Part #1 The tools of
Strategic Analysis
Chapter #1
What is Strategy and the Strategic
Management Process?
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

Opening case: What has
Napster wrought?
How do we buy music?
 Is Napster good or bad for the music
industry?

Music Down loaders
Napster today
 KaZaA
 eDonkey
 Bit Torrent

Down Load for a fee

MusicNet site


Pressplay site




Universal, Sony
MusicNow site
Rhapsody (listen.com) site
iTunes site


AOL/TimeWarner, Berlesman, Emi, and Real
Networks
Apple
Monthly fees and a per song charge
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?

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
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

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.
Star Trek
Anheuser-Busch
Dell
Ford Motor Company
IBM
The Oakland Raiders
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)

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
Ben & Jerry’s




Counter Culture
Compensation
package
Industry mergers
Acquired by Unilever
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)

Low Quality objectives
Do not exist (dodge ball)
 Not quantitative
 Difficult to measure
 Difficult to track over time

External and Internal Analysis

Chapter 2

External Analysis
 Threats

and Opportunities
Chapter 3

Internal Analysis
 Strengths
and Weaknesses
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)

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)

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

Strategy Implementation
Firm Strategies
 Corporate Strategies
 Other issues

Organizational Structure
 Control Processes
 Compensation Policy

Competitive Advantage

Competitive Advantage


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 that few other competitors currently are:
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:
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
Economic performance
WACC
 Cost of Capital



Cost of equity


Interest the firm must pay its debt holders
Return the firm must promise its equity
holders
Standard and Poor’s
Calculating WACC
Firm’s debt rating
 Marginal Tax rate
 Beta
 Risk free and market rates of return
 Information about a firm’s capital structure

Numerical example
Firms’ rating BBB 7.5%
 Marginal tax rate 39%


After tax cost of debt is
 (1-.39)(7.5)
or 4.58%
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 %

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
Capital Structure
Debt 1 million (20%)
 Equity 4 million (80%)
 Plugging in the numbers


20%*(4.58) + 80%*(7.68) = 8.59
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
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
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
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
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
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
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
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
Enron turning debt into revenue


Shell Game
Three players


Step 1


Off-shore company agrees to pay Enron up front
Step 3


Enron agrees to sell a large amount of oil and gas to off-shore
company over time
Step 2


Enron, Bank, off-shore company owned by bank
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
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

Stake holders
Firm’s equity and debt holders
 Suppliers
 Customers
 Employees
 Communities
 Agency problem
 Competing goals

Emergent Vs. Intended Strategies

Intended strategy
Deliberate Strategy
 Unrealized Strategy


Realized Strategy

Emergent strategy
Fed EX (Deliberate)
 Johnson & Johnson (Baby Powder and
Band Aids)
 Marriott (airport food)
 PEZ
 Calvin Ball

Lebron James

Reebok and Adidas


Michael Jordan




2.5 million (5 years)
2.6 billion in sales
Tiger Woods


40 billboards
100 million (5 years)
What might be?
US market 8 billion
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
Mini case

Coke launches C2