STRATEGIC ANALYSIS
Lecturer: Trinh Quoc Dat, PhD
Resources:
Chapter 2 - Business Analysis and Valuation by Palepu, Healy, Bernard
HBR article – “The five competitive forces that shape strategy” by Michael E. Porter, 2008
LEARNING OBJECTIVES
Understand the business through economic, industry, and
competitive analysis, which lays the foundations for
valuation process and assumptions
In focus : Porter’s five forces model for industry analysis
Issues: What is an attractive industry? How do you
evaluate the attractiveness of an industry? What is the
strength of a firm's competitive position in an industry?
What role does market structure play?
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REVIEWING …
Some golden rules for valuing a business
• One does not buy a stock, one buys a business
• Value depends on the business model, the
strategy
• Good firms can be bad buys: avoid the risk of
paying too much for a stock (ex. paying too much for
growth, “new knowledge”, etc..)
• Don’t mix what you know with speculation
• Stick to your beliefs and be patient, prices gravitate
to fundamentals, but that can take some time
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VALUATION APPROACH – THE BIG PICTURE
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THE VALUATION PROCESS
Understanding
the business
Strategic
analysis
Forecasting
company’s
performance
Accounting
analysis
Financial
statement
analysis
Valuation
techniques
applied
Intrinsic value
Vs.
Market price
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STRATEGIC ANALYSIS
In general, it is to answer the following 4 questions:
Industry
analysis
How attractive
is the industry in
terms of offering
prospects for
sustained
profitability?
Competitive
analysis
Competitive
strategies
What is the
company’s
competitive
position?
What is the
company’s
competing
strategies?
Execution
How well has
the company
executed its
strategies for
performance
improvement
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INDUSTRY
ROA
(2008)
Network and other communications
13.1%
Pharmaceutical
11%
Food services
11.4%
Food consumer products
6.8%
Chemicals
5.5%
Computer, office equipment
5.4%
Utilities: Gas and electric
2.9%
Entertainment
-3.1%
Real Estate
-11.8%
Airlines
-14%
Source: www.money.cnn.com
What determines
the profitability of
different
industries?
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PORTER: INDUSTRY ANALYSIS
Porter’s Five Forces define an industry’s structure and
shape the nature of competitive interactions within an
industry
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PORTER FIVE FORCE MODEL
THREAT OF NEW ENTRANTS
Why threat?
- New players bring capacity and a desire to win market
share
- This threat is extremely high when new entrants are
diversifying from other markets (can leverage existing
capabilities and cash flows to shake up competition)
The strength of this threat depends primarily on barriers
to entry and reaction from existing competitors.
When the threat is high, existing players hold down prices
or increase investment to deter new competitors
The industry is more attractive if entry is less likely…
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PORTER FIVE FORCE MODEL
THREAT OF NEW ENTRANTS
Entry is less likely if…
Entrants faces high sunk costs
- Sunk costs are investments that cannot be recovered
Entrants face retaliation
- Potential entrants are likely to be forced out of business
by strategic (pricing) behaviors of existing players
Existing players have competitive advantage
- Potential entrants are at a competitive disadvantage
compared to existing players, simply not profitable to
enter
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PORTER FIVE FORCE MODEL
THREAT OF NEW ENTRANTS
Existing players have competitive advantages:
Patents and licenses
Pioneering brands
Pre-commitment contracts (ex. distributions..)
Large economies of scale
- Supply-side economies of scales
- Demand-side economies of scales (network effect)
Steep learning (experience) curves
Customer switching costs
Restrictive government policy
ex: gas, electricity, water, gas drilling..
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PORTER FIVE FORCE MODEL
THREAT OF NEW ENTRANTS
Are the existing players expected to respond forcefully?
Is there a history of such retaliation
Do established firms have substantial resources to
retaliate (cash, capacity)?
Is there currently slow industry growth?
If yes, then new comers can gain volume only by taking it from
existing players
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PORTER FIVE FORCE MODEL
BARGAINING POWER OF SUPPLIERS
Why threat?
- Powerful suppliers can charge higher prices,
- Limit quality or services,
- Or shift costs to industry participants.
Ex: Microsoft raises prices on operating systems, passing
on cost increases to PC makers
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PORTER FIVE FORCE MODEL
BARGAINING POWER OF SUPPLIERS
A supplier group is powerful if:
It is dominated by a few firms and is more concentrated
than the industry it sells to.
The industry is not an important customer of the
supplier group (if they sell to multiple industries, any
one industry is less important).
The supplier group’s products are differentiated or it
has built up switching costs.
There are few substitutes for the suppliers’ products.
The supplier poses a credible threat of forward
integration.
These factors are subject to change, and are often out of a firm’s
control. A firm can improve its position relative to the industry, however,
by eliminating switching costs, or exploring backward integration.
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PORTER FIVE FORCE MODEL
BARGAINING POWER OF BUYERS
Why threat?
- Buyers can force down prices
- Demand better quality or more service (thereby driving up
costs)
- Play industry participants off against one another, at the
expense of industry profitability
A group of buyers are powerful if they have negotiating
leverage relative to industry participants, and if they are
price sensitive.
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PORTER FIVE FORCE MODEL
BARGAINING POWER OF BUYERS
A group of buyers is powerful if:
There are few buyers or each purchases large volumes
relative to seller sales.
The products it purchases are undifferentiated.
It faces few switching costs.
Buyers pose a credible threat of backward integration.
Buyers are price sensitive if:
The product the group purchases is a significant fraction of the
buyers’ costs or budget.
It earns low profits (under pressure to trim costs)
The industry’s product is unimportant to the quality of the
buyers’ products (i.e care more about price than quality).
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PORTER FIVE FORCE MODEL
THREAT OF SUBSTITUTE PRODUCTS
What’s substitute products?
- A substitute performs the same or similar function as in
industry’s product by a different means
Why threat?
- Substitute product may place a ceiling on prices, offer a
more attractive price-performance trade-off which places a
lid on the industry’s profit potential
Substitutes are always present, but they are easy to overlook
because they may appear to be very different from the industry’s
product!
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PORTER FIVE FORCE MODEL
THREAT OF SUBSTITUTE PRODUCTS
The threat of substitute is high if…
Switching costs are low
Attractiveness price/performance tradeoffs
Cross-price elasticity of Demand
Watch changes in other industries that might impact your
own industry’s substitute!
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PORTER FIVE FORCE MODEL
THREAT OF EXISTING RIVALRY
Why threat?
- Limits the profitability of an industry
- Can take many forms: price discounting, new product
introductions, advertising campaigns, service improvement…
- The degree to which rivalry limits the profitability of an industry
depends on the intensity of the industry and the dimensions
on which they compete
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PORTER FIVE FORCE MODEL
THREAT OF EXISTING RIVALRY
Rivalry is more intense if:
- Competitors are numerous or are roughly equal in size and power
Ex: fragmented vs. consolidated industry (# of rivals, size, power..)
- Industry growth is slow
- There are high exit barriers: specialized assets, fixed costs to exit,
emotional barriers, government restrictions
- Rivals are highly committed to the business
Dimensions of rivalry: If price competition, problem. More
likely when:
- There is low product differentiation, low switching costs
- There are high fixed and low marginal costs
- Perishable product (including obsolescence, unused capacity not
recoverable, no longer relevant)
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KEY TAKEAWAYS
Understand the time horizon for industry analysis
Industry analysis is not to declare the industry attractive
or unattractive but to understand the underpinnings of
competition and the root cause of profitability.
The strength of the competitive forces affects prices,
costs, and the investment required to compete  forces
are directly tied to the F/S of industry participants
Forces and factors change overtime. Watch them!
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IMPLICATIONS FOR STRATEGY
Competitive strategy is about taking action to create a
defendable position against the 5 forces.
Position the firm so its capabilities provide the best
defense against the existing (strong) competitive forces or
to take advantage of the weakest forces.
Anticipate shifts in key factors underlying the forces and
respond so as to exploit the changes.
Shaping industry structure
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IMPLICATIONS FOR STRATEGY
Step one: industry analysis with 5-forces to
understand WHY industry profitability is what it is
- Segments, key drivers, consistent with profitability?
- Recent and likely future changes?
Step two: analyze the firm’s strengths and
weaknesses relative to the industry
- What are more profitable players doing that you aren’t?
- What can be influenced?
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MINI-CASE: SOUTHWEST AIRLINES
an outlier in the US’s airline industry, which is
characterized by intense rivalry and low profit margins
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MINI-CASE: SOUTHWEST AIRLINES
SUPPLIERS: high
• High switching costs
POTENTIAL
ENTRANTS: low threat
• Capital intensive
• Existing players’ advantage
• Very consolidated industry
already
EXISTING RIVALRY
• intense
• High fixed costs
,excess capacity,
high exit barriers,
slow industry growth
 Price wars (max.
load factor)
BUYERS: high
• Flight shopping easy
• Prices readily available
for comparison over the
Internet
SUBSTITUTES:
Railroad, trains, bus
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MINI-CASE: SOUTHWEST AIRLINES
How Southwest Airlines positioned itself in the industry?
“focus on transporting high number of passengers on short trips
with high frequency”
- Do not rely on a “hub and spoke” system but point-to-point
flights
- Short flights, typically an hour or less
- Average plane usage: 11 hours a day, 3 hours above the
industry average
Offer lowest fares
- Use only Boeing 737 : more fuel efficient; reduce training costs
of pilots and mechanics; require lower inventory levels of spare
parts
- Ticket-less travel system
Devotion to employees: company culture
- Fortune’s top 10 companies to work for
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- Owns 11% of the company
BUSINESS ANALYSIS
AND VALUATION
ABOUT YOUR GROUP PROJECT REPORT…
PROJECT REPORT
Form groups of 5-6 students (no team should have fewer
than 5 or more than 6 students)
Analyze and value a company of your choice:
- Could be US or Vietnam companies
- No company should be analyzed by more than 1 group
(first come first served) – deadline 2 weeks from now by
email
- Be prepared to discuss and defend your analysis in the
presentation sessions – 2 last sessions of the course
- Presentation: partial group grades, partial individual
grades applied
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HOW TO CHOOSE A COMPANY FOR YOUR GROUP
PROJECT…
Stay away from:
- Financial services companies: SSI, PVF..
- Banks: VCB, EIB, ACB..
- Insurance companies: BVH, OGC..
Not because they are bad or not worth to look at, but
because they, by nature of their industry, have special
regulations and characteristics that complicate your
valuation
Also avoid companies that operate in multiple industries
like FPT,…  difficult to point out their core businesses
and thus strategies..
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HOW TO CHOOSE A COMPANY FOR YOUR GROUP
PROJECT…
After you filter such companies, you can go with some
suggested criteria:
- Blue-chip stocks
- Market capitalization
- Historical price movements/fluctuations
- Time the company went public (preferred to have at least
3 years of historical financial statements)
Some safe companies to work on: VNM, DHG, KDC,…
these companies have a track of stability, clear strategy
and focus on core business  easier to predict future
performance
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