Lectures 5-7: INTERNAL ANALYSIS

Lecture Outline

1. Internal Analysis of organizations strengths and weaknesses in the following functional areas of business : (I) Management (II) Marketing (III) Finance/accounting (IV) Management information systems (V) Production/operations and (VI) Research and development

2. Internal Factor Evaluation (IFE) Matrix

Internal Analysis focuses on identifying and evaluating a firms strengths and weaknesses in the functional areas of business, including: - management, -marketing, -finance/accounting, --management information systems. -production/operations, and -research and development

A firms strengths that cannot be easily matched or imitated are called: Distinctive Competencies

Strategies should be designed in part to: -Build on firms competitive advantage -Turn weaknesses into strengths, and -Turn strengths into distinctive competencies

(I) Management FunctionsAccording to David in your text book the functions of management consists of five basic activities:-Planning-Organizing -Motivating -Staffing -Controlling NOTE: However according to the literature the functions of management should also include budgeting, organizing. Coordinating, reporting and directing.

Management Audit Checklist Questions According to David in your text book, the following questions can help to identify specific strengths and weaknesses.Does the firm use strategic-management concepts?Are company objectives and goals measurable and well communicated?Do managers at all hierarchical levels plan effectively?Do managers delegate authority well?

5. Is the organizations structure appropriate?6. Are job descriptions and specifications clear?7. Is employee morale high?8. Are employee turnover and absenteeism low?Are organizational reward and control mechanisms effective?

(II) MARKETING FUNCTIONSWhat is marketing?

Marketing is a series of human activities directed at satisfying needs and wants thorough exchange processes. Such activities include:Marketing researchProduct designPackagingBrandingPricing

DistributionSellingAdvertisingPublicitySales PromotionStorage etc Successful marketing begins with the study of peoples needs and wants and the application of the marketing concept.

Marketing Audit Checklist Questions According to David in your text book , the following questions can help to identify specific strengths and weaknesses.Are markets segmented effectively?Is the organization positioned well among competitors?Has the firms market share been increasing?Are present channels of distribution reliable and cost-effective?Does the firm have an effective sales organization?

6. Does the firm conduct market research?7. Are product quality and customer service good?8. Are the firms products and services priced appropriately?9. Does the firm have an effective promotion, advertising, and publicity strategy?10. Are marketing planning and budgeting effective?11. Do the firms marketing managers have adequate experience and training?

(III) FINANCE AND ACCOUNTING FUNCTIONS According to Van Home in David in your text book , the functions of finance include three decisions:

The investment decision (also called capital budgeting). This deals with allocation or re-allocation of capital or resources to projects, products, departments or divisions.

The financing decision. This deals with trying to determine the best capital structure for the firm and the various methods for raising capital.

The dividend decision (e.g. percentage of money to be paid to stock holders).

FINANCIAL RATIOS FOR MEASURING FINANCIAL CONDITIONS

David in your text book (2013 p.111-112) provides a summary of key financial ratios showing how each ratio is calculated and what each ratio measures. They can be classified into five types. (1) Liquidity ratios: These are used to measure a firms ability to meet maturing short-term obligations.Current ratioQuick (acid-test) ratio

(2) Leverage ratios which measure the extent to which a firm has been financed by debt.Debt-to-total assets ratioDebt-to-equity ratioLong-term debt-to-equity ratioTimes-interest-earned (coverage) ratio

(3) Activity ratios measure how effectively a firm is using its resources.Inventory turnover Fixed assets turnoverTotal assets turnoverAccounts receivable turnoverAverage collection period

(4) Profitability ratios measure a managements overall effectiveness as shown by returns generated on sales and investment.Gross profit marginOperating profit marginNet profit marginReturn on total assetsReturn on stockholders equityEarnings per sharePrice-earnings ratio

(4) Growth ratios measure the firms ability to maintain its economic position in the growth of the economy and industry.SalesNet incomeEarnings per shareDividends per share

Finance/Accounting Audit Checklist of QuestionsAccording to David (2013 chapter 4) the questions are:Where is the firm financially strong and weak as indicated by financial ratio analysis?Can the firm raise needed short-term capital?Can the firm raise needed long-term capital through debt and/or equity?Does the firm have sufficient working capital?Are capital budgeting procedures effective?Are dividend payout policies reasonable?Does the firm have good relations with its investors and stockholders?Are the firms financial managers experienced and well trained?

(IV) Management Information Systems Functions

To carry out the responsibilities of strategic business planning, implementation and control, business managers need a great deal of information. Too often, however, such information is not available, comes too late or cannot be trusted.

To overcome these deficiencies companies should improve their management information system. A well designed management information system should consist of the following four major subsystems:

Internal Reports subsystemManagement Intelligence subsystemBusiness Research subsystemAnalytical Methods subsystem/or Information Analysis subsystem

(1)INTERNAL REPORT SUBSYSTEM This refers to periodic internal reports which provides management with current internal data. Every company should produce periodic internal reports which provide management with:

current data on salescostsinventoriescash flowsaccounts receivables and payablehuman resource requirements and development

MANAGEMENT INTELLIGENCE SUBSYSTEM: Whereas the internal reports subsystem supplies executives with results data, the management intelligence subsystem supplies executives with information about development in the external environment.

Lack of market knowledge is the first barrier to be overcome in strategic business planning.

The purpose of this intelligence operation is the gathering of whatever external information is necessary to make sound management decisions.

Management intelligence for strategic business planning should be very broad covering many areas including:Cultural factorsPolitical factorslegal factorsmacro-economic factorsMarket potential etc.

The smaller firm will have information needs similar to those of the large firm.It will however, be less able to conduct the same kind of management intelligence.The firm that is small may rely on the following people for its management intelligence information needs.

its distributors its suppliers its customers its sales people

WHAT INFORMATION ABOUT MARKETS IS REQUIRED?

1. The strategic planner does not need all the facts or information about markets. 2. To economise on research funds and to facilitate storage and retrieval of the data, the strategic planner wants only relevant information that is necessary for the strategic planning of their business operations and decision making.

The initial decision of course is which market(s) to plan for?Richard Holton, using game-theory language, suggests three questions that such intelligence should consider:

(i)Who are the players? (i.e. who are the competitors, customers, suppliers, government officials, and others who can affect our operations?)

(ii)What strategic alternatives or actions is each player likely to consider? (iii) What are the probabilities attached to each strategic alternative?[1] [1] Richard H Holton (1970) Marketing Policies in Multinational Corportaion Journal of International Business Studies, Summer pp.1-20

SOURCES OF SECONDARY INFORMATION Domestic sources that are available include library, local banks, professional organizations etc. Other sources that organization that are planning to enter foreign markets can use include:

American government: No organisation in the world gathers more information than the American government. Some of its work is useful to the firm that needs external information for planning for either local and/or international markets.

2. The United Nations publishes statistical data and market information.3. Foreign governments, chambers of commerce and private companies are increasingly responding to the problems of better market information.

4. Banks: Several large banks are also increasing the amount of information available about foreign markets.

(3) BUSINESS RESEARCH SUBSYSTEM: According to Zikmund (2003), business research is defined as: the systematic and objective process of gathering, recording and analyzing data for aid in making business decisions.

The definition indicates that:1. Research information is not intuitive or haphazardly gathered. The emphasis of business research is to shift decision makers from intuitive information gathering to a systematic and objective investigation. Literally, research (re-search) means to search again.

2. If the information or data gathered, recorded and analysed is to be accurate, the business researcher must be objective. Why?

If bias enters into the research process, then its value is considerably reduced.The objective of business research is to facilitate managerial decision process for all aspects of a business.

3. The objective of business research is to facilitate managerial decision process for all aspects of a business.

By providing the necessary information upon which to base decisions, research can reduce the uncertainty of a decision and thereby reduce the risk of making the wrong decision

The business research process consists of: (i)Identification and definition of research problem (ii)Selection of an appropriate research design and sample (iii) Collection of relevant data (iv) Analysis and interpretation of the data (V) Dissemination of research findings.

(4) ANALYTICAL METHODS SUBSYSTEM The fourth sub-system in the management information system is analytical methods system or information analysis system. This is where advanced statistical procedures and models are applied to information to help develop more rigorous findings.

Examples of statistical and model banks include:-correlation-exponential smoothing-regression-pricing model-advertising budget model-human resource planning model etc.

Management Information Systems Audit Checklist of Questions from David (2009)Do all managers in the firm use the information system to make decisions?Is there a chief information officer or director of information systems position in the firm?Are data in the information system update regularly?Do managers from all functional areas of the firm contribute input to the information system?

5. Are there effective passwords for entry into the firms information system?6. Are strategists of the firm familiar with the information systems of rival firms?7. Is the information system user friendly?8. Do all users of the information system understand the competitive advantages that information can provide firms?9. Are computer training workshops provided for users of the information system?10. Is the firms information system continually being improved in content and user-friendliness?

(V) PRODUCTION/OPERATIONS Functions This consist of all those activities that transform inputs into goods and services. Production/Operations Audit Checklist of Questions According to David (2009)Are suppliers of raw materials, parts, and subassemblies reliable and reasonable?Are facilities, equipment, machinery, and offices in good condition?Are inventory-control policies and procedures effective?Are quality-control policies and procedures effective?Are facilities, resources, and markets strategically located?Does the firm have technological competencies?

(VI) Research and Development -R&D Audit Checklist of Questions According to David (2009)Does the firm have R&D facilities? Are they adequate?If outside R&D firms are used, are they cost effective?Are the organizations R&D personnel well qualified?Are R&D resources allocated effectively?Are management information and computer systems adequate?Is communication between R&D and other organizational units effective?Are present products technologically competitive?

THE INTERNAL FACTOR EVALUATION (IFE) MATRIXList key internal factors as identified in the internal-audit process. Use a total from ten to twenty internal factors including both strengths and weaknesses. Assign a weight ranging from 0 (not important) to 1.0 (very important). The weight indicates the relative importance of the factor to being successful in the firms industry. The sum of all the weights must equal 1.0.Assign a 1-4 rating to each factor to indicate whether that factor represents a major weakness (1), minor weakness (2), minor strength (3), or major strength (4).

4. Multiply each factors weight by its rating to

4. Multiply each factors weight by its rating to determine a weighted score for each variable. 5.Sum the weighted scores for each variable to determine the total weighted score for the organization. For an example see Table 4.9 (David 2013, p. 123) Note: (i) Total weighted scores below 2.5 indicate a weak internal position. (ii) Total weighted scores above 2.5 indicate a strong internal position.

(iii) The number of factors has no effect upon the range of total weighted scores because the weight must always add up to 1.

In table 4-9 Internal Factor Evaluation Matrix (IFE ) Matrix : The two most important factors to be successful in the retail computer store example are: ---Revenues from repair/service in the store (0.45),-Location of the store (0.30)