Various Views of Internal Analysis

1. Various Views of Internal Analysis Traditional Value Chain Balanced Scorecard • Management • - Planning • Organizing • Motivating • Controlling • Inbound Logistics • - Materials handling • Warehousing • Inventory control • Operations Management • - Supplier relations • Production • Distribution • Customer service • Risk management • Manufacturing • Machining • Packaging • Assembly • Equipment maintenance • Marketing • - Customer analysis • Buying supplies • Selling • Product/Service planning • Pricing • Distribution • Market research • Opportunity analysis • Social responsibility • Customer Management • - Customer selection • Acquiring customers • Retaining customers • Customer growth • Outbound Logistics • - Warehousing • Handling • Order processing • Innovation • - Future product research • R & D • New product prototyping • Bringing new products to market • Marketing & Sales • Advertising • Promotions • Distribution network Finance • Social Processes • - Regulation compliance • Social reputation • Operations • - Process decisions • Capacity decisions • Inventory decisions • Quality Decisions • Service • Installation • After-sales support • Repairs • Intangibles • - Human capital • IT/MIS • Infrastructure Research & Development Support IT/MIS

2. Operations Management Processes 1. Develop & Sustain Supplier Relations A company can enjoy a significant competitive advantage by establishing networks of superb supplier relationships e.g. Wal-mart, Toyota One objective is to lower the cost of ownership Best suppliers are low-cost not merely low-price Do suppliers... - accept electronic orders - deliver products with no defects - require no inspection - just-in-time - directly to the point of use - issue no invoices and accept automatic electronic payments Other objectives relate to timeliness & quality of supplied goods & services e.g. Visteon maintains a web site on which suppliers can see their ratings Do suppliers help with our company’s innovation & design ?

3. Operations Management Processes 2. Produce Products and Services The core of operations management is efficient, high-quality and responsive operating processes that produce the goods & services used by the firm’s customers Making use of initiatives like reengineering, business process redesign, continuous improvement, activity-based management, total quality management and time-based management Some objectives for adding value are... - lowering production cost - continuously improving processes - improving cycle times and business responsiveness - making effective use of fixed assets - improving efficiency in areas of inventory turnover, cash-to-cash cycles, etc.

4. Operations Management Processes 3. Distribute Products & Services to Customers The objective is really the downstream version of lowering the total cost of working with suppliers Looking for ways to reduce cost, improve quality and time performance of distribution processes Some objectives for adding value are... - lowering costs of storage and delivery to customers - controlling lead time parameters and assuring on-time deliveries - reducing customer complaints

5. Operations Management Processes 4. Risk Management Not only is cost control important to a firm, but so is reducing financial, operating and technological risk • Managing financial risk • keeping bad debts reasonable • reducing interest rate swing risk, currency & commodity price fluctuations • reviewing liquidity ratios • maintaining reasonable debt-to-equity ratios • review trends in growth and profitability ratios • checking how close to insolvency we are • Managing operating risk • making sure there are no unreasonable backlogs • reviewing capacity utilization • Managing technological risk • looking for obsolescence in products, services and processes • making certain we don’t fall behind the competition

6. Operations Management Processes LIQUIDITY RATIOS Firm’s ability to meet short-term obligations CURRENT ASSETS CURRENT LIABILITIES CURRENT RATIO CURRENT ASSETS LESS INVENTORIES CURRENT LIABILITIES QUICK RATIO

7. Operations Management Processes LEVERAGE RATIOS Extent to which a firm has been financed by debt and its implications TOTAL DEBT TOTAL ASSETS DEBT TO TOTAL ASSETS TOTAL DEBT TOTAL SHAREHOLDERS’ EQUITY DEBT TO EQUITY TOTAL LONG-TERM DEBT TOTAL SHAREHOLDERS’ EQUITY L.T. DEBT TO EQUITY TIMES INTEREST EARNED EARNINGS BEFORE INTEREST & TAXES TOTAL INTEREST CHARGES

8. Operations Management Processes ACTIVITY RATIOS How effectively a firm is using its resources SALES INVENTORY OF FINISHED GOODS INVENTORY TURNOVER SALES FIXED ASSETS FIXED ASSETS TURNOVER SALES TOTAL ASSETS TOTAL ASSETS TURNOVER ACCOUNTS RECEIVABLE TURNOVER ANNUAL CREDIT SALES ACCOUNTS RECEIVABLE AVERAGE COLLECTION PERIOD ACCOUNTS RECEIVABLE AVERAGE SALES PER DAY

9. Operations Management Processes PROFITABILITY RATIOS Management’s effectiveness SALES – COST OF GOODS SOLD SALES GROSS PROFIT MARGIN OPERATING PROFIT MARGIN EARNINGS BEFORE INTEREST & TAXES SALES NET INCOME SALES NET PROFIT MARGIN RETURN ON TOTAL ASSETS NET INCOME TOTAL ASSETS RETURN ON SHAREHOLDERS’ EQUITY NET INCOME TOTAL SHAREHOLDERS’ EQUITY EARNINGS PER SHARE NET INCOME COMMON SHARES OUTSTANDING

10. Operations Management Processes GROWTH RATIOS Firm’s ability to maintain its position as economy and industry grow CURRENT YEAR’S SALES PRIOR YEAR’S SALES SALES GROWTH INCOME GROWTH CURRENT YEAR’S PROFITS PRIOR YEAR’S PROFITS EPS GROWTH CURRENT YEAR’S EPS PRIOR YEAR’S EPS DIVIDEND PER SHARE GROWTH CURRENT YEAR’S DPS PRIOR YEAR’S DPS PRICE EARNINGS RATIO MARKET PRICE PER SHARE EARNINGS PER SHARE

11. Operations Management Processes OTHER FINANCIAL ANALYSIS TREND ANALYSIS Look at trends in ratios - over time - as compared to specific competitors - as compared to industry averages EXPLODE INCOME STATEMENT Calculate each item as a % of SALES and look for anomalies over time EXPLODE BALANCE SHEET Calculate each item as a % of TOTAL ASSETS and look for anomalies over time

12. Operations Management Processes ALTMAN’S Z SCORE Attempts to predict the firm’s likelihood of survival FINANCIAL INFORMATION REQUIRED: From Income Statement - Net Sales ................................................................. 4,000 - EBIT ....................................................................... 1,600 From Balance Sheet - Current Assets ....................................................... 9,500 - Current Liabilities ................................................. 9,600 - Total Liabilities ..................................................... 15,000 - Retained Earnings ................................................ 2,350 - Total Assets ........................................................... 23,350 From the Market - Market Value of Equity ........................................ 3,900

13. Operations Management Processes ALTMAN’S Z SCORE (cont’d) WEIGHT 3.3 0.999 0.6 1.2 1.4 RATIO EBIT/Total Assets Net Sales/Total Assets MV of Equity/Total Liabilities Working Capital/Total Assets Retained Earnings/Total Assets CALCULATION 3.3 X 1,600/23,350 = 0.23 0.999 X 4,000/23,350 = 0.17 0.6 X 3,900/15,000 = 0.16 1.2 X -100/23,350 = -0.01 1.4 X 2,350/23,350 = 0.14 0.71 INTERPRETATION: Z score above 3.0 The firm is safe based on these financial figures only Z score of 2.8 – 3.0 On Alert! One should exercise caution Z score of 1.8 – 2.7 Good chance firm will go bankrupt within 2 years Z score below 1.8 Probability of financial embarrassment is very high

14. Operations Management Processes How does Operations Management add value ? • For the customer • competitive prices • perfect quality • speedy, timely order fulfillment • excellent selection • For Shareholders • increased revenues from satisfied customers • opportunities to capture customers from competitors especially in price-sensitive and value-preferring market segments

15. Customer Management Processes 1. Customer Selection While innovation and operations management processes remain important for strategic success, the evolution of the computer and communications technology, has shifted the balance of power from producers to customers Customer management processes must help the company acquire, sustain, and grow long-term, profitable relationships with targeted customers Identify customer segments that are attractive to the business. E.g. Chemical Bank cultivated relationships with many unprofitable customers Segment the market into niches, each with distinguishing characteristics & preferences Craft a value proposition to appeal to these segments. Customers look for price, service, performance, relationship and brand identity Create a brand image that attracts customers in these segments to the company’s products and services Does the firm understand customer segments ? Does it screen out unprofitable customers ? Does it target high-value customers ? Does it manage the brand ?

16. Customer Management Processes Determining Who to Serve Segment the market cluster customers with similar needs into individual and identifiable groups Factors on Which to Base Segmentation CONSUMER MARKETS Demographic (age, income, etc.) Socioeconomic (social class, etc.) Geographic (cultural, regional diff.) Psychological (lifestyle, personality) Consumption patterns Perceptual factors INDUSTRIAL MARKETS End-user segments Technology differences Production economics Geographic segments Customer size Buying patterns

17. Customer Management Processes 2. Customer Acquisition The most difficult and expensive customer management process. Convincing the targeted customer that your firm will give him the value he is looking for Often enticed with an inexpensive product that does not pose a lot of risk to the customer Firm might use a loss leader or heavily discounted product or service The experience must be perfect to convince the customer to become a regular Does the company properly communicate its value proposition ? Is mass marketing customized toward target customer ? Are potential leads converted to customers ? Review dealer or distributor scorecards to see if they are doing a great job for us

18. Customer Management Processes 3. Customer Retention It is a lot cheaper to retain customers than to add new ones to replace those that defect A satisfied customer is not likely to search for alternatives Companies retain customers by consistently delivering on their primary value proposition Companies must develop customer service and call service units to respond quickly to requests about orders, deliveries & problems More valuable than customer loyalty is customer commitment, when customers tell others of their satisfaction Does the firm provide premium customer service ? Does it attempt to create a value-added partnership with key customers ? Does the firm create highly loyal and committed customers ?

19. Customer Management Processes 4. Customer Growth Increasing the value of the company’s customers is the ultimate objective of any customer management process The size of any ongoing relationship must exceed the cost of acquiring that customer Firms should manage the lifetime values of their customers A company that can cross-sell and partner with customers expands its share of the customer’s spending in the category Increasing the depth and breadth of the relationship enhances the value of customers and increases the customer’s cost of switching to alternative suppliers How prevalent is cross-selling ? Does the company sell solutions ? Does the company make customers feel it is their partner ?

20. Customer Management Processes How does Customer Management add value ? • For the customer • increasing customer satisfaction • offering an attractive value proposition • allows customers and firm to build a deep relationship • creates raving fans • For Shareholders • create new sources of revenue • increase revenue per customer • increase customer profitability • reduces cost per sale and thus increases sales productivity

21. Innovation Processes 1. Identify Opportunities for New Products/Services Sustaining competitive advantage requires that organizations continually innovate to create new products, services and processes. Without innovation, a firm’s value proposition can eventually be imitated leading to competition solely on price Companies should not be too inwardly focused in their search for new ideas Ideas can come from research laboratories, universities, suppliers & customers Should ask customers for the outcomes they want – not the features of a new product Soliciting non customers’ ideas often gives insight into why they are not customers Does the firm anticipate customers’ future needs ? Does the firm work on ways to make products more effective or safer ?

22. Innovation Processes 2. Manage the Research & Development Portfolio Once ideas have been generated, firms must decide which projects to fund, which to defer and which to kill The R&D portfolio should include a mix of: - basic research and advanced development projects - breakthrough development projects (entirely new projects) - platform development projects (the next generation of existing products) - derivative development projects (mutations of existing products) - alliance projects (working with someone else on products or services) Each of the five projects have different resource requirements, project times, and risk profiles Does firm manage the various types of research projects effectively ? Does firm extend current product platforms into new markets ? Does firm nurture collaborative efforts ?

23. Innovation Processes 3. Design & Develop New Products/Services A successful design & development process culminates in a product that has the desired functionality, is attractive to the targeted market and can be produced with consistent quality and at a cost enabling satsifactory profit margins to be earned. The development process must also meet completion time targets and not exceed budget The process typically consists of the following stages : - concept development - product planning (model building, testing, and financial planning) - detailed product and process engineering Does the firm really manage its development projects? Does it control its patents? Does it attempt to reduce development cycle time ? Does it manage development cycle costs?

24. Innovation Processes 4. Bring New Products to Market The conclusion of the innovation process is to get the new product launched effectively so that it becomes a regular product offering Project team releases the product for initial ramp-up into commercial production Starts pilot production to finalize specifications for the production process Validates that all suppliers can deliver their materials within specifications, on-time and at targeted costs Commence commercial production at low volume levels to ensure its production processes and those of suppliers can consistently produce & deliver the product Marketing & sales also come up to speed Verify that there are rapid launches of new products See if manufacturing can get up to speed in a timely manner Check to see if marketing & sales can keep ahead of planned production

25. Innovation Processes How does the Innovation Process add value ? • For the customer • offering enhanced product/service functionality • first-to-market new product/service • extending products/services to new market segments • For Shareholders • increased returns on R & D investments • revenue growth from excited existing customers • revenue growth from newly wowed customers • manage life-cycle costs

26. Regulatory & Social Processes 1. Environmental Performance Companies must continually earn the right to operate in the communities and countries in which they produce and sell. At a minimum, to avoid shutdowns or expensive litigation, companies must comply with all regulations on business practices. Many companies seek to go beyond complying with minimal standards established by regulations. Environmental performance is the most developed of the regulatory & social measurement systems for company reporting • Failure to perform adequately on regulatory & social processes puts at risk the company’s ability to operate, grow & deliver future value to shareholders • Included are regulations dealing with: • energy & resource consumption • water emissions • air emissions • solid waste production & disposal • what happens to their products even after sale to end consumer ? (product end-of-life solutions) • strict definitions of environmental incidents, targets, tracking, reporting and dealing with them

27. Regulatory & Social Processes 2. Safety & Health Performance Companies tend to use relatively few and more standardized measures of employee safety and health performance. Largely triggered by regulatory requirements 3. Employment Practices Much of the quantitative reporting about employment practices relates to increasing the diversity of employees 4. Community Investment Monetary contributions companies make to community-based nonprofit organizations and extensive volunteering done by company employees in communities

28. Regulatory & Social Processes How do Regulatory & Social Processes add value ? • For the customer • part of long term value-creating strategies • enhanced reputation • employees’ pride is reflected in service provided to customers • For Shareholders • reduce cost • differentiate products/service • manage competitors • association agreement does not put any one firm at a disadvantage • redefine markets • manage environmental risk

29. Intangible Assets 1. Human Capital The important aspect of intangible assets is that they be aligned for the internal processes and integrated with each other Strategic Competencies – the availability of skills, talent, and know-how to perform activities required by the strategy 2. Information Capital Strategic Information – the availability of information systems and knowledge applications and infrastructure required to support the strategy 3. Organizational Capital Culture – awareness & internalization of the shared mission, vision & values needed to execute the strategy Leadership – availability of qualified leaders at all levels to mobilize the firm towards their strategies Alignment – coordination of goals & incentives with strategy at all levels Teamwork – sharing of knowledge & staff assets with strategic potential

30. What Have We Been Trying to Uncover ? What adds to or reduces the firm’s competitive advantage ? A competitive advantage can be sustained ONLY when competitors ... - fail to duplicate the benefits of a firm’s strategy - or lack the confidence to attempt imitation To maintain a competitive advantage, a firm must have: VALUABLE CAPABILITIES And they must be... ORGANIZED AND CO-ORDINATED TO EXPLOIT THE SITUATION RARE CAPABILITIES COSTLY-TO-IMMITATE CAPABILITIES

31. An organization must review it’s resources and capabilities to determine how capable it will be to exploit environmental opportunities or neutralize external threats 1. VALUE of a firm’s resources & capabilities Do a firm’s resources and capabilities add value by enabling it to exploit opportunities and/or neutralize threats? Just because a firm’s resources and capabilities have added value in the past, does not mean that they will add value in the future Changes in customer tastes, industry structure or technology may impact their value One of the most important responsibilities of strategic managers is to constantly evaluate whether or not their firm’s resources and capabilities continue to add value, despite changes in the competitive environment A firm’s resources are valuable only when they exploit opportunities and/or neutralize threats Looking Inside for Competitive Advantage J.B. Barney Cont’d.

32. 2. RARENESS If a particular resource or capability is controlled by numerous competing firms, then that resource is unlikely to be a source of competitive advantage for any one of the firms Valuable but common are sources of competitive parity How many competing firms already possess these valuable resources and capabilities? Resources and capabilities must be rare among competing firms in order to be a source of competitive advantage Just because they are not rare, does not mean they are useless Such resources and capabilities may be essential for a firm’s survival Looking Inside for Competitive AdvantageJ.B. Barney Cont’d. Cont’d.

33. 3. IMITABILITY A firm that possesses valuable and rare resources and capabilities can gain, at least, a temporary competitive advantage If, in addition, competing firms face a cost disadvantage in imitating these resources, firms with these special abilities, can obtain a sustained competitive advantage Do firms without a resource or capability face a cost disadvantage in obtaining it compared to firms that already possess it? Imitation can occur in at least two ways: Duplication when a firm builds the same kind of resources Substitution if substitute resources have the same strategic implications and are no more costly to develop, then imitation through substitution will lead to a competitive parity in the long run Looking Inside for Competitive AdvantageJ.B. Barney Cont’d. Cont’d.

34. 4. ORGANIZATION To fully realize the potential of valuable, rare and difficult to imitate resources, a firm must also be organized to exploit its resources and capabilities Is a firm organized to exploit the full competitive potential of its resources and capabilities? Numerous components make up the organization: formal reporting structure explicit management control systems compensation policies These components have limited ability to generate competitive advantage in isolation In combination with other resources and capabilities, they can enable a firm to realize its full competitive advantage Looking Inside for Competitive AdvantageJ.B. Barney Cont’d. Cont’d.

35. VALUABLE A Great Start VALUABLE + RARE Potential Temporary Competitive Advantage Looking Inside for Competitive AdvantageJ.B. Barney Cont’d. VALUABLE + RARE + NOT IMITABLE Potential Long-term Competitive Advantage VALUABLE + RARE + NOT IMITABLE + ORGANIZED Realizing Long-term Competitive Advantage

36. Summarize Your Findings At the very least, summarize your analytical findings of the internal functioning of the firm To increase the use of your analysis, rank the strengths from the one that has the most impact on the firm’s competitive advantage to the least and the weaknesses from the one that threatens the firm’s competitive advantage the most to the least To get the most out of your internal analysis, relate each strength and weakness to your current strategy

37. Internal Factor Evaluation (IFE) Matrix An IFE Matrix is simply a strategic report card; it attempts to rate a business’s current strategy (established to match SWOT at some time in the past) with the current internal factors that are part of the business First, understand and clearly state the current business strategy Then, divide the factors that you identified as you analyzed the current internal situation that defines the business into two groups – strengths that help the business successfully carry out its current strategy and weaknesses that reduce the firm’s ability to be successful with its strategy Third, rank each group from most important to least Now, we are ready to produce a report card

38. IFE Matrix Example Assume we are in the boutique hotel business and our strategy is to aggressively grow by opening 2 – 3 new hotels (converting existing buildings in major cities into luxury hotels) each year in major U.S. cities. Target market are affluent individuals or couples travelling either alone or as couples for business first and leisure. At this point in our analysis we have already matched our strategy to the external environment we face and now we want to evaluate if we have the competitive advantage to make it work successfully. The IFE evaluates if our strengths and weaknesses are aligned with our current strategy. It does not yet tell us anything about our future strategy. Let’s now start building the IFE Matrix report card by listing the results of our internal analysis

39. IFE Matrix Example INTERNAL ANALYSIS RESULTS STRENGTHS We have an excellent brand & customers are always satisfied Room rates are 15% higher than comparable rooms Loyalty programs result in 70% repeat customers Salaries & fringe benefits are 10% more than industry average Hotel managers meet every 6 months to share ideas Revenues growing 14% p.a. (4 years) but profits only 3% p.a. WEAKNESSES Debt/Equity is 2.5 versus industry average of 0.75 CEO has just quit and has joined our closest rival Computer system straining & no internet for customers

40. IFE Matrix Example Assuming we have done a great job of analyzing the company, our list of strengths and weaknesses should describe FULLY the forces that impact our competitive advantage If that is true, then the total of all these internal factors should equal “1”. Anything that we have not listed should be so miniscule, that it does not change the results. In our example, we have identified 9 internal factors that impact this company at this time. If we felt that they all had equal impact on our company, each would have a weight of 0.11 (1/9). But we should be able to say that they do not all have the same impact on the company. An attempt should be made to put relative weights on each factor such that the total comes to 1. Strengths and weaknesses do not have opposite values as they all describe the total internal situation

41. IFE Matrix Example INTERNAL ANALYSIS RESULTS WEIGHT STTENGTHS We have an excellent brand & customers are always satisfied .25 Room rates are 15% higher than comparable rooms .13 Loyalty programs result in 70% repeat customers .10 Salaries & fringe benefits are 10% more than industry average .05 Hotel managers meet every 6 months to share ideas .05 Revenues growing 14% p.a. (4 years) but profits only 3% p.a. WEAKNESSES .18 Debt/Equity is 2.5 versus industry average of 0.75 .12 CEO has just quit and has joined our closest rival .07 Computer system straining & no internet for customers .05

42. IFE Matrix Example Now we want to rate how the current internal factors impact our current strategy Remember our current strategy is to aggressively grow by opening 2 – 3 new hotels (converting existing buildings in major cities into luxury hotels) each year in major U.S. cities. Target market are affluent individuals or couples travelling either alone or as couples for business first and leisure. Do our current strengths and weaknesses allow us to be successful with this strategy ? On a scale of 0 to 4, if the strength really allows the firm to carry out its strategy or if the strategy fully reduces the noted weakness, we should allocate a score of A+ or 4; if there is no correlation, we should give it a score of F or 0. We allocate scores based on an outstanding range (4’s); above average scores (3’s); average scores (2’s); below average scores (1’s) and unacceptable scores ( 0 – 0.9)

43. IFE Matrix Example INTERNAL ANALYSIS RESULTS WEIGHT GRADE STRENGTHS We have an excellent brand & customers are always satisfied 3.8 .25 Room rates are 15% higher than comparable rooms 2.0 .13 Loyalty programs result in 70% repeat customers .10 3.5 Salaries & fringe benefits are 10% more than industry average .05 2.7 Hotel managers meet every 6 months to share ideas .05 2.0 Revenues growing 14% p.a. (4 years) but profits only 3% p.a. WEAKNESSES .18 1.5 Debt/Equity is 2.5 versus industry average of 0.75 .12 1.5 CEO has just quit and has joined our closest rival .07 2.5 Computer system straining & no internet for customers 2.8 .05

44. IFE Matrix Example We multiply the relative importance of each factor of our internal evaluation by the effectiveness of our current strategy in dealing with each factor. Remember, effectiveness is always a positive number - if the strategy is outstanding at taking advantage of a strength it receives a score of 4; similarly if the strategy is outstandingly effective in reducing a weakness, it also should receive a score of 4 We add up the weighted scores and come to an overall GPA and interpret that score using the same 0 to 4 scale (2.5 being average) If the score is average or below, it means that our current strategy is not ideal with the current internal evaluation and should be changed. If it is outstanding or above average, it may not need to be changed in terms of its relationship with the internal evaluation BUT, we must combine this with the external analysis to see how we are doing currently and to decide what we are capable of doing in the future

45. IFE Matrix Example INTERNAL ANALYSIS RESULTS WEIGHT GRADE SCORE TOTAL STRENGTHS We have an excellent brand & customers are always satisfied 2.57 3.8 .95 .25 Room rates are 15% higher than comparable rooms 2.0 .26 .13 Average Changes needed even if strategy does not change Loyalty programs result in 70% repeat customers .10 .35 3.5 Salaries & fringe benefits are 10% more than industry average .05 2.7 .14 Hotel managers meet every 6 months to share ideas .05 2.0 .10 Revenues growing 14% p.a. (4 years) but profits only 3% p.a. WEAKNESSES .18 1.5 .27 Debt/Equity is 2.5 versus industry average of 0.75 .12 1.5 .18 CEO has just quit and has joined our closest rival .07 2.5 .18 Computer system straining & no internet for customers 2.8 .05 .14