How to Do a Strategic Analysis

How to Do a Strategic Analysis Dr. Stan Abraham Summer 2008

What Is Strategic Analysis? • 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

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

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

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, or lack?

2. Where Do We Want to Go?This involves strategicthinking • What are all the possible and feasible directions we could take? • Which opportunities could we pursue? • What alternative business models make sense? • Which is the best alternative? • Why is it the best one?

3. How can we get there?And how fast should we get there? • What vision and strategy 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?

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 • [Know what these terms mean?]

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

A Strategic Analysis Model – that works! (SAMtw) 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?

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

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

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

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

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

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

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

Concentrated vs. Fragmented Industries • Concentrated – when most of the industry’s sales are accounted for by only a few firms • The “Big Four” 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

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

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

Strategic Group Map • A two-dimensionaldiagram with axesthat separate out rivalsin an industry • Plot competitors onthe diagram • Group ones that are“close” to each other onthe map – they are saidto belong to similarstrategic groups • Often, circles around thegroups represent combinedsales of companies in them Very broad Breadth ofproduct line narrow domestic international Geographic scope External Situation Analysis

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 Factor Co. 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 External Situation Analysis

Assessing Industry Attractiveness Example:XYZ 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

Assessing Competitive Strength Example:Your Company Under Analysis 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

G. E. Matrix High IndustryAttractiveness Invest Your Company Medium Divest Low Weak Avg. Strong Competitive Strength Situation Analysis External

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

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

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?

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

Financial Analysis • SAM does all the work for you after you have inputted income-statement and balance-sheet data for the given years • 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 • You end the presentation with a ‘financial conclusion’ slide • Use data from the previous charts shown to support your conclusion Internal Situation Analysis

Financial Charts • Begin with revenues and NIAT • Show breakdowns of revenues or profits (by product line or geographical region), if available • Should include current or quick ratio (not both), D/E or D/A ratio (not both), and Z- or Z2-Score (not both) • 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 Situation Analysis Internal

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 X1 = WC/Total assets X2 = RE/Total assets X3 = EBIT/Total assets X4 = Equity/Total debt X5 = Sales/Total assets Safe Zone 2.99 2.59 Gray Area 1.81 1.11 ManufacturingCompanies Bankrupt Zone Non-ManufacturingCompanies Z-Score Z2-Score Internal Situation Analysis

Financial Conclusion • The last sheet of the financial analysis part in SAMtw asks you to draw one of the following five conclusions about 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

Financial Conclusion Example: Harley-Davidson (1988) H-D has been 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 • NPM almost doubled from 1.7% in 1986 to 3.2% in 1988 • D/E ratio declined 54.5% from 5.5 in 1987 to 2.3 in 1988 • It has $52.3M in cash in 1988 • Z-Score improved to 3.07 (safe zone) in 1988 Set off the conclusion in a different font and color to stand out. Summarize thesupporting data in the order you showed the charts. Cite statistics. Internal Situation Analysis

Company Strengths Core competencies Cost advantages financial strengths 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 and condition is also a key component of Internal Company Analysis, and may reveal some strengths and weaknesses. Don’t use generic strengths (as above), but be specific.Market leadership or increasing market share are never strengths. Internal Situation Analysis

Company 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 Same notes as for ‘Strengths’ slide Internal Situation Analysis

Core Competence and Competitive Advantage Remember to add acolumn for capabilitiesat left-hand side. 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

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

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 Situation Analysis Internal

TOWS Matrix Situation Analysis Internal

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 • Includes four tools • Core-Competence Analysis • The TOWS Matrix • Value Analysis (not shown here) • SPACE Analysis (not shown here) Internal Situation Analysis

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, fate of 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

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

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

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

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

Coming up with Strategic Alternatives • The most difficult part of strategic planning • Requires a lot of thought and creativity • The challenge is to devise 2-4 alternatives (bundles) • The minimum is two • More than four is practically impossible • 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 (or delete the ones not addressed) Alternatives Analysis

Strategic Alternative Bundles Example: Harley-Davidson (1988) #1—Expand #2—Broaden #3—Expand the Market the Product Line into Europe Focus on older males Introduce three new Expand into Europe & women models Design models to Acquire Buell and Trade shows and appeal to this market offer sport bike 100 roving bikers Train dealers to Develop technolog. Create dealer network sell to this market advanced engine from scratch Invest in and grow Maintain HR but Maintain HR but HR sales improve its sales improve its sales Heavy advertising Heavy advertising Heavy advertising & promo campaign & promo campaign & promo campaign Incr. prod. capacity & Incr. prod. capacity & Incr. prod. capacity & maintain high quality maintain high quality maintain high quality Increase market share Increase market share Maintain U.S. share Finance thru debt & cash Finance thru debt & cash Finance thru debt & cash Alternatives Analysis

Choose the Best Alternative • Argue for which one is better or best • hard to do when all are equally good • The choice depends on how each alternative stacks up against selected criteria • Managers that will implement the strategy must be involved in deciding which alternative to pursue Alternatives Analysis

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

How to Do a Strategic Analysis