Part #1 The tools of Part #1 The tools of Strategic AnalysisStrategic Analysis

Chapter #1Chapter #1

What is Strategy and the Strategic What is Strategy and the Strategic Management Process?Management Process?

Learning ObjectivesLearning ObjectivesDefine the concept of StrategyDefine the concept of StrategyDescribe the strategic management Describe the strategic management

processprocessDefine competitive advantage and its Define competitive advantage and its

relationship to firm performancerelationship to firm performanceDescribe the difference between emergent Describe the difference between emergent

and intended strategiesand intended strategiesDiscuss the importance of understanding a Discuss the importance of understanding a

firm’s strategy even if you are not a senior firm’s strategy even if you are not a senior manager in a firmmanager in a firm

Opening case: What hasOpening case: What has Napster wrought? Napster wrought?

How do we buy music?How do we buy music? Is Napster good or bad for the music Is Napster good or bad for the music

industry?industry?

Music Down loadersMusic Down loaders

NapsterNapster today todayKaZaAKaZaAeDonkeyeDonkeyBit TorrentBit Torrent

Down Load for a feeDown Load for a fee MusicNet siteMusicNet site

AOL/TimeWarner, Berlesman, Emi, and Real AOL/TimeWarner, Berlesman, Emi, and Real NetworksNetworks

Pressplay sitePressplay site Universal, SonyUniversal, Sony

MusicNow siteMusicNow site Rhapsody (listen.com) siteRhapsody (listen.com) site iTunes siteiTunes site

AppleApple

Monthly fees and a per song chargeMonthly fees and a per song charge

The music IndustryThe music Industry

What is happening to our industry?What is happening to our industry?What is our competition going to do next? What is our competition going to do next? How should we respond?How should we respond?What can we do to make money in our What can we do to make money in our

business?business?

Strategy and the Strategic Strategy and the Strategic Management processManagement process

A firm’s strategy is defined as its theory A firm’s strategy is defined as its theory about how to gain competitive advantagesabout how to gain competitive advantages

A “good strategy” is a strategy that actually A “good strategy” is a strategy that actually generates such advantagesgenerates such advantages

Strategies are theories because they are Strategies are theories because they are based on how a firm thinks competitors, based on how a firm thinks competitors, consumers and others will respondconsumers and others will respond

Strategic planning processStrategic planning process

Why should we plan?Why should we plan?Can we be successful without planning?Can we be successful without planning?The processThe process

MissionMissionObjectivesObjectivesExternal & Internal AnalysisExternal & Internal AnalysisStrategic ChoiceStrategic ChoiceStrategic ImplementationStrategic ImplementationCompetitive AdvantageCompetitive Advantage

Mission StatementsMission Statements

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

Star TrekStar Trek

Anheuser-BuschAnheuser-Busch

DellDell

Ford Motor CompanyFord Motor Company

IBMIBM

The Oakland RaidersThe Oakland Raiders

What impact does a mission What impact does a mission statement have on the companystatement have on the company

No impact (Enron)No impact (Enron) Integrity: We work with the customers and Integrity: We work with the customers and

prospects openly, honestly and sincerely. prospects openly, honestly and sincerely. When we say we will do something, we will do When we say we will do something, we will do it; when we say we cannot or will not do it; when we say we cannot or will not do something, then we won’t do it.something, then we won’t do it.

Positive impact (visionary firms)Positive impact (visionary firms)Negative (Ben & Jerry’s)Negative (Ben & Jerry’s)

Visionary firmsVisionary firms

3M3M , American Express, Boeing, Citicorp, , American Express, Boeing, Citicorp, Ford, General Electric, Hewlett-Packard, Ford, General Electric, Hewlett-Packard, IBM, Johnson & Johnson, Marriott, Merck, IBM, Johnson & Johnson, Marriott, Merck, Motorola, Nordstrom, Philip Morris, Proctor Motorola, Nordstrom, Philip Morris, Proctor & Gamble, Sony, Wal-Mart, Walt Disney& Gamble, Sony, Wal-Mart, Walt Disney

Are there any on this list that surpriseAre there any on this list that surprise

Ben & Jerry’sBen & Jerry’s

Counter CultureCounter Culture Compensation Compensation

packagepackage Industry mergersIndustry mergers Acquired by UnileverAcquired by Unilever

ObjectivesObjectives

SpecificSpecificMeasurableMeasurableTimeTime3M objectives3M objectives

Growth in earnings per share 10% per yearGrowth in earnings per share 10% per year27% return on employed capital27% return on employed capital30% of sales from newer products (4 years)30% of sales from newer products (4 years)

Low Quality objectivesLow Quality objectives

Do not exist (dodge ball)Do not exist (dodge ball)Not quantitativeNot quantitativeDifficult to measureDifficult to measureDifficult to track over timeDifficult to track over time

External and Internal AnalysisExternal and Internal Analysis

Chapter 2 Chapter 2 External AnalysisExternal Analysis

Threats and OpportunitiesThreats and Opportunities

Chapter 3Chapter 3 Internal AnalysisInternal Analysis

Strengths and WeaknessesStrengths and Weaknesses

Strategic ChoiceStrategic Choice

Business Level StrategiesBusiness Level StrategiesActions firms take to gain competitive Actions firms take to gain competitive

advantages in a single market or industryadvantages in a single market or industryTwo most commonTwo most common

Cost leadership (Chapter 4)Cost leadership (Chapter 4)Product Differentiation (Chapter 5)Product Differentiation (Chapter 5)

Strategic ChoiceStrategic Choice

Corporate level strategiesCorporate level strategiesAre actions firms take to gain competitive Are actions firms take to gain competitive

advantages by operation in multiple markets advantages by operation in multiple markets or industries simultaneouslyor industries simultaneously

Common Corporate level strategiesCommon Corporate level strategiesVertical Integration (chapter six)Vertical Integration (chapter six)Strategic alliance strategies (chapter seven)Strategic alliance strategies (chapter seven)Diversification strategies (chapter eight)Diversification strategies (chapter eight)Mergers and acquisition strategies (chapter 9)Mergers and acquisition strategies (chapter 9)

Choosing a strategyChoosing a strategy

Supports the firm’s missionSupports the firm’s mission Is consistent with a firm’s objectivesIs consistent with a firm’s objectivesExploits opportunities in a firm’s Exploits opportunities in a firm’s

environment with a firm’s strengthsenvironment with a firm’s strengthsNeutralizes threats in a firm’s environment Neutralizes threats in a firm’s environment

while avoiding a firm’s weaknesseswhile avoiding a firm’s weaknesses

Strategy ImplementationStrategy Implementation

Firm StrategiesFirm StrategiesCorporate StrategiesCorporate StrategiesOther issuesOther issues

Organizational StructureOrganizational StructureControl ProcessesControl ProcessesCompensation PolicyCompensation Policy

Competitive AdvantageCompetitive Advantage Competitive AdvantageCompetitive Advantage

When a firm is creating value in a market or industry When a firm is creating value in a market or industry in ways that few other competitors currently are:in ways that few other competitors currently are:

Sustained Competitive AdvantageSustained Competitive Advantage And when those competitors find it very costly to And when those competitors find it very costly to

imitate these actionsimitate these actions Competitive parityCompetitive parity

When a firm is creating value in a market or industry When a firm is creating value in a market or industry in ways similar to that of many of its competitorsin ways similar to that of many of its competitors

Competitive disadvantage:Competitive disadvantage: When a firm fails to create value in a market or When a firm fails to create value in a market or

industry in ways that at leas some of its competitors industry in ways that at leas some of its competitors are:are:

How sustainable are competitive How sustainable are competitive advantages?advantages?

Dennis Mueller (longitudinal study)Dennis Mueller (longitudinal study) Firms that perform well in early time periods also Firms that perform well in early time periods also

performed well in later time periodsperformed well in later time periods Geoffrey WaringGeoffrey Waring

Some industries have competitive advantages that Some industries have competitive advantages that are easier to maintainare easier to maintain

Information complex, require customers to know a great deal, Information complex, require customers to know a great deal, require a great deal of research and development, significant require a great deal of research and development, significant economies of scaleeconomies of scale

Peter RobertsPeter Roberts Studied the pharmaceutical industry Studied the pharmaceutical industry

Economic performanceEconomic performance

WACCWACCCost of CapitalCost of Capital

Interest the firm must pay its debt holdersInterest the firm must pay its debt holdersCost of equityCost of equity

Return the firm must promise its equity Return the firm must promise its equity holdersholders

Standard and Poor’s Standard and Poor’s

Calculating WACCCalculating WACC

Firm’s debt ratingFirm’s debt ratingMarginal Tax rateMarginal Tax rateBetaBetaRisk free and market rates of returnRisk free and market rates of return Information about a firm’s capital structureInformation about a firm’s capital structure

Numerical exampleNumerical example

Firms’ rating BBB 7.5%Firms’ rating BBB 7.5%Marginal tax rate 39%Marginal tax rate 39%

After tax cost of debt isAfter tax cost of debt is(1-.39)(7.5) or 4.58%(1-.39)(7.5) or 4.58%

Beta (how highly correlated the price of Beta (how highly correlated the price of firm’s equity is in comparison to the overall firm’s equity is in comparison to the overall stock market) Published for publicly stock market) Published for publicly traded companies (1.2)traded companies (1.2)

Risk free rate of return historically has Risk free rate of return historically has been three percentbeen three percent

Market rate of return 8.5 %Market rate of return 8.5 %

Capital asset pricing modelCapital asset pricing model

Cost of equity Cost of equity Risk free rate of Return + (Market rate of Risk free rate of Return + (Market rate of

return – Risk free)Betareturn – Risk free)BetaPlugging in the numbersPlugging in the numbers

3 + (8.5 – 3)*1.2 = 9.63 + (8.5 – 3)*1.2 = 9.6

Capital StructureCapital Structure

Debt 1 million (20%)Debt 1 million (20%)Equity 4 million (80%)Equity 4 million (80%)Plugging in the numbers Plugging in the numbers

20%*(4.58) + 80%*(7.68) = 8.5920%*(4.58) + 80%*(7.68) = 8.59

Accounting performance Accounting performance Profitability ratiosProfitability ratios

ROA ROA Profits after taxes/total assetsProfits after taxes/total assets

A measure of return on total investment in a firm. A measure of return on total investment in a firm. Larger is usually betterLarger is usually better

Return on Equity Return on Equity Profits after taxes/total stockholders equityProfits after taxes/total stockholders equity

A measure of return on total equity investment in A measure of return on total equity investment in the firm. Larger is usually betterthe firm. Larger is usually better

More profitability ratiosMore profitability ratiosGross profit marginGross profit margin

(Sales – costs of goods sold)/Sales(Sales – costs of goods sold)/SalesA measure of sales available to cover operating A measure of sales available to cover operating

expenses and still generate a profit. Larger is expenses and still generate a profit. Larger is usually better.usually better.

Earnings per shareEarnings per share (profits after taxes-preferred stock (profits after taxes-preferred stock

dividends)/number of shares of common stock dividends)/number of shares of common stock outstandingoutstandingA measure of profit available to owners of common A measure of profit available to owners of common

stock. Larger is usually betterstock. Larger is usually better

Still more profitability ratiosStill more profitability ratiosPrice earnings ratioPrice earnings ratio

Current market price per share/after tax earning Current market price per share/after tax earning per shareper shareA measure of anticipated firm performance– high p/e A measure of anticipated firm performance– high p/e

ratio tends to indicate that the stock market ratio tends to indicate that the stock market anticipates strong future performance. Larger is anticipates strong future performance. Larger is usually betterusually better

Cash flow per shareCash flow per share (After-tax profits + Depreciation)/ number of (After-tax profits + Depreciation)/ number of

common shares outstandingcommon shares outstandingA measure of funds available to fund activities above A measure of funds available to fund activities above

current level of costs. Larger is usually bettercurrent level of costs. Larger is usually better

Liquidity ratiosLiquidity ratiosCurrent ratioCurrent ratio

Current assets/Current liabilitiesCurrent assets/Current liabilitiesA measure of the ability of a firm to cover its current A measure of the ability of a firm to cover its current

liabilities with assets than can be converted to cash in liabilities with assets than can be converted to cash in the short run. Recommended in the range of 2 to 3the short run. Recommended in the range of 2 to 3

Quick ratioQuick ratio (Current assets – Inventory)/Current liabilities(Current assets – Inventory)/Current liabilities

A ratio of 1 is thought to be acceptable in many industriesA ratio of 1 is thought to be acceptable in many industries

Leverage RatiosLeverage Ratios

Debt to assetsDebt to assetsTotal debt/Total AssetsTotal debt/Total Assets

A measure of the extent to which debt has been A measure of the extent to which debt has been used to finance a firm’s business activities. The used to finance a firm’s business activities. The higher, the greater the risk of bankruptcyhigher, the greater the risk of bankruptcy

Debt to equityDebt to equityTotal debt/Total equityTotal debt/Total equity

A measure of the use of debt versus equity to A measure of the use of debt versus equity to finance a firm’s business activities. Generally less finance a firm’s business activities. Generally less than 1than 1

1 more leverage ratio1 more leverage ratio

Times interest earnedTimes interest earnedProfits before taxes and interest/total interest Profits before taxes and interest/total interest

chargeschargesA measure of how much a firm’s profits can decline A measure of how much a firm’s profits can decline

and still meet its interest obligations. Should be and still meet its interest obligations. Should be well above 1well above 1

Activity ratiosActivity ratios

Inventory turnoverInventory turnoverSales/InventorySales/Inventory

A measure of the speed with wich a firm’s A measure of the speed with wich a firm’s inventory is turning overinventory is turning over

Accounts receivable turnoverAccounts receivable turnoverAnnual credit sales/accounts receivableAnnual credit sales/accounts receivable

A measure of the average time it takes a firm to A measure of the average time it takes a firm to collect on credit salescollect on credit sales

One last activity ratioOne last activity ratio

Average collection periodAverage collection periodAccounts receivable/average daily salesAccounts receivable/average daily sales

A measure of the time it takes a firm to receive A measure of the time it takes a firm to receive payment after a sale has been madepayment after a sale has been made

Enron turning debt into revenueEnron turning debt into revenue Shell GameShell Game Three playersThree players

Enron, Bank, off-shore company owned by bankEnron, Bank, off-shore company owned by bank Step 1Step 1

Enron agrees to sell a large amount of oil and gas to off-shore Enron agrees to sell a large amount of oil and gas to off-shore company over timecompany over time

Step 2Step 2 Off-shore company agrees to pay Enron up frontOff-shore company agrees to pay Enron up front

Step 3Step 3 Off-shore company turns over oil and gas contract to bankOff-shore company turns over oil and gas contract to bank

Step 4Step 4 Bank would sell it back to Enron for a fixed price over timeBank would sell it back to Enron for a fixed price over time

Oil and Gas trades cancelled each other Oil and Gas trades cancelled each other out—since Enron bought back everything out—since Enron bought back everything it sold (no oil or gas was even moved from it sold (no oil or gas was even moved from Enron)Enron)

Enron obtained large upfront payment and Enron obtained large upfront payment and paid back over time in effect a loanpaid back over time in effect a loan

Showed up as revenue to meet Wall Showed up as revenue to meet Wall Street’s performance expectationsStreet’s performance expectations

Stake holdersStake holders

Firm’s equity and debt holdersFirm’s equity and debt holdersSuppliersSuppliersCustomersCustomersEmployeesEmployeesCommunitiesCommunitiesAgency problemAgency problemCompeting goalsCompeting goals

Emergent Vs. Intended StrategiesEmergent Vs. Intended Strategies

Intended strategyIntended strategyDeliberate StrategyDeliberate StrategyUnrealized StrategyUnrealized Strategy

Realized StrategyRealized StrategyEmergent strategyEmergent strategy

Fed EX (Deliberate)Fed EX (Deliberate)Johnson & Johnson (Baby Powder and Johnson & Johnson (Baby Powder and

Band Aids)Band Aids)Marriott (airport food)Marriott (airport food)PEZ PEZ Calvin BallCalvin Ball

Lebron JamesLebron James

Reebok and AdidasReebok and Adidas 40 billboards40 billboards

Michael JordanMichael Jordan 2.5 million (5 years)2.5 million (5 years) 2.6 billion in sales2.6 billion in sales

Tiger WoodsTiger Woods 100 million (5 years)100 million (5 years)

What might be?What might be? US market 8 billionUS market 8 billion

Why do you need to know about Why do you need to know about Strategy?Strategy?

Studying strategy and the strategic management Studying strategy and the strategic management process can give you the tools you need to process can give you the tools you need to evaluate the strategies of firms that may employ evaluate the strategies of firms that may employ you.you.

Once you are working for a firm, understanding Once you are working for a firm, understanding that firm’s strategies, and your role in that firm’s strategies, and your role in implementing those strategies, can be very implementing those strategies, can be very important for your personal success.important for your personal success.

You may be involved in the planning process for You may be involved in the planning process for smaller and entrepreneurial firmssmaller and entrepreneurial firms

Mini caseMini case

Coke launches C2Coke launches C2