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The Strategy Analytics Toolkit

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1 The Strategy Analytics Toolkit
DRAFT The Strategy Analytics Toolkit Gemini Consulting Beta Version: October 1998 1 1 1

2 Contents Introduction - what it is, and what it isn’t 3
Page Introduction - what it is, and what it isn’t Gemini’s Approach to Strategy: Strategy and Results Understanding a Client’s Strategic Position Analytics to Understand a Client’s Strategic Position About the Toolkit Structure and Contents Toolkit Analytics: Competitors/Industry Stream Analytics Customer Needs Stream Analytics Profitability Stream Analytics Capabilities Stream Analytics Developing and Evaluating Options Next Steps and Feedback Process 3 9 35 39 113 159 206 226 247 2 2 2

3 Introduction—what it is, what it isn’t
3 7 7

4 INTRODUCTION The Toolkit describes key analytics used by Gemini in strategic work with clients Designed for use by all Gemini consultants: Most frequent users are likely to be strategy consultants. However, we hope that project managers, business development staff, and consultants from other disciplines will find it a useful reference tool. Contains analytics that, in our experience, are the most relevant and useful for strategy work: Analytics and content developed in consultation with all Gemini POAs. Does not deal with the process of how to engage the client organisation to achieve the desired outcomes: This topic is addressed in more detail by the LMRa discipline Kbase. See also “Gemini’s Evolving Change Model”, on Gemini Compass. Does not provide tools or frameworks to understand the emotional and political domains. The toolkit is intended as an “aide memoire”, and will supplement Gemini strategy training programmes. a. Leadership Mobilisation and Renewal. 4 4 4

5 The Toolkit draws on Gemini’s heritage
INTRODUCTION The Toolkit draws on Gemini’s heritage United Research 1991 Mac Group 1991 Bossard 1998 SIAR 1998 Eurostart 1994 Svennerstal & Partners 1996 IKO (Norway) Ç Asia Advisory Services 1991 Ç Ç Ç Ç Ç Ç Ç Ç Ç Ç Ç Ç Ç Ç Ç Ç Ç Gamma International 1991 Ç CESAT 1995 GTP 1993 With the Toolkit, we hope to build a common language among all Gemini consultants around fundamental strategic tools and techniques. 5

6 The focus of the toolkit is on core analytics
INTRODUCTION The focus of the toolkit is on core analytics Strategy Competency Group Structure Strategy Development & Planning for Growth (J. Schmidt) Growth Strategy Value Innovation Vision Engineering Strategic Intent/Core Competencies Corporate Strategic Planning Transformation Mapping Acquisition Screening Alliance Management Joint Ventures Applied Knowledge Management/Performance Innovation Post merger integration Partnering & Managing Capabilities (TBD) Segmentation/Data Warehousing Marketing Effectiveness Customer Value Management (CVM) Channel Strategy and Management Market Focus/BMFO Sales Effectiveness/ Pricing Strategic Marketing (A. B. de Jaegere) Guiding & Measuring Success (M. Tattum) Balanced Scorecard Shareholder Value/EVA Activity Based Management (ABM) Corporate governance and multi-business role of the centre and organisation Link to Organisational Design Link to IM Strategy Industry/competitor analysis • Profitability analysis • Option formulation and evaluation Capabilities analysis • Customer analysis Core Strategy Analytics Toolkit Focus The strategy competency groups provide a structure for knowledge management. 6 4 7

7 INTRODUCTION Strategy competencies will be built-up from core consulting and strategy skills Strategy Competency Group Overview Partnering & Managing Capabilities Strategic Marketing Covered at GU and project based learning Core Strategy Analytics (Tools & Frameworks) Core Strategy Skills Strategy Development & Planning for Growth Analytical Problem Solving Process Toolkit Guiding & Measuring Success Gap filled by toolkit PoA based training to be developed Core Consulting Skills Covered at GU E.g.: Presentations Interviewing Researching Modelling Etc Covered at Induction, GSW and PoA based training 6 months 1 year Time with Gemini The toolkit plugs a key existing gap. 5 7

8 Develop Conclusions & Recommendations
INTRODUCTION The toolkit supports each stage of the Analytical Problem-Solving Process Analytical Problem-Solving Processa Develop Conclusions & Recommendations Develop Insights Which option should your clients select? How should they implement it? What are the risks? How can they be overcome? How can they measure progress? Analyse Data What is the situation? What are the options to resolve the issues? How can the situation be improved? Gather Data What is the actual strategic position? What supplementary analysis do we need to do? Form Hypotheses What evidence do we need to confirm/refute the hypotheses? What analysis will we do, and what data should we collect? Define Issues What do we believe the strategic position to be? What are the boundaries of the businesses? What are the drivers of value? How are we positioned? What are the options? What might we do? What is the stated issue? Are there more fundamental ones? Main Toolkit Help The Toolkit is particularly helpful in understanding how to gather and analyse data. a. See Gemini University Strategy Skills Course for further details. 8 11 24 24

9 Strategy Analysis Pyramid
INTRODUCTION In any business, there are different levels for which we develop strategy (and vision) Strategy Analysis Pyramid Business Strategy Vision Goals Corporate Strategya Toolkit Focus The toolkit focuses on business level strategy, the key building block. a. Defined as multibusiness. See also corporate level strategy initiative document in German POA, and Koch Training Sessions in South African POA. 9

10 We must be aware of some important caveats . . .
INTRODUCTION We must be aware of some important caveats . . . The toolkit is not a cook book. “Blind” application of many of the analytics could lead to the wrong, or indeed no answer: Analysis, particularly the output, needs guidance and thought. There is no substitute for experience—both in strategy and industry knowledge: The only way to truly develop strategy skills is through an apprenticeship model. There is an “appropriateness of robustness” for all analysis: Analytics can be used with different levels of data, for different situations, e.g. business development, A&D, and RD. Strategic position changes and an industry shifts: It is easy to get stuck in an old paradigm, leading to wrong assumptions and solutions. Beware of accepting industry assumptions without challenging and seeking evidence. Challenge the “status quo” by testing the feasibility of the complete opposite of existing industry “modus operandi”. . . . and don’t forget creativity. 10

11 Gemini’s Approach to Strategy
Strategy and Results Understanding a Client’s Strategic Position Analytics to Understand a Client’s Strategic Position 11 7 7

12 STRATEGY AND RESULTS Gemini is in the business of helping our clients improve business performance and delivering results Three Key Levers For Improving Business Performance Longer Term Unique Capabilities and Assets Strategic Position (Toolkit Focus) Operational Effectiveness Shorter Term An effective business strategy focuses on improving these three fundamentals. 12 8 8

13 Gemini’s strategy is about the right results not just the right answer
STRATEGY AND RESULTS Gemini’s strategy is about the right results not just the right answer Characteristics Required for Strategic Success Robust and creative strategy that can be implemented Strategic actions embedded in day-to-day business Organisational understanding, momentum, and enthusiasm Capability to adapt and evolve strategy as market and industry develop Results are realised only when strategies are implemented. 13 9 9

14 STRATEGY AND RESULTS Good strategies provide measures to monitor performance on a variety of client issues Different entry points/questions asked by clients . . . . . . but with common elements to the solutions Make explicit assumptions about the future. Provide and assess alternate options. Understand the trade-offs of “what to do” and “what not to do”. State the financial impact of alternative options, including doing nothing. Provide milestones and measures to track performance. Detail actions to ensure the organisation fulfils its ambition. “How should we respond to/take advantage of . . .” “We need to fix our performance . . .” “The issue is Can you help us . . .” “We want to be in the X business, how do we develop it . . .” All require an understanding of the client’s unique position both internally, and in relation to its competition and industry. Most importantly, strategies should deliver results. 14

15 STRATEGY AND RESULTS Our approach to strategy development embraces the emotional and political issues as well as the rational ones Rational domain: Strategic position. Operational effectiveness. Capability development. Emotional domain: Development of consensus and commitment at each level and in each area. Political domain: Shifting of power within the organisation. These elements are interdependent, however, the toolkit focuses on rational analysis tools. 15 10 10

16 STRATEGY AND RESULTS In an A&D, we assess the company’s strategic position to identify improvement opportunities and issues to address Understand Strategic Position Characteristics Required for Strategic Success Robust and creative strategy that can be implemented Strategic actions embedded in day-to-day business Define Key Strategic Issues to Address Review Existing Strategy/Actions Organisational understanding, momentum, and enthusiasm Capability to adapt and evolve strategy as market and industry develop Understand client mindset, assumptions and issues Operational effectiveness probes and diagnostics identify other improvement areas. 16 12 12

17 STRATEGY AND RESULTS In Results Delivery, we assess the strategic position to resolve key strategic issues Political & Emotional Rational Robust and creative strategy that can be implemented Strategic actions embedded in day-to-day business Organisational understanding, momentum, and enthusiasm Capability to adapt and evolve strategy as market and industry develop Define Strategic Issues Understand Strategic Position Develop and Evaluate Options Results Implementation Capability Strategy development is not a simple, sequential task—it is creative, interactive, and iterative. 17 13 13

18 Gemini’s Approach to Strategy
Strategy and Results Understanding a Client’s Strategic Position Analytics to Understand a Client’s Strategic Position 18 14 14

19 UNDERSTANDING A CLIENT’S STRATEGIC POSITION
The key to strategy formulation is understanding a client’s unique strategic position, and how that is changing over time A company’s strategic position shapes on its ability to create more value than its competitors: Customer value. Economic value to reward other stakeholders (shareholders, employees, partners, etc.). The drivers of strategic position in an industry or industry segment shift over timea, but are a function of: Industry attractiveness, competitors’ strength. Ability to serve customer needs. Cost position. Capabilities and resources. It is vital to understand the company’s unique strategic position and to choose what it will, and won’t do: How do we position the client as a player among other industry players. What are the specific trade-offs it must make vis-à-vis its unique capabilities and position in the industry? a. See also M Porter’s article: “What is Strategy”, HBR November–December 1996. 19 16 16

20 Industry Dynamics Framework Future Industry Scenarios
UNDERSTANDING A CLIENT’S STRATEGIC POSITION The actions of companies influence industry scenarios and therefore their own strategic positions Industry Dynamics Framework Historical development Industry logic: Business logic Social logic Competitor map: Position and role Forces at play (Porter) Key Success Factors (KSFs) Industry evolution and future logic Business opportunities Strategic options and new KSFs Present Structure Future Industry Scenarios Industry scenario planning through international comparisons and analogies from other industries Driving Forces of Change Dynamic Pressures and Competitive Actions “Triggers of change”: Technology Regulation New industry Segments Change in input costs and availability Buyer learning, experience and uncertainty Industry growth, profitability and cyclicality New actors Innovations New business strategies: New business concepts Investments and divestments M&A and alliances Status quo forces or barriers to change: Lack of resources or knowledge Committed resources and investments Power structure Inertia and complacency Understanding the future development of driving forces and competitive actions is a major consideration when evaluating alternative strategic options. Source: SIAR School. 20

21 UNDERSTANDING A CLIENT’S STRATEGIC POSITION
To understand a business’s current and emerging strategic position, we need to understand the “rules of the game” Strategic Position What are the (economic) boundaries of the businesses the company is in? How are they changing? What should the company do? How can it best shape and influence the future industry? Evaluate options Decide on action How do companies create value in each of the businesses? How is this changing? How is the client company positioned relative to the competition to create value? How is it changing? The ways in which companies operate and interface inherently assume answers to these questions. 21 17 17

22 Key Industry Groupings Industry Perspective—Benefits
UNDERSTANDING A CLIENT’S STRATEGIC POSITION Companies can be analysed and understood based on a set of industry perspectives Key Industry Groupings Industry Perspective—Benefits Emerging Industries Biotechnology Raw Material Pulp and paper Mining Fragmented Industries Furniture textiles Services Core Technology Industries Automotive machine tools Ball bearings Distribution-oriented Retailing Service Management Industries Consumer services Professional services Intermediary Industries Construction Mgt consulting Shipbuilding Brand-based Food computers Financial services Network Industries Banking Telecommunication Credit cards Medra This is a set of ideal types of industries—provides perspectives to highlight competitive issues and focus analysis on the most important areas: “Get to the point fast”. Brings understanding from earlier experience Provides a starting point for diagnosing industry logic and dynamics: Generate strategic options Focus development of business strategy Industry perspectives help focus the analysis and brings past experience to bear—we must continue to enhance this understanding. Source: SIAR School. 22

23 UNDERSTANDING A CLIENT’S STRATEGIC POSITION
There are some key issues specific to each industry which help focus analysis Industry Perspectives Industry Technology-based Project-based Brand-based Raw Material-based Service Business Network Industry Market Dynamics Product lifecycle Technology Investment waves; customer pull, technology push Product lifecycle Quality demands Positioning Cyclical Substitutes Technology Local business Information technology Scale economies Deregulation Information technology Infrastructure Competitive Logic Market segmentation Technology Economies of scale Customer base Technology Customer loyalty Advertising Integration Capacity Low cost sources/ production Market segmentation Quality standards Market segmentation Network coverage Technology Success Measure Market share New products/ models Customer base status Brand strength Cost efficiency Customer retention Customer retention Utilisation Critical Assets Technology Product/ manufacturing Customer base Flexible organ. Financial strength Brands Raw material Production efficiency Human resources Management Networks Risk and Growth Mechanisms R&D investments New technologies New applications Exploit new demand waves Piggy back on customers Project risks Extension Revitalisation Integration Exploration Utilisation of excess raw material Overcome fragmentation Duplication mentation Network-based Changes in infrastructure Regulation Capital expenditure Issues Key Factors in Coping with Risks Achieving Synergies Marketing power Distribution Alliances Balancing own development and production vs. sub-contracting component supplies Customer base management Organisational flexibility Project management Financial management Brand management Advertising/ promotion Syndication Cash flow synergies Vertical integration Balancing upstream and downstream Economies of scale Organisational innovations Local dominance Strategic alliances Systems development Internationalisation Organic Acquisitions Partnerships Licensing Acquisition Exploiting cost gaps 23

24 Industry and Competitors Profitability Drivers
UNDERSTANDING A CLIENT’S STRATEGIC POSITION The necessary analysis to understand the strategic position usually falls into four natural streams of activity Typical Categories of Analytical Work to Determine Business-Unit-Level Strategic Position Industry and Competitors Customer Needs Profitability Drivers Capabilities Understanding the strategic position is a creative process relying on insights across all streams of analysis. 24 19 19

25 Competition/Industry
UNDERSTANDING A CLIENT’S STRATEGIC POSITION To develop strategic position insights, we must consider evidence and facts from all four streams Evidence and Facts Strategic Position Competition/Industry Customer Needs Profitability Capabilities What are the (economic) boundaries of the businesses the company is in? How are they changing? What are the boundaries/scope of the competition? Are there successful niche players/broad-focus players, and where do they make money? How big is the market? How fast is it growing? Are some parts growing faster than others? What are the average returns in the industry? How have they changed over time? How do they vary between players? Have there been any new entrants, and why? Are they making money? Has anyone left the industry? Why? Is the business constrained by regulation? What are the boundaries of regulation? Why do customers purchase? What is generating value? How do customers purchase? What is the trigger? What different needs-based segments exist? What is the underlying customer need? What substitute products are there? What trends are emerging? What are the pricing determinants? What are the natural boundaries of unit cost drivers (by product/ geography)? What are the boundaries of the capabilities required to compete successfully? How does the industry deliver value to its customers? Is this changing? What are the key purchase criteria by segment? Are purchase behaviours changing? How? Why? How do companies make money? How is pricing determined in each business? What are the major areas of unit cost position? What are their drivers? How is the cost structure changing? Why? What capabilities are required to deliver value? How is this changing? How do companies create value in each of the businesses? How is this changing? What and why is the overall performance of our client relative to competitors (e.g. market share, profitability)? How does our client meet the key purchase criteria compared with the competitors? How well is our client positioned to set prices compared with its competitors? What is the cost position of our client relative to its competitors? Is it changing? How strong are our client’s key capabilities, relative to its competitors? How is the client company positioned relative to the competition to create value? How is it changing? 25

26 Gemini’s Approach to Strategy
Strategy and Results Understanding a Client’s Strategic Position Analytics to Understand a client’s Strategic Position 26 14 14

27 ANALYTICS TO UNDERSTAND A CLIENT’S STRATEGIC POSITION
Analytics help us understand particular elements of the client’s strategic position Key Questions to Understand Strategic Position Key Analytics to Understand Strategic Position What are the (economic) boundaries of the businesses the company is in? How are they changing? Essential to understand the strategic position of our clients: Without analytics, any assessment of strategic position will be flawed Essential to evaluate client’s strategic options Break-even analysis Cluster analysis Company/competitor analysis Cost structure Customer experience Financial/ratios analysis Key purchase criteria Market-sizing and share Relative cost-positioning Segmentation Strengths and weaknesses Value chain Venkat matrix CORE ANALYTICS How do companies create value in each of the businesses? How is this changing? Relevant in specific businesses or situations Adoption cycle Business/unit profitability Economies of scale Experience curve Growth share matrix Key success factors PEST Porter’s five forces Price elasticity Product life cycle Product substitution SWOT SUPPLEMENTARY ANALYTICS How is the client company positioned relative to the competition to create value? How is it changing? Analytics are divided into core and supplementary and are broken down by stream. 27

28 Competitors/Industry Stream: Questions and Analytics
ANALYTICS TO UNDERSTAND A CLIENT’S STRATEGIC POSITION Competitors/Industry Stream: Questions and Analytics Competitors/Industry Stream Strategic Questions Strategic Position Main Analytics What are the (economic) boundaries of the businesses the company is in? How are they changing? How do companies create value in each of the businesses? How is this changing? How is the client company positioned relative to the competition to create value? How is it changing? What are the boundaries/scope of the competition? Are there successful niche players/broad-focus players, and where do they make money? How big is the market? How fast is it growing? Are some parts growing faster than others? What are the average returns in the industry? How have they changed over time? How do they vary between players? Have there been any new entrants, and why? Are they making money? Has anyone left the industry? Why? Is the business constrained by regulation? What are the boundaries of regulation? Value chain Financial/ratios analysis Company/Competitors analysis Market-sizing and share How does the industry deliver value to its customers? Is this changing? SWOT PEST Porter’s five forces What and why is the overall performance of our client relative to competitors (e.g. market share, profitability)? Growth/Share matrix Key success factors Core Analytic Supplementary Analytic 20 28 20 20

29 Customer Needs Stream: Questions and Analytics
ANALYTICS TO UNDERSTAND A CLIENT’S STRATEGIC POSITION Customer Needs Stream: Questions and Analytics Customer Needs Stream Strategic Questions Strategic Position Main Analytics What are the (economic) boundaries of the businesses the company is in? How are they changing? How do companies create value in each of the businesses? How is this changing? How is the client company positioned relative to the competition to create value? How is it changing? How and why do customers purchase? What is the trigger? What different needs-based segments exist? What substitute products are there? What is the underlying customer need? What trends are emerging? Segmentation and targeting Cluster analysis Customer experience Product substitution Adoption cycle Key purchase criteria Product life cycle What are the key purchase criteria by segment? Are purchase behaviours changing? How? Why? How does our client meet the key purchase criteria compared with its competitors? Core Analytic Supplementary Analytic 21 29 21 21

30 Profitability Stream: Questions and Analytics
ANALYTICS TO UNDERSTAND A CLIENT’S STRATEGIC POSITION Profitability Stream: Questions and Analytics Profitability Stream Strategic Questions Strategic Position Main Analytics What are the (economic) boundaries of the businesses the company is in? How are they changing? How is pricing determined? What are the natural boundaries of unit cost drivers (by product/geography)? Break-even analysis Value chain Cost structure Relative cost-positioning How do companies make money? How is pricing determined in each business? What are the major areas of unit cost position? What are their drivers? How is the cost structure changing? Why? Economies of scale How do companies create value in each of the businesses? How is this changing? Experience curve Price elasticity How well is our client positioned to set prices versus the competitors? What is the cost position of our client relative to its competitors? Is it changing? How is the client company positioned relative to the competition to create value? How is it changing? Business/Unit profitability Core Analytic Supplementary Analytic 22 30 22 22

31 Capabilities Stream: Questions and Analytics
ANALYTICS TO UNDERSTAND A CLIENT’S STRATEGIC POSITION Capabilities Stream: Questions and Analytics Capabilities Stream Strategic Questions Strategic Position Main Analytics What are the (economic) boundaries of the businesses the company is in? How are they changing? What are the boundaries of the capabilities required to compete successfully? Strengths and Weaknesses What capabilities are required to deliver value? How is this changing? Venkatramen Matrix How do companies create value in each of the businesses? How is this changing? How strong are our client’s key capabilities relative to its competitors? How is the client company positioned relative to the competition to create value? How is it changing? Core Analytic 31 23 23 23

32 Competitors/ Industry Summary of Stream Analytics
ANALYTICS TO UNDERSTAND A CLIENT’S STRATEGIC POSITION On projects, most of the analytics may be useful across more than one stream Competitors/ Industry Customers Needs Profitability Capabilities Summary of Stream Analytics List of Analytics Break-even analysis Ÿ Cluster analysis Ÿ Company/competitor analysis Ÿ Ÿ Ÿ Ÿ Cost structure Ÿ Ÿ Customer experience Ÿ Ÿ Financial/ratios analysis Ÿ Ÿ Core Key purchase criteria Ÿ Market-sizing and share Ÿ Relative cost-positioning Ÿ Ÿ Segmentation Ÿ Ÿ Strengths and weaknesses Ÿ Ÿ Value chain Ÿ Ÿ Venkatramen matrix Ÿ Ÿ Ÿ Adoption cycle Ÿ Ÿ Business/unit profitability Ÿ Ÿ Economies of scale Ÿ Ÿ Experience curve Ÿ Ÿ Ÿ Growth share matrix Ÿ Ÿ Supplementary Key success factors Ÿ Ÿ Ÿ Ÿ PEST Ÿ Porter’s five forces Ÿ Ÿ Price elasticity Ÿ Ÿ Ÿ Product life cycle Ÿ Ÿ Ÿ Product substitution Ÿ Ÿ SWOT Ÿ Ÿ Ÿ 32

33 Understand Logics and Targets of Stream
ANALYTICS TO UNDERSTAND A CLIENT’S STRATEGIC POSITION When starting on projects, consultants should follow some basic mental checks Process Flow: Understand Logics and Targets of Stream Set Issues to Address Choose/Use Analytics Flesh out Answers Mental Checks What’s the scope of my stream compared with other streams? Make sure no unnecessary overlaps occur Make sure the whole scope of the project is covered by at least one stream What kind of answers am I looking for? What questions must I address? Refer to stream-specific questions Validate understanding of questions, with: Team manager JTMs Client What analytic can help me answer my questions? Refer to stream-specific analytics Analytics may be shared: Avoid duplication Make sure you answer all relevant questions Make sure all answers are documented Ensure communication across all projects streams: Strategy streams (highly interdependent) NWTs The value is from combined output and insights, not from the individual stream alone. 33 1

34 Some useful tips when conducting analysis . . .
Analysis Top Tips Ask for help Identify key Gemini contacts and experts Draw on faculty Talk to others who have performed similar analysis Facts! Facts! Facts! Derive facts Validate and cross reference Gain insight Master the information overload Set priorities Structure analysis Define hypotheses early Be open to break-through solutions but approach the client carefully Consider creative ways to do business Validate and prove hypotheses prior to communicating them Handle the client and the politics behind the scene Identify client’s interest and hidden agendas Ensure early discussion of possible strategic options with client, preferably in face-to-face meetings 34

35 About the Toolkit Structure and Contents
35 14 14

36 The analytics are broken down into five main sections
STRUCTURE AND CONTENTS The analytics are broken down into five main sections Toolkit Roadmap Competitors/ Industry Analytics Customer Needs Analytics Profitability Analytics Capabilities Analytics Developing and Evaluating Options 36

37 The Toolkit contains both core and supplementary analytics
STRUCTURE AND CONTENTS The Toolkit contains both core and supplementary analytics Core Supplementary Analytics Analytic Competitors/industry: Value chain Market-sizing and share Financial/ratio analysis Company/competitor analysis Customer needs: Segmentation/Needs-based Cluster analysis Key purchase criteria Customer experience Profitability: Cost structure analysis Break-even analysis Relative cost-positioning Capabilities: Strengths and weaknesses analysis Venkat matrix Developing and evaluating options: Segment attractiveness Financial valuation Analytic Competitors/industry: SWOT PEST Porter’s five forces Growth share matrix Key success factors Customers’ needs: Product life cycle Product substitution S-curve Adoption cycle Profitability: Economies of scale Experience curve Price elasticity Business/unit profitability 37 26 26

38 The Toolkit follows a standard pattern for each stream’s section
STRUCTURE AND CONTENTS The Toolkit follows a standard pattern for each stream’s section Typical Structure of a Section For Each Analytic Introduction Analytics (core, then supplementary): What it is Why we use it Strengths and limitations How to apply Illustrative output Potential insights Hints and pitfalls Data sources Case examples Related analytics Compilation of stream-specific analytics: Definition of analytic Rationale for using the analytic Outlines of strengths and limitations of analytic High level steps for how to use the analytic (no detailed guidance) Graphical output of analytic/electronic link Outline of how the analytic helps generate insights Practical tips on using the analytic Typical sources for data required References of good Gemini examples of the analytic’s use References of other analytics that supplement or complement this analytic Conclusion: Link to strategy questions and answers, general caveats 38 1

39 Competitors/Industry Stream Analytics
Introduction Value Chain Market/Sizing and Share Financial/Ratio Analysis Company/Competitor Analysis SWOT Analysis PEST Analysis Porter’s Five Forces Growth Share Matrix Key Success Factors Conclusions 39 14 14

40 Competitors/Industry Stream: Questions and Analytics
ANALYTICS TO UNDERSTAND A CLIENT’S STRATEGIC POSITION Competitors/Industry Stream: Questions and Analytics Competitors/Industry Stream Strategic Questions Strategic Position Main Analytics What are the (economic) boundaries of the businesses the company is in? How are they changing? How do companies create value in each of the businesses? How is this changing? How is the client company positioned relative to the competition to create value? How is it changing? What are the boundaries/scope of the competition? Are there successful niche players/broad-focus players, and where do they make money? How big is the market? How fast is it growing? Are some parts growing faster than others? What are the average returns in the industry? How have they changed over time? How do they vary between players? Have there been any new entrants, and why? Are they making money? Has anyone left the industry? Why? Is the business constrained by regulation? What are the boundaries of regulation? Value chain Financial/ratios analysis Company/Competitors analysis Market-sizing and share How does the industry deliver value to its customers? Is this changing? SWOT PEST Porter’s five forces What and why is the overall performance of our client relative to competitors (e.g. market share, profitability)? Growth/Share matrix Key success factors Core Analytic Supplementary Analytic 20 40 20 20

41 Competitors/Industry Stream Analytics
Introduction Value Chain Market/Sizing and Share Financial/Ratio Analysis Company/Competitor Analysis SWOT Analysis PEST Analysis Porter’s Five Forces Growth Share Matrix Key Success Factors Conclusions 41 14 14

42 COMPETITORS/INDUSTRY STREAM—INTRODUCTION
We have provided tools for understanding our client’s business scope and overall attractiveness Why? How? Establish the scope of our analysis, and focus our effort: Define the boundaries of the business and relevant segments in which our client competes: A fundamental step, usually the first in most strategy engagements Often clients perceive themselves to be competing in the business, not the segments, thus: They miss opportunities, or They are vulnerable to competitors Help reshape clients’ perceptions of where they are competing: Particularly useful in an industry in which the competitive boundaries have shifted Potentially, uncover opportunities in under-served segments, or areas in which our client is vulnerable to competitors In some instances, defining the business and segments can be done very quickly In other cases, it is a highly iterative process requiring input from other analytics, and applying our judgement to this At a high-level, we can usually define a client’s business quickly by: Questioning our client. Examining broker reports, annual reports, industry reports, and textlines. However, to gain a deeper understanding, and generate meaningful insights, we typically need to: Construct a value chain for the industry, and for our clients. Determine the size of the business, and segments, and how these have changed, and are expected to change. Determine the market share of competitors in the business and sub-segments, and how and why these are changing. Review the relative and absolute performance of our client and key competitors (including their financial performance). We describe each of these four processes later 42

43 Competitors/Industry Stream Analytics
Introduction Value Chain Market/Sizing and Share Financial/Ratio Analysis Company/Competitor Analysis SWOT Analysis PEST Analysis Porter’s Five Forces Growth Share Matrix Key Success Factors Conclusions 43 14 14

44 Value chain—introduction
COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS Value chain—introduction What It Is Why We Use It A description of the key activities performed either across an industry or across a company: Usually shown as a linear flow of activities. A company value chain, also shows the support activities performed, e.g. systems support. Michael Porter codified the value chain concept in a A value chain should show where value is being created within an industry or company: Should be quantitative, not qualitative. Should show the value of costs and revenues at each stage in the value chain. Primary objective is to determine where and how value is created in an industry or company Value chains are also used to: Understand the key activities within an industry or company. Determine whether there is any backward or forward integration in an industry.b Map key players at each stage of an industry’s value chain. Strengths & Limitations Strengths: Clarifies key stages in an industry or company, showing where value is created, and can demonstrate key shifts along the value chain. Limitations: Users do not apply the analytic fully, i.e. they stop at describing key activities, and do not determine where value is created. a. In his book “Competitive Advantage”, Free Press. b. Forward = purchasing supplier, backward = purchasing customer. 44 25 33 33

45 Value chain—how to apply it
COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS Value chain—how to apply it There are three steps in developing a value chain: Identify individual value activities: The appropriate degree of disaggregation depends on the economics of the activities and the purposes for which the value chain is being analysed. Distinguish between primary and support activities. Assign the value activities to the categories (or functions) that best represent their contribution to a firm’s competitive advantage. Order the activities, broadly following the process flow: Determine the links between activities. Once the activities are detailed in the value chain, map costs, returns and players across the value chain where applicable. 26 45 35 35

46 Value chain—illustrative output
COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS Value chain—illustrative output Distribution of Operations Costs in Flow Control Values Generic Manufacturing Company Value Chain Primary Activity Links with suppliers Logistics Marketing and Sales After-sales Support Primary Activities Operations/ Manufacturing Infrastructure Support Activities Margin 1% Human Resources Support Activities Margins R&D Procurement Procurement HR Management Infrastructure R&D Inbound Logistics Operationsa Outbound Logistics Marketing and Sales Service Source: Adapted from M. E. Porter, Competitive Advantage, Free Press 1985. a. 27% = HR costs; 40% = Purchased operating inputs. Source: M. E. Porter, Competitive Advantage, Free Press, 1985. Competitors can also be mapped along the value chain. 32 46 34 34

47 Value chain—top tips Potential Insights Hints and Pitfalls
COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS Value chain—top tips Potential Insights Analytic helps determine: Key shifts within an industry (backwards or forwards along the value chain) Why competitors may be targeting specific sections of the value chain Whether the industry value chain is changing Hints and Pitfalls Do: Quantify the cost at each stage in an industry or company value chain Understand the dynamics of a value chain—what’s changed? why? Read Porter’s book on the roles of the value chain analytic in assessing competitive position: This is not necessarily a Gemini point of view, but provides useful background context 47 27 36 36

48 Value Chain—data sources, case examples and related analytics
COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS Value Chain—data sources, case examples and related analytics Data Sources Gemini project work (providing value chain output from previous projects) Questioning clients and/or industry experts Piecing together the activities via secondary data sources: Annual reports Broker reports Industry reports Database searches Internal cost data (client management accounts) Case Examples The following documents contain good examples of value chain analysis and output: “Crossing the Rubicon: The Business Implications of the Euro”, EuroCoE, Gemini Compass Various documents from BUPA project, on London Server archives Related Analytics Developing an industry and company value chain is typically a critical step in defining a client’s business (see introduction of this section): One of several of analytical steps in defining a business Used to map out a customer’s experience of our client company: See Customer Experience HBR May/June 1998—“Profit Pools—a fresh look at strategy” 48 34 37 37

49 Competitors/Industry Stream Analytics
Introduction Value Chain Market/Sizing and Share Financial/Ratio Analysis Company/Competitor Analysis SWOT Analysis PEST Analysis Porter’s Five Forces Growth Share Matrix Key Success Factors Conclusions 49 14 14

50 Market-sizing and share—introduction
COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS Market-sizing and share—introduction What It Is Why We Use It Quantifying the size and growth of a market or segments either by: Value (of revenue or profitability over a specified period). Volume (of units produced over a specified period). As with many strategy analyses, it is important to show the dynamic, i.e. quantify the size of a business or segment over time: Historically (over a number of years). Forecasting (projecting out over future years). In some cases, market size may be available from secondary data sources—otherwise we must estimate it. Measure of how much of a business market or segment individual competitors account for. Market share can be measured by: Value (i.e. proportion of total revenue or profit). Volume (i.e. proportion of total units produced). Typically, we look at both absolute market share, and relative market share (i.e. share compared with other competitors’). There are several market share measures: Absolute and relative share of total business market. Absolute and relative share of total business segment. Absolute and relative share of total addressable market (i.e. segments in which our client competes). Help determine absolute and relative share of competitors in a business or segment: Essential to understand which competitors are successful or unsuccessful. Helps determine the attractiveness of a business or segment: Its size. Whether it is growing, flat, or shrinking. Relative attractiveness compared with other businesses or segments. Determine the power of competitors compared with each other, customers, and suppliers. To determine the relative performance and position of competitors, and how this is changing over time: Who’s successful/unsuccessful? Why? Are new entrants gaining share? Are substitutes being used? In conjunction with other analytics, establishes whether share builds other advantages, e.g. lower unit costs, RMS vs. ROCE. Strengths & Limitations Strengths: Provides a quantitative measure of business of segment attractiveness. Provides the key benchmark against which we measure market share, and determine relative performance of competitors. Essential to understanding competitors’ relative size, importance, and performance. Limitations: Sizing a market from scratch can take weeks or months. Not the only determinant of attractiveness c.f. potential to make money. 50 25 43 38

51 Market sizing and share—how to apply it
COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS Market sizing and share—how to apply it Market Sizing Sizing Based on Publicly Available Data Constructing Own Estimate of Market Size Understand how sources size the market (i.e. methodology). Evaluate reliability of source data. Try to obtain 2–3 independent estimates of market or segment size, and cross-check estimates. Understand trends in market size and underlying root causes. Validate total size and trends with client and/or industry experts. Identify key drivers of market size, e.g.: Number of customers in total business or segment. Number of units of goods or services (e.g. number of flights, number of cars produced). Average number of units purchased per customer. Identify key drivers of future market size, e.g.: Relevant macroeconomic trends. Changes influencing customer demand. Changes in number of customers, or average purchases per customer. Develop methodology to size the market—there are two broad approaches: Top-down, i.e. from macro-variables (e.g. total size of related businesses). Bottom-up, i.e. from micro-variables (e.g. number of customers). Often we use both a top-down and bottom-up approach to check results. Develop picture of how things have changed over time: What is the 5 year growth rate? Calculate Compound Annual Growth Rate (CAGR). Split out real and nominal growth for value basis, i.e. adjust for inflation. The time available and degree of accuracy required will determine choice of methodology. Once you have developed your methodology, the key stages are: Developing and documenting assumptions. Gathering data. Building market size estimates. Validating and refining market size estimates. Current size Starting size 1/n CAGR = n = number of years growth 36 51 44 39

52 Market sizing and share—how to apply It
COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS Market sizing and share—how to apply It Calculating Market Share Steps before Determining Market Share Determine the business market(s) or segments to be sized Size the business market(s) or segment(s): See Market-sizing Identify the company's or individual competitors’ sales, profits or units of output Various Market Share Measures Exist Measure of Share How to Do Absolute Market Share—Business Total Company Sales Total Market Sales Absolute Market Share—Segment Company Segment Sales Market Segment Sales Relative Market Share—Businessa Total Company Sales Total Sales of Largest Competitor Relative Market Share—Segmenta Company Segment Sales Biggest Competitors’ Segment Sales a. If company is the largest, compare to other players. 52 43 48

53 Market-sizing and share—illustrative output
COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS Market-sizing and share—illustrative output Market Sizing Evolution of sales by Business Segment Evolution of % of Total Sales by Business Segment 500 1000 1500 2000 2500 3000 3500 4000 4500 5000 1993 1994 1995 1996 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 1993 1994 1995 1996 Business CAGR Other 9 % Medipsy 11 % GSMS 301 % Dynamis 23 % Acute care 25 % Overall 24 % 53

54 Market-sizing and share—top tips
COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS Market-sizing and share—top tips Potential Insights Analytic helps determine: Industry attractiveness (past, present, future). Relative success of competitors (when used to determine absolute and relative market share). Competitive pressure (from growth rates and consolidation). Degree of market concentration/fragmentation. Relative performance of competitors, and how this is changing. Critical issues to probe further (e.g. why competitor X is gaining share; cost advantages of holding dominant share). Hypotheses regarding market share and profitability of competitors. Hints & Pitfalls Do: Sanity check first (comparisons with GDP, demographic data, other countries). Cross-check all data (both publicly available market size data and own estimates). Test/validate with client market size assumptions and output. Gather past, present, and future market size estimates. Probe for the root causes of changes in total market size. Ensure consistency between methodology for measuring total market size and measuring individual companies’ performance. Look at relative share (i.e. not solely absolute share). Don’t Only use this data to determine attractiveness Just use to size revenue (can size by other units, e.g. units at output). Over analyse—insight often comes from other analysis. Assume a client’s calculation is correct: Always check industry assumptions. Forget to look at historical developments. 54 37 46 40

55 COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS
Market-sizing and share—data sources, case examples and related analytics Data Sources Publicly available data: Client’s data (business plans, and internal reports) Annual reports (for client and competitors) Broker reports (from investment banks) Industry reports Database sources Industry associations Covered in relevant sections on related analytics: No additional data required to determine market share. Case Examples The following documents contain good examples of market-sizing analysis and output: Global Transaction Services (Market Sizing Methodology): FS Kbase, Gemini Compass Related Analytics Market-sizing is a critical step within Business Definition (see introduction of this section) Company/competitor analysis Financial analysis/ratios analysis 55 37 45 41

56 Competitors/Industry Stream Analytics
Introduction Value Chain Market/Sizing and Share Financial/Ratio Analysis Company/Competitor Analysis SWOT Analysis PEST Analysis Porter’s Five Forces Growth Share Matrix Key Success Factors Conclusions 56 14 14

57 Financial analysis—Introduction
COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS Financial analysis—Introduction Financial analysis consists of analysing the financial performance of a company, over time and relative to its peers’: In particular to understand whether and how companies create value. Used to assess where a company’s problems might lie. Can be done internally for own company, or externally for competitors. Ratios are especially useful in comparisons with competitors. Building on three different kind of financial statements, financial analysis allows either trends, ratios or cost structure analyses. Inputs to Financial Analysisa Dimensions of Financial Analysisa Ratio/Trends Analysis The Balance Sheet The Profit and Loss (P&L) Account The Cash Flow statement Assess evolution of: Revenues, profits, and costs. Capital base (debt, equity). Asset base (tangible, intangible). Cashflow. Assesses/measures specific financial features of a firm. Cost Structure Analysis Breaks down cost structure into constituents (see cost structure analytic) a. See detail in following pages. 57 2

58 Financial analysis—introduction (cont.)
COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS Financial analysis—introduction (cont.) All of the statements are linked together and relate back to the ongoing activities of the firm. Balance Sheet Profit and Loss ONGOING STREAM OF EVENTS Summarises the value of what a company owns less what it owes, and balances them with the sources of financing (debt and shareholders’ funds). Stated at a specified point in time (not for a period) P&L—Matches costs to associated revenues in a given year to give a representative picture of profitability. Hence, assets are Depreciated over time and charged to P&L gradually as the asset is “used up” over its useful life to enable the revenues to be created. Transactions in year Cash received and paid credit given and received Trading Revenues Recorded in Year Expenditure Recorded in Year Other Capital Paid In Borrowing Assets Purchased Opening BALANCE SHEET Assets Fixed Assets Working capital Financing Owners’ interests Outside liabilities Closing BALANCE SHEET Assets Fixed Assets Working capital Financing Owners’ interests Outside liabilities PROFIT AND LOSS ACCOUNT Revenues relevant to year = Income Expenditure relevant to year = Expenses Profit (loss) CASHFLOW STATEMENT Operating activities Investing activities Servicing of financing Taxation Financing Cashflow Shows the real cash flows associated with income and expenses in a given year, to show the actual change in cash position. Costs and revenues are not matched. 58 98 91 57 65

59 Financial analysis—introduction
COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS Financial analysis—introduction Definition of Common Financial Terms Accounts Payable Money owed to suppliers Accounts Receivable (or Trade Credit) Money owed by customers Assets Things owned Book Value The value at which an item is reported in financial statements (cf. market value) Capital The amount invested in a venture Capitalisation Sum of all long-term sources of financing to the firm (equals total assets less current liabilities) Cashflow The amount of cash generated or consumed by an activity over a certain period of time Common Shares (or Common Stock) Securities representing an ownership in a firm Cost of Goods Sold Cost of sales Total of all costs required to acquire and prepare goods for sale Cost of Debt Yield to maturity on debt (i.e. internal rate of return to maturity)—frequently after tax, in which event it is 1 minus the tax rate times the yield to maturity Debt (Liability) An obligation to pay cash or to provide other goods or services to another party 59

60 Financial analysis—introduction (cont.)
COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS Financial analysis—introduction (cont.) Definition of Common Financial Terms Depreciation Reduction in the value of a long-lived asset from use or obsolescence. The decline is recognised in accounting by a periodic allocation of the original cost of the asset to current operations Dilution The deduction in any per share item (such as earnings per share or book value per share) due to an increase in the number of shares outstanding either through new issue or conversion of outstanding securities Earnings (or Income; Net Income, Net Profit; Profit) The excess of revenues over all related expenses for a given period Equity (or Owners’ equity, shareholders’ equity, net worth) The ownership interest of common and preferred stockholders in a company (on a balance sheet, equity equals total assets less all liabilities) Fixed Cost Any cost that does not vary over the observation period with changes in volume (as opposed to variable costs) Insolvency The condition of having debts greater than the realistic value of one’s assets (as opposed to solvency) Liquid Asset Any asset that can be quickly converted to cash without significant loss of value Liquidity Extent to which a company has assets that are readily available to meet obligations Market Value Price at which an item can be sold (cf. book value) Operating Expenses Costs incurred to produce goods or services Revenues Sales Trading Profit (or EBIT) Earning before interest and tax (see method of calculation in following pages) 60

61 Financial analysis—introduction (cont.)
COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS Financial analysis—introduction (cont.) P&L Account The P&L account provides a representative picture of profitability in a given year Turnover - Cost of Goods Sold Gross Profits (Sales—could be minus discounts) (Direct costs) Costs such as assets are matched and are depreciated over time and charged to the P&L gradually as the asset is “used up” (Administration - indirect costs and depreciation) (Trading profit = operating profit) - Overheads PBIT - Interest PBT (Interest charges for financing) (Profit Before Tax) - Tax PAT (Corporate tax) (Profit After Tax) Dividend Retained for Reserves (Appropriation of profits transferred to balance sheet in retained profit) 61 99 92 58 66

62 Financial analysis—introduction (cont.)
COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS Financial analysis—introduction (cont.) The Balance Sheet The balance sheet shows a company’s financial position at a specific date The balance sheet features two basic areas of the company’s financials: 1. Assets 2. Liabilities/Funds Fixed Assets All long-term assets: Intangibles (Goodwill, patents, etc.) Net fixed assets (land, building, equipment, etc.) Long-term investments (share in associated companies) Owners Funds Issued common stock Capital reserves: Surpluses from sources other than normal trading and that belong to ordinary shareholders Revenues reserves: Surpluses generated by trading Long-term Liabilities All long-term loans (more than 1 year) Current Assets All short-term assets: Inventories (stocks, work in progress, raw materials, etc.) Cash Accounts receivable (due from trade debtors) Miscellaneous (all other short-term assets) Current Liabilities All short-term liabilities (to be paid within 1 year): Account payable (due to trade creditors—suppliers) Short-term loans (bank overdraft and all other interest-bearing short-term debts) Miscellaneous (all other short-term liabilities) What the business owns Uses for where the money is spent Amounts owed by the business Sources from which the money is obtained 100 62 93 67 59

63 Financial analysis—introduction (cont.)
COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS Financial analysis—introduction (cont.) Cash Flow Statement Cash flow statement tells how a company’s cash position has changed during the year Operating activities: All items that relate to the company’s operations. The key difference between the P&L and cash flow is that the cashflow shows real sources of income and expenditures, whereas the P&L only shows a representative picture, by for example, including only an allocation of asset expense. Investing activities: All buying and selling of fixed assets that relate to the company’s operations. Servicing of finance: Interest paid on loans and dividends paid to shareholders. Taxation Financing: All transactions relating to the raising of funds. 63 101 94 60 68

64 Financial ratio analysis—introduction
COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS Financial ratio analysis—introduction What It Is Why We Use It Ratios are measures of a firm’s specific financial features Financial ratios typically fall into four categories: Financial ratios help us diagnose the financial health of a firm: Profitability/efficiency ratios measure how well a firm uses its assets to generate profits Liquidity ratios measure a firm’s ability to meet short-term liabilities Solvency ratios are an indicator of a firm’s financial strength (assess the mix of funds in the balance sheet and measure firm’s ability to withstand operating setbacks) Investment ratios are indicative of the market’s perceptions of a company. They are used mainly by investors to value a company. Key strategic ratios Other ratiosa 1 Return on sales: Profit margin Gross margin Return on net assets Return on equity Inventory turnover Days inventory Total asset turnover Days receivable Fixed asset utilisation Profitability/ Efficiency Ratios Strengths & Limitations 2 Liquidity Ratios Current ratio Quick ratio Working capital Strengths: Can be used to identify potential areas of improvement Limitations: Accounting principles can differ making comparisons difficult Need to be wary of management “managing” year-end figures Book values for fixed assets may be out of date 3 Solvency Ratios Debt equity ratio Interest cover 4 Investment Ratios Price-earning ratio Earning per share Dividend yield Earning yield Dividend cover Dividend per share a. To be used selectively, according to the industry and/or the level of detail required. 64 25 65 71

65 Financial ratio analysis—how to do it
COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS Financial ratio analysis—how to do it Key Strategic Ratios (1/5) Profitability/Efficiency Ratios Return on sales (ROS): Are goods sold at an appropriate price and produced efficiently? Two ratios reflect ROS: Ratio Formula What It Does Drivers Profit Margin (also known as operating margin) PBIT Sales Where: PBIT: profit before interest and tax Sales – cost of goods sold – operating expenses Trading profit Measures bottom line company profitability Indicates the effectiveness of sales and production in producing profit Constitutes a good ratio for comparing the performances of competitors in the same industry Sales: Price Volume Operating expenses Gross Margin Gross profit Sales Where: Gross profit Sales – cost of goods sold Measures percentage of revenue remaining after the cost of goods sold is covered Constitutes a weak ratio—looks at variablea costs only Price Cost of producing goods a. Costs that are altered by a change in output. 65

66 Financial ratio analysis—how to do it
COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS Financial ratio analysis—how to do it Key Strategic Ratios (2/5) Profitability/Efficiency Ratios (cont.) Return on Net Assets (RONA): How profitable is this company? Ratio Formula What It Does Drivers RONA is also known as: Return on Asset (ROA) Return on Capital Employed (ROCE) (Profit Before Interest + Tax)a Fixed Assets + (Current Assets – Current Liabilities)b (Profit Margin x Asset Turnover) a. Can be defined as profit after tax, but before deduction of interest. b. Current assets – current liabilities = working capital. It represents the amount of day-to-day operating liquidity available to business. Measures profitability Measures how well assets have been employed, irrespective of how the company is financed Profit margin: Price Cost Asset turnover: Sales Capital employed Return on Equity (ROE): What is shareholders’ profit? Ratio Formula What It Does Drivers ROE Profit After Tax Ordinary Fundsa a. Issued capital + capital reserves + revenues reserves Measures the return on ordinary shareholders’ funds: Assesses the efficiency with which the firm employs owners’ capita Measures return for shareholder Profit margin: Price Cost Asset turnover: Sales Capital employed Financing: Debt to equity ratio Cost of debt Tax-effectiveness Profit after tax used because it is the return from which dividend is subtracted. 66

67 Financial ratio analysis—how to do it
COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS Financial ratio analysis—how to do it Key Strategic Ratios (3/5) Profitability/Efficiency Ratios (cont.) Current Ratio: Will the company have sufficient cash in the immediate future to meet its short-term liabilities? Ratio Formula What It Tells Drivers Current Ratio Current Assets Current Liabilities i.e.: (cash and near-cash assets available to business) over (upcoming cash requirements) Indicates a company’s short-term financial position: Compares the assets that will turn into cash within the year to the liabilities that must be paid within the year A company with a low current ratio lacks liquidity in the sense that it cannot reduce its current asset investment to supply cash to meet maturing obligations: It must rely instead on operating income and outside financing The most informative feature of a current ratio is its normal level and any trend from year to year Nature of the industry: Some have to carry large stocks and, have long production cycles Others carry almost no stock and receive more credit than they give Type of current asset: Some are more liquid (i.e. easier to sell readily) Volatility of working capital requirements Debtor and creditor management: Bargaining power of company 67

68 Financial ratio analysis—how to do it
COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS Financial ratio analysis—how to do it Key Strategic Ratios (4/5) Solvency Ratios Debt to Equity ratio (D/E): What is the mix of funds in the balance sheet?: The D/E turns up under many different names and with different methods of calculation, which causes some confusion. Ratio Formula What It Does Drivers D/E Often referred to as “leverage” or “bearing” Total Debt Total Equity Where: Debt = long-term liabilities + current liability and Equity = ordinary funds = Issued capital + capital reserves + revenue reserves 2. Total debt Total funds Total funds: Makes a comparison between: Funds that have been supplied by the owners (equity). Funds that have been borrowed (debt). Defines level of safety to lender: Measures a company’s ability to withstand operating setbacks. Typically high leverage equates to high financial risk, as debt is paid prior to shareholders’ equity when a company is wound up. This is a fundamental ratio Debt and its nature, i.e.: Long-term loans only, vs. Long- and short-term loans (i.e. all interest-bearing debt), vs. Long-term loans, plus all current liabilities There is an optional leverage for a given business risk—one of the drivers is hence industry or company risk. Tracking leverage over a period shows when the company is exposing shareholders to more risk. Some businesses shy-away from investing debt, and under-leverage. Fixed assets + current assets Ordinary funds + long-term liabilities + current liabilities 68

69 Financial ratio analysis—how to do it
COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS Financial ratio analysis—how to do it Key Strategic Ratios (5/5) Investment Ratios These ratios are indicative of the market’s perception of the company: They are used mainly by investors to value the firm. They reflect a company’s performance and expectations of future performance. They do not explain what has happened operationally or in terms of financial structure. Ratio Formula What It Does Drivers Pricing-Earning Ratio (PE) Share Price EPS Share price to be found in the “Financial Times” Alternatively stated as: Market Capitalisation Profit After Tax Widely quoted parameter of share value Value is determined by investors based on company’s ability to deliver a good return to the equity shareholder Provides a quick indication of whether a company is rated highly or lowly Indicates expected growth (relative to other companies or the stock market in general) Investors’ view of future return on equity compared with this year’s earning per share Level of stock market Earning per Share (EPS) Profit After Tax Number of Shares Profit After Tax of share to be found in the notes to the financial statements Absolute amount of EPS tells nothing about a company’s performance However, growth in earnings per share has a significant impact on market price Investors look for stability as well as growth Profit 69

70 Financial ratio analysis—how to do it
COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS Financial ratio analysis—how to do it Other Ratios (1/4) Profitability/Efficiency Ratios These ratios must be used selectively, according to the business and/or the level of detail required. Ratio Formula What It Tells Drivers Inventory Turnover Cost of Goods Sold Ending Inventory Helps to tell whether an appropriate level of stock is held: Measures how often an inventory item turns over per year (or how many times it has been sold) Sales (volume) Inventory: Size Appropriateness Days Inventory (also called “stock turns”) 365 Inventory Turnover Measures the number of days required to sell the inventory once Sales (volume) Size of inventory Total Asset Turnover Sales Total Assets Indicates how well a company uses its assets: Measures sales generated by each unit of assets Measures capital intensity: A low asset turnover signifies a capital–intensive business A high turnover signifies a business that is not capital-intensive Sales (volume, price) Assets: Fixed Inventories Accounts receivable Days Receivable (also called “debtor days”) Accounts Receivable Sales Measure of how long it takes a company to collect what it is owed Monitors credit control department effectiveness Collection period Fixed Asset Utilisation Sales Fixed Assets Measures how well plant, buildings, etc, are utilised Heavily influenced by nature of industry so seldom used Sales (volume, price) Assets: Level Valuation 70

71 Financial ratio analysis—how to do it
COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS Financial ratio analysis—how to do it Other Ratios (2/4) Liquidity Ratios Ratio Formula What It Does Drivers Quick Ratio (acid test) Current Assets – Inventory Current Liabilities Tests what would happen if the company had to settle up with all its creditors and debtors immediately: If the quick ratio is less than 1 it would be unable to settle quickly If a ratio is low and declining it points to a rising overdraft Nature of the company’s business (see “current ratio”) Working Capital to Sales Ratio Current Assets – Current Liabilities Sales Where: Working capital = (current assets – current liabilities) Shows how much capital is required to finance operations in addition to capital invested in fixed assets A falling ratio indicates the possibility of over-trading (insufficient resources in the balance sheet to carry the level of existing business) Nature of the company’s business (see “current ratio”) 71

72 Financial ratio analysis—how to do it
COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS Financial ratio analysis—how to do it Other Ratios (3/4) Solvency Ratios Ratio Formula What It Does Drivers Interest Cover PBIT Interest Where: PBIT = Profit Before Interest and Tax Interest being the cost of financing (item of the Profit and Loss Account) The “cover” is expressed as “so many times” Measures a company’s ability to service its borrowing Operating profit Total amount borrowed Rate of interest 72

73 Financial ratio analysis—how to do it
COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS Financial ratio analysis—how to do it Other Ratios (4/4) Investment Ratios Ratio Formula What It Does Drivers Dividend Yield DPS Share Price DPS = dividend per share (see below) Important ratio for both the investor and the company Yield ratios allow investors to make comparison between the return on shares and other types of investment Profit Financing structure (reinvestment—dividend only) Earning per Share EPS Share Price EPS = Earning Per Share (see “Key Strategy ratios”, p. xx) Dividend Cover EPS DPS Indicates future stability and growth of dividend: High cover suggests dividend is fairly safe Also indicates company is aiming for high growth Profit Reinvestment Dividend Per Share Dividendsa Number of Shares a. In Profit and Loss account. b. In notes to the financial statements. Profit available after reinvestment in company Important for the many of investors who are keen to see steady dividends Profit Reinvestment 73

74 Financial analysis illustrative output
COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS Financial analysis illustrative output Cashflow, £m, 1983–1994 Trends in ratios can similarly be plotted Source: Dawson International; see also further examples in document 1232Ldn23Jun94Dl-db. 74

75 Financial ratio analysis—illustrative output
COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS Financial ratio analysis—illustrative output A Dupont Treea (also known as RONA model) is a useful way to structure and present output. Levers RONA/Dupont Model Shareholder Value Margin Costs Asset Base 75

76 Financial ratio analysis—top tips
COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS Financial ratio analysis—top tips Potential Insight The ratios are useful when viewed over time or compared with other companies’ (usually in the same industry): Analysing over five years helps smooth ups and downs Ratio analyses are a key input to a comparison of competitors Hints and Pitfalls Do: Look for divisional data when analysing diverse multi-product conglomerates Look for industry-specific ratios Be wary of management “managing” end-of-year figures Find out what the terminology used means: US and European terminology differ Accounting principles differ, making comparisons difficult Always treat the notes and main statements as inseparable: You need both to get the job done properly Always look for trends and differences over time (5 years) Try to obtain comparative data on companies in the same industry (international comparisons can be hard (especially Germany), due to different accounting principals) Make sure you are comparing like with like Ask the questions “Why” and “So what”? Don’t: Ever draw conclusions from one parameter 76 27 61 69

77 COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS
Financial ratio analysis—data sources, case examples, and related analytics Data Sources Company reports (annual report, IOK in US) Analysts’ reports Industry reports (e.g. ICC in UK for ratio reports) SEC (Securities Exchange Commission, USA) Case Examples The following documents provide training material: “How to Understand and Use Company Accounts”, (Strategic Research Kbase)i “Financial Analysis, Using and Interpreting Ratios”, August 1998 (Consultant Group KBase) St Gallen University training (in German POA) Financial analysis (A&D Kbase) Related Analytics Cost structure analysis Business case (see A&D Kbase for training material) Financial analysis spreadsheet model - Sten-Erik Molander ( ) 77 30 67 73

78 Competitors/Industry Stream Analytics
Introduction Value Chain Market/Sizing and Share Financial/Ratio Analysis Company/Competitor Analysis SWOT Analysis PEST Analysis Porter’s Five Forces Growth Share Matrix Key Success Factors Conclusions 78 14 14

79 Company/competitor analysis—introduction
COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS Company/competitor analysis—introduction What It Is Why We Use It Background information: Date founded Overview of what the company does Executive team Vision statement Ownership structure Organisation structure: Size of subsidiaries’ workforce Key financials: Current, historical, and projected, (see financial analysis) Market positioning: Market share, geographical markets, target customer segments Channel usage: Percentage through each, productivity Product portfolio: Main products Price brackets Relationship to industry value chain: Key suppliers and customers Distribution channels Recent actions/moves—”late breaking news” Strategic issues and behaviour An assessment of a company’s own (or competitors) performance that should, at the least, include: Provides a basic understanding of a company and its performance Directs further analysis by highlighting key strengths and capabilities Use of a common template can enable a comparison between players Identify number, names and focus of players Understand strategic positions (product/service offering, channel usage) Identify strengths and weaknesses of different players in an industry Identify gaps in portfolios and capabilities of client Identify relative strength of client company Understand key competitor moves Strengths & Limitations Strengths: Gives a clear overview of basic facts about a company: Necessary to add insight to competitor or market analysis Provides direction to further analysis Efficient way to capture vital data on competitors Gives overview of competitors’ attributes along multiple axes Limitations: May provide few insights in itself: Requires benchmarking over time or against competitors Often complex and difficult to use effectively in presentations: Need to extract key messages and display using other tools Requires effort to summarise Often focuses on the present rather than the future: Difficult to determine competitors’ strategic shifts 79 25 51 51

80 Company/competitor analysis—how to do it
COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS Company/competitor analysis—how to do it Acquire a Basic Understanding of the Company/Industry Determine data needed Gather and analyse data Evaluate Company Read general information about the company on its Internet site Read introduction to analysts’ company reports Establish where it fits in the value chain Ensure all necessary background information is included Include information related to the strategic issue being examined by the project There are a wide variety of sources available Analyse data where appropriate: Use financial analysis techniques Product/channel analysis Understand key trade-offs that competitors in an industry have: e.g. niche vs scale Plot competitor field maps Understand relative competitive positions and rationale: Product/Service offerings Channel usage Depending on what we need to know, use SWOT model to help evaluate competitor Ensure analysis relates to, or answers the questions, we are trying to answer 80 52 52

81 Company/competitor analysis—illustrative output
COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS Company/competitor analysis—illustrative output Company Profile Template (Tailored to Specific Use) Competitive Field Map Competitive Field map 4: Multi -local vs . Global Networked Chase Chase Major money domestic Seeks BKB centre focu s; relationship s Serve both local supplement ed Citibank Citibank and cross-b order with partn er banks businesses well Stan.Chart. Stan.Chart. Asian Focu s BofA BofA Local Global Scale HSBC HSBC Scale Deutsche Deutsche German-centric Focus: European companies ABN ABN AMRO AMRO Islands 81

82 Company/competitor analysis—top tips
COMPETITORS/INDUSTRY STREAM—CORE ANALYTICS Company/competitor analysis—top tips Potential Insights Provides an overview of what the company is about, and an indication of success to date: Directs further analysis Drives insights when benchmarked against competitors (see competitor’s comparison) Identifying competitors’ strengths and weaknesses helps us to understand threats and opportunities for our client Must tie in with KSFs for industry Hints and Pitfalls Do: Use creativity in data gathering if information is not readily available Ensure you use an 80/20 rule: You can do much of the analysis very quickly, then fill only critical gaps after that Gain basic knowledge about the company at a very early stage: Obtain/produce an overview of the company’s activities Pay particular attention to revenue Check with your client if you have not used the client’s own data Consider ‘outsourcing’ to shop or institute Focus on major players if the market is highly fragmented, Remember that competitors’ definition of segments often differ Draft template early in the analysis process: Use as a framework for data capture and to direct further analysis Be clear about what information is necessary: Keep in mind why you are conducting this analysis, and structure and collect data accordingly Display findings to create an impact: Use symbols and graphics to display the message Shade the key findings on the template Don’t: Give unnecessary excessive detail: Avoid including irrelevant data Indulge in “data dumping” Make template unnecessarily complex Fail to include all relevant competitors Take for given what the company says are its strengths: May not be in reality May be associated with corollary weaknesses 82 27 53 53

83 COMPETITORS/INDUSTRY STREAM–CORE ANALYTICS
Company/competitor analysis—data sources, case examples, and related analytics Data Sources Annual report Analysts’ reports Internet sites On-line searches Internal company data (if available) Interviews Trade associations Industry overview Industry journals Industry experts (Gemini and external) Case Examples Strategic Research Kbase, “Understanding the Strategies of Mobile Operators in Hong Kong, Sweden, and the UK.” three documents (London Shop, October 1997): Basic company profiles of major mobile operators Financial services Kbase, “Global Transaction Services (Competitor Analysis) The following documents contain good case examples of competitors comparison analysis and output: Michael M. Kaiser, Associates Inc., “Understanding the Competition: A Practical Guide to Competitive Analysis”. Strategic Research K Base, “Succeeding in the UK Private Banking Market”, (London Shop, 20/02/98) pp Telcos in US market (VIAG), Cambridge Shop Related Analytics Company/competitor analysis is often the centre-piece of strategic position assessment However, it can be complemented and supplemented by the following analytics: Financial analysis/ratios analysis Porter’s five forces SWOT Scenario planning/war gaming 83 30 54 54

84 Competitors/Industry Stream Analytics
Introduction Value Chain Market/Sizing and Share Financial/Ratio Analysis Company/Competitor Analysis SWOT Analysis PEST Analysis Porter’s Five Forces Growth Share Matrix Key Success Factors Conclusions 84 14 14

85 SWOT analysis—introduction
09/15/98 COMPETITORS/INDUSTRY STREAM–SUPPLEMENTARY ANALYTICS SWOT analysis—introduction What It Is Why We Use It The SWOT (Strengths-Weaknesses/ Opportunities and Threats) analysis is one of the earliest strategy frameworks: Developed in the 1960s at Harvard Business School by Learned, Christensen, Andrews, and Guth. Gives basic directions for structuring strategic analysis. The underlying theory is that assessment of competitive position should combine both an external and an internal analysis: Derives insight into a company’s competitive position. Internal Assessment External Assessment Strengths & Limitations Strengths: Provides a good summary. Efficient for expository purpose. Limitations: Needs to be compared to how industries create value i.e. what are the industry CSFs Better as a facilitative tool than analytic Client has often already done this analysis Weaknesses Strengths Opportunities Threats Strategic Choices 25 85 6

86 SWOT analysis—how to apply it
09/15/98 COMPETITORS/INDUSTRY STREAM–SUPPLEMENTARY ANALYTICS SWOT analysis—how to apply it Relying on findings from related analytics, produce an overview of: The company’s strengths and weaknesses, regarding in particular: Value chain Financials Organisation Capabilities Portfolio Opportunities/threats in the industry, focusing in particular on: Competitors moves (past/current/forecasted). Prioritise each element after validation with JTMs and industry experts: Greatest strengths and opportunities. Most important weaknesses and threats. 7 86

87 SWOT analysis—illustrative output
COMPETITORS/INDUSTRY STREAM–SUPPLEMENTARY ANALYTICS SWOT analysis—illustrative output Company: A Strengths Weaknesses 2 strong products Dynamic management team High production costs Geographical position Opportunities Threats Growing Asian markets Diversification into service Increasing demand for service Competition in ex-USSR 87

88 SWOT Analysis—top tips
09/15/98 COMPETITORS/INDUSTRY STREAM–SUPPLEMENTARY ANALYTICS SWOT Analysis—top tips Potential Insights Analytic key to obtain a quick grasp of the company’s position in its industry: Highlight areas for development. Hints and Pitfalls Do: Start by defining the market and boundaries. Access all client data. Call market research firms for free contents pages of their reports. Focus on trends (what's changing? why?) Limit the number of elements in each section (max 5) Data Sources Competitors analysis sources. Client’s market research data. Market research firms. Focused market interviews. Database searches. Case Examples The following documents contain good examples of SWOT analysis and output: Related Analytics Porter’s five forces PEST Competitors comparison Capabilities analysis Value chain Financial/ratio analysis Break-even analysis Scenario modelling 30 88 8

89 Competitors/Industry Stream Analytics
Introduction Value Chain Market/Sizing and Share Financial/Ratio Analysis Company/Competitor Analysis SWOT Analysis PEST Analysis Porter’s Five Forces Growth Share Matrix Key Success Factors Conclusions 89 14 14

90 Strengths & Limitations
09/15/98 COMPETITORS/INDUSTRY STREAM–SUPPLEMENTARY ANALYTICS PEST (Political, Economic, Socio—demographic and technology) analysis—introduction What It Is Why We Use It An analytical framework that assesses the impact of four major forces that shape an industry, i.e.: Political forces Economic forces Socio-demographic forces Technology forces The PEST framework: Presents the characteristics of each of these forces (as well as their evolutions). Explains how those forces affect: Competitive environment (as described by Porter through his five forces—see related analytics). Industry value chain. Industry financials. Complement other industry analysis frameworks. Explain ongoing changes in the industry. Strengths & Limitations Strengths: Deals with dimensions such as socio-demographics or policies that may be key to some industries. Limitations: Needs to be seen against how industries create value i.e. what are the industry CSFs Better as a facilitative tool than analytic 25 9 90

91 PEST analysis—top tips
09/15/98 COMPETITORS/INDUSTRY STREAM–SUPPLEMENTARY ANALYTICS PEST analysis—top tips Potential Insights Reveals key trends and issues in the industry, e.g.: Emerging/declining constraints. New rules of the game. Hints and Pitfalls Do: Focus on the most significant aspect if you do not intend to deliver a thorough industry analysis. Don’t: Lose sight of factors that truly influence your clients’ business Data Sources Analysts’ reports Industry reports Database searches Industry experts Case Examples The following documents contain good examples of PEST analysis and output: Related Analytics Porter’s five forces Value chain analysis 30 91 10

92 Competitors/Industry Stream Analytics
Introduction Value Chain Market/Sizing and Share Financial/Ratio Analysis Company/Competitor Analysis SWOT Analysis PEST Analysis Porter’s Five Forces Growth Share Matrix Key Success Factors Conclusions 92 14 14

93 Porter’s five forces—introduction
09/15/98 COMPETITORS/INDUSTRY STREAM–SUPPLEMENTARY ANALYTICS Porter’s five forces—introduction What It Is Why We Use It Porter’s five forces constitutes a framework for analysing a company’s environment (or industry structure): Porter first structured the framework in his 1980 book Competitive Strategy. Porter assumes that competition in an industry depends on five basic forces: The collective strength of these forces determines the ultimate profit potential and allocation in the industry. Assess attractiveness on the basis of competition in an industry. Highlight areas in which industry trends may pose opportunities or threats. Analyse where the company stands vis-a-vis the underlying causes of each competitive force. To understand/diagnose levels of return. Potential Entrants Strengths & Limitations Threat of new entrants Bargaining power of suppliers Industry Competitors Bargaining power of buyers Strengths: Quite comprehensive framework. Good starting point to understand key drivers and trends. Limitations: Very often used strictly qualitatively. Suppliers Buyers Rivalry Among Existing Firms Threat of substitute products or services Substitutes Source: M.E. Porter, Competitive Strategy, 1980, p. 4 Free Press. 25 93 11

94 Porter’s five forces—potential insight/output
09/15/98 COMPETITORS/INDUSTRY STREAM–SUPPLEMENTARY ANALYTICS Porter’s five forces—potential insight/output Several important economic and technical characteristics of an industry are critical to the strengths of each competitive force: Threat of New Entrants Competitive Advantage Barriers to entry: Economies of scale (including shared resources) Product differentiation (proprietary) Capital requirements Switching costs Access to distribution channels Cost disadvantages independent of scale Government policy Expected reaction of incumbent Lower Cost Differentiation Cost Leadership Differentiation Broad Competitive Scope Cost Focus Differentiation Focus Narrow Bargaining Power of Suppliers Intensity of Rivalry Bargaining Power of Buyers A supplier group is powerful when: It is dominated by a few companies and is more concentrated than the industry it sells to. There are no substitute products. The industry is not an important customer. Its products are important to the industry. Products are differentiated or suppliers have built up switching costs. It poses a credible threat of forward integration. Intense rivalry results from: Numerous or equally balanced competitors Slow industry growth High fixed or storage costs Lack of differentiation or switching costs Capacity augmented in large increments Diverse competitors High strategic stakes High exit barriers A buyer group is powerful when: It is concentrated or purchases large volumes relative to seller sales. The products represent a significant fraction of the buyers’ costs or purchases. The products are standard or undifferentiated. It faces few switching costs. It earns low profits. It poses a credible threat of backward integration. The bought product is unimportant. It has full information. Pressure from Substitute Products Exit Barriers Take offensive or defensive actions to create a defensible position against the forces: Search for products that can perform the same function. Assess buyers’ propensity to substitute. Focus on those that: Are improving their price performance trade-off compared with the industries products. Require low switching costs. Are produced by industries earning high profits. L H Positioning the firm so its capabilities provide the best defence. Influencing the balance of forces through strategic moves. Anticipating shifts in the factors underlying the forces and responding to them. Low, stable returns Low, risky returns Entry Barriers L H High, stable returns High, risky returns 12 94

95 Porter’s five forces—top tips
09/15/98 COMPETITORS/INDUSTRY STREAM–SUPPLEMENTARY ANALYTICS Porter’s five forces—top tips Hints and Pitfalls Do: Define precisely the industry before conducting analysis. Quantify your findings where possible. Don't: Just use as a static tool—show trends in each of the areas. Data Sources Industry reports Analysts’ reports Database searches See also related analytics sources Case Examples The following documents contain good examples of Porter’s five forces analysis and output: Related Analytics PEST SWOT Segment attractiveness Product life cycle Product substitution Competitors comparison 30 13 95

96 Competitors/Industry Stream Analytics
Introduction Value Chain Market/Sizing and Share Financial/Ratio Analysis Company/Competitor Analysis SWOT Analysis PEST Analysis Porter’s Five Forces Growth Share Matrix Key Success Factors Conclusions 96 14 14

97 Growth share matrix—introduction
09/15/98 COMPETITORS/INDUSTRY STREAM–SUPPLEMENTARY ANALYTICS Growth share matrix—introduction What It Is Why We Use It Developed by BCG, the growth share matrix displays graphically in a 2-by-2 matrix the position of each business of a company’s portfolio or compares the position of players in one industry. The growth share matrix is based on the use of industry growth and relative market share (RMS) as proxies for: The competitive position of a firm in its industry (RMS). The attractiveness of the segment (growth) The matrix has the following quadrants which have different cash flow characteristics and implications: Star High High Cash cows High Low Dogs Low Low Question marks Low High The key idea is that business units located in each of the quadrants will be in fundamentally different cash flow positions and should be managed differently. Provides a framework to suggest the kind of investment strategy to follow for each business. Assess trends in the evolution of a company’s portfolio of business (when matrix is drawn for both the current year and past years). Understand the competitive position of each business, possible cash requirements and focus attention on key issues. Strengths & Limitations Strengths: Coherent and simple framework. Good starting point for thinking about a firm’s portfolio. Limitations: May fuel simplistic conclusions: The matrix assumes that high relative market share automatically results in high cash generation. This is not true in all industries. Can lead to the interpretation that cash generation is more important than profit generation. Can also lead to wrong behaviour, i.e. milking of cash cow when it needs investment (typically when industry changes). Very rare that a company’s businesses are truly independent. May neglect niche strategies. Quadrant Relative Share Market Growth 25 1 97

98 Growth share matrix—how to do it
09/15/98 COMPETITORS/INDUSTRY STREAM–SUPPLEMENTARY ANALYTICS Growth share matrix—how to do it Steps: 1. Isolate business by defining the appropriate business segments.a 2. For each business, determine: Dollar scale. Market shares of the business and of its biggest competitors. Growth rate of the market in which the business operates. 3. For each business, calculate its relative market share (RMS): RMS = Company market share Market share of biggest competitors 4. Draw the matrix, with a log scale on the horizontal axis and a regular scale on the vertical axis: Divide into quadrants, with the vertical line at 1.0 relative market share and the horizontal line at nominal GNP growth (12.5% in the example set out below). 5. Place each business in the matrix: The centre of the circle is at the intersection of the business’s relative share and its industry growth rate. The area of the circle is proportional to the business’s size. 6. If you wish to understand any trend, repeat steps 1 to 5 with data from previous years. a. See R Koch training material in South African POA for further analysis of business segment definition. 2 98

99 Growth share matrix—illustrative output
09/15/98 COMPETITORS/INDUSTRY STREAM–SUPPLEMENTARY ANALYTICS Growth share matrix—illustrative output Example: Northwest Industries Growth/Share Matrix Major Business Area 1980 Revenues $ 3-Year Business Growth % 3-Year Industry Growth % 1980 Revenues of Largest Competitor $ Relative Share 30% 25% 20% 15% 10% 5% Industrial Group: Tubular steel and ingot moulds Component parts: Connecting devices Lamp Ballasts Chemical Group: Consumer Group: Manufactured consumer products: Apparel Batteries Beverages 986.8 375.3 227.8 147.5 193.2 866.9 605.0 261.9 454.2 16.7 4.7 9.2 -1.6 13.3 7.1 59.7 13 9 5 6 15 11 14 825 275 125 400 250 225 500 1.20 0.83 1.18 0.48 0.91 Tubular Steel Apparel Industry Growth (%) Beverages Batteries Connecting Devices Lamp Ballasts Chemicals Total 2,876.4 4 1.5 1.0 .5 .25 Relative Share Source: Mac Group Core Practice manual, adapted from Michael M. Kaiser Associates. 99 4 106 2 86

100 Growth share matrix—top tips
09/15/98 COMPETITORS/INDUSTRY STREAM–SUPPLEMENTARY ANALYTICS Growth share matrix—top tips Potential Insight The growth share matrix suggests the following strategies for each business unit type: Expected Cash Characteristics of Each Quadrant of the Market Typical Strategic Prescriptions Typical Strategic Movement Prescriptions High “Star” Cash in Balance (some + some -) “Dilemma” Cash Users Build/ hold share Build Market Share selectively Do nothing if cash is positive Invest or turn to a star Divest if not critical SBU Rate of market growth “Cash cows” Cash generators “Dogs” Cash in Balance (some + some -) Hold share/ harvest Withdraw Harvest Share Use to invest in other units Low High Low Strategic movements Relative market share (log scale) Cash movements Hints and Pitfalls Do: Validate your market definition with your client: It is critical in measuring both relative market share and industry growth rate. Don’t: Use as the only generic model—use in conjunction with other analytics (e.g. scenario modelling) 30 3 100

101 Growth share matrix—data source, case examples, and related analytics
09/15/98 COMPETITORS/INDUSTRY STREAM–SUPPLEMENTARY ANALYTICS Growth share matrix—data source, case examples, and related analytics Data Sources Publicly available data for market growth (see market sizing) and competitors’ market share. Client’s internal data: Sales Market share Case Examples The following document contains goods examples of growth share analysis and output: Related Analytics Segment attractiveness. Market-sizing. Market share measures. 30 5 101

102 Competitors/Industry Stream Analytics
Introduction Value Chain Market/Sizing and Share Financial/Ratio Analysis Company/Competitor Analysis SWOT Analysis PEST Analysis Porter’s Five Forces Growth Share Matrix Key Success Factors Conclusions 102 14 14

103 Key success factors and index of key success factors—introduction
COMPETITORS/INDUSTRY STREAM–SUPPLEMENTARY ANALYTICS Key success factors and index of key success factors—introduction What They Are Why We Use Them Key Success Factor (KSF): Any dimension in which excellence is crucial for competitive success, for example: Parts of the marketing mix Research and development Low-cost manufacturing Also known as a critical success factor (CSF) Analysis of KSFs is crucial in most studies of competitive strategies: Skill is in identifying appropriate KSFs Index of key success factors: A summary table that scores and ranks each competitor against the KSFs for the business or segment Note: The important insights come from understanding what is key to success in the industry or segment: The index is simply a device to display the output Refer to section on industry dynamics Key success factors: Determines at what companies must excel to be successful in a business or segment They should be the logical outcome (the so what) of PEST, Porter etc. analysis Index of key success factors: Evaluate competitors’ strengths and weaknesses in areas that are critical to success To position our client relative to competitors Strengths & Limitations Benefits: If rigorously applied, clarifies what capabilities or skills companies need to compete successfully Index allows us to quantify competitors’ relative strengths against KSFs Index provides a structured, concise technique for comparing competitors Drawbacks: The KSFs and comparative index are only as good as the business understanding and judgement used to develop them 103 25 29 29

104 Index of Key Success Factors
COMPETITORS/INDUSTRY STREAM–SUPPLEMENTARY ANALYTICS Key success factors and index of key success factors —how to apply them Key Success Factors Index of Key Success Factors Determining KSFs requires a thorough understanding of a business or segment, and therefore draws on several of other analytics in the toolkit. Relevant issues in understanding the business or segment are: How customers buy, and what’s important to them in the purchase decision: See key purchase criteria Who’s successful in the business or analytic segment, and why. See: Company analysis Financial analysis Trends within the business or segment Other sources of insights into key success factors are: Client’s executives/staff Industry analysts or commentators Determining KSFs is an iterative process: initial research, developing draft hypotheses, testing and, refining these hypotheses The purpose of developing an index of KSFs is to understand: Which ones are most important How competitors perform relative to each key success factor Ranking KSFs, and scoring competitors, requires a good understanding of the business or segments Key steps in the process for ranking and weighting KSFs: Identify KSFs (see box, left) Give each KSFs a weighting reflecting its relative importance (this is a non-trivial task): How would you allocate investment resources for a competitor? Score each competitor against each key success factor: Document the rationale for each score Add up the total scores for each competitor Convert the total for each competitor into a percentage (i.e. what proportion of the perfect score it achieved?) The resulting percentages indicate the relative performance of each competitor 104 25 29 29

105 COMPETITORS/INDUSTRY STREAM–SUPPLEMENTARY ANALYTICS
Key success factors and index of key success factors—illustrative output Index of Key Success Factors—Hypothetical Example Relative Importance for As National Marketer As Regional Marketer National Marketer Regional Marketer Competitor A Competitor B Competitor A Competitor B Effective Distribution 5 4 4 2 4 3 Strong Brand 5 3 5 3 3 4 Innovative Product 2 3 2 1 3 2 Tiered Pricing 2 3 1 1 3 2 Multiple Segment Participation 4 1 4 1 1 1 Low Cost Manufacturing 1 3 1 1 3 3 High R&D spend 2 1 2 2 1 1 Total 21 18 19 11 18 16 19/21 11/21 18/18 16/18 = 90% = 52% = 100% = 89% Note: The scale does not matter. A five-point maximum per factor is convenient because people are used to making five-point scale evaluations. Source: MAC Group, Core Practice Manual. 48 105 45 57

106 Key success factors & index of key success factors—guidelines
COMPETITORS/INDUSTRY STREAM–SUPPLEMENTARY ANALYTICS Key success factors & index of key success factors—guidelines Key Success Factors—Identification Techniques Technique Focus Sources Advantages Disadvantages I Environmental analysis (e.g. PEST) Macro Environment scanning (Corp. Staff) Econometric models Socio-political consulting services Future orientation Macro orientation: analysis goes beyond industry-firm focus Can be linked to threats/ opportunity evaluation More difficult to operationalise into specific industry or firm KSFs Results may not lend themselves to incorporate usage in current timeframe (today’s KSFs) II Analysis of industry structure (e.g. Porter, Value Chain) Industry Macro A variety of industry structure frameworks Specific focus is on industry Frameworks allow user to understand interrelationships between industry structural components Can force more macro level focus (beyond industry boundaries) While excellent source for industry-wide KSFs not so useful in determining firm-specific KSFs III Industry/business experts Industry Micro Industry association executives Financial analysts specialising in industry Outsider familiar with firms in industry Knowledgeable insiders who work in industry Means of soliciting “conventional wisdom” about industry and firms Subjective information often not discovered with more objective, formal and analytical approaches Lack of objectivity often leads to questions in verifying/justifying IV Analysis of competition (focus is limited to the competitive environment, how firms compete) Industry Micro Staff specialities Line managers Internal consultants External consultants Narrowness of focus, offers, advantage of detailed, specific data Depth of analysis leads to better means of justification Narrowness of focus— KSF development limited to competitive arena (as opposed to industry structure approach) Source: Leidecker and Bruno, Identifying and using Critical Success Factors, 1984. Note: “CSFs” = Critical Success Factors. 46 106 44 55

107 Key success factors & index of key success factors—guidelines (cont.)
COMPETITORS/INDUSTRY STREAM–SUPPLEMENTARY ANALYTICS Key success factors & index of key success factors—guidelines (cont.) Key Success Factors Identification Techniques Technique Focus Sources Advantages Disadvantages V Analysis of dominant firm in the industry Industry Micro Staff specialities Line managers Internal consultants External consultants Dominant competitor may set industry KSFs Understanding of No. 1 may assist in co-ordinating firm’s specific KSFs Narrow focus may preclude seeking alternative explanations of success May limit individual firm’s strategic response and focus VI Company assessment (comprehensive firm-specific) Micro Internal staff line organisations (detailed analyses by organisation function—checklist approach) Thorough functional area screening reveals internal/external strengths and weaknesses that may assist KSF development Narrow focus of analysis precludes inputs of more macro approaches Check-list approach can be very time consuming and become data bound VII Temporal/intuitive factors (firm-specific) Micro Internal staff Brainstorming CEO/general management observation More subjective and not limited to functional analysis approach Leads to identification of important short-run KSFs that may go unnoticed in more formal reviews Difficulty in justifying as KSF if only of short term Important may be overstated, if in fact a short-lived phenomenon VIII PIMS results Industry Micro Articles on PIMS Project results Empirically based Excellent starting point General nature Applicability to your firm or industry Determination of relative importance Source: Leidecker and Bruno, Identifying and using Critical Success Factors, 1984. 47 107 44 56

108 Key success factors and index of key success factors—top tips
COMPETITORS/INDUSTRY STREAM–SUPPLEMENTARY ANALYTICS Key success factors and index of key success factors—top tips Potential Insights Determining key success factors, based on a thorough understanding of a business or segment, can highlight areas on which clients should focus: Strengthen capabilities Defend capabilities Helps determine which competitors are well positioned to compete successfully, and estimate the relative performance of competitors Hints and Pitfalls Do: Focus on drawing up the right key success factors Choose a simple scale for weighting criteria Recognise that the index largely involves quantifying judgements: Where possible, try to obtain quantitative data on each competitors performance against each key success factor 108 27 61 69

109 COMPETITORS/INDUSTRY STREAM–SUPPLEMENTARY ANALYTICS
Key success factors and index of key success factors—data sources, case examples, and related analytics Data Sources Key success factors: Publicly -available data on business or segment, and competitors, i.e.: Investment analysts’ reports, annual reports, databases Gemini analyses on business or segment, and competitors Client’s data on business or segment, and competitors Interviews with client, industry experts, and customers Case Examples The following documents contain a checklist of potential approaches for identifying key success factors: Attach Leidedner & Bruno material Also attached are good examples of key success factor analysis and reports Related Analytics Analytics required to develop key success factors: Key purchase criteria Company/competitor analysis Financial analysis/ratios analysis PEST and Porter 109 27 61 69

110 Competitors/Industry Stream Analytics
Introduction Value Chain Market/Sizing and Share Financial/Ratio Analysis Company/Competitor Analysis SWOT Analysis PEST Analysis Porter’s Five Forces Growth Share Matrix Key Success Factors Conclusions 110 14 14

111 COMPETITORS/INDUSTRY STREAM–CONCLUSIONS
The industry/competitors analysis should start to determine some key facts How firms are creating value. Who is successful/unsuccessful, and why. What our clients’ situation is compared with what it believes its situation to be. Whether the business or segments are attractive. Whether any competitors dominate the value chain. Relative power at key stages within the industry. 111

112 But you must keep in mind a few guiding principles
COMPETITORS/INDUSTRY STREAM–CONCLUSIONS But you must keep in mind a few guiding principles Start with the Analytical Problem Solving Process to generate some initial hypotheses. Always constructively question a client’s paradigm about the business. Defining the business and segments may take several stages and you may have to refine your definition in the light of further analysis. Do not rely on either the clients’ or brokers’ definitions of the business and sub-segments: Unless doing a “quick-and-dirty” industry analysis. The solution is not in the analysis alone—take time to think about the findings: Solutions come from drawing insights. 30 112 32 32

113 Customer Needs Stream Analytics
Introduction Segmentation and Targeting Cluster Analysis Customer Experience Key Purchase Criteria Product Life Cycle Product Substitution Adoption Cycle Conclusions 113 14 14

114 Customer Needs Stream: Questions and Analytics
ANALYTICS TO UNDERSTAND A CLIENT’S STRATEGIC POSITION Customer Needs Stream: Questions and Analytics Customer Needs Stream Strategic Questions Strategic Position Main Analytics What are the (economic) boundaries of the businesses the company is in? How are they changing? How do companies create value in each of the businesses? How is this changing? How is the client company positioned relative to the competition to create value? How is it changing? How and why do customers purchase? What is the trigger? What different needs-based segments exist? What substitute products are there? What is the underlying customer need? What trends are emerging? Segmentation and targeting Cluster analysis Customer experience Product substitution Adoption cycle Key purchase criteria Product life cycle What are the key purchase criteria by segment? Are purchase behaviours changing? How? Why? How does our client meet the key purchase criteria compared with its competitors? Core Analytic Supplementary Analytic 21 114 21 21

115 Customer Needs Stream Analytics
Introduction Segmentation and Targeting Cluster Analysis Customer Experience Key Purchase Criteria Product Life Cycle Product Substitution Adoption Cycle Conclusions 115 14 14

116 Elements of Customer Analysis What differentiators? (what segments)
CUSTOMER NEEDS STREAM— INTRODUCTION The customer needs stream aims to analyse the three fundamental dimensions of a customer analysis Elements of Customer Analysis Key purchase criteria Adoption cycle Product life cycle Product substitution What needs? What purchase criteria? What behaviours? Customer Analysis Core Analytics Supplementary Analytics What differentiators? (what segments) How well are we serving the customer? Segmentation and targeting Cluster analysis Customer experience The purpose is both to determine what customers to target and how to acquire and retain them. 116

117 Customer Needs Stream Analytics
Introduction Segmentation and Targeting Cluster Analysis Customer Experience Key Purchase Criteria Product Life Cycle Product Substitution Adoption Cycle Conclusions 117 14 14

118 Segmentation & targeting—introduction
CUSTOMER NEEDS STREAM— CORE ANALYTICS Segmentation & targeting—introduction Overview of Segmentation Focus on Needs-based Segmentation Process of dividing markets into groups of potential customers with similar characteristics: The underlying assumption is that these customers are likely to exhibit similar purchase behaviours. Segmentation aims to answer the following questions: What are the characteristics of my customers? How can they be differentiated (segmented)? How well are competitors serving each segment? Which segment should I target and how? There are a number of ways to segment customers: Choice of products or brand. Demographics e.g. by age, life stage, social class. Psychographics—using attitudes and behaviours. Needs (see opposite). Channels. Financial assets (good for personal finance market). Etc. Segmentation can be developed by a combination of a quantitative or qualitative approach: Cluster analysis involves a very quantitative approach. Needs based/BMFO is more qualitative. Specific type of segmentation, which splits current and/or prospective customers into homogeneous groups based on product and/or service needs. Thus, needs-based segmentation is a means to: Analyse what customers’ key needs are. Understand how to serve the different emerging segments. Determine the attractiveness of these segments. Gemini often uses an needs-based approach as it is linked heavily with Gemini’s Building Market Focused Organisation (BMFO) methodology: See strategy kbase on Gemini Compass for detailed material. A needs-based approach is used to ensure a customer is more likely to respond to a proposition: Specific needs are addressed and targeted. Guidance should be sought as to what type of segmentation to use—Gemini contacts Shirley Lo, Julia Beck. 118 25 29 29

119 Segmentation & targeting—introduction (cont.)
CUSTOMER NEEDS STREAM— CORE ANALYTICS Segmentation & targeting—introduction (cont.) Why We Use It Strengths & Limitations Isolates sections of market for which strategy needs to be uniquely defined: Finds niche opportunities. Identifies customers more likely to undertake a given attitude. Evaluates segments and chooses one or more for target activity. Identifies which customer groups the company should focus. Identifies appropriate products, services, and marketing for different segments. Strengths: Focused approach which helps increase revenue and margin. Foundation on which all other marketing actions can be based. Provides greater customer-focus: Allows the organisation to gain a clear picture of each segment and its service needs. Limitations: Requires a major corporate commitment. Can become too reliant on statistically significant segments at the expense of industry experience and business sense. Can cost more than a mass marketing approach. For needs-based segmentation, it is unlikely that customer needs data is already available: Time consuming to collect information required. A considerable amount of time is required to collate data (minimum 2 weeks): Careful consideration of use of analytic must be given. 119 25 29 29

120 Segmentation & targeting—how to do it
CUSTOMER NEEDS STREAM— CORE ANALYTICS Segmentation & targeting—how to do it Conducting segmentation requires the following steps: Define Scope Select Segmentation Bases Gather Data Analyse Data Target Establish research objectives Review segmentation viability/segment formation criteria: Time available Level of detail required Seek guidance from experts or books Contact Shirley Lo or Julia Beck Choose type of market segmentation: Generate hypothesis about market Determine, criteria/variables for segmentation Design and choose data gathering approach, e.g.: Identify information required Test approach with joint team Plan/conduct data gathering: Phone surveys Day in life of studies Workshops Focus/groups Sampling Identify attributes captured during customer interviews Use statistical techniques to groups respondents, including: Cluster analysis Group the attributes in a manageable number of segments: Profile each segment Can segment be ranked? Can segment be reached? Will segment respond? Evaluate the attractiveness of each segment (see example overleaf): Size and growth (on the basis of your sampling procedure assumptions, infer segment size) Key Purchase Criteria vs. your value proposition Profitability vs. efforts needed to serve segment Accessibility Select the target segment for your activities: Validate segments Conduct gap analysis Assess capabilities/ability to serve potential segments: Existing v. required Use checklist of segmentation criteria (see below) CUSTOMER DATABASE 120

121 Segmentation & targeting—selection criteria
CUSTOMER NEEDS STREAM— CORE ANALYTICS Segmentation & targeting—selection criteria Selection Criteria 1. Targetability: Can you easily ‘reach’ your customers? 2. Measurability: Can you quantify the segment by size and product usage? Can you rank the buying factors that are meaningful to your customers? 3. Accessibility: How efficient are the channels at serving each segment? 4. Sustainability: How many segments are reasonable? Are the segments large enough to warrant the resources and effort necessary for a targeted marketing effort? Is cluster membership stable? Is the solution stable? 5. Profitability: Is the segment potentially profitable enough to make the effort worthwhile? 6. Compatibility with competition: How interested in the segment are your major competitors? Are they actively pursuing it, or are they showing only a mild interest? 7. Effectiveness: Does your sales force have the skills and resources needed to serve the segment effectively for the long haul? Do clusters offer actionable opportunities? 8. Defendability: Can your company defend this segment against attack by a major competitor? Source: Adapted from Norton Paley, “Cut Out For Success”, Sales and Marketing Management, Vol. 146, No. 11, 1994. 121

122 Segmentation & targeting—illustrative output
CUSTOMER NEEDS STREAM— CORE ANALYTICS Segmentation & targeting—illustrative output Example Segment Profile: Needs Low priorities Characteristics Availability and reliability dominate all other needs Reliability deliveries Mixed pallets not required Few display pallets Promotions are important for some Understanding of needs is important Most will have EDI and scanning Cross-docking and back-hauling unlikely in 3-5 years time Many will require non-standard pack sizes Handling of returns and credits Secondary packaging specification Multi-functional contact Chiefly supermarket chains Few delivery points Warehouse deliveries Key Performance Gaps (Competitor Performance vs. Lever Performance) Delivery reliability from Lever today: +/- 2.5 hours from best in class today: +/- 2.5 hour future need: +/- 1 hour Product availability from Lever today: 97% from best in class today: 99% future need: 100% Understanding of needs Promotion type and exclusivity some require twice as many exclusive promotions Delivery lead time from Lever today: 3.5 days from best in class today: 3.5 days future need: 1 day Importance and Performance Ratings Need Importance Lever Performance Competitor Performance Note: Figures are average for each segment. 122

123 Segmentation & targeting—top tips
CUSTOMER NEEDS STREAM— CORE ANALYTICS Segmentation & targeting—top tips Potential Insights May reveal new opportunities Segmentation is a critical aspect of customer analysis Analytic helps determine: What the characteristics of your customers are How these customers can be differentiated based on their characteristics Where niche opportunities lie: Existing unsatisfied needs Opportunities to create new needs Hints and Pitfalls Do: Consider needs along the whole value chain Ensure segments are targetable—ensure sufficient demographic data Spend sufficient time hypothesising needs, listing other information required, and writing and testing survey Consider conducting a preliminary survey—may be useful to identify a full set of customer needs Consider using a market research agency to carry out survey, tabulate results, and perform cluster analysis Make sure you validate your segmentation criteria—test with people who will use it Be specific about how you are going to reach and serve each segment Don’t: Collect too little relevant information Use an insufficient sample size Use non-uniform information collected across all product categories Rely on information systems incapable of cross communication Try to do this in a limited timeframe Be side-tracked by recent ups or downs in the clients service level, and how this impacts customer perception 123 27 61 69

124 CUSTOMER NEEDS STREAM— CORE ANALYTICS
Segmentation & targeting—data sources, case examples, related analytics Data Sources Primary sources: Focus groups Personal interviews Telephone interviews Secondary sources: Publicly available data Market research Consumer surveys Case Example The following documents contain good case examples of needs-based segmentation and output: Lever: “Understanding Customer Service Requirements”; Part 2 Customer Segmentation by Needs British Steel, London Server Related Analysis Cluster analysis Segment attractiveness BMFO methodology (see Strategy Kbase on Gemini Compass) 124 27 61 69

125 Customer Needs Stream Analytics
Introduction Segmentation and Targeting Cluster Analysis Customer Experience Key Purchase Criteria Product Life Cycle Product Substitution Adoption Cycle Conclusions 125 14 14

126 Cluster analysis—introduction
CUSTOMER NEEDS STREAM— CORE ANALYTICS Cluster analysis—introduction What It Is Why We Use It Cluster analysis is part of a statistical process which aims to generate segments: A cluster (or segment) consists in the grouping of customers presenting similar features (I.e. needs, buying criteria, etc.) A cluster results from the extraction within a wide statistical population of “similar” individuals The cluster analysis process is a “data crunch” process: Allows you to interpret any market as the sum of several clusters: Each cluster presents a specific profile Can be used to help develop needs-based segments To build a strong fact-based segmentation: Identifying of segments Characterising of segments Relatively sizing clusters Note: We generally use the output of cluster analysis—the data mining and crunching aspect being frequently outsourced to service providers Strengths & Limitations 1. Identify key dimensions which explain variance in data set 2. “Cluster” respondents according to how they scored against the key Develop segment profiles from statistical clusters Cluster Analysis Strengths Indispensable to achieve rigorous segmentation Limitations Cumbersome process when criteria for segmentation are complex Apply hypotheses Apply factor analysis 126 25 29 29

127 Cluster analysis—how to do it
CUSTOMER NEEDS STREAM— CORE ANALYTICS Cluster analysis—how to do it Iterative Loop Why are clusters emerging? Can we act on these clusters? 1. Analyse potential criteria 2. Determine criteria for clustering 3. Choose clusters 4. “Flesh out” segment profiles Conduct upfront factor analysis to determine factors Apply industry hypotheses Set your targets: What do you need to understand from your population What dimensions characterise/ influence your market: Focus on explanatory dimensions Validate your target criteria: Workshops Focus groups Analysis of customer surveys Clusters are chosen by looking at a number of different criteria to see which result in the most distinct segments Using either a spreadsheet or specific software, clusters are extracted from a customer database Group individuals according to their scores in the dimensions previously identified: Anyone within a cluster is nearer to the mid-point of that cluster than any other The number of clusters is ultimately a matter of judgement: Can in theory be limitless See segmentation Run cluster breaks against all statements Examine the “hard” demographic data available for each cluster Develop “pen-portraits” for each segment 127 25 29 29

128 Cluster analysis—top tips
CUSTOMER NEEDS STREAM— CORE ANALYTICS Cluster analysis—top tips Potential Insights Critical step in the segmentation process Allows client to determine parameters which differentiate their market Enables understanding of how different parts of the market operate Hints and Pitfalls Do: Make sure that your example is statistically significant Try multiple criteria to see which form the best cluster Try to outsource where possible—Cap Gemini have a group that perform this function Don’t: Rely totally on the analysis — use judgement and knowledge to choose the best cluster Data Sources Customer surveys Workshops Interviews Client’s customer database Case Examples The following documents contain good examples of cluster analysis and output Related Analytics Segmentation Multi-variant statistical analysis, e.g. Conjoint analysis (see Strategy Kbase on Gemini Compass for detailed material) Key purchase criteria 27 128 61 69

129 Customer Needs Stream Analytics
Introduction Segmentation and Targeting Cluster Analysis Customer Experience Key Purchase Criteria Product Life Cycle Product Substitution Adoption Cycle Conclusions 129 14 14

130 Customer experience—introduction
CUSTOMER NEEDS STREAM— CORE ANALYTICS Customer experience—introduction What It Is Why We Use It Illustrates key areas of customers interactions with a business: Usually shown as a succession of interaction with a company Should account for what the customer goes through from the time they first become aware of a product to the point they stop using it Can be generic for an industry or specific for a given company Provides a starting point to identify areas of potential differentiation Answers a series of questions as to what, where, when, how and why customers buy, e.g.: How do consumers become aware of their needs? How do consumers order and purchase? How is your product repaired or serviced? Highlights what criteria are important to customers in purchase and discontinuation decisions A variant of the value chain concept: Plots customer interaction against it Understand what events affect the customer’s relationship to decide what levers the client should manage strategically and operationally to retain the customer Highlight what processes are key to efficiently serve and retain the customer: Both practical (eg. switchboard) and technical (eg. R&D) Help focus creativity on areas where opportunities to create a competitive advantage appear Strengths & Limitations Strengths: Interprets the industry/company value chain from customers’ perspective Helps put them in their customers’ shares: Can help make understanding very tangible for clients: Puts them in their customers’ shoes. Limitations: Lengthy process: Requires wide ranging customer surveys 130 25 38 46

131 Customer experience—how to do it
CUSTOMER NEEDS STREAM— CORE ANALYTICS Customer experience—how to do it 1. Get a rough understanding of how and why consumers are buying: Analyse consumer surveys. Talk to experts in the client company. For each key dimension of the customer experience, capture: What takes place, where, with whom, and how. What influences the customer and why. What customers are satisfied/dissatisfied with and why. Validate your understanding with customers: Conduct customer focus groups and customer interviews. 2. Map the customer’s experience to the client’s processes. 3. Identify associated activities—to deliver the customers’ experience. 4. Use focus groups to analyse where areas exist for potential improvement. 131 47 39

132 Customer experience—illustrative output
CUSTOMER NEEDS STREAM— CORE ANALYTICS Customer experience—illustrative output An Illustration of Customer Experience in the Telcos Product & service availability The Customer Experience Brand awareness Ease of buying Ease of connection The First Experience Usage quality Quality of service Ease of leaving Delivering the Customer Experience Branding & Positioning Product Development Sales Credit Checking Set-up & Activation Delivery Usage Customer Services Billing & Collection Service Termination Activities to Deliver the Customer Experience Company/Industry Value Chain Source: London Shop Training Module: “Production Market/Industry Analyses and Using Strategic Frameworks”, 27/2/98, p. 14. 42 132 40 42 50

133 Customer experience—top tips
CUSTOMER NEEDS STREAM— CORE ANALYTICS Customer experience—top tips Potential Insights Highlights typical source of customer satisfaction and retention by appreciating the context within which each step of the consumption chain unfolds Suggests levers for differentiation Provides a basis for exploring many non-traditional ways to create value Hints and Pitfalls Do: Perform the exercise for each important customer segment Compare customers’ actual experience with your client’s perception of what that experience is Link to functions and processes Use personal experience a a starting point to understand the process Don’t: Over simplify the customer experience: Its complexity may suggest levers for differentiation Develop your point of view from a too limited set of specific experiences 133 27 40 48

134 Customer experience—data sources, case examples and related analytics
CUSTOMER NEEDS STREAM— CORE ANALYTICS Customer experience—data sources, case examples and related analytics Data Sources Personal experience Customer survey Interviews: Customer Experts Focus groups Market research Experience on other projects Case Examples The following documents contain good case examples of customer experience: Related Analytics Most useful when conducting a customer analysis Can be complemented by the following analytics: Needs based segmentation 134 30 41 49

135 Customer Needs Stream Analytics
Introduction Segmentation and Targeting Cluster Analysis Customer Experience Key Purchase Criteria Product Life Cycle Product Substitution Adoption Cycle Conclusions 135 14 14

136 Key purchase criteria—introduction
CUSTOMER NEEDS STREAM— CORE ANALYTICS Key purchase criteria—introduction What It Is Why We Use It Key purchase criteria: Criteria that are most important to customers in the buying process: Aim is to understand the most important drivers of purchase behaviour Usually learned via structured customer interviews A technique for scoring competitors against customers’ key purchase criteria: Outlined by Richard Koch in his Guide to Strategya Koch describes a four-step process to evaluate competitors against the key purchase criteria Typically there are three elements: 1. Assessment of customers’ key purchase criteria 2. Rating of clients against those criteria 3. Rating of competitors’ against those criteria Understand what drives customers’ purchase decisions Identify opportunities from unmet needs Determine how client is rated against competitors Strengths & Limitations Strengths: Provides a quantitative assessment of how competitors perform against criteria and with respect to each other Limitations: Criteria and analysis are only as good as the thinking and business judgement that went into them! a. FT Pitman Publishing, 1995 25 136

137 Key purchase criteria—how to apply it
CUSTOMER NEEDS STREAM— CORE ANALYTICS Key purchase criteria—how to apply it Key Purchase Criteria Set-up a solid questionnaire based on your target customer purchase criteria: Brainstorm the potential criteria with industry/market experts Test them with focus groups Select target customers and conduct interviews: Establish a clear list of selection criteria based on target customer profiles (see segmentation) Ask interviewees to rank their purchase criteria on a scale from 1 (unimportant) to 5 (essential) Record answers in a spreadsheet and display the average result graphically (see illustrative output) Ask customers to score client on each of the purchase criteria, on a 1 to 5 scale. Then ask customers to score client’s competitors on a similar scale on each of the criteria: Overlay results on the same graph 26 137

138 Key purchase criteria—illustrative output
CUSTOMER NEEDS STREAM— CORE ANALYTICS Key purchase criteria—illustrative output Importance and Performance Ratings Need Importance Rating 1,000 Lever Performance 900 Competitor Performance 800 700 600 500 400 300 200 100 Low DPC Packaging EDI Capability Regular Range Rationalisation Delivery Reliability Promotion Type Product Availability Promotion Exclusivity Delivery Lead Time Content Accuracy Efficient Invoicing Needs Understanding Innovation Lead Time Promotion Frequency Partnership Approach Promotion Lead Time Information Provision Complaints Response Spec. of Secondary Order Taking Efficiency Good Arrival Condition Delivery Configuration Multi-Functional Contact Efficiency of Off-Loading Communications Frequency Handling of Returns / Credits Source: Internal Interviews. N= 33. 138 106 86

139 Key purchase criteria—top tips
CUSTOMER NEEDS STREAM— CORE ANALYTICS Key purchase criteria—top tips Potential Insights Highlights potential levers for pursuing competitive advantage Show how well the client company is meeting the segment purchasing criteria Hints and Pitfalls Do: Try to understand peoples subconcious needs (one-third are rational, two-thirds are emotional) Understand the drivers of market share Make sure that your sample is statistically significant (size, characteristics, etc.) Don’t: Confuse price as being a key factor - identify value for money benefits Take information at face value in a commodity market - question and challenge it Data Sources Key Purchase Criteria: Customers surveys (questionnaire) Case Examples The following documents contain good examples of output of business definition analysis: Lever: London Project Archive T&N: London Project Archive Cellnet: London Project Archive Also refer to Richard Koch’s book Guide to Strategy Related Analytics Customer experience Price elasticity Adoption cycle 30 139

140 Customer Needs Stream Analytics
Introduction Segmentation and Targeting Cluster Analysis Customer Experience Key Purchase Criteria Product Life Cycle Product Substitution Adoption Cycle Conclusions 140 14 14

141 Product life cycle—introduction
CUSTOMER NEEDS STREAM— SUPPLEMENTARY ANALYTICS Product life cycle—introduction What It Is Why We Use It Based on the age of a product category, predicts how sales will develop Distinguishes five stages of development: Introduction Growth Maturity Saturation Decline/termination Length of time in each period varies tremendously: Some products have very short cycles, others take decades or even centuries to go through the cycle Growth is still possible in mature categories, but typically will require greater investment or greater creativity than in less mature categories Predict sales growth, and associated customer and competitor behaviours Prescribe appropriate marketing strategy Assess strengths/weaknesses of product portfolio Phases of sales growth Phases of sales decline Strengths & Limitations Strengths: Most useful as one of several sources of evidence, e.g. with conjoint analysis Limitations: Any prediction is tricky Companies can affect the shape of the growth curve through product innovation and repositioning 141 25 29 29

142 Product life cycle—how to use it
CUSTOMER NEEDS STREAM— SUPPLEMENTARY ANALYTICS Product life cycle—how to use it Establish if the concept is applicable Predict how sales will develop Predict the timing of future developments Data required: Sales figures/timeframe: Either actual past/current sales Or forecasted figures Use statistical/graphical analysis: Plot past category sales data in a spreadsheet, in such a way that a long term pattern is easily shown Use strategic/judgmental analysis: Use the theoretical curve to evaluate where the category stands Consider use of conjoint analysis It is important to predict the highest level that sales will reach, e.g. for a household appliance the simplified formula might be: Annual Sales = (Number of new households) x (percentage who will buy) + (Number of existing owners) x (percentage who replace each year) The uptake percentage must be established using: Customer surveys Industry forecasting models where available Look to the category’s past behaviour and compare with similar products Look out for: Technology shifts Lead markets Substitute products Telecoms/e-commerce 25 142 29 29

143 Product life cycle—illustrative output
CUSTOMER NEEDS STREAM— SUPPLEMENTARY ANALYTICS Product life cycle—illustrative output Household Durables in Early 1970s Decline/ Termination Introduction Growth Maturity Saturation Refrigerators Freezers Ranges & Ovens Automatic Washers Room A/C B&W TV Colour TV Saturation/Sales Adoption Dishwasher Compactor Introduction Wringer Innovators 2.5% Early Adopters 13.5% Early Majority 34% Late Majority 34% Laggards 16% Time Source: Mac Group Core Practice Manual. 143

144 Product life cycle—potential insight
CUSTOMER NEEDS STREAM–SUPPLEMENTARY ANALYTICS Product life cycle—potential insight Typical Insight Provided by Product Life Cycle Analysis Introduction Growth Maturity Decline Buyers and Buyer Behaviour High-income purchaser Buyer inertia Buyers must be convinced to try the product Widening buyer groups uneven quality Mass market Saturation Repeat buying Choosing among brands is the rule Customers are sophisticated buyers of the product Products and Product Change Poor quality Product design and development key Many different product variations; no standards Frequent design changes Basic product designs Products have technical and performance differentiation Reliability key for complex products Competitive product improvements Good quality Superior quality Less product differentiation Standardisation Less rapid product changes—more minor annual model changes Trade-ins become significant Little product differentiation Spotty product quality Marketing Very high advertising/sales (a/s) Creaming prices strategy High marketing costs High advertising, but lower percent of sales than introductory Most promotion of ethical drugs Advertising and distribution key for non-technical products Market segmentation Efforts to extend life cycle Broaden line Service and deals more prevalent Packaging important Advertising competition Lower a/s Low a/s and other marketing Manufacturing and Distribution Over capacity Short production runs High skilled-labour content High production costs Specialised channels Under capacity Shift toward mass production Scramble for distribution Mass channels Some over capacity Optimum capacity Increasing stability of manufacturing process Lower labour skills Long production runs with stable techniques Distribution channels pare down their lines to improve their margins High physical distribution costs due to broad lines Mass channels Substantial over capacity Mass production Speciality channels Source: M.E. Porter, Competitive Strategy, 1980, pp. 159–161. 106 144 86 66

145 Product life cycle—potential insight (cont.)
CUSTOMER NEEDS STREAM–SUPPLEMENTARY ANALYTICS Product life cycle—potential insight (cont.) Typical Insight Provided by Product Life Cycle Analysis Introduction Growth Maturity Decline R&D Changing production Foreign Trade Some exports Significant exports Few imports Falling exports Significant imports No exports Significant imports Overall Strategy Best period to increase market share R&D engineering are key functions Practical to change price or quality image Marketing the key function Bad time to increase market share particularly if low-share company Having competitive costs becomes key Bad time to change price image or quality image “Marketing effectiveness” keys Cost control key Competition Few companies Entry Many competitors Lots or mergers and casualties Price competition Shakeout Increase in private brands Exits Fewer competitions Risk High risk Risks can be taken here because growth covers them up Cyclically sets in Margins and Profits High prices and margins Low profits Price elasticity to individual seller not as great as in maturity High profits Highest profits Fairly high prices Lower prices than introductory phase Recession resistant High P/Es Good acquisition climate Falling prices Lower profits/lower margins Lower dealer margins Increased stability of market shares and price structure Poor acquisition climate: Tough to sell companies Lowest prices and margins Low prices and margins Falling prices Prices might rise in late decline Source: M.E. Porter, Competitive Strategy, 1980, pp. 159–161. 106 145 86 66

146 Product life cycle—top tips
CUSTOMER NEEDS STREAM–SUPPLEMENTARY ANALYTICS Product life cycle—top tips Hints and Pitfalls Do: When creating the curve, beware of seasonal, non-recurring sources of fluctuations: May be necessary to smooth those fluctuations Ensure you understand if life cycle of a product has been extended by line extensions/modifications Don’t: Ignore version change Data Sources Market surveys, Nielsen databases for: Benchmarks against similar products Consumer take up Segment sales Client sales data Case Examples The following documents contain good examples of product life cycle analysis: Various documents on C4 Kbase, Gemini Compass Related Analytics Key purchase criteria and comb analysis Needs-based segmentation Product portfolio analysis Scenario modelling 27 146 61 69

147 Customer Needs Stream Analytics
Introduction Segmentation and Targeting Cluster Analysis Customer Experience Key Purchase Criteria Product Life Cycle Product Substitution Adoption Cycle Conclusions 147 14 14

148 Product substitution—S-curve: introduction
CUSTOMER NEEDS STREAM–SUPPLEMENTARY ANALYTICS Product substitution—S-curve: introduction What It Is Why We Use It Substitution is the process by which one product or service supersedes another in performing a particular function for a buyer Successful substitution often follows the shape of an S-curve: Along the S-curve, the substitution process gradually intensifies as it goes through the three typical phases: Testing phase Take-off phase Peak At each stage the competitive environment evolves Usually linked to product functionality or customer need Often used in conjunction with conjoint analysis To understand/forecast market’s reaction to new product introduction To assist in directing adaptation of strategy to market dynamics: Generally used qualitatively Strengths & Limitations Strengths: Useful qualitative tool Limitations: Assessing quantitatively the threat of substitution can be laborious and time consuming Listing all substitutes requires lateral thinking 148 25 29 29

149 Product substitution—typical S-curve
CUSTOMER NEEDS STREAM–SUPPLEMENTARY ANALYTICS Product substitution—typical S-curve Eventual upper bound may be higher than original market High prices Low supply High uncertainty Low awareness UPPER BOUND Pioneer switching Awareness increases Successful precedents are set Flaws appear and are fixed Substitution as % of total demand TAKE-OFF PHASE Uncertainty decreases due to precedents Pressure to switch arises from creation of competitive gap Costs of switching decrease Competition in new supply industry lowers prices and increases value INFORMING AND TESTING PHASE Time Source: Strategy Discipline Core Skills Learning Module, “Substitution”, September 1995. 149

150 Product substitution—S-curve: how to do it
CUSTOMER NEEDS STREAM–SUPPLEMENTARY ANALYTICS Product substitution—S-curve: how to do it Understanding product substitution requires several stages of analysis: Identify substitutes Understand the economics Understand the dynamics Offensive Strategies 1 2 3 Define the Threat Predict Evolution Defensive Strategies List all potential substitutes Assess the threat of substitutes Model the S-curve Focus on products/ process that could fulfil similar function(s) Consider options such as: Not performing the function at all Reducing usage rate Consider both quantitative and qualitative factors, i.e.: Relative value/price, affected by: usage rate, financing cost, value proposition, etc. Propensity to switch, affected by: resources/risk profile, etc. Barriers to switching, affected by: cost, retaining and relearning, etc. Quantify where possible and make value judgement Several functions exist to model this curve. The most widely used is the logistic curve. This curve has the function: To find K and c, plot known values of F/(1-F) on a log scale against time on a linear scale The points should lie on a straight line with equation: Solve the simultaneous equation to get K, c and plot F against t to draw the S-curve F 1n = K.(t+c) (1 - F ) 25 150 29 29

151 Product substitution—S-curve: top tips
CUSTOMER NEEDS STREAM–SUPPLEMENTARY ANALYTICS Product substitution—S-curve: top tips Potential Insights Can account for industry/firm growth or decline Hints and Pitfalls Do: Assess factors for each of the individual segments within the target market: Substitution follows different paths in different segments Don’t: Restrict the market too much: Risk overlooking an impending threat of substitution from outside Data Sources Market surveys Industry reports Focus groups To determine economies and substitutes To validate substitutes Case Example The following documents include good examples of product substitution analysis: Various documents on C4 Kbase, Gemini Compass Related Analytics Product life cycle Adoption cycle Scenario modelling 27 151 61 69

152 Customer Needs Stream Analytics
Introduction Segmentation and Targeting Cluster Analysis Customer Experience Key Purchase Criteria Product Life Cycle Product Substitution Adoption Cycle Conclusions 152 14 14

153 Adoption cycle—introduction
CUSTOMER NEEDS STREAM–SUPPLEMENTARY ANALYTICS Adoption cycle—introduction What It Is Why We Use It Adoption is an individual’s decision to become a regular user of a product or service The adoption cycle accounts for the process through which a potential consumer passes from first hearing about product/brand to final adoption That process can be divided into 4 stages: Awareness: the consumer becomes aware of the product/brand but lacks information about it Qualification: the consumer is informed and considers whether to try the product/brand Trial: the consumer tries the product/brand to improve his estimate of its value Adoption: the consumer decides to make full and regular use of the innovation Often used in conjunction with conjoint analysis We generally use it qualitatively to help build an effective strategy for early market penetration: The new product/brand marketer should induce consumer transition from one stage to the next Strengths & Limitations Strengths: Supplements segmentation to help further focus marketing efforts Limitations: n/a 153 25 29 29

154 Adoption cycle—how to apply it
CUSTOMER NEEDS STREAM–SUPPLEMENTARY ANALYTICS Adoption cycle—how to apply it Establish at which stage of a cycle your market stands Predict future developments Work on the basis of market researchers asking a significant sample of consumers the following questions: “Are you aware of product/brand X?” “Would you bury product/brand X?” “Have you tried product/brand X?” “Have you purchased product/brand X within the last month?” Etc. Note that the first group necessary “Aware but have not tried” is derived by singling out those respondents who answered yes to the first question and no to the second. The same procedure is followed for the subsequent groups. Record findings in a spreadsheet and present average results graphically Analyse against theoretical curve Determine likely timing through benchmarking with similar products/services categories Develop marketing scenarios and test impact on adoption cycle with customer focus groups: Objective being to identify the most efficient scenario to speed up adoption 154 25 29 29

155 Adoption cycle—top tips
CUSTOMER NEEDS STREAM–SUPPLEMENTARY ANALYTICS Adoption cycle—top tips Potential Insight Key factors to manage at each stage include: To determine potential problem areas, it is useful to study the client’s relative position in each of these stages Awareness Qualification Trial Adoption Advertising volume Brand image (produced by advertising and packaging) Product characteristics, packaging and distribution efforts such as merchandising Similar to selection, plus after-sales services, etc. Hints & Pitfalls Do’s Define the groups—to avoid double counting, as the consumers who “drop out” of each stage: Thus each group consist of those customers who are at a certain stage, e.g. “Aware”, but not at the next, e.g. “Have tried” (see below) Check the methodology of the market research for typical errors: Poor sampling procedure Vague questions or questions that are difficult to interpret Don’ts Few market research surveys segment the categories as neatly as “Aware” , “Qualify”, etc.: A good substitute is level of consumption (“Aware”, “Have tried”, “Buy occasionally”, “Buy frequently”) 27 155 61 69

156 Adoption cycle—data sources, case examples and related analytics
CUSTOMER NEEDS STREAM–SUPPLEMENTARY ANALYTICS Adoption cycle—data sources, case examples and related analytics Data Sources To estimate where your target market falls you can refer to: Market surveys—usually client driven Nielsen data Case Examples The following documents contain good examples of adoption cycle analysis and output: Various documents on C4 Kbase, Gemini Compass Related Analytics Key purchase criteria Segmentation Product life cycle 156 27 61 69

157 Customer Needs Stream Analytics
Introduction Segmentation and Targeting Cluster Analysis Customer Experience Key Purchase Criteria Product Life Cycle Product Substitution Adoption Cycle Conclusions 157 14 14

158 CUSTOMER NEEDS STREAM–CONCLUSIONS
When conducting a customer analysis, always keep in mind fundamental caveats Top tips for conducting good customer analysis: Know what the segmentation will be used for and design questionnaires around strong hypotheses: Make sure that the research agency understands this process. You will always get best cluster definitions with thousands of samples and few well thought out questions—as opposed to hundreds of samples and long questionnaires: Respondents of interviews get bored with long and complex questionnaires—response quality quickly drops. When setting up your questionnaire—see document on interviewing training (Cambridge Shop New Analyst Training) on Gemini Compass: Make sure that wording is totally unambiguous: Test on idiots first! Use 4 or 6 point scales: Forces negative or positive responses (as opposed to neutral ones) Find a research agency that specialises in your industry sector and carefully manage the quality of the sample, data handling and analysis: Agencies can make basic mistakes—and no one usually notices They don’t like you doing this—but you need to! Plan to analyse the analysis output yourself: Research agencies don’t achieve good insight—whatever they say Manage client expectations versus cost of research—(could be £100,000+!) 158

159 Profitability Stream Analytics
Introduction Cost Structure Analysis Relative Cost Positioning Break-even Analysis Economies of Scale Experience Curve Price Elasticity Business/Unit Profitability Conclusion 159 14 14

160 Profitability Stream: Questions and Analytics
ANALYTICS TO UNDERSTAND A CLIENT’S STRATEGIC POSITION Profitability Stream: Questions and Analytics Profitability Stream Strategic Questions Strategic Position Main Analytics What are the (economic) boundaries of the businesses the company is in? How are they changing? How is pricing determined? What are the natural boundaries of unit cost drivers (by product/geography)? Break-even analysis Value chain Cost structure Relative cost-positioning How do companies make money? How is pricing determined in each business? What are the major areas of unit cost position? What are their drivers? How is the cost structure changing? Why? Economies of scale How do companies create value in each of the businesses? How is this changing? Experience curve Price elasticity How well is our client positioned to set prices versus the competitors? What is the cost position of our client relative to its competitors? Is it changing? How is the client company positioned relative to the competition to create value? How is it changing? Business/Unit profitability Core Analytic Supplementary Analytic 22 160 22 22

161 Profitability Stream Analytics
Introduction Cost Structure Analysis Relative Cost Positioning Break-even Analysis Economies of Scale Experience Curve Price Elasticity Business/Unit Profitability Conclusion 161 14 14

162 Profitability stream—introduction
This section provides some basic analytics to understand the revenues and cost drivers: For the client. For the industry. Analytics complement, but do not detail how to construct economic models: See key documents in the A&D Kbase, Gemini Compass. It does not detail approaches for business/benefits cases: It does not cover Activity Based Costing/Management: See the “Guiding and Measuring Success” competency group, and other material on the Gemini Compass. Financial accounts and ratio analysis can be found in the “industry/competitors stream” analytics. Net present value calculation can be found in the ‘Developing and Evaluating options’ section. 162

163 The profitability stream—introduction (cont.)
Profitability Stream Analytics Cost structure analysis Relative cost positioning Break even analysis Understanding Revenue/Cost Drivers? Price elasticity Experience curve Core Analytics Supplementary Analytics Economies of scale Analytics useful to understand these drivers are detailed as the following pages. 163

164 Profitability Stream Analytics
Introduction Cost Structure Analysis Relative Cost Positioning Break-even Analysis Economies of Scale Experience Curve Price Elasticity Business/Unit Profitability Conclusion 164 14 14

165 Cost structure analysis—introduction
PROFITABILITY STREAM—CORE ANALYTICS Cost structure analysis—introduction What It Is Why We Use It Graphically presents a company’s cost structure Builds cost bars taking account of: The various components of the cost structure The importance (relative or in absolute terms) of the components in the cost structure Understand where revenues, costs and profits are incurred Establish comparisons between cost structures for: A product/business over time A product/business in each of several companies Several product lines in the same company for one time period Strengths & Limitations Strengths: Allows a quick appreciation of trends and differences. Provides a homogeneous basis for comparison. Limitations: None 25 165

166 Cost structure analysis—how to apply it
PROFITABILITY STREAM—CORE ANALYTICS Cost structure analysis—how to apply it Identify the different components of the cost structure by analysing the building blocks of the business/products: Do not forget to take into account overheads. Allocate direct costs as they are. Allocate indirect costs in proportion. When building the graphs, many measures are available for the vertical axis, e.g.: Current currency value. Constant currency value. Percentage of sales. 166

167 Cost structure analysis—Illustrative output
PROFITABILITY STREAM—CORE ANALYTICS Cost structure analysis—Illustrative output Cost Structure for One Product over Time Cost Structures for Same Product in Different Companies Cost Structure for Different Products in One Company Current Dollars Current Dollars Current Dollars Annual sales ($mm) Percentage of total sales 100 19 120 22 150 28 170 31 Cost components as percent of sales Overhead Materials Advertising Sales R&D Source: MAC Group Core Practice Manual. 42 167 40

168 Cost structure analysis—top tips
PROFITABILITY STREAM—CORE ANALYTICS Cost structure analysis—top tips Potential Insights Assesses cost drivers: Helps identify which cost components have increased or decreased the most Triggers questions for further research and analysis Identifies potential areas for value differentiation Hints and Pitfalls Do: Make sure you use correct measures of a company’s costs (especially with costs shared among products or business units) Check accuracy of competitors’ data Consider pure play benchmarks from other markets if competitor example not available Don’t: Compare competing products that are not truly comparable Data Sources Clients’ internal data: Accounting systems Competitors’ cost data are generally much more difficult to obtain—you will probably have to use an estimate Look at US data for benchmarks which often has costs split out Case Examples The following documents contain good examples of cost structure analysis and output: Cinven: Paris project archive Dawson International: London project archive Related Analytics Value chain Competitors/company comparison Break-even analysis 30 168

169 Profitability Stream Analytics
Introduction Cost Structure Analysis Relative Cost Positioning Break-even Analysis Economies of Scale Experience Curve Price Elasticity Business/Unit Profitability Conclusion 169 14 14

170 Relative cost positioning—introduction
PROFITABILITY STREAM—CORE ANALYTICS Relative cost positioning—introduction What It Is Why We Use It Assesses the cost position of a firm for a product relative to that of a competitor: Measure of a firm cost advantage/disadvantage Should be assessed at each stage of the value chain Breaks down inputs and outputs: Volume/value of outputs: Raw materials Labour Overheads Maps physical production process Tends to be correlated with relative market share (RMS) Highlights differences between competitors, and in particular, determines sources of cost advantage: Can lead to cost saving through imitation Strengths & Limitations Strengths: Remains effective even when comparing products of different brands or quality levels: The cost position can be locked with the price realisation of each supplier indexed at 100 Limitations: Can be difficult to establish Expensive and worth doing only when the products being compared have a high turnover 170 25 29 29

171 Relative cost positioning—how to do it
PROFITABILITY STREAM—CORE ANALYTICS Relative cost positioning—how to do it If competitors compete in the same segment, and you know their profits and prices, you can infer the relative cost position (RCP): RPPa ROS RCP Client 100 2% 100 (98) Competitor 95 5% 92 (90) Calculation example: Price of competitor = 95% of client ROS for competitor = 5% Competitor costs = 95% x 95% = 90% Client cost position = 98% Competitor cost position = 90/98 x 100 = 92% Source: Richard Koch, Training Session 4, February 1998, South African POA. a. Relative price position. 171

172 Relative cost positioning—illustrative output
PROFITABILITY STREAM—CORE ANALYTICS Relative cost positioning—illustrative output Relative Cost of Production of Men’s Placket Shirt (High Labour Content) (in US$/Dozen) $37.77 0.62 $34.96 1.79 $33.72 Store Advertising 0.62 1.67 0.62 1.59 Irregulars/Carry Cost 3.18 Additional Freight and Duty 11.07 35.36 28.34 Product Cost a 21.6 a. Includes quota cost. 172

173 Relative cost positioning—potential insight
PROFITABILITY STREAM—CORE ANALYTICS Relative cost positioning—potential insight Explaining a Company’s Cost Advantage What to Do? Lower input costs: Raw materials Labour Overhead Greater productivity: Technology Know-how Operating skill Costs shared with other segment(s) Company is leader in focused segment Cost reduction essential Relative cost position analysis valuable Sell/JV or Harvest Not lowest Cost Reinforce market leadership Reinforce cost leadership Gain market share quickly Buy leader Lowest Cost Segment Leader Segment Follower 25 173 29 29

174 Relative cost positioning—top tips
PROFITABILITY STREAM—CORE ANALYTICS Relative cost positioning—top tips Hints and Pitfalls Do: Remember that clients do not generally have costs equal to competitors’ Data Sources Client’s and competitors’ cost data: Ex-employees of competitors (qualitative survey) Industry reports Case Examples The following documents contain good examples of relative cost positioning and output: Dawson International: London project archive See also Richard Koch Training Session (South Africa POA) Related Analytics Break-even analysis Cost structure analysis 27 174 61 69

175 Profitability Stream Analytics
Introduction Cost Structure Analysis Relative Cost Positioning Break-even Analysis Economies of Scale Experience Curve Price Elasticity Business/Unit Profitability Conclusion 175 14 14

176 Break-even analysis—introduction
PROFITABILITY STREAM—CORE ANALYTICS Break-even analysis—introduction What It Is Why We Use It Break-even level is the level of output at which the company makes neither a loss nor a profit—just covers its costs Important cross-over point: Any lower and the company makes a loss The analytic establishes a relationship between: Fixed costs Variable costs Revenues Applies to: Entire company Individual product line Particular manufacturing operation Helps set minimum sales targets Helps set price levels, but is not the only determinant: Driven by other factors such as customer needs and competitor actions Strengths & Limitations Strengths: Useful tool for presenting information and explaining the dynamics of a production unit Limitations: Static analytic: Many costs are considered fixed in the short run but variable over the long term Very often the relationship between profit and volume is not linear: Assumptions underlying the chart may not be 100% accurate 176 25 29 29

177 Break-even analysis—how to do it and illustrate output
PROFITABILITY STREAM—CORE ANALYTICS Break-even analysis—how to do it and illustrate output How to do it Illustrative output 1. Gather data needed, i.e.: Total costs Break down of total costs into fixed and variable Associated volumes Associated revenue 2. Plot the costs and revenue lines on a graph: Start with the fixed costs line which has function: y = (value of fixed costs) Determine what function governs variable costs and represent it graphically on top of the fixed cost line 3. The break-even point stands at the intersection of cost and revenues lines: The break-even point is the number of units sold for which operating profit = 0 in the following equation: OP = [(USP) x (NUS)] - [FOC + (UVC) x (NUS)] where: OP: operating profit USP: unit selling price NUS: number of units sold FOC: fixed operating costs UVC: unit variable costs Illustrative Break-even Charta Profit Total Revenue Line Total Cost Line Budget Values Break-even point Revenue and Costs ($000s) Variable Costs Fixed Costs Loss Units Capacity a. Ciaran Walsh, “Key Management Ratios, How to Analyse, Compare and Control the Figures that Drive Company Value”, 1996, p. 223 FT Pitman Publishing. 177 25 29 29

178 Break-even analysis—top tips
PROFITABILITY STREAM—CORE ANALYTICS Break-even analysis—top tips Potential Insights States the target output above which the company becomes profitable Hints and Pitfalls Do: Take sufficient care to distinguish between fixed, variable, and semi-variable costs Consult a textbook on cost accounting of managerial economies Don’t: Use break-even analysis as the only measure of the viability of a business, division, or project 27 178 61 69

179 Break-even analysis—data sources, case examples, and related analytics
PROFITABILITY STREAM—CORE ANALYTICS Break-even analysis—data sources, case examples, and related analytics Data Sources Company’s internal cost and revenue data: Divisional accounts Case Examples The following documents contain good examples of break-even analysis and output: Related Analytics Break-even analysis is a critical step within profitability analysis and is often used in conjunction with: Relative cost position Economies of scale 179 27 61 69

180 Profitability Stream Analytics
Introduction Cost Structure Analysis Relative Cost Positioning Break-even Analysis Economies of Scale Experience Curve Price Elasticity Business/Unit Profitability Conclusion 180 14 14

181 Economies of scale—introduction
PROFITABILITY STREAM—SUPPLEMENTARY ANALYTICS Economies of scale—introduction What It Is Why We Use It A company or industry benefits from economies of scalea when the unit cost of a product declines as the number of units produced per period increases: Typically, we use the concept qualitatively not quantitatively: To understand the nature of competition in a business market or segment We are unlikely to quantify economies of scale across an industry Understand the importance of relative size and relative cost within an industry Highlight the existence of a minimum efficient size: Below this, it is not cost-effective to compete Determine whether scale acts as a barrier to entry A B Unit Cost Company A Company B Number of Units Produced Company B has a much lower unit cost because it produces a much higher value Strengths & Limitations Strengths: Fundamental economic concept relevant at both a company and industry level Helps build understanding of the structural characteristics of an industry Can provide a quantitative measure of the benefit of scale, and an estimate of optimum size Limitations: None a. It is also possible to have dis-economies of scale, i.e. as more units are produced, the unit cost increases. 25 181 29 29

182 Economies of scale—how to apply it
PROFITABILITY STREAM—SUPPLEMENTARY ANALYTICS Economies of scale—how to apply it Gemini practice usually unfolds in two steps: To Determine Whether Scale is Critical to Success Quantify Economies of Scale Identify competitors in the market or segment Determine absolute and relative size of competitors, and absolute and relative returns (profit, ROCE, ROE): See company analysis and financial analysis Determine absolute and relative share: See market-sizing Identify type of products produced, and number of units produced Identify key success factors: See key success factors Review all of the above to determine: Whether scale of operation is critical to success in this market or segment If so, why? Minimum scale? By competitor, plot: Average unit costa (y axis) over a specified period Number of units produced over same period (x axis) a. Given that average unit cost is unlikely to be available for all competitors, you could use average unit price as a substitute for cost. 182

183 Economies of scale—illustrative output
PROFITABILITY STREAM—SUPPLEMENTARY ANALYTICS Economies of scale—illustrative output Production Economies of Scale— German Soft Drink Bottlers 10.0 9.0 8.0 7.0 6.0 5.0 4.0 3.0 2.0 .9 .8 .7 .6 .5 .4 .3 .2 0.1 In this case, economies of scale are present, but not of major importance: A doubling of volume, from 1 million leads to only a 2–3% decrease in cost. Production Costs per Unit DM/Case .1 .5 1 5 10 Total Productions (Cases) Millions Source: MAC Group, Core Practice Manual. 183 106 2 86

184 Economies of scale—top tips
PROFITABILITY STREAM—SUPPLEMENTARY ANALYTICS Economies of scale—top tips Potential Insight Analytic helps determine: Minimum efficient size Whether the presence of scale deters market or segment entry by: Forcing the entrant to produce on a large scale and risk strong reaction, or produce on a small scale and accept a cost disadvantage Some limits to economies of scale as an entry barrier are as follows: Large sale business may involve making trade-offs with other potentially valuable barriers to entry such as product differentiation Technological change may be catastrophic for a large-scale firm if its facilities are more specialised Hints and Pitfalls Do: Make sure you use comparable data when plotting different companies Examine carefully cause and effect relationships when the number of data points is limited Ensure the concept is applicable by comparing the individual plants along several dimensions other than scale: Decreasing costs may be due to factors other than scale, such as labour rates, age of equipment, etc. Don’t: Use data from different periods: Experience effect will distort the data 184 27 61 69

185 Economies of scale—data sources, case examples and related analytics
PROFITABILITY STREAM—SUPPLEMENTARY ANALYTICS Economies of scale—data sources, case examples and related analytics Data Source Industry reports Brokers’ reports Competitors’ financial statements Companies’ internal cost data Database searches Case Examples The following documents contain goods examples of economy of scale analysis: Related Analytics Experience curve Value chain Economies of scope 185 27 61 69

186 Profitability Stream Analytics
Introduction Cost Structure Analysis Relative Cost Positioning Break-even Analysis Economies of Scale Experience Curve Price Elasticity Business/Unit Profitability Conclusion 186 14 14

187 Experience curve—introduction
PROFITABILITY STREAM—SUPPLEMENTARY ANALYTICS Experience curve—introduction What It Is Why We Use It Quantifies the effect of a company’s accumulated experience on unit costs: Also known as the learning curve The hypothesis underpinning the experience curve is that, over time, companies become faster or better at producing their goods or services: Where this is true, over time, the unit cost to produce a product declines In some industries, accumulated experience or knowledge can create significant competitive advantage: Incumbents can be significantly faster or cheaper than new entrants because they effectively apply knowledge based on experience Developed by the Boston Consulting Group in as “the Learning Curve”, less frequently used as quantitative tool Typically we use the concept qualitatively, not quantitatively, to understand relative competitive advantages within a business market or segment Determines whether accumulated knowledge gives a competitive advantage to incumbents Determines relative cost advantages of competitors Potentially, to develop share-gain strategies that exploit the experience curve Strengths & Limitations Strengths: As a concept, describes importance of accumulated, applied knowledge in building advantage Can be very relevant in certain industries where experience can build competitive advantage Limitations: Assembling the data for an experience curve analysis is often time-consuming Product innovation can render the current experience curve useless as a strategy tool You should question whether you need to quantify the effect for your client, and if it is feasible to do so As a quantitative tool, is less frequently used today, because of difficulty establishing accumulated production volume 187 25 29 29

188 Experience curve—how to do it
PROFITABILITY STREAM—SUPPLEMENTARY ANALYTICS Experience curve—how to do it The experience curve is based on: Accumulated production data. Unit cost data for the entire industry and individual competitors. Accumulated production is often difficult to calculate: It is the total number of units of a product made by the company (or the total number of units of a product made by all players in the market). Plot accumulated volume against unit cost on graph. 188

189 Experience curve—illustrative output
PROFITABILITY STREAM—SUPPLEMENTARY ANALYTICS Experience curve—illustrative output Illustrative Experience Curve 200 400 600 800 1,000 2,000 4,000 50 40 30 20 10 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 Slope 20% Accumulated Unit Volume (log) (000s) Log Unit cost ($) The slope of this curve is 20%, meaning that with each doubling in volume, unit cost decreases by 20%. The curve has been extrapolated to predict future cost levels. We could plot various competitors against the curve. Source: MAC Group, Core Practice Manual. 106 189 86 141

190 Experience curve—illustrative output (cont.)
PROFITABILITY STREAM—SUPPLEMENTARY ANALYTICS Experience curve—illustrative output (cont.) The Experience Curve as a Diagnostic Tool The theoretical curve represents the industry standard The observed company seems to learn at a lower speed than average competitor A simple gap analysis highlights opportunities to drive down cost to industry standards 1990 Observed 93% curve 1997 Firm Real Unit Costs Theoretical 80% curve Catch-up Firm Accumulated Experience Source: R. Koch Training Session 4, February 1998, South African POA. 106 190 86 142

191 Experience curve—top tips
PROFITABILITY STREAM—SUPPLEMENTARY ANALYTICS Experience curve—top tips Potential Insight Strategies based on experience curve analysis are particularly effective industries where: Cost is a significant competitive factor Expertise is developed through experience A whole set of strategic options can be derived from the experience curve (see indicative outputs): In relation to competitors’ relative cost position In relation to competitors’ relative price position The experience curve is no guarantee that costs will decrease: The company must actively manage costs down Theoretically, experience curve effects decrease in relative importance over time: The greatest effects occur in the early stages Hints and Pitfalls Do: Use it as a concept rather than try to quantify an experience curve for your client Use price data if cost data is not available Don’t: Use cost data that are not defined in the same manner Take into account overheads and costs not related to what you are studying when using company cost-accounting data Average industry price = Total market revenue Total market volume [ ] 191 27 61 69

192 Experience curve—data sources, case examples, and related analytics
PROFITABILITY STREAM—SUPPLEMENTARY ANALYTICS Experience curve—data sources, case examples, and related analytics Data Sources Company internal data for: Costs Accumulated production Government agencies and trade associations for historical accumulated industry production Case Examples The following documents contain good examples of experience curve analysis: Related Analysis Economies of scale 192 27 61 69

193 Profitability Stream Analytics
Introduction Cost Structure Analysis Relative Cost Positioning Break-even Analysis Economies of Scale Experience Curve Price Elasticity Business/Unit Profitability Conclusion 193 14 14

194 Price elasticity—introduction
PROFITABILITY STREAM—SUPPLEMENTARY ANALYTICS Price elasticity—introduction What It Is Why We Use It Measure of the responsiveness of demand to changes in price: If demand is elastic, it is responsive to changes in price If demand is inelastic, it is unresponsive to changes in price Price elasticity of demand is measured as: In general, two factors determine elasticity: Availability of substitute goods Number of uses to which goods may be put Long-term price elasticity may differ from short-term price elasticity: See adoption cycle p.xx and product life cycle. Measuring price elasticity of demand may be a key analytic in marketing strategy work Helps to understand customer purchase behaviour Determines customer sensitivity to price changes: Model of likely demand under different pricing situations e = V% P% = Volume change Price change [ ] Strengths & Limitations Strengths: Provides a quantitative measure of customer responsiveness to price changes Helps to understand better customer buying decisions on a particular product Limitations: Factors other than price can influence demand—need to understand the impact of these variables Can be difficult to obtain measures of price and volume changes Considerable skills needed to build the appropriate model and fit the data with the proper statistical techniques Provides only an historical perspective 194 25 29 29

195 Price elasticity—how to apply it
PROFITABILITY STREAM—SUPPLEMENTARY ANALYTICS Price elasticity—how to apply it Approach Overcoming Data Gaps Agree scope of analysis: Product Market (e.g. which country? National or regional?) Period to cover (and time intervals between price data) Identify and gather appropriate price and volume data: May need to make judgements on issues about price differentials between stores and/or geographic regions Check data to ensure it is accurate Calculate elasticity over the specified period using the formula: Repeat formula Give example of calculation Interpret results: If elasticity is greater than 1, a 1% decrease in price will lead to more than a 1% increase in volume If elasticity is less than 1, a 1% decrease in price will lead to less than a 1% increase in volume If price data is not available, consider running a price experiment: Gather required price and volume data in a pilot study Test impact of price reductions or increases Results from a price experiment should be viewed as only indicative guidance: Timeframe likely to be too short Could be other variables influencing results that would have less impact over a longer period Look for comparable studies: Price and volume data for similar companies Price and volume data for similar industries e = V% P% = Volume change Price change [ ] 195 25 29 29

196 Price elasticity—illustrative output
PROFITABILITY STREAM—SUPPLEMENTARY ANALYTICS Price elasticity—illustrative output Example of Elasticity Calculation for Beer Market Observation of the Elasticity of Beer Volume to Its Price Calculation of the Elasticity of Beer Volume to its Price 1998 1992 1986 1980 1974 1968 130 120 110 100 90 80 70 Beer Volume Beer Price 106.2 100 100 90 Price change Volume change Beer Volume A 10% price decrease leads to a 6.2% volume increase Elasticity Beer price elasticity is: Beer Volume Source: Bossard/United Distillers, “Impact of Taxation Rates on Government Revenues”, October 1997. 106 196 86 127

197 Price elasticity—illustrative output (cont.)
PROFITABILITY STREAM—SUPPLEMENTARY ANALYTICS Price elasticity—illustrative output (cont.) Regression enables us to discover complex multiple relationships. Example of Multiple Regression on Cider Market Example of Multiple Regression Cider Volume = B + A1 * Cider Price + A2 * Beer Price + A3 * Wine Price + A4 * Temperature ESTIMATED B = A1 = -0.84 A2 = 3.16 A3 = 1.05 A4 = 0.70 Data Available to Explain Cider Market Behaviour 1998 1994 1990 1986 1982 1978 1974 170 150 130 110 90 70 50 Wine Price Temperature Beer Price Cider Volume Cider Price Explanation of Changes in Cider Volume Explained Cider Volume 160 140 Temperature 120 100 80 60 40 Wine price Beer price 20 Cider price 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 Note: Variables are indexed. Source: Bossard/United Distillers, “Impact of Taxation Rates on Government Revenues”, October 1997. 106 197 86 128

198 Price elasticity—top tips
PROFITABILITY STREAM—SUPPLEMENTARY ANALYTICS Price elasticity—top tips Potential Insights Analytic can help: Forecast the likely revenue impact of price changes Determine an appropriate pricing strategy Hints and Pitfalls Do: Use logarithmic scales on both axes Price sensitivity will often vary considerably by customer and product segment: Be careful to define accurately the market segment for which price sensitivity is to be estimated Do not: Overlook the fact that if the company changes marketing-mix factors other than price, the effect of the price change itself will be hard to isolate—conjoint analysis will help do this Data Sources Internal company data: Values Prices Publicly available data: Market research price levels and volumes Studies of comparable companies or industries Case Examples The following documents contain good examples of analysis of price elasticity of demand: Related Analytics Conjoint analysis (see Competency Group): Good for estimating future potential 27 198 61 69

199 Profitability Stream Analytics
Introduction Cost Structure Analysis Relative Cost Positioning Break-even Analysis Economies of Scale Experience Curve Price Elasticity Business/Unit Profitability Conclusion 199 14 14

200 Business/unit profitability—introduction
PROFITABILITY STREAM—CORE ANALYTICS Business/unit profitability—introduction What It Is Why We Use It Measures the profitability of: Businesses across a company’s portfolio, or Competitors in a business or segment Profitability measured as: Return on sales (ROS), or Return on capital employed (ROCE) Input to developing business segment strategy: Used, in particular, with competitive position and segment attractiveness analyses. At a corporate level, provides data on relative performance of business units. At a business segment level, provides data on returns generated within the segment. Strengths & Limitations Strengths: Quantifies relative performance of business units, or Quantifies relative returns (and hence attractiveness) of a business or segment. Limitations: For accurate results at segment level, requires significant time, effort, and data. Estimating ROS or ROCE for a business unit takes time if good internal data is not available. 25 200

201 Business/unit profitability—how to apply it
PROFITABILITY STREAM—CORE ANALYTICS Business/unit profitability—how to apply it At Business or Unit Level At Corporate Level (Portfolio of Businesses) See financial analysis for how to calculate ROS and ROCE Full Allocated Costs Operating Profit = Sales - Identify products per business segment Calculate turnover, direct costs, indirect costs, and overheads for each product Operating Profit for Segment = Product Sales - Product Direct Costs - Product Indirect Costs ROS = Operating profit Sales ROCE = Operating profit Capital Employed Indirect costs and overheads should be allocated proportionally to resource All costs must be allocated across the full set of business segments 25 201

202 Business/unit profitability—illustrative output
PROFITABILITY STREAM—CORE ANALYTICS Business/unit profitability—illustrative output Business Unit Gross Sales Operating Profit Interest Overhead Expenses R&D Costs Admin. Expenses Direct Expense Gross Margin Business Unit ROS % 1 2 3 4 Business Units Return on Capital Employed ROCE % 1 2 3 4 Business Units 202 89 72

203 Business/unit profitability—top tips
PROFITABILITY STREAM—CORE ANALYTICS Business/unit profitability—top tips Potential Insights Reveals levers for improving business segment returns. Disaggregates company performance: Allows informed decision about individual business segments Hints and Pitfalls Do: Take into account all relevant players when assessing segment profitability Don’t: Data Sources Companies’ financial statements Case Examples The following documents contain good examples of business/segment profitability analysis and output: Dawson International: London project archive Related Analytics Business/segment attractiveness Company/competitors comparison 30 203

204 Profitability Stream Analytics
Introduction Cost Structure Analysis Relative Cost Positioning Break-even Analysis Economies of Scale Experience Curve Price Elasticity Business/Unit Profitability Conclusion 204 14 14

205 Profitability stream: Conclusions
The main focus of the profitability stream is often the building of an economic model: Helps predict and model future profitability, depending on strategic options generated (see A&D Kbase, Gemini Compass for further material). Often linked with an activity based costing analysis to understand true costs of products/customers (see Strategy Kbase, Gemini Compass for detailed material). Analytics detailed in this section are an excellent starting point to help understand the drivers of profitability: Providing valuable insight in themselves. But also as a starting point for a more detailed economic model. 205

206 Capabilities Stream Analytics
Introduction Strength and Weaknesses Analysis Venkat Matrix Conclusions 206 14 14

207 Capabilities Stream: Questions and Analytics
ANALYTICS TO UNDERSTAND A CLIENT’S STRATEGIC POSITION Capabilities Stream: Questions and Analytics Capabilities Stream Strategic Questions Strategic Position Main Analytics What are the (economic) boundaries of the businesses the company is in? How are they changing? What are the boundaries of the capabilities required to compete successfully? Strengths and Weaknesses What capabilities are required to deliver value? How is this changing? Venkatramen Matrix How do companies create value in each of the businesses? How is this changing? How strong are our client’s key capabilities relative to its competitors? How is the client company positioned relative to the competition to create value? How is it changing? Core Analytic 23 207 23 23

208 Capabilities Stream Analytics
Introduction Strength and Weaknesses Analysis Venkat Matrix Conclusions 208 14 14

209 Capabilities stream analytics—introduction
CAPABILITIES STREAM—INTRODUCTION Capabilities stream analytics—introduction Capabilities are bundles of expertise, technology and skills that are critical factors (i.e. differentiated) for current of future business success. There are two high level elements to a capabilities analysis: Capabilities analysis can be done “quick and dirty” or “in-depth”, depending on time available: Trade-off comes in level of detail and number of surveys carried out. Identify Client Strengths and Weaknesses With respect to the competition That are/are not sustainable and leverageable in future That are potentially exportable (key for overseas/new market expansion) Establish Gaps in Capabilities Required for Future Strategic Options What to compete on What not to compete on 209

210 Capabilities analysis—hierarchy of capabilities
CAPABILITIES STREAM—INTRODUCTION Capabilities analysis—hierarchy of capabilities Capabilities assessment can be conducted on several levels: Capabilities Hierarchy Core Organisation Individual Level I: An aggregated level of up to 8–10 core capabilities that underpin a company’s success and performance, but are not easily seen by the organisation or its customers (e.g. miniaturisation of Sony). Level II: A summarised number of capabilities (40–70) that an organisation demonstrates across functional barriers that tend to be visible to the organisation and its customers (e.g. Virgin’s ability to leverage its brand, bringing new products to market). Level III: A large number (many thousands) of capabilities relating to individual employees’ skills (e.g. Telco’s engineers’ ability to repair faults quickly). Generally, we focus on organisational capabilities. 210

211 Gemini’s new change modela defines capabilities at a number of levels
CAPABILITIES STREAM—INTRODUCTION Gemini’s new change modela defines capabilities at a number of levels The process of change—The development of capabilities Environmental Intelligence Asset Management Capability Dimensions Process Alignment Learning/ Innovation Client Issues Individual Key Group Organisation Development Levels Assessment of capability and design of change strategies to develop these will form a key element of our A&D approach. a. See “Gemini’s New Change Model”, Tracker InnovL8Sep98Rpassr.ppt, on London Server. 211

212 Capabilities Stream Analytics
Introduction Strength and Weaknesses Analysis Venkat Matrix Conclusions 212 14 14

213 Strengths and weaknesses analysis—introduction
CAPABILITIES STREAM—CORE ANALYTICS Strengths and weaknesses analysis—introduction What It Is Why We Use It Identification of a client’s strengths and weaknesses that impact its ability to implement a strategic option. Assess strengths and weaknesses: With respect to the competition That are/are not sustainable and leverageable in the future That are potential exportable (new market expansion) Validates opportunities for developing a company Determines a strategic direction consistent with: Company’s capabilities Industry requirements Strengths & Limitations Strengths: Comprehensive process (depending on time taken for analysis) Can engage client early on in assignment with a familiar topic Limitations: Time-consuming process 25 213 29 29

214 Strengths and weaknesses analysis—how to do it
CAPABILITIES STREAM—CORE ANALYTICS Strengths and weaknesses analysis—how to do it Conduct Capabilities Survey Benchmark Against External Sources Analyse Findings Agree with your client the definition of capabilities List capabilities using: Previous capabilities studies Internal survey for clients Expert studies Etc. Test list on sample of client personnel and refine Conduct a survey: Choose group for distribution: Ensure it is significant in terms of size and scope Consider best use/coverage of: Focus interviews Postal/fax surveys Workshops Ask respondents to assess current and future importance of the surveyed capabilities in your industry: Establish ranking categories Map capabilities onto the value chain, differentiating: Top 10, bottom 10 Most important 10, least important 10 Choose external constituents (recognised for their knowledge of the industry) Identify best practices against which you can test your client’s capabilities: Ask interviewees to rank company’s performance against these Identify capabilities in the required industry Position your client on a capabilities spectrum relative to competitors Assess gaps Brainstorm to drive insight 25 214 29 29

215 Strengths and weaknesses analysis—how to do it
CAPABILITIES STREAM—CORE ANALYTICS Strengths and weaknesses analysis—how to do it Analysis Process Selected 400 in company Interviews with top managers Choose competitors to compare Review analysis regarding capability identification Design capabilities survey Internal Input Develop list of industry capabilities Capabilities validation: questionnaire (100 internal) List of capabilities Conduct capabilities survey internally and externally Analyse capabilities survey results Validate results with strategy group & executive managers Validated capabilities Gemini industry experts develop capabilities along value chain Validation by strategy group External Input Gemini consultants (who have worked on similar projects) Analysts, head hunters & journalists Source: Gemini Consulting, C4 K.Base, Capabilities Analysis—A How to Guide, 1996. 106 215 86 136

216 Strengths and weaknesses analysis—illustrative output (1)
CAPABILITIES STREAM—CORE ANALYTICS Strengths and weaknesses analysis—illustrative output (1) XYZ’s Above-Average Capabilities Sales & Distribution Channel Management Execution & Control Product Development Marketing Understanding client financial needs Understanding local markets (international) Managing brand image Pricing Communicating financial product offering Developing innovative products Width / depth of the product range Designing bundles of products Repackaging existing products Corporate finance skills Size of the branch network Size of investor base Local presence (international) Efficient salesforce Long-term oriented selling culture Consultative selling (including assets and liabilities, business and personal matters) Managing risk Trading global debt, equity, currencies Processing transactions Making OTC transactions Compliance Credit / underwriting skills International communication network Equity and economic research Sales support system Quote and brokerage information system Risk management system Managing Information Recruiting & retaining talented people Managing incentives Training and managing the sales force Effective teamwork Leadership / People Development Identifying and exploiting new business opportunities Allocating resources to meet strategic objectives Managing External Relationships Ethical and trustworthy public image Building institutional relationships Managing government relations Managing professional advisors Funding and Financing Managing local funding Strong capital base Debt ratings 216

217 Strengths and weaknesses analysis—illustrative output (2)
CAPABILITIES STREAM—CORE ANALYTICS Strengths and weaknesses analysis—illustrative output (2) Percentage of respondents rating capability as Good, Best in Industry or World Class Across Industry Overall Capabilities Summary Strong Weak 100 90 80 70 60 50 40 30 20 10 Source: Internal capabilities survey based on 171 responses. Note: Capability is listed to the right of the dot. 106 217 86 137

218 Strengths and weaknesses analysis—top tips
CAPABILITIES STREAM—CORE ANALYTICS Strengths and weaknesses analysis—top tips Potential Insights Highlights capabilities necessary to become “best-in-class” player in industry: Summarises discrepancies between external and internal views Summarises capabilities by section in value chain Groups stronger capabilities to highlight business opportunities Hints and Pitfalls Do: Spend time building a solid list of capabilities—it provides the basis for a powerful analysis Build a hypothesis of likely output before sending out the survey (can be derived from analyst reports) Stick to a generic value chain when breaking down capabilities along it (unless the client has a broadly accepted view of its industry and its value chain) Do not: Mistake capabilities with: Record of achievements Long list of the basics necessary to compete in market Summary of individual strengths Data Sources Gemini experts • Interviews with clients and competitors are a key source Joint team/company executives Previous capabilities studies SICC database on Lotus Notes Case Example The following projects are good examples of capabilities analysis : Abbey National (Tamsen Wallis, Penney Frohling) BT (Tim Bradshaw) Ericsson Related Analytics Key success factors and index of key success factors • VenKat Matrix See also London Shop training material on • Build, Buy, Ally options (Gemini Compass): Benchmarking Interviewing 27 218 61 69

219 Capabilities Stream Analytics
Introduction Strength and Weaknesses Analysis Venkat Matrix Conclusions 219 14 14

220 Venkat matrix—introduction
CAPABILITIES STREAM—CORE ANALYTICS Venkat matrix—introduction What It Is Why We Use It Helps identify differentiating versus parity capabilities on which client can compete A tool developed by Professor N. VenKatraman (Gemini faculty) To identify: Best-in-class capabilities Parity capabilities Differentiating capabilities Helps prioritise what to do with key capabilities for strategic options Strengths & Limitations Strengths: Provides focus on key capabilities for strategic options Engages client in implementation needs Limitations: No major 25 220 29 29

221 Venkat matrix—how to apply it
CAPABILITIES STREAM—CORE ANALYTICS Venkat matrix—how to apply it Step 1 The Venkartraman Model Rank identified capabilities by: Strategic importance to future option: “Core” to achieve competitive differentiation. “Necessity” to be the business. “Support” to be in any business. Relative position (vis-à-vis competitors): “Stronger”: best-in-class. “Equal”: as good as most. “Weaker”: needs catching up. Plot on Venkat matrix. Relative Position Strategic Importance Core “. . . to achieve competitive differentiation” Necessity “. . . to be in business” Support “. . . to be in nay business” Weaker (Needs catching up) Equal (As good as most) Stronger (Best-in-class) Differentiation Zone Investment Centre Profit Centre Cost Centre Parity Zone Step 2 221

222 Venkat matrix—illustrative output
CAPABILITIES STREAM—CORE ANALYTICS Venkat matrix—illustrative output Relative Position Strategic Importance Core “. . . to achieve competitive differentiation” Necessity “. . . to be in business” Support “. . . to be in nay business” Weaker (Needs catching up) Equal (As good as most) Stronger (Best-in-class) Differentiation Zone Investment Centre Profit Centre Cost Centre Parity Zone UK Mortgages Company Example Funding and financing Leadership and people development Processing information/ customer service Product development Sales and distribution channel management Managing information Marketing Risk management/ control External relationships 222

223 Venkat matrix—top tips
CAPABILITIES STREAM—CORE ANALYTICS Venkat matrix—top tips Potential Insights Best-in-class core capabilities allow us to: Reinvent rules, generate significant revenue at high margins, create barriers to entry/exit Parity zone capabilities are: Non–value-adding, business as usual function—potential to outsource or get rid of Differentiating zone capabilities are: Potential focus for investment Hints and Pitfalls Do: Validate all data with client Run workshops to develop and validate matrix Use expert resources to help develop options Do not: Data Sources Capabilities survey analysis Analysts Industry experts Penney Frohling, VMS Case Example The following are good case examples : ABN AMRO GTS Abbey National expansion opportunities Related Analytics Strengths and weaknesses analytic Build, buy, ally options See also M&A/Alliances CoE, Gemini Compass 27 223 61 69

224 Capabilities Stream Analytics
Introduction Strength and Weaknesses Analysis Venkat Matrix Conclusions 224 14 14

225 Capabilities analysis stream—conclusions
CAPABILITIES STREAM—CORE ANALYTICS Capabilities analysis stream—conclusions Provides a vital insight to a company’s ability to follow or implement a potential strategic option. Helps client prioritise and focus on key capabilities for strategic options. Is a key input to the option development and evaluation process: Options to fill capability gaps are often resource constrained. The chosen route to fill gaps, e.g. build, buy, ally has implications for time, cost and ease of implementation. Many clients overlook the importance of a capabilities analysis—it is key to demonstrate implications for the chosen strategy. 225

226 Developing and Evaluating Options
Introduction Segment Attractiveness Net Present Value 226 14 14

227 Developing and Evaluating Options
Introduction Segment Attractiveness Net Present Value 227 14 14

228 Developing strategic options is more of an “art” than a “science”
DEVELOPING AND EVALUATING OPTIONS—INTRODUCTION Developing strategic options is more of an “art” than a “science” Option development is not prescriptive: It is heavily reliant on experience and expertise Creativity is required The process and solution is unique to each client: Dependent on the client’s unique position and set of capabilities Scenario modelling and vision engineering can sometimes help generate options, but is not included in the scope of this toolkit: See strategy discipline Kbase, Gemini Compass There are no pure ‘analytics’ to enable us to arrive at the answer (although tools do exist to help evaluate them). There are however a few guidelines to help the process. 228

229 Option Development and Evaluation
DEVELOPING AND EVALUATING OPTIONS—INTRODUCTION In developing options, there are some important factors to bear in mind Link back to the initial issues and hypotheses in the APSPa: Do options address the client’s problem? What additional options would help? Option Development and Evaluation Examine the insights and answers from the analytics performed: What specific answers have been derived? How is the client’s strategic position impacted? How is this likely to change? Brainstorm (using experience and expertise) potential options for how the client should position itself in the future vis-à-vis: Industry dynamics Competitors Customers Factor-in what capabilities exist to implement the proposed options: What are the gaps? What would it cost to fill gaps? Evaluate options: Financially: are hurdle rates met? Practically: what is the ease/risk of implementation? I M P L E N T A O a. Analytical Problem Solving Process: See Strategy Core Skills, GU Kbase, Gemini Compass. 229

230 Dependent on strategic position, there are eight “generic” options
DEVELOPING AND EVALUATING OPTIONS—INTRODUCTION Dependent on strategic position, there are eight “generic” options Generic Strategies Strategic Position Competitive position Profitability Future attractiveness (Industry Dynamics, Customer Demand) Future Positioning 1 4 Invest in segment and grow market share 2 8 Improve profitability (lower costs, increase price) 3 Hold position and grow if possible Invest and grow market share/sell Alliance or JV 5 Increase profitability/harvest 6 Investigate new technology and/or capabilities to gain market share 7 Hold position for as long as possible Harvest or exit/avoid Key: 4 = Favourable, 8 = unfavourable In each case we need to establish whether the necessary capabilities can be developed. 230

231 DEVELOPING AND EVALUATING OPTIONS—INTRODUCTION
New opportunities can be assessed in terms of capabilities and core business Total Solution / Capabilities Matrix Core Business Substantial investment in capabilities or Alliances and JVs Invest and grow Pursue if profitable in short term Non-Starter Non-Core Business Completely new capabilities Leveraging Existing Capabilities Completely new capabilities Source: R. Koch. 231

232 There are some tools which supplement the stream analytics
DEVELOPING AND EVALUATING OPTIONS—INTRODUCTION There are some tools which supplement the stream analytics Streama analytics will provide insight and answers to help understand a client’s strategic position. Two tools however, help evaluate options: “Segment attractiveness”: helps quantify future attractiveness of options “Net present value”: helps quantify financial impact of options These tools are detailed in this section. a. See competitor/industry, customer, cost, capabilities stream analytics section of tool kit. 232

233 Developing and Evaluating Options
Introduction Segment Attractiveness Net Present Value 233 14 14

234 Segment attractiveness—introduction
DEVELOPING AND EVALUATING OPTIONS–CORE ANALYTICS Segment attractiveness—introduction What It Is Why We Use It Segment attractiveness assesses the benefits of being in (or entering) a given segment. It is defined by a set of quantitative and qualitative factors: Each factor is weighted according to its importance and to your own requirements. Segment attractiveness is derived by the sum of the factors. Although there are different approaches for evaluating segment attractiveness, all assess the pitfalls and opportunities of the segment analysed. Help make decisions in portfolio management: Identify where to invest/divest. Provides an input to evaluating strategic options. Helps quantify future attractiveness of markets/segments. Strengths & Limitations Strengths: Provides a structure for opportunities assessment. Objective assessment. Limitations: Reliable data-driven analysis is time-consuming. It is qualitative, and vulnerable to poor judgement. Does not factor in capabilities/ease implementation. 25 234

235 Segment attractiveness—how to apply it
DEVELOPING AND EVALUATING OPTIONS–CORE ANALYTICS Segment attractiveness—how to apply it On the basis of discussions with industry experts and JTMs, identify the factors that should be taken into account for a given segment, e.g.: Market size/market growth. Capacity/demand balance. Barriers to entry. Returns, NPV. Find a way to measure qualitative factors, and combine quantitative and qualitative factors in an index. Rate each factor from: 1 (very unattractive), to 5 (very attractive). This is not a trivial exercise. Requires expertise and validation to assign ratings. Multiply the ratings by weightings reflecting the factors’ relative importance. Calculate the total value for each dimension. 235

236 Segment attractiveness—illustrative output
DEVELOPING AND EVALUATING OPTIONS–CORE ANALYTICS Segment attractiveness—illustrative output Segment Evaluation Option A Market Attractiveness Factor Weight Score Value (Factor x Score) Overall market size Predicted customer demand Historical profit margin Competitive intensity Technological requirements Inflationary vulnerability Energy requirements Environmental impact Social/political/legal 0.20 0.15 0.05 Must be acceptable 1.00 4 5 2 3 0.80 1.00 0.60 0.30 0.15 0.10 Total 3.70 236

237 Segment attractiveness—top tips
DEVELOPING AND EVALUATING OPTIONS–CORE ANALYTICS Segment attractiveness—top tips Potential Insights Combined with an analysis of a company’s competitiveness in each segment, it helps decide how best to distribute financial and managerial resources between segments. Hints and Pitfalls Do: Quantify each factors. Define the time period being scored: A segment that is attractive today may not remain so, and vice versa. Don’t: Over engineer/make too complex Data Sources Industry reports Analysts’ reports Industry experts Client internal data Industry associations Related Analytics Business/segment profitability Company/competitor analysis Capability analysis Cost analysis 30 237

238 Developing and Evaluating Options
Introduction Segment Attractiveness Net Present Value 238 14 14

239 Net present value—introduction
DEVELOPING AND EVALUATING OPTIONS–CORE ANALYTICS Net present value—introduction What It Is Why We Use It A technique to evaluate an investment decision (e.g. whether to invest £x m in a new venture) There are other techniques to evaluate investment decisions, however they are inferior to the net present value technique: Interior rate of return (IRR). Payback. Average-return-on book. The key stages in determining net present value of a project are to: Forecast cash flows generated by the project. Determine the opportunity cost of having capital tied up in the project. Discount the cash flows to determine their present value (PV), and Deduce the project’s investment cost to get the net present value (NPV) If the NPV is greater than zero, the company should invest in the project To make decisions in whether to invest in particular project: Part of process to evaluate strategic options Methodology can also be applied to determine the value of: A company or enterprise. Part of a company or enterprise (e.g. part of a business to be sold) Strengths & Limitations Strengths: The most correct and rigorous methodology to evaluate an investment decision Limitations: Forecasting cash flows requires enormous care and skill, and may prove impossible to derive an accurate result Some clients are more comfortable with other methodologies (e.g. payback) Very sensitive to the terminal value 239

240 Net present value—how to apply it
DEVELOPING AND EVALUATING OPTIONS–CORE ANALYTICS Net present value—how to apply it Step 1 Determining the Value of a Project Involves Six Steps 1 Define Time Period 3 Estimate Terminal Value 1 Define Time Period Determine period over which you will estimate future cash flows: e.g. 3 years, 5 years, 10 years Today Forecast Period (years) 1 2 3 4 5 6 7 8 9 10 11-20 21-30 etc. . . 2 Forecast Cash Flows Forecast the size and timing of future cash flows 3 Estimate Terminal Value Estimate the likely cash flows beyond the forecast period 2 Forecast Cash Flows XX YY 4 Determine Opportunity Cost Determine the rate at which you will discount future cash flows to derive their present value 5 Calculate Present Value & Net Present Value Calculate the present value of those future cash flows 6 Conduct Sensitivity Analysis Test the sensitivity of the present value to key assumptions 6 Conduct Sensitivity Analysis 5 Calculate Present Value 4 Determine Discount Rate 240

241 Net present value—how to apply it (cont.)
DEVELOPING AND EVALUATING OPTIONS–CORE ANALYTICS Net present value—how to apply it (cont.) Step 2 Determining the Value of a Company or Project Involves Six Steps Forecast Cash Flow 1 Define Time Period Determine period over which you will estimate future cash flows: e.g. 3 years, 5 years, 10 years Cash flow is the difference between money received and money paid out: However, one common pitfall is confusing cash flow with accounting profit: they are not the same Accounting profit reflects when money is earned or expensed, rather than when the cash flows actually occur In addition, depreciation (which is not cash out) is deducted from accounting profits When identifying cash flows, we should include all additional, or incremental cash flows that are generated from acceptance of the project Forecasting future cash flows requires making multiple assumptions about future revenues (and sources of future revenues) and future costs: The forecasts are only as strong as the underlying logic Forecasting incremental cash flows is a relatively difficult process—which we do not detail here: For more information on how to do it see ‘data source p.xx’ the key areas to look-out for, however, are: Incremental (not average) cash flows Changes in working capital Consistent treatment of inflation Adjustments for depreciation Adjustments for taxes 2 Forecast Cash Flows Forecast the size and timing of future cash flows 3 Estimate Terminal Value Estimate the likely cash flows beyond the forecast period 4 Determine Opportunity Cost Determine the rate at which you will discount future cash flows to derive their present value 5 Calculate Present Value & Net Present Value Calculate the present value of those future cash flows 6 Conduct Sensitivity Analysis Test the sensitivity of the present value to key assumptions 241

242 Net present value—how to apply it (cont.)
DEVELOPING AND EVALUATING OPTIONS–CORE ANALYTICS Net present value—how to apply it (cont.) Step 3 Determining the Value of a Company or Project Involves Six Steps Estimate Terminal Value 1 Define Time Period Determine period over which you will estimate future cash flows: e.g. 3 years, 5 years, 10 years The terminal value is the value of the project beyond the forecast period: Also known as the residual value For example, the anticipated project could be launched into a new market: The forecast period may be 5 years, However, we would expect an impact of the market entry to continue beyond those 5 years. The terminal value should reflect the financial impact beyond the 5 year forecast period To determine the terminal value, you would review the planned project, and anticipate the likely cash flows generated from that project Typically there are 2 principal ways to estimate the terminal value: Assume small incremental cash flow out over a long period (10-20 years) Assume incremental cash flows tail off to zero (over years) 2 Forecast Cash Flows Forecast the size and timing of future cash flows 3 Estimate Terminal Value Estimate the likely cash flows beyond the forecast period 4 Determine Opportunity Cost Determine the rate at which you will discount future cash flows to derive their present value 5 Calculate Present Value & Net Present Value Calculate the present value of those future cash flows 6 Conduct Sensitivity Analysis Test the sensitivity of the present value to key assumptions 242

243 Net present value—how to apply it (cont.)
DEVELOPING AND EVALUATING OPTIONS–CORE ANALYTICS Net present value—how to apply it (cont.) Step 4 Determining the Value of a Company or Project Involves Six Steps 1 Define Time Period Determine period over which you will estimate future cash flows: e.g. 3 years, 5 years, 10 years Determine Discount Rate The discount rate should reflect: The time value of money (i.e. £1 in 10 years from today is not worth as much as £1 today); and The risk involved in the particular project being considered. To determine the discount rate we calculate the weighted average cost of capital (WACC) of the firm: WACC = The hard part is to estimate rE. Use client guidance Use Fruhan matrix 2 Forecast Cash Flows Forecast the size and timing of future cash flows 3 Estimate Terminal Value Estimate the likely cash flows beyond the forecast period 4 Determine Opportunity Cost Determine the rate at which you will discount future cash flows to derive their present value D V X rD + E V X rE Where: D = Outstanding debt E = Number of share x share price (Equity) V = D+E rD = Current borrowing rate rE = Expected return on equity 5 Calculate Present Value & Net Present Value Calculate the present value of those future cash flows 6 Conduct Sensitivity Analysis Test the sensitivity of the present value to key assumptions 243

244 Net present value—how to apply it (cont.)
DEVELOPING AND EVALUATING OPTIONS–CORE ANALYTICS Net present value—how to apply it (cont.) Step 5 Determining the value of a company or project involves six steps Calculate Present Value and Net Present Value 1 Define Time Period Determine period over which you will estimate future cash flows: e.g. 3 years, 5 years, 10 years To calculate PV apply the following formula: To calculate NPV apply the following formula: If the NPV is less than zero, the project should not go ahead: It will destroy value If the NPV is greater than zero, the project should go ahead PV = discount factor x C1 1 1+r = X X C1 2 Forecast Cash Flows Forecast the size and timing of future cash flows Where: r = rate of return (or opportunity cost) C1 = expected pay-off at time period 1 3 Estimate Terminal Value Estimate the likely cash flows beyond the forecast period 4 Determine Opportunity Cost Determine the rate at which you will discount future cash flows to derive their present value NPV = PV-required investment NPV = C0 + C1 1+r Where C0 = Cash flow at time period 0 5 Calculate Present Value & Net Present Value Calculate the present value of those future cash flows 6 Conduct Sensitivity Analysis Test the sensitivity of the present value to key assumptions 244

245 Net present value—how to apply it (cont.)
DEVELOPING AND EVALUATING OPTIONS–CORE ANALYTICS Net present value—how to apply it (cont.) Step 6 Determining the value of a company or project involves six steps 1 Define Time Period Determine period over which you will estimate future cash flows: e.g. 3 years, 5 years, 10 years Conduct Sensitivity Analysis Sensitivity analysis is simply testing how sensitive the final result (i.e. the NPV value) is to key assumptions To run a sensitivity analysis, one-by-one change each key assumption by see 5% (or 10%, or 15%), and capture the revised NPV This should identify two things: The impact of being % out on forecasts underlying those key assumptions; and Which are the key assumptions that influence the NPV output You should ensure that these most influential assumptions are robust, and are fully validated 2