How to Do a Strategic Analysis

1. How to Do a Strategic Analysis Dr. Stan Abraham Fall 2003

2. What Is Strategic Analysis? • One person’s or one group’s attempt at arriving at a strategy, objectives, and key programs for a company • Also refers to performing an intermediate analytical task • For example, calculating the effect on shareholder value of a proposed strategy • An essential precursor to strategic planning

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

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

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

6. 2. Where Do We Want to Go?This involves strategicthinking • What are all the possible and feasible directions we could go? • Which opportunities could we pursue? • What alternative business models make sense? • 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? • What strategy or strategies should we pursue? • What objectives should we set? • For the next year and three years’ hence? • What programs should we implement? • What contingencies can we devise in case things go wrong?

8. What Is Strategy? • Strategy is how a company actually competes • 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 thinking drives the process Operational planning Strategic-planning process Strategic analysis informs the process Evaluation & control Implementation Strategic management Figure 1.1 – page 20

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

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

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

13. Dominant Economic Characteristics (2) Degree of Vertical Integration • 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 • 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 • 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 External Situation Analysis

14. Dominant Economic Characteristics (3) Product Characteristics • Highly standardized and commodity-like Scale Economies • 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 • Efficiency is highest when producing between 90-100% of rated plant capacity. Unit costs rise appreciably when utilization drops below 90% Industry Profitability • 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 Analysis External

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

16. Industry Lifecycle Curve TotalIndustry Sales Shake-out Emerging Growth Maturity Decline Time Situation Analysis External

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

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

19. The Value ChainExample – Wool Suits Breeding Raw Cloth Cloth Sheep on Wool Mill Wholesaler Tailor Retailer Farm Wholesaler Dyer Final Customer Vertical Integration BackwardsForwards Situation Analysis External

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

21. Porter’s Five-Forces ModelExample: The U.S. Motorcycle Industry • Intense rivalry among manufacturers • Getting stronger as the market declines and technological competition heats up • Industry has bargaining power • Because most manufacturers are differentiated • Barriers to entry are quite high • Industry not very attractive, intense competition, takes time to develop a brand image and dealer network, requires technical know-how, and substantial capital • Biggest substitute threat is the car • Especially as people get older and have families External Situation Analysis

22. Competitive IntelligenceCompetitive 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. External Situation Analysis

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:The U.S. Motorcycle Industry Competitors Critical Success Factor H-D A B C D Honda 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 External Situation Analysis

24. Assessing Industry Attractiveness Example:The motorcycle industry Industry Factor Weight Rating Product Sales growth rate 25 0.3 7.5 Market size 20 0.6 12.0 Industry profitability 18 0.8 14.4 Intensity of competition 15 0.7 10.5 Barriers to entry 12 0.9 10.8 Degree regulated 10 1.0 10.0 ----- ---- ------ TOTALS 100 65.2 External Situation Analysis

25. Assessing Competitive Strength Example:Harley-Davidson, Inc. Competitive Factor Weight Rating Product Technological innovativeness 22 0.6 13.2 Marketing/distribution 20 0.9 18.0 Caliber of management 18 0.9 16.2 Relative cost position 17 0.6 10.2 Brand reputation 12 1.0 12.0 Financial strength 11 0.7 7.7 ----- ------ TOTALS 100 77.3 Situation Analysis External

26. G. E. Matrix High IndustryAttractiveness Invest H-D Medium Divest Low Weak Avg. Strong Competitive Strength Situation Analysis External

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

28. Environmental AnalysisCategories 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 Analysis External

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

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 • Includes these four tools: Porter’s 5-Forces Model, G.E. Matrix (Industry Attractiveness vs. Competitive Strength), CSF Analysis, Strategic Group Map External Situation Analysis

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

32. Financial Summary for H-D H-D is performing very well and is financially in good condition • Motorcycle revenues grew an average 23.5%/yr from 1986-88 in a declining industry • NIAT grew 12.7% in 1988, and NROS almost doubled from 1986 (1.65% to 3.16%) • D/E ratio declined 54.5% from 5.5 in 1987 to 2.3 in 1988 • Z-Score improved to 3.07 (safe) in 1988 • It has $52.3M in cash in 1988 Internal Situation Analysis

33. Financial Summary for H-D Some areas of concern in 1988, but none of these are considered “major” • A/R increased by 37% and average collection period by 24% • Quick ratio is 0.83 (needs to be >1.0) • Inventory may be too high at $100M • HR sales grew only 2.6% Internal Situation Analysis

34. Altman’s Z- and Z2-Scores Z-score = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5 Z2-score = 6.5X1 + 3.26X2 + 6.72X3 + 1.05X4a Safe Zone 2.99 2.59 Gray Area 1.81 1.11 ManufacturingCompanies Bankrupt Zone Non-ManufacturingCompanies Z-Score Z2-Score Internal Situation Analysis

35. Harley-Davidson’s Z-Score X1 = WC/Total assets X2 = RE/Total assets X3 = EBIT/Total assets X4 = Equity/Total debt X5 = Sales/Total assets 3.19 19871988 X1 0.169 0.197 X2 0.054 0.117 X3 0.147 0.174 X4 0.198 0.383 X5 1.800 1.989 Safe 3.0 Gray 2.68 1.8 Bankrupt 1987 1988 Internal Situation Analysis

36. Company Potential Strengths Core competencies Cost advantages Adequate financial resources Better advertising campaigns Reputation with buyers Product innovation skills Well-conceived programs Proven management Access to economies of scale Ahead on the experience curve Protected from competition Efficient manufacturing Proprietary technology Superior technology skills Financial analysis of recent company performance is also akey component of Internal Company Analysis, and may reveal some strengths and weaknesses Internal Situation Analysis

37. Strengths of H-D • High quality built into products • Impressive sales growth in declining industry • Strong brand image, strengthened through licensing program • Cult following and HOGs (loyal customers) • Strong marketing and promotion programs • High employee morale • Good financial condition • Strong management team Internal Situation Analysis

38. Company Potential Weaknesses No clear strategic direction Falling behind in R&D Obsolete facilities Product line too narrow Sub-par profitability because . . . Weak market image Little or no managerial depth/talent Weak distribution network Missing key skills/competencies Weak marketing skills Poor implementation record Unable to finance strategies Internal operating problems High relative costs Poor product quality Worsening customer service Deteriorating union relations Slow development of new products Internal Situation Analysis

39. Weaknesses of H-D • Cost structure probably too high • Innovation doesn’t seem to be a priority • Narrow product line • Vulnerable to attack in its one segment • HR not growing fast enough • Receivables and collection days increasing • Inventory increasing Internal Situation Analysis

40. Core Competence and Competitive Advantage Criteria for Core Competence Is the Is the Is the Is thecapability capability capability capabilityvaluable? Rare? costly to nonsubsti- Competitive Performance imitate? tutable? Consequences Implications No No No No Competitive Below-average disadvantage returns Yes No No Yes/No Competitive Average parity returns Yes Yes No Yes/No Temporary Average + advantage returns Yes Yes Yes Yes Sustainable Above average advantage returns Internal Situation Analysis

41. H-D Core Competence and Competitive Advantage • Customer loyalty and brand image • Valuable? Yes • Rare? Yes • Costly to imitate? Yes • Nonsubstitutable? Yes A core competence and a sustainable competitive advantage • Large-displacement motorcycles • Valuable? Yes • Rare? Yes (for now) • Costly to imitate? No • Nonsubstitutable? Yes Yields only a temporary competitive advantage Internal Situation Analysis

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

43. Opportunities for H-D • Enter the smaller-displacement segments with new models • Introduce a sport bike • Expand the market to include women and older men (35+) • Expand into Europe • Introduce a new model with a more technologically advanced engine Internal Situation Analysis

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

45. External Threats for H-D • Stiffening noise and air-pollution regulations, enactment of the helmet law • Shrinking of the 15-24 yr old segment • Upswing in currency-exchange rates • Honda and others developing a more advanced engine and other innovations • Honda and others reentering the large-displacement segment Internal Situation Analysis

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

47. 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 • Includes financial-analysis charts, a financial conclusion, and a SWOT analysis • Includes these three tools: Core-Competence Analysis, Value Analysis, and SPACE Analysis Internal Situation Analysis

48. Key Strategic Issues A key strategic issue is a: • Future event or trendthat 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 • Decision the firm is considering makingthat 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 issuesfor the simple reason that they constitute the most important problems and issues the company faces Alternatives Analysis

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

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