Frieda, an accounting student, states: “Strategy analysis seems to be an unnecessary detour in doing financial statement analysis. Why can’t we just get straight to the accounting issues? “Explain to Frieda why she might be wrong. Without strategy analysis, it is impossible to identify what drive profits and what are key risks. Moreover, assessing firm’s current performance and doing realistic forecasts of future performance are also directly linked with firm’s strategy. Three important strategic choices affect firm’s earnings. First, the choice of industry the firm operates in. second, the way firm intends to compete. Third, how successfully firm can exploit synergies. Therefore, for a firm to earn profit, it is necessary to do strategy analysis and better understand what strategy a business is executing. Question 2:
Discuss the major steps that strategy analysis involves.
Three important steps:
Industry Analysis: Every industry has a different profit potential, some are more profitable while other are less, because literature suggests that the profitability of an industry is influenced by the five forces. In this step, factors which drive the industry profitability are identified. In general profit is influenced by the degree of rivalry among existing competitors, the ease with which new firms cant the industry, the availability of substitute products, the power of buyers, and the of power suppliers. In industry analysis analyst asses the strength of each of these forces in an industry and make forecasts of any likely future changes. Competitive Strategy analysis: how a firm will compete? Firm can either compete on price or on differentiation. In this step analyst identifies which one of these two is firm’s intended strategy and whether or not the firm possesses the competencies required to execute the strategy, and recognize the key risks that the firm has to guard against. Analyst should also evaluate how sustainable the strategy is. While competing on price, firm should achieve cost leadership by achieving economies of scale or by bringing efficiency in cost control system. On the other hand, while competing on differentiations firm can provide either good quality or any other innovative characteristic for which customer is willing to pay a price premium. Corporate Strategy Analysis: Many firms operate in multiple businesses. Therefore, analyst has to evaluate the economic consequences of managing all the different businesses under one corporate umbrella. Analyst should evaluate whether transaction costs in markets are higher than the costs of similar activities inside a well-managed organization and analyst should try to find a best fit between the companies’s specialized resources and the portfolio of businesses in which the company is operating. Analyst should find ways how to improve coordination across business units. Corporate strategy analysis involves examining whether a company is able to create value by being in multiple businesses at the same time.
Examples of European firms that operate in the pharmaceutical industry are GlaxoSmithKline and Bayer. Examples of European firms that operate in the tour operating industry are Thomas Cook and TUI. Rate the pharmaceutical and tour operating industries as high, medium or low on the following dimensions of industry structure: (1) Rivalry, (2) Threat of new entrants, (3) Threat of substitute, (4) Bargaining power of suppliers, and (5) Bargaining power of buyers. Given your ratings, which industry would you expect to earn the highest returns? | Pharmaceutical Industry| Tour Operating Industry|
Rivalry| high| high|
Threat of new entrants| low| medium|
Threat of substitute products| medium| high|
Bargaining power of buyers| medium| medium|
Bargaining power of suppliers| low| low|
The pharmaceutical industry consists of firms that develop, patent, and distribute drugs. This industry has important...