Dupont Analysis
Adapted by P. V. Viswanath with permission
from http://marriottschool.net/teacher/swinyard/Retailing/
The Du Pont Identity
• ROA = NI/ TA
• ROA = (NI/ Sales)*(Sales / TA)
• ROA = (Net Profit Margin)*(Asset Turnover)
• ROE = (NI/Sales)*(Sales/TA)*(TA/TE)
•
= Net Profit Margin*Asset Turnover*Equity Multiplier
• Net Profit margin is a measure of the firm’s operating efficiency
– how well it controls costs
• Total asset turnover is a measure of the firm’s asset use
efficiency – how well it manages its assets
• Equity multiplier is a measure of the firm’s financial leverage.
• Let’s first look at the ROA identity – a firm could have a high
volume/low margin strategy, which would be reflected in high
asset turnover but low profit margins or the reverse.
P.V. Viswanath
• ROE = NI / TE
2
ROA: Turnover vs Margin
High Turnover
Unattainable
High
Margin
Low
Margin
Failure
Low Turnover
Two of the four segments might be unattainable or undesirable. But how
should a manager improve the firm’s positioning in the other two
segments?
Illustrations of the Dupont
Identity
• The Dupont identity is fairly well known as an accounting
identity. Accountants use it as a model for managerial control
and as a basis for firm valuation.
• However, it can also be the basis for alternative marketing
strategies.
• Let us see how this works, as reflected in the practices of
some US corporations.
• We first look at Provo Bakery and Zales Jewelry, two firms in
two different industries.
Return on Assets
Net Profit
Margin
Provo Bakery
Zales Jewelry
10%
90%
X
Asset =
Turnover
Return on
Assets
X
9 times =
90%
X
1 time
=
90%
• Both firms have the same ROA, but different combinations of profit
margin and asset turnover. Perhaps the different approaches simply
reflects the difference in industries?
• Let’s now look at two firms in the same industry: Tiffany, a jewelry
retail firm and Walmart, which is another jewelry retail firm – and,
according to its website, the world’s largest – but quite different.
(http://walmartstores.com/sustainability/9137.aspx)
Income Statements: Wal-Mart vs Tiffany
(2013, in millions)
Wal-Mart
Tiffany
$ 469,162
$ 3,794
$ 352,488
$ 1,631
$ 116,674
$ 2,163
Less: Operating expense
$ 88,873
$ 1,466
Less: Interest expense
$
$
Net sales
Less: Cost of goods sold
Gross margin
Total expense
$ 90,937
Other Income, Net
Net profit, pretax
Less: Taxes*
Tax rate
2064
$ 1525
-
$
5
$ 25,737
$
644
$
$
227
7,981
31.01%
Net profit after tax
59
$ 17,756
35.34%
$
416
* Effective tax rates often differ among corporations due to different tax breaks and advantages.
Which has the higher net margin?
Source: Wal-Mart Stores Inc(WMT) Annual Report (10K) 2013
Tiffany & Co. (TIF) Annual Report (10K) 2013
Profit Margin Model: Wal-Mart vs Tiffany
(2013, in millions)
Net Sales
$469,162
$3,794
Cost of
goods sold
$352,488
$1,631
Operating
expenses
$88,873
$1,466
+
Interest
expenses
$2,064
$59
Gross
margin
$116,674 (24.9%)
$2,163 (57%)
Total
expenses
$90,937
$1,525
Top Number
= Wal-Mart
Bottom Number = Tiffany
Net profit
before tax
$25,737
$638+5
-
Taxes
$7,981
$227
Net profit
after taxes
$17,756
$417
/
Net sales
$469,162
$3,794
Net profit
margin
3.78%
10.96%
Profit Margins
• Clearly, Tiffany has the larger profit margin (gross margins 57%
vs 24.9%; net margins 10.96% vs 3.78%)%.
• The model in the previous slide also shows exactly where the
profit margin comes from.
• The focus in this approach is on the numerator of the profit
margin ratio, viz. on Net Profit After Taxes (NPAT).
• It behooves the savvy manager to look at the components of
NPAT as a fraction of sales.
• Is it possible to improve cost of goods sold and operating
expenses as a fraction of sales – but without affecting sales?
• How are these being used to improve sales?
Asset Turnover Model: Wal-Mart vs Tiffany
(2013, in millions)
Accounts
receivable
$6,768
$174
Top Number
= Wal-Mart
Bottom Number = Tiffany
+
Merchandise
inventory
$43,803
$2,234
+
Cash
$7,781
$504
Total current
assets
$59,940
$3,152
+
+
Other current
assets
$1,588
$238
Fixed assets
$143,165
$1,479
Net sales
$466,114
$3,794
/
Total assets
$203,105
$4,631
What does this
represent?
From income
statement
Asset
turnover
2.29
0.82
From balance sheet
The sales $ generated
by each $ of assets
Asset Turnover
• Clearly, Walmart has the larger asset turnover.
• The model in the previous slide also shows exactly what is the
source of the higher asset turnover.
• The focus in this approach is on the denominator of the asset
turnover ratio, viz. on Total Assets.
• It behooves the savvy manager to look at the components of
total assets in terms of how they contribute to sales.
• Is it possible to reduce accounts receivable and merchandise
turnover and other assets – but without affecting sales?
• How are these assets being used to improve sales?
Dupont Analysis: Wal-Mart vs Tiffany
(2000, in millions)
2000 data
Net Profit
Asset Turnover
Margin
Net Sales/TA
Net Income/Net
Sales
ROA
Walmart
3.78
2.29
8.66
Tiffany’s
10.96
0.82
8.98
Although Walmart and Tiffany clearly have different
marketing/merchandising strategies, they end up with approximately the
same ROA!
In principle, this approach could be extended to look at ROE and include
leverage choices as part of the mix. The next slide shows how different
firms have made different choices in terms of net profit margin, asset
turnover and leverage.
Financial Objectives:
The Strategic Profit Model (SPM)
Return on
Investment
=
Return on
Assets
Net Profit
Net Worth
Return on
Assets
Net Profit
Total Assets
x
Net Profit
Total Assets
=
Asset
Turnover
Net Sales
Total Assets
The $ sales
generated
by each $ of assets
Leverage
Ratio
Total Assets
Net Worth
x
Net Profit
Margin
Net Profit
Net Sales
The net profit
generated
by each $ of sales
and so ...
SPM Examples
Return on Equity
Investment
Big Lots:
24.6%
1998 data
=
Net Profit
Margin %
x
Asset
Turnover
x
Leverage
Ratio
13.1
1.5
1.2
Albertson’s:
18.9%
2.1
4.2
2.1
The Dress Barn:
32.4%
7.4
2.9
1.5
Land’s End:
40.2%
6.8
3.1
1.9
The Limited:
32.3%
6.7
2.2
2.2
The Gap:
25.5%
6.6
2.4
1.6
ROI Model, Including
The Strategic Profit Model
Which is … the income statement? Balance sheet? SPM?
Net Sales
Cost of
goods sold
Gross
margin
Variable
expenses
+
Fixed
expenses
Total
expenses
Income Statement
Balance Sheet
Strategic Profit Model
Net profit

Net profit
margin
Net Sales
x
Inventory
+
Accounts
receivable
Net sales
Total current
assets
+
+
Other current
assets
Fixed
assets

Total
assets
Return on
assets
x
Asset
turnover
Financial
Leverage
=
Return on
Net Worth
Retail Stratgies
Look at some of these firms and figure out their strategy
http://marriottschool.net/teacher/swinyard/Retailing/retail_links.htm
As the previous slide points out, the two arms of the Dupont ROA
identity could be thought of as reflecting alternatives focusing on the
income statement (profit margin) versus on the balance sheet
(volume).
However, both approaches really reflect different uses of a
company’s assets/capabilities.
The next two slides show how Walmart has worked on one aspect of
its balance sheet, while the remaining slides look at how Tiffany’s
marketing focus on profit margin is reflected in its asset choices.
Walmart’s focus on efficient asset use
The use of information technology has been an essential part of
Wal-Mart's growth. A decade ago Wal-Mart trailed K-Mart, which
could negotiate lower wholesale prices due to its size. Part of WalMart's strategy for catching up was a point-of-sale system, a
computerized system that identifies each item sold, finds its price in
a computerized database, creates an accurate sales receipt for the
customer, and stores this item-by-item sales information for use in
analyzing sales and reordering inventory. Aside from handling
information efficiently, effective use of this information helps WalMart avoid overstocking by learning what merchandise is selling
slowly. Wal-Mart's inventory and distribution system is a world
leader. Over one 5 year period, Wal-Mart invested over $600 million
in information systems.
http://www.prenhall.com/divisions/bp/app/alter/student/useful/ch1walmart.html
Walmart’s focus on efficient asset use
Wal-Mart uses telecommunications to link directly from its stores to
its central computer system and from that system to its supplier's
computers. This allows automatic reordering and better
coordination. Knowing exactly what is selling well and coordinating
closely with suppliers permits Wal-Mart to tie up less money in
inventory than many of their competitors. At its computerized
warehouses, many goods arrive and leave without ever sitting on a
shelf. Only 10% of the floor space in Wal-Mart stores is used as an
inventory area, compared to the 25% average for the industry.
http://www.prenhall.com/divisions/bp/app/alter/student/useful/ch1walmart.html
Financial Information
Tiffany
Net Sales/Cash from Sales
Net Sales/Net A/R
Net Sales/Inventory
Asset Turnover
Net Income/Sales
ROA
ROE
2012
0.993
18.600
1.757
0.876
12.06%
10.56%
18.70%
2011
0.995
15.602
1.898
0.826
11.94%
9.86%
16.92%
2010
1.003
15.791
1.898
0.777
9.80%
7.62%
14.11%
2009
1.006
16.401
1.786
0.922
7.69%
7.09%
13.85%
2008
0.991
11.915
2.141
0.979
11.01%
10.78%
18.85%
Signet Jewelers
Net Sales/Cash from Sales
Net Sales/Net A/R
Net Sales/Inventory
Asset Turnover
2012
1.003
3.445
2.875
1.038
2011
1.001
3.673
2.903
1.112
2010
0.999
3.815
2.791
1.075
2009
0.995
4.033
2.439
1.086
2008
1
3.952
2.536
1.212
Zales
Net Sales/Cash from Sales
Net Sales/Net A/R
Net Sales/Inventory
Asset Turnover
2012
1
N/A
2.517
1.594
2011
1
N/A
2.418
1.464
2010
1
N/A
2.299
1.393
2009
1
N/A
2.404
1.446
2008
1
N/A
2.743
1.503
Do \you see a difference in the strategies of the three firms?
Tiffany, in particular, has a low asset turnover compared to Whitehall and
Zales, particularly in the later years. Let’s see why..
The Tiffany Approach
In the following videos, consider Tiffany’s and asset
use and think of our previous discussion.
http://www.youtube.com/watch?v=tbG0btCu1S4&f
eature=related
http://www.trendhunter.com/trends/tiffany-co-tolaunch-70-new-stores
Let’s now look at how Tiffany’s management
considers the issue in its 10K report.
Tiffany Brand Strategy
•Tiffany focuses on the profit margin. To do this, it needs to
spend more on certain assets than Walmart.
•The TIFFANY & CO. brand is the single most important asset of
Tiffany. The strength of the Brand goes beyond trademark rights
and is derived from consumer perceptions of the Brand.
Management monitors the strength of the Brand through focus
groups and survey research.
•Management believes that consumers associate the Brand
with high-quality gemstone jewelry, particularly diamond
jewelry; excellent customer service; an elegant store and online
environment; upscale store locations; “classic” product
positioning; distinctive and high-quality packaging materials
(most significantly, the TIFFANY & CO. blue box); and
sophisticated style and romance.
•Intangible Assets consist primarily of Product Rights and
Trademarks (about $10m. in 2010)
Tiffany Brand Strategy
•Tiffany’s business plan includes many expenses and strategies
to maintain the strength of the Brand. Stores must be staffed
with knowledgeable professionals to provide excellent service.
• Elegant store and online environments increase capital and
maintenance costs.
•Display practices require sufficient store footprints and lease
budgets to enable Tiffany to showcase fine jewelry in a retail
setting consistent with the Brand’s positioning.
•Stores in the best “high street” and luxury mall locations are
more expensive and difficult to secure, but reinforce the
Brand’s luxury connotations through association with other
luxury brands.
Tiffany Brand Strategy
•The classic positioning of Tiffany’s product line supports the
Brand, but limits the display space that can be afforded to
fashion jewelry. Tiffany’s packaging practices support
consumer expectations with respect to the Brand and are
more expensive.
•Some advertising is done primarily to reinforce the Brand’s
association with luxury, sophistication, style and romance,
while other advertising is primarily intended to increase
demand for particular products.
•Maintaining its position within the high-end of the jewelry
market requires Tiffany to invest significantly in diamond and
gemstone inventory and accept reduced overall gross
margins; it also causes some consumers to view Tiffany as
beyond their price range.
The Walmart Stores
In the following videos, look at Walmart’s asset use
and think of our previous discussion. How does it
differ from Tiffany?
Walmart Stores
http://www.youtube.com/watch?v=RJphoRD1w0I
http://vimeo.com/11111204
http://projects.flowingdata.com/walmart/
Crafting strategy post Dupont
• Once we look at the firm’s Dupont and other ratios (such as
Sales/GSA Expense ratio), we might want to suggest that the firm
move in the direction of increasing profit margin or in the direction
of increasing volume.
• This decision has to be taken, keeping in mind the capabilities and
resources that the firm possesses. It is also necessary to look at the
competitive environment. If there are many competing brands, then
it might not be a valuable strategy to create a new brand, ab initio,
in the same space. All the other Porter framework forces have to be
considered.
• If the decision is to move in the direction of higher profit margin,
then the firm has to think of a better brand. It might want to look at
the ratio of Sales to advertising expenses.
• It might want to increase trade promotion efforts, as well.
• If it pursues the goal of higher volume, then a lower price and all
that it entails is indicated. However, this may be achieved through
different strategies, e.g. coupons or other off-price methods. Better
credit terms may also be an option.