 Instructor: Michael Cooke  Address :  Office: IC room 817  Class hours:Friday 09:00-12:00  Class Location: IC room 822

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch 3 -2

– Environmental Scanning – Industry Analysis Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch 3 -3 External Strategic Management Audit

Identify & evaluate factors beyond the control of a single firm – Increased foreign competition – Population shifts – Aging society – Fear of traveling – Stock market volatility Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch 3 -4 External Strategic Management Audit

Purpose of an External Audit ◦Develop a finite list of  opportunities that could benefit a firm  threats that should be avoided Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch 3 -5 External Strategic Management Audit

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch 3 -6

Gather competitive intelligence Assimilate information Evaluate Resulting in a list of the most important key external factors Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch 3 -7 External Audit

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch 3 -8 Performing External Audit External Factors Measurable Long-term Orientation Applicable to Competing Firms Hierarchical

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch 3 -9 Industrial Organization (I/O) View Industry factors are more important than internal factors Performance determined by industry forces

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch Economies of Scale Industry Properties Barriers to Market Entry Product Differentiation The Economy I/O Perspective Firm Performance Level of Competitiveness

 GDP growth rate ◦ Disposable income ◦ Consumer optimism  Currency trends ◦ Affect export/import strategy ◦ Where to manufacture  Interest rates and liquidity ◦ Slope of yield curve affects GDP growth and access to capital ◦ Cost of borrowing affects investment decisions  At the macro level interest rates affect GDP growth  At the micro level it affects hurdle rates and choices -Example 1: Net rental income 6%, interest cost 8% -Example 2: Average P/E ratio 15/1, risk free interest 7%

 Financial risk factors The Company is exposed to credit risk, liquidity risk and market risk. Market risk arises from currency risk, interest rate risk and fair value risk associated with investments. The Company has a risk management program in place to monitor and actively manage such risks.  Market Risk ◦ Foreign exchange risk The Company is exposed to foreign exchange risk arising from various currency exposures. To minimize foreign exchange risk arising from operating activities, the Company’s foreign exchange management policy requires all normal business transactions to be in local currency, or cash- in currency be matched up with cash-out currency. The Company limits all speculative foreign exchange transactions and operates a system to manage receivables and payables denominated in foreign currency. ◦ Interest rate risk Interest rate risk is defined as the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market interest rates. The Company is exposed to interest rate risk mainly arising through interest bearing liabilities and assets. In order to avoid interest rate risk, the Company maintains minimum external borrowing by facilitating cash pooling systems on a regional and global basis.  Credit risk Credit risk arises during the normal course of transactions and investing activities, where clients or other party fails to discharge an obligation. The Company monitors and sets the counterparty’s credit limit on a periodic basis based on the counterparty’s financial conditions, default history and other important factors. To minimize such risk, the Company transacts only with banks which have strong international credit rating  Liquidity risk  The Company manages its liquidity risk to maintain adequate net working capital by constantly managing projected cash flows.

 Choose two companies in similar lines of business  From the most recent Annual Reports ◦ Revenue 2010 and 2011 ◦ Cost of Goods 2010 and 2011 ◦ Gross profit for each period, and GP % ◦ Research and Development as % of Revenue each pd ◦ Receivables as % of revenue each period ◦ Inventories as % of revenue each period ◦ Company comments about FX risk and interest rate risk  A couple of comments about any differences among the companies that seem noteworthy

 The US dollar is the most common reserve currency ◦ Oil and many other commodities traded in dollars ◦ Easily converted nearly anywhere in the world ◦ An artifact from post WWII when US dollar was the only strong currency  Euro is relatively new, sometimes considered an alternative to the dollar  Japanese yen is important because of Japan’s role in the world economy  Chinese yuan is not widely used outside China due to restrictions - this could quickly change

◦ In a fixed exchange system the local currency is pegged to another currency  Hong Kong Dollar pegged to US dollar  No exchange risk in trade between the two countries  Requires intervention by Hong Kong government ◦ Basket of currencies approach  Singapore Dollar managed against several currencies  Chinese Yuan thought to be managed against a basket  Not tied to the fortunes of one foreign currency ◦ Variable (floating) exchange rates  Pose risks for importers and exporters  Rates are an extremely important factor for international trade  Difficult or impossible to predict  Governments may intervene in the float without warning to protect exports ◦ Barter might be used where countries impose rigid FX controls (USSR) or where local currencies are worthless

◦ Goods imported from Japan to USA become more expensive in USA  Company purchasing equipment made in Japan would pay more in US dollars for the same product  Banks will agree to a forward rate, locking in the current rate to a future period ◦ Japanese companies might choose to relocate manufacturing facilities to USA as the yen rises  Profits of US subsidiaries lower in yen terms  Foreign exchange losses on parts imported from Japan

f Korea Indonesia Malaysia Phillippines Singapore Thailand Hong Kong China Taiwan Sources: Columbia University and IMF

 Exports became cost competitive in world markets ◦ How would a Japanese manufacturer with operations in Thailand and Japan respond to a 50% devaluation of the baht? ◦ Products from Thailand became cheaper relative to currencies that did not devalue  Imports and foreign travel for Thai people became more expensive  Thailand’s tourism industry gained ◦ Airlines chose to base fares to and from BKK in Thai baht ◦ Tourists perceived ‘value for money’ in Thailand, with services and local products in Thai baht  Multinational in-country company response to the crisis ◦ Emphasize product value ◦ Change the product mix or package size (cheaper, smaller) ◦ Increase local procurement (use Thai goods rather than use imports)  Inflow of foreign currencies caused baht to gain

 Currency can be under or overvalued relative to another  PPP is an estimate of real purchasing power ◦ When Thai baht were officially 55-1 dollar  Currency undervalued  Thai economy looked small in dollar terms  But Thai people could buy Thai products and services  In PPP terms the Thai economy was larger than in $ terms ◦ In theory, currency nominal value will eventually = PPP  Currently, W Europe overvalued, many Asian currencies (excl Japan) undervalued

 Demographic variables are a factor in country wealth ◦ Working age population relative to non-working ◦ China and Thailand will soon have shrinking % working age ◦ Often overlooked implications of large % population = elderly  Socioeconomic Variables ◦ Per Capita income  Issues in using per capita income as an indicator:  Transactions are valued in an international currency (monetization of transactions)  Official exchange rates seldom reveal true buying power within a country  Services are provided in-country using local currency  Goods not traded across borders (housing, etc)  Use Purchasing Power Parity to estimate buying power  Gray and Black Market sectors of the economy (cash or barter) ◦ Income inequality – Gini index  Lower number means more income equality  Scandinavian countries have least inequality  Thailand, China, USA relatively unequal (higher index) 20

World Gini Compared to USA The Atlantic

Income Inequality in Selected Countries South Africa (2)65 (2005) 59.3 (1994)South Africa Thailand (12)53.6 (2009) 42 (2002) China (27)48 (2009) 41.5 (2007)China USA (42)45 (2007) 40.8 (1997) Germany (124)27 (2006) 30 (1994)Germany Sweden (136)23 (2005) 25 (1992) Implication: Low per capita GNP can mask affluent areas/segments.

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch Social, Cultural, Demographic, and Natural Environmental Forces Major Impact – Products Services Markets Customers

 Low population growth rate, falling rate by 2050 ◦ 69MM 2010 world 6.9BB Thailand = 1.00% of world ◦ 73MM 2030 world 8.3BBThailand = 0.88% of world ◦ 68MM 2060world 9.6BBThailand = 0.71% of world  Low birth rate ◦ 12.8/1,000 is similar to China ◦ 20.1/1,000 is replacement rate ◦ Declining family size. Declining % under 15 years of age. ◦ More women delay marriage or never marry  Low urbanization, high rate of change ◦ Thailand 34% urban, change 1.8% per year ◦ China 47% urban, change 2.3% per year ◦ USA 82% urban, change 1.2% per year  Longer lives ◦ Increasing number of retired (age 65+ =11.4% in 2020) ◦ Decreasing number of working age (similar to China) Population forecast: /

Population Pyramid Thailand

Population Pyramid China Ch 3 -29

Population Pyramid Philippines 2008 population 96MM2050 population 172MM

Population Pyramid Malaysia 2008 population 25MM 2050 population 43MM

Population Pyramid Cambodia 2008 population 14MM2050 population 24MM

Population Pyramid Japan 2008 population 127MM 2050 population 94MM

Ethiopia 2008 population 83MM 2050 population 278MM

Implications of Demographic Shift Smaller households require different housing Families with fewer children spend more/child With fewer people of working age – Cost of labor will rise – Low skill jobs will go to countries with younger populations – Need to move to higher value added (skills) More retirees and elderly – a unique market Japanese model – Higher value added industries – Investment abroad Pressures for immigration from labor surplus countries

Social, Cultural, Demographic, and Natural Environmental Forces Trends ◦More American households with people living alone ◦Aging Americans – affects all organizations Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch 3 -36

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch Political, Governmental, and Legal Forces Key opportunities & threats Antitrust legislation Tax rates Lobbying activities Patent laws Government Regulation

 Protectionist policies  Governments taking equity stakes in companies Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch

 Internet ◦ Alters product life cycles ◦ Speed of distribution ◦ Consumer access to information about products and companies  Automation – capital intensive versus labor  Data mining – access to aggregated information about consumers  Communication technologies

 Bigger and more profound than e-commerce or internet alone  Growth of worldwide secure financial settlements ◦ Rapid spread of ATMs from the mid-90s for example ◦ Ease of doing financial transactions across borders  Rapid spread of cellular technology connected whole regions to the outside world, from late 1990s  Rapid decrease in the price of bandwidth late 1990s ◦ Large scale long distance data transfer became viable  Fiber optic technology means very cheap prices across oceans  Google and others have mix of local and central content ◦ Offshore factories and suppliers have real time access ◦ Distributors have real time access to retail inventory ◦ Medical information and other data intensive documents exchanged real time  Cultural diffusion via better communication ◦ Often thought of as from developed countries to LDCs ◦ Growing exposure and interest work in both directions

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch Technological Forces Significance of IT Chief Information Officer (CIO) Chief Technology Officer (CTO)

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch Technological Forces Essential for nearly every strategic decision

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch Competitive Forces Collection & evaluation of data on competitors is essential for successful strategy formulation

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch Competitive Forces Strengths Weaknesses Capabilities Opportunities Threats Objectives Strategies Identify Rival Firms’

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch Competitive Forces Competition in virtually all industries can be described as intense

Key Questions Concerning Competitors Their strengths Their weaknesses Their objectives and strategies Their responses to external variables Their vulnerability to our alternative strategies Our vulnerability to strategic counterattack Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch 3 -46

Key Questions Concerning Competitors Our product/service positioning Entry and exit of firms in the industry Key factors for our current position in industry Sales/profit ranking of competitors over time Nature of supplier and distributor relationships The threat of substitute products/services Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch 3 -47

 Market share matters  Understanding what business you are in  Broke or not, fix it  Innovate or evaporate  Acquisition is essential to growth  People make a difference  No substitute for quality Copyright © 2011 Pearson Education, Inc. Publishing as Prentice HallCh 3 -48

 A systematic and ethical process for gathering and analyzing information about the competition’s activities and general business trends to further a business’s own goals Copyright © 2011 Pearson Education, Inc. Publishing as Prentice HallCh 3 -49

 Internet  Employees  Managers  Suppliers  Distributors  Customers  Creditors  Consultants  Trade journals  Want ads  Newspaper articles  Government filings  Competitors Copyright © 2011 Pearson Education, Inc. Publishing as Prentice HallCh 3 -50

Objectives of Competitive Intelligence Provide a general understanding of industry and competitors Identify areas where competitors are vulnerable and assess impact of actions on competitors Identify potential moves that a competitor might make Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch 3 -51

Market Commonality The number and significance of markets that a firm competes in with rivals Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch 3 -52

Resource Similarity Extent to which the type and amount of a firm’s internal resources are comparable to a rival Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch 3 -53

1. Identify key aspects or elements of each competitive force 2. Evaluate how strong and important each element is for the firm 3. Decide whether the collective strength of the elements is worth the firm entering or staying in the industry Copyright © 2011 Pearson Education, Inc. Publishing as Prentice HallCh 3 -55

The Five-Forces Model Rivalry among competing firms ◦Most powerful of the five forces ◦Focus on competitive advantage of strategies over other firms Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch 3 -56

 High number of competing firms  Similar size of firms competing  Similar capability of firms competing  Falling demand for the industry’s products  Falling product/service prices in the industry Copyright © 2011 Pearson Education, Inc. Publishing as Prentice HallCh 3 -57

 Consumers can switch brands easily  Barriers to leaving the market are high  Barriers to entering the market are low  Fixed costs are high among firms competing  The product is perishable Copyright © 2011 Pearson Education, Inc. Publishing as Prentice HallCh 3 -58

 Rivals have excess capacity  Consumer demand is falling  Rivals have excess inventory  Rivals sell similar products/services  Mergers are common in the industry Copyright © 2011 Pearson Education, Inc. Publishing as Prentice HallCh 3 -59

 Potential Entry of New Competitors  Barriers to entry are important  Quality, pricing, and marketing can overcome barriers Copyright © 2011 Pearson Education, Inc. Publishing as Prentice HallCh 3 -60

 Bargaining Power of Suppliers is increased when there are:  Large numbers of suppliers  Few substitutes  Costs of switching raw materials is high  Backward integration is gaining control or ownership of suppliers Copyright © 2011 Pearson Education, Inc. Publishing as Prentice HallCh 3 -61

The Five-Forces Model Potential development of substitute products – Pressure increases when: Prices of substitutes decrease Consumers’ switching costs decrease Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch 3 -62

 Often overlooked or underestimated by established industry players ◦ HP in 2004 saw Personal Computers as a commodity  Build cheap in high volume  Main competitor thought to be Dell Computer of TX  $3BB R&D under-utilized  Substitutes can restructure entire industries ◦ Common in technology industries ◦ Always a threat in the petroleum industry  But cost of entry for substitutes is high  Once a substitute gains entry, costs may rapidly drop  Pattern is to have price spikes, followed by periods of prices too low for substitutes to thrive ◦ Synthetic rubber became a substitute when war cut natural rubber supplies

The Five-Forces Model Bargaining power of consumers ◦Customers being concentrated or buying in volume affects intensity of competition ◦Consumer power is higher where products are standard or undifferentiated Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch 3 -64

Conditions Where Consumers Gain Bargaining Power If buyers can inexpensively switch If buyers are particularly important If sellers are struggling in the face of falling consumer demand If buyers are informed about sellers’ products, prices, and costs If buyers have discretion in whether and when they purchase the product Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch 3 -65

Sources of External Information: Unpublished Sources Customer surveys Market research Speeches at professional or shareholder meetings Television programs Interviews and conversations with stakeholders Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch 3 -66

Sources of External Information: Published Sources Periodicals Journals Reports Government documents Abstracts Books Directories Newspapers Manuals Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch 3 -67

Sources of External Information: Web Sites Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch 3 -68

 Forecasts use or make assumptions about future trends and events  Quantitative techniques – most appropriate when historical data is available and there is a constant relationship  Qualitative techniques (opinions, intuition)  All forecasts should be informed by knowledge of business and markets

Assumptions Estimates of future events based upon the best available information in the present Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch 3 -70

 Economic  Social  Cultural  Demographic  Environmental  Political  Governmental  Technological  Competitive  Legal Copyright © 2011 Pearson Education, Inc. Publishing as Prentice HallCh 3 -71

1. List key external factors 2. Weight from 0 to 1 3. Rate effectiveness of current strategies 4. Multiply weight * rating 5. Sum weighted scores Copyright © 2011 Pearson Education, Inc. Publishing as Prentice HallCh 3 -72

Total weighted score of 4.0  Organization response is outstanding to threats and weaknesses Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch Industry Analysis EFE Total weighted score of 1.0 Firm’s strategies not capitalizing on opportunities or avoiding threats

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch Industry Analysis: Competitive Profile Matrix (CPM) Identifies firm’s major competitors and their strengths & weaknesses in relation to a sample firm’s strategic positions Critical success factors include internal and external issues

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice HallCh 3 -75