Part #1 The tools of Strategic Analysis

1. Part #1 The tools of Strategic Analysis Chapter #1 What is Strategy and the Strategic Management Process?

2. Learning Objectives • Define the concept of Strategy • Describe the strategic management process • Define competitive advantage and its relationship to firm performance • Describe the difference between emergent and intended strategies • Discuss the importance of understanding a firm’s strategy even if you are not a senior manager in a firm

3. Opening case: What has Napster wrought? • How do we buy music? • Is Napster good or bad for the music industry?

4. Music Down loaders • Napster today • KaZaA • eDonkey • Bit Torrent

5. Down Load for a fee • MusicNet site • AOL/TimeWarner, Berlesman, Emi, and Real Networks • Pressplay site • Universal, Sony • MusicNow site • Rhapsody (listen.com) site • iTunes site • Apple • Monthly fees and a per song charge

6. The music Industry • What is happening to our industry? • What is our competition going to do next? • How should we respond? • What can we do to make money in our business?

7. Strategy and the Strategic Management process • A firm’s strategy is defined as its theory about how to gain competitive advantages • A “good strategy” is a strategy that actually generates such advantages • Strategies are theories because they are based on how a firm thinks competitors, consumers and others will respond

8. Strategic planning process • Why should we plan? • Can we be successful without planning? • The process • Mission • Objectives • External & Internal Analysis • Strategic Choice • Strategic Implementation • Competitive Advantage

9. Mission Statements • Missions define both what a firm aspires to be in the long run, and what it wants to avoid in the mean time.

10. Star Trek

11. Anheuser-Busch Dell Ford Motor Company IBM The Oakland Raiders

12. What impact does a mission statement have on the company • No impact (Enron) • Integrity: We work with the customers and prospects openly, honestly and sincerely. When we say we will do something, we will do it; when we say we cannot or will not do something, then we won’t do it. • Positive impact (visionary firms) • Negative (Ben & Jerry’s)

13. Visionary firms • 3M , American Express, Boeing, Citicorp, Ford, General Electric, Hewlett-Packard, IBM, Johnson & Johnson, Marriott, Merck, Motorola, Nordstrom, Philip Morris, Proctor & Gamble, Sony, Wal-Mart, Walt Disney Are there any on this list that surprise

14. Ben & Jerry’s • Counter Culture • Compensation package • Industry mergers • Acquired by Unilever

15. Objectives • Specific • Measurable • Time • 3M objectives • Growth in earnings per share 10% per year • 27% return on employed capital • 30% of sales from newer products (4 years)

16. Low Quality objectives • Do not exist (dodge ball) • Not quantitative • Difficult to measure • Difficult to track over time

17. External and Internal Analysis • Chapter 2 • External Analysis • Threats and Opportunities • Chapter 3 • Internal Analysis • Strengths and Weaknesses

18. Strategic Choice • Business Level Strategies • Actions firms take to gain competitive advantages in a single market or industry • Two most common • Cost leadership (Chapter 4) • Product Differentiation (Chapter 5)

19. Strategic Choice • Corporate level strategies • Are actions firms take to gain competitive advantages by operation in multiple markets or industries simultaneously • Common Corporate level strategies • Vertical Integration (chapter six) • Strategic alliance strategies (chapter seven) • Diversification strategies (chapter eight) • Mergers and acquisition strategies (chapter 9)

20. Choosing a strategy • Supports the firm’s mission • Is consistent with a firm’s objectives • Exploits opportunities in a firm’s environment with a firm’s strengths • Neutralizes threats in a firm’s environment while avoiding a firm’s weaknesses

21. Strategy Implementation • Firm Strategies • Corporate Strategies • Other issues • Organizational Structure • Control Processes • Compensation Policy

22. Competitive Advantage • Competitive Advantage • When a firm is creating value in a market or industry in ways that few other competitors currently are: • Sustained Competitive Advantage • And when those competitors find it very costly to imitate these actions • Competitive parity • When a firm is creating value in a market or industry in ways similar to that of many of its competitors • Competitive disadvantage: • When a firm fails to create value in a market or industry in ways that at leas some of its competitors are:

23. How sustainable are competitive advantages? • Dennis Mueller (longitudinal study) • Firms that perform well in early time periods also performed well in later time periods • Geoffrey Waring • Some industries have competitive advantages that are easier to maintain • Information complex, require customers to know a great deal, require a great deal of research and development, significant economies of scale • Peter Roberts • Studied the pharmaceutical industry

24. Economic performance • WACC • Cost of Capital • Interest the firm must pay its debt holders • Cost of equity • Return the firm must promise its equity holders • Standard and Poor’s

25. Calculating WACC • Firm’s debt rating • Marginal Tax rate • Beta • Risk free and market rates of return • Information about a firm’s capital structure

26. Numerical example • Firms’ rating BBB 7.5% • Marginal tax rate 39% • After tax cost of debt is • (1-.39)(7.5) or 4.58%

27. Beta (how highly correlated the price of firm’s equity is in comparison to the overall stock market) Published for publicly traded companies (1.2) • Risk free rate of return historically has been three percent • Market rate of return 8.5 %

28. Capital asset pricing model • Cost of equity • Risk free rate of Return + (Market rate of return – Risk free)Beta • Plugging in the numbers • 3 + (8.5 – 3)*1.2 = 9.6

29. Capital Structure • Debt 1 million (20%) • Equity 4 million (80%) • Plugging in the numbers • 20%*(4.58) + 80%*(7.68) = 8.59

30. Accounting performance Profitability ratios • ROA • Profits after taxes/total assets • A measure of return on total investment in a firm. Larger is usually better • Return on Equity • Profits after taxes/total stockholders equity • A measure of return on total equity investment in the firm. Larger is usually better

31. More profitability ratios • Gross profit margin • (Sales – costs of goods sold)/Sales • A measure of sales available to cover operating expenses and still generate a profit. Larger is usually better. • Earnings per share • (profits after taxes-preferred stock dividends)/number of shares of common stock outstanding • A measure of profit available to owners of common stock. Larger is usually better

32. Still more profitability ratios • Price earnings ratio • Current market price per share/after tax earning per share • A measure of anticipated firm performance– high p/e ratio tends to indicate that the stock market anticipates strong future performance. Larger is usually better • Cash flow per share • (After-tax profits + Depreciation)/ number of common shares outstanding • A measure of funds available to fund activities above current level of costs. Larger is usually better

33. Liquidity ratios • Current ratio • Current assets/Current liabilities • A measure of the ability of a firm to cover its current liabilities with assets than can be converted to cash in the short run. Recommended in the range of 2 to 3 • Quick ratio • (Current assets – Inventory)/Current liabilities A ratio of 1 is thought to be acceptable in many industries

34. Leverage Ratios • Debt to assets • Total debt/Total Assets • A measure of the extent to which debt has been used to finance a firm’s business activities. The higher, the greater the risk of bankruptcy • Debt to equity • Total debt/Total equity • A measure of the use of debt versus equity to finance a firm’s business activities. Generally less than 1

35. 1 more leverage ratio • Times interest earned • Profits before taxes and interest/total interest charges • A measure of how much a firm’s profits can decline and still meet its interest obligations. Should be well above 1

36. Activity ratios • Inventory turnover • Sales/Inventory • A measure of the speed with wich a firm’s inventory is turning over • Accounts receivable turnover • Annual credit sales/accounts receivable • A measure of the average time it takes a firm to collect on credit sales

37. One last activity ratio • Average collection period • Accounts receivable/average daily sales • A measure of the time it takes a firm to receive payment after a sale has been made

38. Enron turning debt into revenue • Shell Game • Three players • Enron, Bank, off-shore company owned by bank • Step 1 • Enron agrees to sell a large amount of oil and gas to off-shore company over time • Step 2 • Off-shore company agrees to pay Enron up front • Step 3 • Off-shore company turns over oil and gas contract to bank • Step 4 • Bank would sell it back to Enron for a fixed price over time

39. Oil and Gas trades cancelled each other out—since Enron bought back everything it sold (no oil or gas was even moved from Enron) • Enron obtained large upfront payment and paid back over time in effect a loan • Showed up as revenue to meet Wall Street’s performance expectations

40. Stake holders • Firm’s equity and debt holders • Suppliers • Customers • Employees • Communities • Agency problem • Competing goals

41. Emergent Vs. Intended Strategies • Intended strategy • Deliberate Strategy • Unrealized Strategy • Realized Strategy • Emergent strategy

42. Fed EX (Deliberate) • Johnson & Johnson (Baby Powder and Band Aids) • Marriott (airport food) • PEZ • Calvin Ball

43. Lebron James • Reebok and Adidas • 40 billboards • Michael Jordan • 2.5 million (5 years) • 2.6 billion in sales • Tiger Woods • 100 million (5 years) • What might be? • US market 8 billion

44. Why do you need to know about Strategy? • Studying strategy and the strategic management process can give you the tools you need to evaluate the strategies of firms that may employ you. • Once you are working for a firm, understanding that firm’s strategies, and your role in implementing those strategies, can be very important for your personal success. • You may be involved in the planning process for smaller and entrepreneurial firms

45. Mini case • Coke launches C2