Strategic Audit Report

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Welcome to Strategic Management Week 2

Chapter 1 Review

Strategy and the Strategic Management Process

What is Strategy?

The Art of War

• Strategos (Ancient Greek) • Army leader or genralship • Chinese military general

and theorist Sun Tzu (544 BC to 496 BC) wrote “The Art of War.”

• In book, he laid out principles for engaging enemies in war and diplomacy.

• “The general who wins the battle makes many calculations in his temple before the battle is fought. The general who loses makes but few calculations beforehand.”

What is Strategy?

• Strategy: A firm’s theory about how to gain competitive advantage(s) – This entails assumptions and hypotheses about competition/industry

• Example: (Michael Eisner’s strategy for Disney) – People will pay a premium price for extraordinary

entertainment. We have the necessary resources to create extraordinary entertainment. Therefore, let’s redeploy our resources in a different way and offer something extraordinary to people. This strategy was largely continued by his successor (Michael Iger) (see the book’s example on Disney vs. Rovio’s approach to app development)

What is Strategy?

• Strategy: A firm’s theory about how to gain competitive advantage(s) – Business-level

• Differentiation and cost advantages • Firm-specific advantage

– Corporate-level • Vertical integration, diversification, M&As, alliances,

etc. • Country-specific advantage(s)

Missions & Objectives

• Mission statement – Lots of overlap between different companies

language & not always very descriptive of a firm’s strategy

– Missions may be strongly influenced by founders (see Ben & Jerry’s example)

– Smaller specific, measurable targets (objectives) are used to pursue the mission

Competitive Advantage

• What is competitive advantage? – Creating more economic value than rival firms – EV(firm 1) > EV(industry avg.)

• Perceived value (in eyes of the customer) less: economic cost of product/services

• When do competitive advantage, competitive disadvantage, & competitive parity occur? – Sustained vs. temporary

• In theory there should be normalization under perfectly competitive conditions with free flow of knowledge (convergence towards parity)

– This is not what we observe though

What is Strategy?

Intended ↓

Unrealized/Deliberate ↓

Emergent ↓

Realized

Strategy is natural! You have used and will be using strategies in your life and work even if you do not know it

Emergent strategies can be successful, but the most successful companies often use strategic

planning and follow luck with planning/strategy

The Structure-Conduct-Performance Model

Developing C.A.

How can a business unit strategy be described?

• What is this firm’s Theory on How to Get Competitive Advantage (C.A.)?

• What are A and B and the plan to go from A to B? What are the who/what/how of each point?

BStrategy is knowing : 2. Where you’re going

A 1. Where you are

3. How to get there

What is Strategy?

The Who/What/How (WWH) framework: – Who are the customers at time t? – What is the product at time t? – How do we deliver the product at time t?

How can the strategy be evaluated?

• Will the plan get the company from A to B? • Are the Who/What/How in B Consistent? • Are the Who/What/How in B Unique/Rare? • Is the Who/What/How combination valuable?

Aka Does this firm create EV? • Does the firm create more Economic Value

(EV) than competing firms (E.V. =Perceived Benefits by Customers – Total Costs). [aka]

Accounting for Competitive Advantage

• Profitability, liquidity, leverage, & activity ratios

• What do each measure?

Profitability Ratios ROA Net profit/total assets ROE Net profit/total SE Gross profit margin (Sales-COGS)/Sales EPS Net profit/# of shares PE Ratio Price per share/EPS

Liquidity Ratios Current ratio Current assets/current liabs Quick ratio (Current assets - inv.)/current liabs

Leverage Ratios Debt to assets Total debt/total assets

Activity Ratios Inventory turnover Sales/turnover Accounts receivable turnover Annual cedit sales/AR Avg. collection period AR/avg. daily sales

Economic Measures of EV

WACC (Cost of equity)×(%) + (Cost of debt)×(%)

ROIC (Net income-Dividends)/ (Debt+Equity )

Ratios vs. Raw Numbers

• Moving past raw figures • Enhancing comparability

– Consider industry and competitors

Evaluating Performance

• Consider whether a ratio is relevant to the focal firm/industry

• Consider whether there are strategic considerations to weigh

• Consider industry classification & uniformity • Are there any important metrics for the focal firm's industry?

– Financial/Nonfinancial

• Are there any important metrics relative to the focal firm’s goals that were disclosed? • Financial/Nonfinancial

What is a Strategic Audit?

The Key Steps in a Strategic Audit of a Company

• Understand its goal and strategy Strategy Analysis • Analyze its external environment Industry/External Analysis • Evaluate its resources (exc. Leaders) Resource/Internal Analysis • Assess its performance? Performance Analysis • Make Strategic Recommendations:

– Use the Issues identified in the 5 parts of the analysis above. – Identify several strategic options that the company can follow – Evaluate these options (pros and cons/how likely to address the issues

raised and risks) – Make your recommendations with any warnings to the management.

What is this Performance Analysis?

• Part 1: Describe the Performance • Part 2: Evaluate the Performance in relation to

the strategy • Part 3: Draw Clear Conclusions: Where is the

company doing well and why? Where is doing poorly and why (use logic to explain what you know happened)? Potential fixes?

Performance Analysis

– Metrics • General Metrics • Key Industry Metrics • Important Internal Metrics • Change Over Time

– Don’t evaluate performance as if it is static – Benchmarking

• Competitors & Comparators • Past & Within company (other decisions) • Goals

a. Performance Analysis i. How has your company done relative to its competitors – does it have competitive advantage 1.Key financial metrics for the industry are important (See Table 1.1)

2.There are often important non-financial metrics for a given industry (e.g. occupancy rate for hotel chains, new customer activations for wireless network carriers, new product releases/patents for technology companies, etc.)

3.Don’t forget metrics that are more important to your industry (it’s OK to use more common metrics like ROA/revenue growth/TWCC, but don’t only present these)

4.Make sure to benchmark (against competitors, against the company’s past performance, and against stated goals (when available; theses may be disclosed in annual reports or investors’ meetings)

ii.How has the current strategy affected performance (remember that some long term strategies entail short-term sacrifices early in their implementation)?

Other Strategic Considerations: Ethics

• Stakeholders vs. Shareholders – Who owns a publically-traded firm? – Who else has a defensible interest

• Residual claimants • Practical reasons for ethical considerations

What does ethical mean?

• “Directors, managers, and employees need to exercise their own fundamental sense of right and wrong when making decisions on behalf of the corporation and its shareholders.”

-Constance E. Bagley (HBR)

Ethics & Strategy

• Shareholder vs. stakeholder theory – Who are the stakeholders we should consider?

• Residual claimants view – Equity holders should be paid on investment after

all legitimate stakeholder claims are satisfied

• An oft-cited method for making ethical managerial decisions was prescribed Constance E. Bagley, Senior Research Scholar in Law at Yale Law School – The Ethical Leader’s Decision Tree is a simple tool that

assigns a ‘Do It’ or ‘Don’t Do It’ response to a proposed course of action

– The response is based answers to four questions (along diverging two paths, resulting in three total question for each possible scenario)

• Answering, the questions may not always be simple, however

Ethical Leader’s Decision Tree

Bagley, C., 2003, ‘The Ethical Leader’s Decision Tree’, Boston: Harvard Business

Using the Ethical Leader’s Decision Tree

• What the decision tree highlights: – Which group a firm consider first (primary/secondary

stakeholders)? – Does a firm only have to consider outcomes to engaging in

a particular activity? • Considerations when using the decision tree:

– Can we catalogue all potential actions? – What does it mean for an action to be ethical?

• Standards • Subjective Evaluation