiliates– Bottlers ship beverages to retail stores
Dr. Nancy Mangold, CSUH 23
Business strategy analysis is an important starting point for the analysis of financial statements
It allows the analyst to probe the economics of the firm at a qualitative level
It allows the identification of the firm’s profit drivers and key risks
Business Strategy Analysis
Dr. Nancy Mangold, CSUH 24
Business Strategy Analysis
Enabling the analyst to assess the sustainability of the firm’s performance and make realistic forecasts of future performance
Dr. Nancy Mangold, CSUH 25
Business Strategy Analysis
Useful in guiding financial analysis Cross-sectional analysis
– expect firms with cost leadership strategy to have lower gross margins and higher asset turnover than firms that follow differentiated strategies
Dr. Nancy Mangold, CSUH 26
Business Strategy Analysis
Useful in guiding financial analysis Time-series analysis
– closely monitor any increases in expense ratios and asset turnover ratios for low cost firms.
– monitor any decreases in investments critical to differentiation for firms that follow differentiation strategy.
Dr. Nancy Mangold, CSUH 27
Industry Analysis
In analyzing a firm’s profit potential, an analyst has to first assess the profit potential of each of the industries in which the firm is competing.
The profitability of various industries differs systematically.
Dr. Nancy Mangold, CSUH 28
Industry Analysis
ROE - 1971-1990 All US Mfg. Companies 12.6% Food & kindred prod. ind. 15.2% Paper & allied prod. ind. 12.5% Iron & Steel ind. 3.9%
Dr. Nancy Mangold, CSUH 29
Industry Analysis
Industry structure influences profitability of firms in an industry
Average profitability of an industry is influenced by five forces.
Dr. Nancy Mangold, CSUH 30
Porter’s Five Forces Classification
Degree of actual and potential competition– Rivalry among existing firms– Threat of New Entrants– Threat of Substitute Products
Bargaining power in input and output mkts– Bargaining power of buyers– Bargaining power of suppliers
Dr. Nancy Mangold, CSUH 31
Industry Structure and Profitability
Degree of Actual and Potential Competition
Industry Profitability
Bargaining Power of Buyers
Rivalry Among Existing firms
Threat of New Entrants
Threat ofSubstitute Products
Bargaining Power in Input and Output Markets
Bargaining Power of Suppliers
Dr. Nancy Mangold, CSUH 32
Degree of Actual and Potential Competition
Rivalry Among
Existing Firms
Industry Growth
Concentration
Differentiation
Switching Costs
Scale/Learning economies
Fixed-Variable costs
Excess Capacity
Exit Barrier
Threat of
New Entrants
Scale Economies
First mover Advantage
Distribution Access
Relationships
Legal Barriers
Threat of
Substitute Products
Relative price and performance
Buyers’ willingness to switch
Dr. Nancy Mangold, CSUH 33
Bargaining Power in Input and Output Markets
Bargaining Power
of Buyers
Switching costs
Differentiation
Importance of product for cost and quality
Number of buyers
Volume per buyer
Bargaining Power
of Suppliers
Switching costs
Differentiation
Importance of product for cost and quality
Number of suppliers
Volume per supplier
Dr. Nancy Mangold, CSUH 34
Degree of Actual and Potential Competition
Profits in an industry are a function of the max price that customers are willing to pay for the industry’s product or service
One of the key determinants of price is the degree of competition among suppliers of the same or similar products
Dr. Nancy Mangold, CSUH 35
Degree of Actual and Potential Competition
Perfect Competition– Price = marginal cost– few opportunities for super-normal profits
Monopoly– earn monopoly profits
Most Industry in between perfect competition and monopoly
Dr. Nancy Mangold, CSUH 36
3 Competitive Forces in an Industry
Rivalry between existing firms Threat of entry of new firms Threat of substitute products or services
Dr. Nancy Mangold, CSUH 37
Competitive Force 1:Rivalry among Existing Firms
In some industries, firms compete aggressively, pushing price close to marginal cost
In other industries, they find ways to coordinate their pricing, or compete on non-price dimensions (innovation, brand image)
Several factors determine the intensity of competition between existing players in an industry
Dr. Nancy Mangold, CSUH 38
Industry Growth Rate
If an industry is growing very rapidly, existing firms need not grab market share from each other to grow
In stagnant industries, the only way existing firms can grow is by taking share away from the other players– price wars
Dr. Nancy Mangold, CSUH 39
Concentration and Balance of Competitors
The number of firms in an industry and their relative sizes determine the degree of concentration in an industry
The degree of concentration influences the extent to which the firms in an industry can coordinate their pricing and other competitive moves
Dr. Nancy Mangold, CSUH 40
Concentration and Balance of Competitors
One dominant firm in an industry– IBM mainframe computer ind. in 1970s
– it can set and enforces the rules of competition
Two or three equal-sized players– Coke and Pepsi in US soft-drink industry
– can implicitly cooperate with each other to avoid destructive price competition
Industry Fragmented – Severe price competition
Dr. Nancy Mangold, CSUH 41
Degree of Differentiation and Switching Costs
The extent of competition depends on the extent to which firms in an industry can differentiate their products and services
If the products in an industry are very similar, customers are ready to switch from one competitor to another purely on the basis of price
Dr. Nancy Mangold, CSUH 42
Degree of Differentiation and Switching Costs
Switching costs determine customers’ propensity to move from one product to another
When switching costs are low, there is a greater incentive for firms in an industry to engage in price competition
Dr. Nancy Mangold, CSUH 43
Scale /Learning Economies and the Ratio of Fixed to Var. Costs
If there is a steep learning curve or there are other types of scale economies in an industry, size becomes an important factor for firms in the industry
In such situations, there are incentives to engage in aggressive competition for market share
Dr. Nancy Mangold, CSUH 44
Scale /Learning Economies and the Ratio of Fixed to Var. Costs
If the ratio of fixed to variable costs is high, firms have an incentive to reduce prices to utilize installed capacity– Airline industry, price wars are common
Dr. Nancy Mangold, CSUH 45
Excess Capacity and Exit Barrier
If capacity in an industry is larger than customer demand, there is a strong incentive for firms to cut prices to fill capacity.
Excess capacity will be more problem if there are significant barriers for firms to exit the industry
Exit barriers are high when the assets are specialized, or if there are regulations which make exit costly.
Dr. Nancy Mangold, CSUH 46
Competitive Force 2: Threat of New Entrants
The potential of earning abnormal profits will attract new entrants to an industry.
The very threat of new firms entering an industry potentially constrains the pricing of existing firms within it.
The ease with which new firms can enter an industry is a key determinant of its profitability.
Dr. Nancy Mangold, CSUH 47
Competitive Force 2: Threat of New Entrants
Several factors determine the height of barriers to entry in an industry– Economies of scale– First mover advantage– Access to channels of distribution and
relationships– Legal barrier
Dr. Nancy Mangold, CSUH 48
Economies of Scale
When there are large economies of scale, new entrants face the choice of having– either to invest in a large capacity which night
not be utilized right away, – or to enter with less than the optimum capacity
New entrants will at least initially suffer from a cost disadvantage in competing with existing firms
Dr. Nancy Mangold, CSUH 49
Economies of Scale
Economies of scale might arise from large investments in– research and development
» Pharmaceutical or Jet engine industries
– brand advertising» Soft-drink industry
– physical plant and equipment» Telecommunications industry
Dr. Nancy Mangold, CSUH 50
First Mover Advantage
Early entrants in an industry may deter future entrants if there are first mover advantages
First mover might be able to – set industry standards
– enter into exclusive arrangements with suppliers of cheap raw materials
– acquire scarce government licenses to operate in regulated industries
Dr. Nancy Mangold, CSUH 51
First Mover Advantage
If there are learning economies, early firms will have an absolute cost advantage over new entrants.
First mover advantages are also likely to be large when there are significant switching costs for customers once they start using existing products. (DOS, Windows)
Dr. Nancy Mangold, CSUH 52
Access to Channels of Distribution and Relationships
Powerful barriers to entry Limited capacity in the existing distribution
channels High costs of developing new channels
Dr. Nancy Mangold, CSUH 53
Access to Channels of Distribution and Relationships
Examples Formidable barriers for a new entrant into
the domestic auto industry– difficulty of developing a dealer network
New consumer goods manufacturer– difficult to obtain supermarket shelf space for
their products
Dr. Nancy Mangold, CSUH 54
Access to Channels of Distribution and Relationships
Existing relationships between firms and customers in an industry make it difficult for new firms to enter an industry– Auditing– Investment banking– Advertising
Dr. Nancy Mangold, CSUH 55
Legal Barriers
Patents and copyrights in research-intensive industries limit entry
Licensing regulations limit entry into – medical services– broadcasting – telecommunications
Dr. Nancy Mangold, CSUH 56
Competitive Force 3:Threat of Substitute Products
Substitutes for travel over short distance– Airlines and car rental services
Substitutes as packaging in the beverage industry– plastic bottles and metal cans
New technology changes usage of product– Energy conserving technology reduce
consumption of electricity and fossil fuels
Dr. Nancy Mangold, CSUH 57
Competitive Force 3: Threat of Substitute Products
The threat of substitutes depends on– the relative price and performance of the
competing products or services– on customers’ willingness to substitute
Dr. Nancy Mangold, CSUH 58
Competitive Force 3:Threat of Substitute Products
Customers’ willingness to switch A critical factor in making this competitive
dynamic work– tap water and bottled water (price premium)– designer label clothing (price premium),
customers place a value on the image offered by designer labels.
Dr. Nancy Mangold, CSUH 59
Relative Bargaining Power in Input and Output Market
On the input side, firms enter into transactions with suppliers of – Labor, raw materials and components– Finances
On the output side, firms either – Sell directly to the final customers or– Enter into contracts with intermediaries in the
distribution chain
Dr. Nancy Mangold, CSUH 60
Relative Bargaining Power in Input and Output Market
The relative economic power of the two sides is important to the overall profitability of the industry firms
Dr. Nancy Mangold, CSUH 61
Competitive Force 4: Bargaining Power of Buyers
Two factors Price sensitivity
– determines the extent to which buyers care to bargain on price
Relative bargaining power– determines the extent to which they will
succeed in forcing the price down
Dr. Nancy Mangold, CSUH 62
Price Sensitivity
Buyers are more price sensitive when the product is– undifferentiated and– there are few switching costs– the importance of the product to their cost
structure
Dr. Nancy Mangold, CSUH 63
Price Sensitivity
When the product represents a large fraction of the buyers’ cost– Buyer is likely to expend the resources to shop
for a lower cost alternative. If the product is a small fraction of the
buyers’ cost– Buyer may not expend resources to search for
lower cost alternatives
Dr. Nancy Mangold, CSUH 64
Price Sensitivity
The importance of the product to the buyers’ product quality also determines whether or not price becomes the most important determinant of the buying decision
Dr. Nancy Mangold, CSUH 65
Relative Bargaining Power
Relative bargaining power in a transaction depends ultimately on the cost to each party of not doing business with the other party
Dr. Nancy Mangold, CSUH 66
Relative Bargaining Power The buyers’ bargaining power is determined by
– the number of buyers relative to the number of suppliers
– volume of purchases by a single buyer
– number of alternative products available to the buyer
– buyers’ costs of switching from one product to another
– threat of backward integration by the buyers
Dr. Nancy Mangold, CSUH 67
Relative Bargaining Power
Automobile industry Car manufacturers have considerable power
over component manufacturers– large buyers– several alternative suppliers to choose from– switching costs are relatively low
Dr. Nancy Mangold, CSUH 68
Relative Bargaining Power
PC industry Computer makers have low bargaining
power relative to the operating system software producers because of high switching costs
Dr. Nancy Mangold, CSUH 69
Competitive Force 5: Bargaining Power of Suppliers
Suppliers are powerful when – there are only a few companies– there are few substitutes available to their
customers
Dr. Nancy Mangold, CSUH 70
Competitive Force 5: Bargaining Power of Suppliers
In the soft-drink industry– Coke and Pepsi very powerful relative to the
bottlers– metal can suppliers not powerful because
» intense competition among can producers
» threat of substitution of cans by plastic bottles
Dr. Nancy Mangold, CSUH 71
Competitive Force 5: Bargaining Power of Suppliers
Suppliers also have a lot of power over buyers when the suppliers’ product or service is critical to buyers’ business– Airline pilots in the airline industry
Dr. Nancy Mangold, CSUH 72
Competitive Force 5: Bargaining Power of Suppliers
Suppliers also tend to be powerful when they pose a credible threat of forward integration– IBM powerful relative mainframe computer
leasing companies because of IBM’s unique position as a mainframe supplier
Dr. Nancy Mangold, CSUH 73
The Industry Analysis:The PC Industry
The PC industry began in 1981 when IBM announced its PC with Intel’s microprocessor and Microsoft’s DOS operating system
In 1997 US had an installed base of 100 million personal computers
In 1997 shipments were 30 million units, up 21% from 1996
Dr. Nancy Mangold, CSUH 74
The Industry Analysis:The PC Industry
Despite this spectacular growth, the PC industry in 1993 was characterized by low profitability
IBM, Compaq and Dell reported poor performance in the early 1990s and were forced to undergo internal restructuring
Dr. Nancy Mangold, CSUH 75
Competition in the PC IndustryReasons
the industry was highly fragmented – many firms producing virtually identical
products– Top 5 vendors controlling 60% market share– Competition intense, leading to routine price
cuts on a monthly basis
Dr. Nancy Mangold, CSUH 76
Competition in the PC IndustryReasons
Component costs accounted for more than 60% of total hardware costs of a personal computer
Volume purchases of components reduced these costs
intense competition for market share among competing manufacturers
Dr. Nancy Mangold, CSUH 77
Competition in the PC IndustryReasons
Products produced by different firms in the industry were virtually identical and
There were few opportunities to differentiate the products
Brand name and service customers value in the early years
Less important as PC buyers became more informed about the technology
Dr. Nancy Mangold, CSUH 78
Competition in the PC IndustryReasons
Switching costs across different brands of PCs were relatively low
Vast majority of the PCs used Intel microprocessors and Microsoft Windows operating systems
Dr. Nancy Mangold, CSUH 79
Competition in the PC IndustryReasons
Access to distribution was not a significant barrier– Dell Computers distributed through direct mail
in 1980s and introduced Internet-based sales in the mid 1990s
– Computer superstores, CompUSA, willing to carry several brands
Dr. Nancy Mangold, CSUH 80
Competition in the PC IndustryReasons
Virtually all the components needed to produce a personal computer were available for purchase
There were very few barriers to entering the industry– Michael Dell in early 1980s assembled PCs in
his Univ. of Texas dormitory room
Dr. Nancy Mangold, CSUH 81
Competition in the PC IndustryReasons
Apple’s Macintosh computers offered significant competition as a substitute product.
Work stations produced by Sun, DEC, and other vendors were potential substitutes at the higher end of the PC market.
Dr. Nancy Mangold, CSUH 82
The Power of Suppliers and Buyers
Suppliers and buyers had significant power over firms in the industry
Key hardware and software components for PCs were controlled by firms with virtual monopoly
Intel - microprocessor production Microsoft - DOS and Windows op. systems
Dr. Nancy Mangold, CSUH 83
The Power of Suppliers and Buyers
Buyers gained more power during the ten years from 1983 to 1993
Corporate buyers (a significant portion of the customer base) were highly price sensitive since the expenditure on PCs represented a significant cost to their operations
Dr. Nancy Mangold, CSUH 84
The Power of Suppliers and Buyers
As customers became knowledgeable about PC technology, they were less influenced by brand name in their purchase decision
Buyers increasingly viewed PCs as commodities and used price as the most important consideration in their buying decision
Dr. Nancy Mangold, CSUH 85
The Industry Analysis:The PC Industry
Intense rivalry and low barriers to entry in the personal computer industry, there was severe price competition among different manufacturers
There was tremendous pressure on firms to spend large sums of money to – introduce new products rapidly– maintain high quality– provide excellent customer support
Dr. Nancy Mangold, CSUH 86
The Industry Analysis:The PC Industry
These factors led to a low profit potential in the industry
The power of suppliers and buyers reduced the profit potential further
PC industry represented a technologically dynamic industry, its profit potential was poor.
Dr. Nancy Mangold, CSUH 87
The Industry Analysis:The PC Industry
Few indications of change in the basic structure of the personal computer industry, there was little likelihood of viable competition emerging to challenge the domination of Microsoft and Intel in the input markets
The profitability of the PC industry may not improve significantly any time in the future
Dr. Nancy Mangold, CSUH 88
Competitive Strategy Analysis
Dr. Nancy Mangold, CSUH 89
Competitive Strategy Analysis
The profitability of a firm is influenced not only by its industry structure but also by the strategic choices it makes in position itself in the industry
There are two main competitive strategies– Cost leadership– Differentiation
Dr. Nancy Mangold, CSUH 90
Cost LeadershipSupply same product or service at a lower cost
Economies of scale and scope
Efficient production
Simpler product designs
Lower input costs
Low cost distribution
Little R& D or Brand advertising
Tight cost control system
DifferentiationSupply a unique product or service at a cost lower than the price premium customers will pay
Superior product quality
Superior product variety
Superior customer service
More flexible delivery
Investment in brand image
Investment in R&D
Control system focus on creativity and innovation
Competitive Advantage
Match between firm’s core competencies and key success factors to execute strategy
Match between firm’s value chain and activities required to execute strategy
Sustainability of competitive advantage
Competitive Strategy Analysis
Dr. Nancy Mangold, CSUH 91
Sources of Competitive Advantage
Cost Leadership Differentiation
Dr. Nancy Mangold, CSUH 92
Competitive Strategy 1:Cost Leadership
enables a firm to supply the same product or service offered by its competitors at a lower cost
When the product or service is a commodity, cost leadership might be the only way to achieve superior performance
Dr. Nancy Mangold, CSUH 93
Ways to Achieve Cost Leadership
Economies of scale and scope Economies of learning Efficient production Simpler product design Lower input costs low cost distribution Little R & D Little brand advertising Tight cost control systems Efficient organizational processes
Dr. Nancy Mangold, CSUH 94
Cost Leader Focus on tight cost control make investment in efficient scale plants Focus on product designs Reduce manufacturing costs Minimize overhead costs Make little investment in risky R & D Avoid serving marginal customers Have organizational structures focus on cost
control
Dr. Nancy Mangold, CSUH 95
Cost Leaders
Able to earn above-average profitability by merely charging the same price as its rivals
The cost leader can force its competitors to– cut prices and accept lower returns or– exit the industry
Dr. Nancy Mangold, CSUH 96
Differentiation
Providing a product or service that is distinct in some important respect valued by the customer
Nordstrom- exceptionally high customer service
Filene’s Basement Stores - discount retailer competing purely on a low cost basis
Dr. Nancy Mangold, CSUH 97
Differentiation
Seeks to be unique in its industry along some dimension that is highly valued by customers
Supply a unique product or service at a cost lower than the price premium customers will pay
Dr. Nancy Mangold, CSUH 98
Differentiation
To be successful– Needs to identify one or more attributes of a
product or service that customers value– Position itself to meet the chosen customer
need in a unique manner– achieve differentiation at a cost that is lower
than the price the customer is willing to pay for the differentiated product or service
Dr. Nancy Mangold, CSUH 99
Drivers of Differentiation
Superior product quality Superior product variety Superior customer service Bundled services Delivery timing
Dr. Nancy Mangold, CSUH 100
Differentiation requires
Investment in R & D Investment in brand image Investment in product appearance Investment in reputation Investment in engineering skills Investment in marketing capabilities Organizational structure to foster creativity and
innovation
Dr. Nancy Mangold, CSUH 101
Choice between Cost Leadership and Differentiation
Firms target differentiation still need to focus on costs, so the differentiation can be achieved at an acceptable cost
Cost leaders cannot compete unless they achieve at least a minimum level on key dimensions on which competitors might differentiate, such as quality and service
Dr. Nancy Mangold, CSUH 102
Achieving & Sustaining Competitive Advantage
To evaluate whether a firm will achieve its competitive advantage, Ask
What are the key success factors and risks associated with the firm’s chosen competitive strategy?
Does the firm currently have the resources and capabilities to deal with the key success factors and risks?
Dr. Nancy Mangold, CSUH 103
Achieving & Sustaining Competitive Advantage
Has the firm made irreversible commitments to bridge the gap between its current capabilities and the requirements to achieve its competitive advantages
Dr. Nancy Mangold, CSUH 104
Achieving & Sustaining Competitive Advantage
Has the firm structured its activities– R&D
– design
– manufacturing
– marketing
– distribution
– customer service
in a way consistent with its competitive strategy?
Dr. Nancy Mangold, CSUH 105
Achieving & Sustaining Competitive Advantage
Is the company’s competitive advantage sustainable?
Are there any barriers that make imitation of the firm’s strategy difficult?
Dr. Nancy Mangold, CSUH 106
Achieving & Sustaining Competitive Advantage
Are there any potential changes in the firm’s industry structure that might dissipate the firm’s competitive advantage– new technology– foreign competition– changes in regulation– changes in customer requirements
Is the company flexible enough to address these changes?
Dr. Nancy Mangold, CSUH 107
Competitive Strategy AnalysisDell Computer
Michael Dell assembled IBM in 1984 and sell directly to end users at a significantly lower price than competitors
Now– Fourth largest computer maker
– 18 billion in revenue
– 1.5 billion in net income
– 51% growth in sales and 78% growth in net income
Dr. Nancy Mangold, CSUH 108
DellLow Cost Competitive Strategy
Direct selling to customers, saves on retail markups– As computer become standardized on the
Windows-Intel platform, the value of distribution through retailers decline
– Began selling through Internet in 1996– By 1999 generate several million dollars of
sales per pay through Internet
Dr. Nancy Mangold, CSUH 109
Dell-Low-Cost Competitive Strategy
Made-to-Order Manufacturing– Developed flexible manufacturing system that allowed
the company to assemble and ship computers very quickly, usually five days of receiving the order
– Avoid large inventories of parts and assembled computers
– Low inventories allowed Dell to save working capital costs
– Reduced costly write-offs of obsolete inventories
Dr. Nancy Mangold, CSUH 110
Dell-Low-Cost Competitive Strategy
Third-party services– Low cost approaches to after-sales service
» Telephone based service
» Third-party maintenance service
– Several hundred technical support representatives accessible to the customers by phone any time of the day
– Using a comprehensive electronic maintenance system, the service representatives could diagnose and help the customer to resolve problems in the majority of cases
Dr. Nancy Mangold, CSUH 111
Dell-Low-Cost Competitive Strategy
Third-party services– When on-site maintenance is required, Dell
used 3rd party maintenance contracts with office equipment companies such as Xerox.
– Dell avoid investing in an expensive field service network without compromising on service qulaity
Dr. Nancy Mangold, CSUH 112
Dell-Low-Cost Competitive Strategy
Low Accounts Receivable– Reduce its accounts receivable days to an
industry minimum by encouraging its customers to pay by credit card at the time of the purchase or through electronic payment immediately after the purchase
Dr. Nancy Mangold, CSUH 113
Dell-Low-Cost Competitive Strategy
Focused investment in R&D– Recognized most of the basic innovations in the
personal computer industry were led by the component suppliers and software producers
– Dell’s innovations were primarkly in creating a low-cost, high-velocity organization that can respond quickly to these changes
– By focusing its R&D innovations, Dell was able to minimize these costs and get high return on its investments
Dr. Nancy Mangold, CSUH 114
Dell-Low-Cost Competitive Strategy
As a result of the above strategy Dell achieved a significant cost advantage over its competitors in the personal computer industry
This advantage resulted in a consistent pattern of rapid growth increasing market share and very high profitability in an industry that is characterized by – rapid technological changes– significant supplier – buyer power and intense competition
Dr. Nancy Mangold, CSUH 115
Dell-Low-Cost Competitive Strategy
Dell’s strategy involved activities that are highly interrelated and involved continuous organizational innovations, Dell’s business model was difficult to replicate, making Dell’s competitive advantage sustainable
No competitor today has been able to replicate Dell’s business model
The extraordinarily high earnings and book value multiples is likely to be sustained
Dr. Nancy Mangold, CSUH 116
Economic Attributes Framework
Useful in studying the economic characteristics of a business because it ties in with items reported in the financial statements
Dr. Nancy Mangold, CSUH 117
Economic Attributes FrameworkDemand
Customers highly sensitive to price (autos) Customers insensitive to price (soft drink) Is demand growing rapidly (internet service) Industry relatively mature (grocery stores) Does demand move with the economic cycle
(construction of new homes and offices)
Dr. Nancy Mangold, CSUH 118
Economic Attributes FrameworkDemand
Is demand insensitive to business cycles (food products and medical care)
Does demand vary with the seasons of a year (toys or ski equipment)
Is demand relatively stable throughout the year (office supplies)
Dr. Nancy Mangold, CSUH 119
Economic Attributes FrameworkSupply
Are there many suppliers offering similar products?
Are there few suppliers offering unique products?
Are there high barriers to entry? Are there low barriers to entry?
Dr. Nancy Mangold, CSUH 120
Economic Attributes FrameworkManufacturing
Is the manufacturing process Capital intensive? (electric utility) Labor intensive? (advertising, professional
services) Combination of the two (auto
manufacturing or airline transportation)
Dr. Nancy Mangold, CSUH 121
Economic Attributes FrameworkManufacturing
Is the manufacturing process Complex with low tolerance for error (high
tech, heart pacemakers) Simple with ranges of acceptable-quality
products (nonmechanized toys?)
Dr. Nancy Mangold, CSUH 122
Economic Attributes FrameworkMarketing
Is the product promoted To other businesses
– sales staff play a key role To consumers
– advertising, coupons are principal promotion mechanisms
Dr. Nancy Mangold, CSUH 123
Economic Attributes FrameworkMarketing
Does demand pull products through distribution channels?
Do firms have to create demand continually?
Dr. Nancy Mangold, CSUH 124
Economic Attributes FrameworkFinancing
Are the assets of firms in the industry relatively short term
– commercial banks relatively long term
– Electric utilities
Dr. Nancy Mangold, CSUH 125
Economic Attributes FrameworkFinancing
Relatively little risk in the assets of firms in the industry– Firms can carry high proportions of debt
financing High risks in the assets resulting from
– Short product life cycles– product liability concerns– Firms have low debt and high equity financing
Dr. Nancy Mangold, CSUH 126
Economic Attributes FrameworkFinancing
Is the industry relatively profitable and mature?– Generating more cash flow from operations
than is needed for acquisitions of property, plant, and equipment?
Is the industry growing rapidly and in need of external financing?
Example of Soft Drink Industry
Dr. Nancy Mangold, CSUH 127
Framework for Strategy Analysis
Nature of Product or Service Degree of Integration within Value Chain Degree of Geographical Diversification Degree of Industry Diversification
Dr. Nancy Mangold, CSUH 128
Coke
Compete broadly in the beverage industry Products
– soft drinks– fruit juices– tonic waters– sport drinks
Differentiated product through– Brand recognition– Domination of distribution channels
Dr. Nancy Mangold, CSUH 129
Degree of Integration within Value Chain
Vertical integration strategy– participating in all phases of the value chain– or select only certain phases within the chain
Dr. Nancy Mangold, CSUH 130
Degree of Integration within Value Chain
Manufacturing– Conduct all manufacturing operations itself
(steel manufacturing)– Outsource all manufacturing (athletic shoes)– Outsource the manufacturing of components
but conduct the assembly operation in house (auto, computer hardware)
Dr. Nancy Mangold, CSUH 131
Degree of Integration within Value Chain
Distribution– Maintain control over the distribution function
» Wendy’s - owns most of its restaurants
– Outsource distribution» (McDonalds - independent franchisees
» Computer hardware firms use indirect sellers - value added resellers and systems
integrators
Dr. Nancy Mangold, CSUH 132
CokeDegree of Integration with Value Chain
Engages in– New product development– Manufacture its concentrate– Promotes its products
Outsource– Bottling– Distribution
Dr. Nancy Mangold, CSUH 133
Coke Degree of Integration with Value Chain
Perceives its value-added activities are– Secret formula that makes up the concentrate– Promoting its product for brand name and brand
loyalty Outsource bottling operation
– Not value enhancing– Capital intensive– Requires LT debt financing– Coke appears less risking with less debt
Dr. Nancy Mangold, CSUH 134
Coke Degree of Integration with Value Chain
Seller power over its bottlers– maintain significant portion of profit margin
Bottlers accept smaller margin for monopoly power in a particular area and strong demand for Coke products.
Dr. Nancy Mangold, CSUH 135
Degree of Geographical Diversification
Target domestic market? Integrate horizontally across many
countries?– Create opportunity for growth– exposes to risks from
» exchange rate changes
» political uncertainties
» additional competitors
Dr. Nancy Mangold, CSUH 136
Coke -Geographical Diversification
North America– 6.6% growth rate
Outside North America– 67% revenues– 79% operating income – 7.2% growth rate
Central Europe, Middle East and Far East– 54% revenues– 58% operating income
Dr. Nancy Mangold, CSUH 137
Degree of Industry Diversification
Operate in a single industry? Diversify across multiple industries?
– Moderate the product, cyclical, regulatory, and other risks that it encounters when operating in a single industry
– Need to understand and manage multiple and different businesses effectively
Dr. Nancy Mangold, CSUH 138
CokeDegree of Industry Diversification
Operates exclusively in the beverage industry Product line includes
– Orange juice (Minute Maid)– fruit juices (Hi-C)– Iced tea (Nestea)– sports drinks
Principal products - soft drink– Coke, Barq’s Root Beer, Sprite, Fanta)