case study

Module3-HandoutsExternalandInternalAnalysis.pdf

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The External Environment

LEARNING OBJECTIVES 1. Describe the three tiers of environmental

factors that affect firm performance

2. List five factors in the remote/ industry / operating environment. Be able to give examples of, e.g., economic, social, political, technological, and ecological influences, influences of competitors, creditors, etc.

3. Explain the five forces model of industry analysis and give examples of the influences of entry barriers, supplier power, buyer power, substitute availability, and competitive rivalry on a business

EXTERNAL ENVIRONMENT FACTORS

Factors beyond the firm’s control that influence its actions (3 tiers):

3 Ex. 4.1 The Firm’s External Environment

Also ‘micro’ and ‘macro’

REMOTE ENVIRONMENT - PESTLE • Political • Economic • Social • Technological • Legal • Ecological (also ESTEMPLE – includes Media, Ethical)

Think of some examples and how they impact a firm

Examples • Political: (influences customers and suppliers) – trade tariffs,

immigration / tax / wage legislation, EPA policies, Globalization…

• Economic: interest rates, unemployment, GNP

• Social: beliefs and values, demography, lifestyles (e.g. women entering labor market, shift in age distribution, quality of life issues, internet)

• Technological: forecasting to seize opportunities, avoid disruption from e.g. AI and changing industries

• Legal: regulation

• Ecological: climate change, pressures for sustainable sourcing, resource availability, pollution (e.g. plastic in food chain), need for more eco- efficiency than competitors

"Industry" Environment Defined

‘General conditions for competition that influence all businesses that provide similar products and services.’

• The essence of strategy formulation is coping with competition.

• Porter’s 5 helps to link remote factors to the operating environment

• The strategists’ goal is to find a position in the industry where the company can best defend itself against these forces - or can influence them.

INDUSTRY & COMPETITIVE ANALYSES Key questions to ask:

1. What are the boundaries of the industry (a collection of firms offering similar products / services)? o Can be complex to define due to evolution, industries within industries etc

2. What is the structure of the industry? (its distinctive characteristics)

3. Which firms are our competitors? (concentration in only a few dominant firms?)

4. What are the major determinants of competition / barriers to entry?

INDUSTRY ENVIRONMENT: PORTER’S 5 FORCES, A MEASURE OF COMPETITION

Prof. Michael Porter, Harvard University (1979)

Don’t forget to quantify each force as high/ medium/ low

Ex. 4.9 PORTER’S 5 FORCES: A MEASURE OF INDUSTRY COMPETITION

Threat of new entrants “How easy is it to get into this industry?”

Barriers to entry might include:

• Economies of Scale

• Product Differentiation

• Capital Requirements

• Cost Disadvantages Independent of Size

• Access to Distribution Channels

• Government Policy

e.g., international parcel delivery, oil/gas exploration, telecommunications

Powerful Suppliers “Are there supplies / raw materials my business depends on?”

A supplier group is powerful if:

• It is dominated by a few companies and is more concentrated than the industry it sells to

• It poses a credible threat of integrating forward into the industry’s business

• The industry is not an important customer of the supplier group

• Its product is unique / differentiated

• There are no obvious alternative / rival products

• e.g. rare earth metal suppliers, upstream oil exploration

Powerful Buyers Reduces profit potential. A buyer group is powerful if:

• It is concentrated or purchases in large volumes

• The products it purchases from the industry are standard

• The products it purchases from the industry form a component of its product and represent a significant fraction of its cost

• It earns low profits

• The industry’s product is unimportant to the quality of the buyers’ products or services

• The industry’s product does not save the buyer money

• The buyers pose a credible threat of integrating backward

e.g.s consumer goods like washing powder, bottled water etc; paper cup suppliers to Starbucks

Substitute Products

• Substitute products that deserve the most attention strategically are those that are – subject to trends improving their price-performance

trade-off with the industry’s product or – produced by industries earning high profits

“Can my product easily be imitated / replaced by an alternate?”

Industry rivalry Intense rivalry occurs when:

• Competitors are numerous or are roughly equal

• Industry growth is slow, precipitating fights for market share that involve expansion

• The product or service lacks differentiation or switching costs

• Fixed costs are high or the product is perishable, creating strong temptation to cut prices

• Capacity normally is augmented in large increments

• Exit barriers are high

• Rivals are diverse in strategy, origin, and personality

• e.g. meal kit companies, fast food chains

Operating Environment (‘Competitive’ or ‘Task’ Environment)

• Factors in immediate competitive situation that impact success in acquiring needed resources.

• Includes competitor positions & customer profiling based on following factors: o Geographic o Demographic o Psychographic o Buyer Behavior

• Also includes suppliers, creditors

• HR dynamics: access to (qualified/available /cost effective) labor market o E.g. labor shortage in trucking industry, farm workers, FL attempts to

attract high wage jobs, etc. o “3 Ds of robotization” – automating tasks that are dull, dangerous, dirty

KEY TERMS

• Barriers to entry

• Economies of scale

• External environment

• Industry

• Product differentiation

• Industry environment

• Operating environment

• Remote environment

• Technological forecasting (i.e. predicting the tech future)

Internal Analysis

LEARNING OBJECTIVES 1. Understand and apply various internal analysis tools:

• SWOT analysis • Value chain analysis (used to disaggregate a firm’s activities) • V-R-I-O • Three circle analysis – to examine product / service attributes

against key competitors relative to customer needs • Ratios and other financial analyses

2. Understand the resource-based view (RBV) of a firm

3. Apply four different perspectives for making meaningful comparisons to assess a firm’s internal strengths and weaknesses

INTERNAL ANALYSES – benchmarking for success

A strategist seeks to determine whether a firm’s current internal capabilities represent strengths or weaknesses in new competitive arenas

• The key determinants of success common to an industry may be used to identify a firm’s internal strengths and weaknesses

• Can use the firm’s historical experience to evaluate internal factors

• Managers need objective standards to use when examining internal resources and value-building activities

• Benchmarking: comparing the way “our” company performs a specific activity compared to competitors, or companies in other industries performing the same activity

Strengths

Internal characteristics and capabilities that give the firm an advantage over others

Opportunities

Weaknesses

Threats

Elements in the external

environment that could cause trouble

for the firm

Internal limitations that

place the firm at a disadvantage

relative to others

Elements in the external environment that could be used to the firm’s advantage

SWOT ANALYSIS Provides quick overview of a company’s strategic situation. Considered an internal analysis but includes external factors.

SWOT ANALYSIS LINKS TO STRATEGY

Ex. 6.2 SWOT Analysis links to strategy (alternate)

Limitations of SWOT Analysis

• Can overemphasize a single strength / internal strengths, and downplay external threats

• Can be static and risk ignoring changing circumstances

• A strength is not necessarily a source of competitive advantage

Show your research and avoid general/ obvious statements – e.g., ‘strong brand’ as a strength without any additional info, ‘competition’ as a threat. Quantify and give examples.

RESOURCE-BASED VIEW (RBV) Proponent: Jay Barney

 Analyzing and identifying a firm’s strategic advantages based on examining its distinct combination of assets, skills, capabilities, and intangibles

 The RBV’s underlying premise is that firms differ in fundamental ways because each firm possesses a unique “bundle” of resources

 Each firm develops competencies from these resources, and these become the source of the firm’s competitive advantage

Terms:  Core Competence: capability or skill where a firm excels  Competitive advantage: something the firm is doing to create

value (usually $$) not currently being imitated by competitors  Sustained competitive advantage: the Holy Grail! Competitors

are not able to duplicate your strategy

RESOURCE-BASED VIEW (RBV)

 Key idea: identify your core competences and unique resources, and exploit them better than your competitors

THREE BASIC RESOURCES

1. Tangible assets (physical) -often found on balance sheet

2. Intangible assets (not physical)

3. Organizational capabilities (i.e. abilities / strengths)

e.g. fixed assets (machinery, buildings, land), current assets (inventory, cash)

e.g. brand names, reputation, organizational morale, technical knowledge, intellectual property (IP) e.g. patents and trademarks, accumulated experience

e.g. skills that a company uses to transform inputs into outputs – innovation, inspiring leadership, speed to market, HR management

V-R-I-O

Valuable • Does it enable a firm to exploit opportunities /

defend against threats?

Rare • Only a few companies have it. Rare and valuable

can lead to temporary competitive advantage.

Costly to Imitate • Hard for others to copy or recreate.

Is the Organization equipped to exploit its potential? • If so, it is a source of SUSTAINED COMPETITIVE

ADVANTAGE

Especially pertinent for intangible assets and capabilities.

VRIO examples

29Do you agree with this breakdown? Plenty of examples out there.

Ex. 6.11 Applying the Resource Based View (from the book)

VALUE CHAIN PERSPECTIVE • Value chain analysis (VCA) examines the contributions of different

internal activities to see where and how value is created o i.e. ‘where is the money’, ‘where are our differentiators?’ o aim to perform these activities better/cheaper than competitors o can lead to outsourcing / efficiencies

• Divides business into primary and support activities

Value Chain Analysis

•Primary Activities • Activities involved in the physical creation of the

product, marketing and transfer to the buyer, and after-sales support

•Support Activities • Activities that assist the firm as a whole by

providing infrastructure or inputs that allow the primary activities to take place on an ongoing basis

Ex. 6.3 Primary Activities in a Value Chain

Ex. 6.3 Support Activities in a Value Chain

Ex. 6.5 Traditional Cost Accounting VS Activity Based Cost Accounting

Difficulty in Activity-Based Cost Accounting

• Many existing financial management and accounting systems are not set up to easily provide activity- based cost breakdowns

• The information requirements to support activity- based cost accounting can create redundant work

• The time and energy to change to an activity-based approach can be formidable

THREE CIRCLES ANALYSIS Analyze how your firm’s offering differs from competitors (better or worse!) by looking at o Customers’ needs o Your firm’s offerings o Competitors’ offerings

• Circle A o How big and sustainable are our

advantages? o Are they based on distinctive capabilities?

• Circle B o Are we delivering effectively in areas of

parity?

• Circle C o How can we counter our competitors’

advantages?

PRODUCT LIFE CYCLE A product’s sales, profitability, and competencies that are key drivers of its success through a sequence of stages: development, introduction, growth, maturity, decline, and eventual removal from market.

Why does it matter?

• Need to calculate production rates to be able to meet demand, and costs so that these can be recuperated once the product goes to market

• Research and development output needed for a full pipeline o What will be your next ‘big thing’, when do you release it without

cannibalizing the product already in-market?

o how to prevent a customer switching to a competitor – e.g. car dealers sending out buy-back offers for your old car)

Exhibit 6.13 Product Life Cycle

39 IPhone life cycle model pipeline (note: typically one new model and 1-2 older models available in any calendar year)

Typical life cycle model

Product Life Cycle Competencies Needed at Each Stage

• Introduction o Ability to create awareness o Good channel relationships (get goods to market, fast, to meet demand) o Premium pricing to “skim” profitability / recuperate R&D costs o Solid relationship with and access to trendsetting early adopters o Financial resources to absorb an initial cash drain

• Growth o Brand awareness and ability to build brand o Advertising skills and resources to back them o Product features that differentiate o Establishing market shares o Access to multiple distribution channels o Ability to add additional features

Product Life Cycle Competencies Needed at Each Stage (contd.)

• Maturity o Resources to initiate and sustain price wars o Sustained brand awareness o Ability to differentiate products and features o Operating advantages to improve slimming margins o Judgment to know whether to stay in or exit

• Decline o Ability to withstand intense price-cutting o Brand strength to allow reduced marketing o Cost cutting capacity and slack to allow it o Good supplier relationship to gain cost concessions o Innovation skills to create / remodel new products o Ability to change over processes to replacement product

FINANCIAL RATIOS Helps determine company’s strength, vulnerabilities, resilience

UsesRatio type • Firm’s ability to meet short term obligations, including currently

maturing long term debt. • A large current ratio is not a good sign and suggests inefficient

use of assets(ratio of 1 is common, 2-3 is acceptable).

Liquidity

• Indebtedness, looks at sources of capital (creditors etc). Interest rates may amplify either profits or losses.

• A firm with no access to (reasonably priced) credit will find it difficult to grow.

Leverage

How efficient are the firm’s operations? Norm for inventory turnover for US industries is around 9, but varies enormously with industry and its practices (‘just in time’, etc).

Activity

The net result of the policies and strategies chosen, an indicator of (in)effective management. Varies widely between industries, the US average is 5% return on sales. Return on equity is the measure of return on a stockholder’s investment.

Profitability

Industry-specific operational metrics / KPIs (e.g. % of total sales generated by each sub-department, etc)

Operating

RATIOS SourceFormulaRatioRatio

Balance SheetCurrent Assets / Current LiabilitiesCurrent Ratio

LIQUIDITY Balance Sheet

Current Assets minus inventories/ Current Liabilities

Acid-Test Ratio

Income Statement & Balance SheetRevenue / Avg Accounts ReceivableA/R Turnover

365 Days / A/R TurnoverAvg Collection Period

Balance SheetTotal Assets / Total LiabilitiesSolvency Ratio

LEVERAGE/ SOLVENCY

Balance SheetTotal Liabilities / Members EquityDebt-to-Equity Ratio

Income Statement & Balance SheetEBITDA / Interest ExpenseTimes Interest Earned

Income Statement & Balance Sheet (EBITDA + Lease Expense) / (Interest Expense + Lease Exp.)

Fixed Charge Coverage

Income Statement & Balance SheetCost of Food Sold / Average Food InventoryInventory Turnover

ACTIVITY # of Days / Inventory TurnoverDays on Hand

Income Statement & Balance SheetTotal Revenue / Total AssetsTotal Asset Turnover

Income Statement(Revenue – Cost of Goods) / RevenueGross Profit Margin

PROFITABILITY

Income StatementOperating Income / Total RevenueOperating Efficiency

Income StatementNet Income / Total RevenueNet Profit Margin

Income Statement & Balance SheetNet Income / Average Total AssetsReturn on Assets

Income Statement & Balance SheetNet Income / Average Members’ EquityReturn on Members’ Equity

Income StatementDept. Revenue / Total RevenueSales Mix OPERATING/ OTHER

Income StatementTotal Food Revenue / # of coversAverage Food Check

Income StatementCost of Food Sold / Food RevenueFood Cost Percent 43

*EBITDA: ‘net earnings’ i.e. earnings before interest, tax, depreciation, amortization

KEY TERMS

• Benchmarking

• Core competence

• Primary activities

• Support activities

• Organizational capabilities

• (In)tangible assets

• Isolating mechanisms

• SWOT analysis

• Product life cycle

• Resource-based view

• Three circles analysis

• Value chain

• Value chain analysis