1. How to Do a Strategic Analysis Dr. Stan Abraham Fall 2004 Revised Fall 2006

2. What Is Strategic Analysis? v One person’s or one group’s attempt at arriving at a strategy and key strategic decisions for a company –For example, vision statement, objectives, and key programs –An essential precursor to strategic planning

3. Why Do It? v To gain strategic-planning skills v To integrate functional business courses you have taken to-date v To be able to help companies or organizations decide their future v To do a better job of running your own business one day

4. The Essential Questions 1. What’s the current situation? 2. Where do we want to go? 3. How can we get there?

5. 1. What’s the Current Situation? v What’s changing in our industry, markets, competitors, the economy, and other areas that may affect us? v Where are the opportunities? v How have we been performing and what financial condition are we in? v What strengths, resources, weaknesses, and competitive advantages do we have?

6. 2. Where Do We Want to Go? This involves strategic thinking v What are all the possible and feasible directions we could go? –Which opportunities could we pursue? –What alternative business models make sense? v Which is the best alternative? –Why is it the best one?

7. 3. How can we get there? And how fast should we get there? v What vision and strategy should we pursue? v What objectives should we set? –For the next year and three years’ hence? v What programs should we implement? v What contingencies can we devise in case things go wrong?

8. What Is Strategy? v Strategy is how a company actually competes v The best strategy is embedded in a business model that both provides customer value and gives the organization a sustainable competitive advantage

9. Strategic Planning vs. Strategic Management Strategic-planning process Operational planning ImplementationEvaluation & control Strategic management Strategic thinking drives the process Strategic analysis informs the process Book Figure 1.1

10. A Strategic Analysis Model – that works! Alternatives Analysis Strategic Issues Identifying Strategic Alternatives Arguing For and Choosing a Preferred Strategy Recommendations Short-Term Plans Goals & Objectives Strategic Intent Programs Contingencies Long-Term Plans Goals & Objectives Strategic Intent Programs Contingencies Situation Analysis External Review Industry Analysis Competitive Analysis Market Analysis Environmental Analysis Internal Review Financial Analysis Strengths & Weaknesses Opportunities & Threats 1. What is the current situation? 2. Where do we want to go? 3. How can we get there?

11. Industry and Competitive Analysis v Dominant economic characteristics v Industry driving forces v Sources of competitive threat u Porter’s 5-forces model v Competitive positioning of major rivals v Critical success factors v Competitive strength analysis v Industry attractiveness Situation Analysis External

12. Dominant Economic Characteristics Example: Industry for a chemical commodity Industry Size v $500 million sales; 4 million tons total volume Scope of Competitive Rivalry v Primarily regional; producers rarely sell outside a 250-mile radius of plant due to high cost of shipping long distances Industry Growth Rate v 2-3 percent annually Stage in Lifecycle v Mature Number of Competitors v About 30 companies with 110 plant locations and capacity of 4.5 million tons. Market shares range from 3-21 percent Customers v About 2,000 buyers; most are industrial chemical firms Situation Analysis External

13. Dominant Economic Characteristics (2) Degree of Vertical Integration v Mixed. Five of the ten largest firms are integrated backward into mining operations and also forward in that sister industrial chemical divisions buy over 50% of their plant output; all other firms are engaged solely in manufacturing Ease of Entry/Exit v Moderate entry barriers exist: it costs $10 million to construct a new plant of minimum efficient size and a new entrant must build a customer base within 250 miles from the plant Technology/Innovation v Production technology is standard and slow to change. Biggest changes are occurring in products--about 1-2 newly formulated specialty chemical products introduced annually, accounting for nearly all the industry growth Situation Analysis External

14. Dominant Economic Characteristics (3) Product Characteristics v Highly standardized and commodity-like Scale Economies v Moderate. All firms have virtually equal manufacturing costs, but scale economies exist in shipping in multiple carloads to the same customer and in purchasing large quantities of raw materials Capacity Utilization v Efficiency is highest when producing between 90-100% of rated plant capacity. Unit costs rise appreciably when utilization drops below 90% Industry Profitability v Subpar to average. The commodity nature of the product results in intense price-cutting when demand slackens, but prices firm up during periods of strong demand. Profits thus track the strength of demand for the industry’s products Situation AnalysisExternal

15. Industry Driving Forces v Changes in the industry growth rate v Changes in who buys the product and how they use it v Product or marketing innovation v Technological change v Entry or exit of major firms v Diffusion of technical know-how v Increasing globalization of the industry v Changes in cost and efficiency v Emerging buyer preferences for differentiation v Regulatory influences and government policy changes v Changing societal concerns, attitudes, lifestyles Situation Analysis External

16. Industry Lifecycle Curve Total Industry Sales Shake-out Emerging Growth Maturity Decline Time Situation AnalysisExternal

17. Industry Lifecycle Curve (2) Shake-out Stage Supply = DemandCompetitors leave the (max. slope)arena or are acquired (Supply > Demand) Competitors enter the arena (Supply < Demand) Situation AnalysisExternal

18. Concentrated vs. Fragmented Industries v Concentrated – when most of the industry’s sales are accounted for by only a few firms u The “Big Four” accounting firms audit 96% of public companies in the U.S. u Only three firms make jet engines for the world’s commercial aircraft; only two make the aircraft v Fragmented – when no company has more than a one-percent share of the market u Beauty salonsBookkeepers u PlumbersCement-mixing companies Situation AnalysisExternal

19. The Value Chain Example – Wool Suits Situation AnalysisExternal Vertical Integration Backwards Forwards Breeding Raw Cloth Cloth Sheep on Wool Mill Wholesaler Tailor Retailer Farm Wholesaler Dyer Final Customer

20. Potential New Entrants Barriers to Entry Suppliers Rivals Buyers Substitutes Sources of Competition Porter’s 5-Forces Model of Competitive Threats Situation Analysis External Intensity of Rivalry ? Bargaining Power (a) of buyers? (b) of suppliers? Barriers to Entry ? Threat of Substitutes ?

21. Competitive Intelligence Competitive Positioning of Major Rivals Com- Geographic Strategic Competitive Strategic Competitive petitor Scope Intent Position Posture Strategy A Local Be the leader Getting stronger Mostly offensive Low-cost B Regional Overtake leader Well entrenched Mostly defensive leadership C National Stay in top 5 Stuck in middle Combo (off./def.) Market niche: D Multicountry Go into top 10 Seeking different Aggressive - High end Etc. Global Climb 1-2 places market position risk-taker - Low end Overtake a Losing ground Conservative - Specialist rival Retrenching to follower Differentiation Maintain a defensible - Quality position position - Service - etc. Situation Analysis External

22. Strategic Group Map Breadth of product line Geographic scope Very broad narrow domesticinternational A two-dimensional diagram with axes that separate out rivals in an industry Plot competitors on the diagram Group ones that are “close” to each other on the map – they are said to belong to similar strategic groups Often, circles around the groups represent combined sales of companies in them Situation Analysis External

23. Critical-Success-Factor Analysis A critical success factor (CSF) is something a company must do well in order to succeed in the industry. Example: XYZ Industry Competitors Critical Success FactorCo. A B C D E Engine technology 8 9 9 7 6 10 Styling and features 9 8 9 8 7 9 Brand reputation 10 8 9 7 6 9 Strong distribution/dealer network 7 8 9 6 7 10 Efficient manufacturing 6 8 8 7 8 9 Effective marketing 9 8 9 8 7 9 Situation Analysis External

24. Assessing Industry Attractiveness Example: XYZ industry Industry Factor Weight Rating Product Sales growth rate250.3 7.5 Market size200.612.0 Industry profitability180.814.4 Intensity of competition150.710.5 Barriers to entry120.910.8 Degree regulated101.010.0 --------------- TOTALS 10065.2 Situation Analysis External

25. Assessing Competitive Strength Example: Your Company Under Analysis Competitive Factor Weight Rating Product Technological innovativeness220.613.2 Marketing/distribution200.918.0 Caliber of management180.916.2 Relative cost position170.610.2 Brand reputation121.012.0 Financial strength110.7 7.7 ----------- TOTALS 10077.3 Situation AnalysisExternal

26. G. E. Matrix High Medium Low WeakAvg.Strong Divest Invest Competitive Strength Industry Attractiveness Your Company Situation AnalysisExternal

27. Market and Customer Analysis Covered in your Marketing course... v Identify the target market/segment v Identify customer needs (present and future) v Identify principal market segments v How does the customer buy (channels)? v What are the channel markups? v Extent to which customer responds to advertising and promotion, and which media v How price-sensitive is the customer? Situation Analysis External

28. Environmental Analysis Categories to Scan Continually Demographic changes -- regional population shifts, birth rates, age cohorts, etc. Impending regulatory/legislative changes -- healthcare reform, tax bills, etc. Political changes (esp. at election time) -- tax changes, party platforms, etc. Lifestyle/attitude trends -- fitness, disease prevention, seeking adventure, etc. Sociocultural trends -- consumer activism, greater tolerance of diversity, etc. Current economic climate and trends -- extended recession, devaluation, etc. Technological advances -- industry & federal spending on R&D, new patents, etc. All the above, for each foreign country in which the company does business. Ask, “What changes/trends affect my company either negatively or positively?” The larger the potential impact, the more specific data are needed about the trend/change. Situation AnalysisExternal

29. Phase Coverage in Class Alternatives Analysis Strategic Issues Identifying Strategic Alternatives Arguing For and Choosing a Preferred Strategy Recommendations Short-Term Plans Goals & Objectives Strategic Intent Programs Contingencies Long-Term Plans Goals & Objectives Strategic Intent Programs Contingencies Situation Analysis External Review Industry Analysis Competitive Analysis Market Analysis Environmental Analysis Internal Review Financial Analysis Strengths & Weaknesses Opportunities & Threats 1. What is the current situation? 2. Where do we want to go? 3. How can we get there? I II IIIIV

30. Scope of Phase 1 The group that does Phase 1 on a particular case goes only as far as this point  Phase 1 involves an external analysis of the industry, competition, market, and environment u Includes four tools –Porter’s Five-Forces Model –G.E. Matrix (including Industry Attractiveness vs. Competitive Strength) –CSF Analysis –Strategic Group Map Situation Analysis External

31. Financial Analysis v SAM does all the work for you after you have inputted all the income-statement and balance- sheet data v You have to select which kinds of financial data to present in order to give a reasonable and complete picture of the company’s recent performance and current financial condition v You end the presentation with a ‘financial conclusion’ slide

32. Financial Charts v Begin with revenues and NIAT v Show breakdowns of revenues or profits (by product line or geographical region if given) v Should include current or quick ratio (not both), D/E or D/A ratio (not both), and Z- or Z 2 -Score v In addition, especially for a smaller company –Does it have enough cash? –Are its receivables climbing? –Does it have too much invested in inventory? –Where D/A ratio > 100%, show that equity is negative –Any other aspect that is worth pointing out

33. Altman’s Z- and Z 2 -Scores Safe Zone Gray Area Bankrupt Zone Manufacturing Companies Non-Manufacturing Companies 2.99 1.81 2.59 1.11 Z-ScoreZ 2 -Score Situation Analysis Internal Z-score = 1.2X 1 + 1.4X 2 + 3.3X 3 + 0.6X 4 + 1.0X 5 Z 2 -score = 6.5X 1 + 3.26X 2 + 6.72X 3 + 1.05X 4a X 1 = WC/Total assetsX 2 = RE/Total assets X 3 = EBIT/Total assetsX 4 = Equity/Total debt X 5 = Sales/Total assets

34. Financial Conclusion v The last sheet of the financial analysis part in SAM tw asks you to draw one of the following five conclusions about the company u Has been well managed and performing well, and is in good financial condition  Same as above except for one major bad thing... u Has had mixed results, indeterminate  Same as below except for one major good thing... u Has been poorly managed, is performing poorly, may be in serious trouble, should be bankrupt, etc. And support your conclusions with numbers! Situation Analysis Internal

35. Financial Conclusion Example: Harley-Davidson (1988) H-D has been performing very well and is financially in good condition v Motorcycle revenues grew an average 23.5%/yr from 1986- 88 in a declining industry v NIAT grew 12.7% in 1988 v NPM almost doubled from 1.7% in 1986 to 3.2% in 1988 v D/E ratio declined 54.5% from 5.5 in 1987 to 2.3 in 1988 v It has $52.3M in cash in 1988 v Z-Score improved to 3.07 (safe zone) in 1988 Situation Analysis Internal Set off the conclusion in a different font and color to stand out. Summarize the supporting data in the order you showed the charts. Cite statistics.

36. Company Potential Strengths Core competenciesCost advantages Adequate financial resourcesBetter advertising campaigns Reputation with buyersProduct innovation skills Well-conceived programsProven management Access to economies of scaleAhead on the experience curve Protected from competitionEfficient manufacturing Proprietary technologySuperior technology skills Financial analysis of recent company performance is also a key component of Internal Company Analysis, and may reveal some strengths and weaknesses Situation Analysis Internal

37. Company Potential Weaknesses No clear strategic directionFalling behind in R&D Obsolete facilitiesProduct line too narrow Sub-par profitability because...Weak market image Little or no managerial depth/talentWeak distribution network Missing key skills/competenciesWeak marketing skills Poor implementation recordUnable to finance strategies Internal operating problemsHigh relative costs Poor product qualityWorsening customer service Deteriorating union relationsSlow development of new products Situation Analysis Internal

38. Core Competence and Competitive Advantage Criteria for Core Competence Is theIs theIs theIs the capabilitycapabilitycapabilitycapability valuable?Rare?costly tononsubsti-CompetitivePerformance imitate?tutable?ConsequencesImplications NoNoNoNoCompetitiveBelow-average disadvantagereturns YesNoNoYes/NoCompetitiveAverage parityreturns YesYesNoYes/NoTemporaryAverage + advantagereturns YesYesYesYesSustainableAbove-average advantagereturns Situation Analysis Internal

39. Potential Opportunities (Concentration strategies) Existing Expanded New ExistingImprovedNew Only Product/Market Issues are Opportunities Products Market Development Product Development Markets Situation Analysis Internal

40. Potential External Threats v Entry of low-cost foreign competitors v Adverse shifts in foreign exchange rates and trade policies v Slower market growth v Adverse demographic changes v Costly regulatory requirements v Impending economic downturn v Growing bargaining power of buyers and suppliers v Changing buyer needs and tastes v Rising sales of substitute products v Legislation with adverse impact Situation AnalysisInternal

41. TOWS Matrix StrengthsWeaknesses Opportunities Using strengths to exploit opportunities Seeking opportunities that overcome/mitigate weaknesses Threats Using strengths to avoid/mitigate threats Minimizing weaknesses or avoiding/mitigating threats

42. Other Key Questions to Answer v Does the corporate culture support or hinder achieving the strategy? v How innovative is the company? v How quickly are new products produced? v How cost-competitive is the company? v Is the company flexible enough for these changing times? v Does the company have a sustainable competitive advantage? v Is the quality of the company’s products/services high enough? v Are managers well served by the M.I.S.? Situation Analysis Internal

43. Scope of Phase 2 The group that does Phase 2 on a particular case goes only as far as this point  Phase 2 involves an internal analysis of the company, including financial-analysis charts, a financial conclusion, and a SWOT analysis u Includes four tools –Core-Competence Analysis –The TOWS Matrix –Value Analysis (not shown here) –SPACE Analysis (not shown here) Situation Analysis Internal

44. Key Strategic Issues A key strategic issue is a: v Future event or trend that may have a significant impact on the firm (e.g., deregulation of an industry, signing the NAFTA trade agreement) and that should be closely monitored v Decision the firm is considering making that will have a strategic and dramatic impact on it (e.g., merging with another company, changing its strategy, focusing on international operations) Any strategic plan must address these strategic issues for the simple reason that they constitute the most important problems and issues the company faces Alternatives Analysis

45. Sources of Strategic Issues Most critical external issues * Competition * Industry trends * Market trends * Other trends and threats Most salient internal issuesStrategic * Financial weaknesses Issues * Weaknesses, problems Other options worth considering Alternatives Analysis

46. Menu of Possible Strategies Staying in the same business: v Concentration – Product or market development v Vertical Integration – Forward or backward v Acquisition of or merger with a competitor v Harvest or be acquired v Retrenchment and Turnaround (including Bankruptcy Chapters 11, 13) v Low-cost leadership, differentiation, or focus v Strategic alliances, including joint ventures Exiting the business: v Liquidation (including Bankruptcy Chapter 7) Entering another business: v Diversification through acquisition – related or unrelated business v Internal diversification Alternatives Analysis

47. Porter’s Generic Competitive Strategies Cost Leadership Differen- tiation Cost Focus Focused Differen- tiation Competitive Advantage Competitive Scope Broad Target Narrow Target Source: Michael E. Porter, Competitive Advantage, Free Press, 1985 Lower Cost Differentiation Alternatives Analysis

48. Low-Cost Leadership and Differentiation – How They Work Low-Cost LeadershipDifferentiation P C Internal emphasis External emphasis Focus on cost drivers Focus on customer needs Don’t lower prices Don’t let costs rise Alternatives Analysis

49. Coming up with Strategic Alternatives v The most difficult part of strategic planning – Requires a lot of thought and creativity v The challenge is to devise 2-4 alternatives – The minimum is two v Must meet four criteria – Mutually exclusive (i.e., doing one means not being able to do the others) – Feasible (i.e., doable and internally consistent) – Lead to success (as defined by the company) – Address all strategic issues Alternatives Analysis

50. #1—Expand #2—Broaden #3—Expand the Market the Product Line into Europe Focus on older malesIntroduce three newExpand into Europe & women models Design models toAcquire Buell andTrade shows and appeal to this marketoffer sport bike100 roving bikers Train dealers toDevelop technolog.Create dealer network sell to this marketadvanced enginefrom scratch Invest in and growMaintain HR butMaintain HR but HR salesimprove its salesimprove its sales Heavy advertisingHeavy advertisingHeavy advertising & promo campaign& promo campaign& promo campaign Incr. prod. capacity &Incr. prod. capacity & Incr. prod. capacity & maintain high qualitymaintain high quality maintain high quality Increase market shareIncrease market shareMaintain U.S. share Finance thru debt & cash Finance thru debt & cashFinance thru debt & cash Strategic Alternative Bundles Example: Harley-Davidson (1988) Alternatives Analysis

51. Choose the Best Alternative v Argue for which one is better or best – hard to do when all are equally good v The choice depends on how each alternative stacks up against certain criteria v Managers who must implement the strategy should be involved in deciding which alternative to pursue Alternatives Analysis

52. Criteria for Choosing a Successful Strategy v Shareholder Value—Often used as the measure of the effectiveness of strategic planning v Revenues—Particularly appropriate when the firm wants to increase market share v Profitability—Important when earnings or cash flow have been flat or negative, or when the firm is highly leveraged v Investment Required—Does the firm have, or can it acquire, the resources it needs? Does it make sense to be acquired? v Degree of Risk—How certain is the firm to succeed if it undertakes this alternative? Is it risk-averse? Alternatives Analysis

53. Criteria for Choosing a Successful Strategy (cont.) v Return on investment—ROI is another profitability measure v Breakeven point—The sooner the investment is recouped the better v Match with existing company culture—While it may be better to choose an alternative that does not require changing the culture, the culture may have to change to take advantage of a better alternative v Attainment of a core competence or competitive advantage— This is the secret of being competitive and attaining above-industry-average profits Alternatives Analysis

54. Criteria for Choosing a Successful Strategy (cont.) v Timing—Is the timing right to implement a particular alternative? Is it better to implement now or later? v Strengthening its value proposition—the key to developing a revenue stream and loyal customers v Strength of bargaining power—which will increase it more with either buyers or suppliers, thus earning higher profits? Alternatives Analysis

55. Two Types of Criterion Positively Correlated v Revenues v Profits v Return on investment v Shareholder value v Gaining or extending a competitive advantage v Strengthening its value proposition v Strength of bargaining power Negatively Correlated v Investment required v Time to breakeven v Competitive retaliation v Culture change required v Riskiness (0 to +10)(0 to –10) Alternatives Analysis

56. Criteria Matrix Example for Harley-Davidson (1988) Alternatives Analysis

57. Scope of Phase 3 Phase 3 ends at this point v The group will continually work at improving its list of strategic issues and bundles in class as Phases 1 and 2 are unfolding  It will then present its strategic issues and bundles for class discussion u We all understand it’s a “work in process”  Strive for understanding, not perfection  Include a criteria matrix at the end with your choice of a preferred bundle v For the 3 rd to 6 th cases, also include Phase 4 Alternatives Analysis

58. Recommendations Format for Short- and Long-Term Plans Should include: v Specific measurable objectives to be achieved next year and in three years’ time – At least Revenues and NIAT – 1-3 others that are important v Strategic Intent v Major programs to implement that will achieve the set objectives and implement the strategy v Trigger and contingency pairs -- what could go wrong (trigger) and what would the firm do differently if that happened (contingency)?

59. Triggers and Contingencies Criteria to meet… Triggers… v Must be quantitatively expressed v State one at a time (no “dual” triggers) Contingencies… v Must address (alleviate) the trigger v Cannot renege on the chosen strategy v Must be something different from what the company is currently doing v Must be operational and implementable quickly

60. The Vision Statement What Do We Aspire to Be? v Typically created for a period of 5-10 years v Can include numbers (objectives) or not v Typically created by the organization’s leader u Must be sold to the rest of the organization v Must be realistic (possible to attain) and hence worth striving for v Can you tell when you have achieved it?

61. The Mission Statement How Should We Do Business? What’s Our Raison D’Etre? v Should encompass the company’s current business and future strategy v Should include its value proposition (products or services offered to which target market) v Should include what makes the company special u How it creates value in order to win and keep its customers’ business

62. Creating Vision/Mission Statements v One of the more challenging tasks leaders/managers undertake u Most don’t do it well—they consider it time wasted u Many are unable to think clearly enough and get too frustrated u If you cannot do it, you don’t know your business well enough v Leaders must get the commitment of the whole organization to the vision/mission statements u Key people should participate in its preparation u Should not be revised for several years, or until it no longer fits what the company is doing

63. When to Create Them?  After doing a strategic analysis u Because the strategy and direction of the company may change u A good time to check whether the existing vision and mission statements need changing v Otherwise, the vision and mission statements essentially govern what the company does (or doesn’t do) next

64. That’s it, folks! The whole process will come to life as you start to do the strategic analyses yourselves…