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Session 04

This document provides an overview of strategy analysis and its key components. It discusses analyzing a firm's industry environment, including the five competitive forces that determine industry profitability: rivalry among existing firms, threat of new entrants, threat of substitute products, bargaining power of buyers, and bargaining power of suppliers. Understanding a firm's industry and competitive positioning is an important starting point for financial statement analysis and valuation.

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Sameera Jayaratne
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51 views18 pages

Session 04

This document provides an overview of strategy analysis and its key components. It discusses analyzing a firm's industry environment, including the five competitive forces that determine industry profitability: rivalry among existing firms, threat of new entrants, threat of substitute products, bargaining power of buyers, and bargaining power of suppliers. Understanding a firm's industry and competitive positioning is an important starting point for financial statement analysis and valuation.

Uploaded by

Sameera Jayaratne
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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STRATEGY ANALYSIS

MBA 617 Business Analysis and Valuation


MBA in Finance
Postgraduate and Mid-career Development Unit
Faculty of Management & Finance
University of Colombo
OBJECTIVE AND APPROACH

Introduction to Strategy Analysis


 Important starting point for the analysis of
Financial statement
 It allows the analysts to probe the economics of the
firm at a qualitative level so that the subsequent
accounting and financial analysis is grounded in
business reality

 Identification of firms profit Drivers and key risks


- Thereby sustainability of the firm
- Some times may have more than one business
1
OBJECTIVE AND APPROACH

Introduction to Strategy Analysis (cont.…)


 While the cost of capital is determined by
the capital market, the firms ability to earn a
return over it is determined by its strategy

 Strategy analysis involves:


 Choice of industry
 Competitive strategy (the manner in which the
firm intends to compete with other firms)
 Corporate Strategy (the way in which the firm expects
to create and exploit synergies) 2
INDUSTRY ANALYSIS

 Profit potential of a firm depend on the


profit potentials of each of the industries it
involves in
 It differs from industry to industry
systematically and over time
i.e:
take different industries overtime, banking,
plantation, construction etc.
 At a given point of time average return varies
widely across industries
 For a given firm it varies over time as well 3
INDUSTRY ANALYSIS

 Industry profitability depends on its


industry structure Eg. Tea industry
 According to literature industry
profitability is influenced by 5 forces that
determines:
 The degree of accrual and potential
competition with in the industry
 Bargaining power in input and output
market

4
INDUSTRY ANALYSIS (CONT.…)

5
DEGREE OF ACTUAL AND POTENTIAL
COMPETITION
The profits in a industry are a function of the price
that the customers are willing to pay for the
product and services

According to micro economics:


- If there is perfect competition, prices will be equal to
marginal costs – normal profits
- If the industry is dominated by a single firm, there will
be a potential to earn monopoly profits – demand
elasticity is an important factor
In reality, industries fall in between perfect competition
and monopoly

6
DEGREE OF ACTUAL AND POTENTIAL
COMPETITION (CONT...)

 There are three competitive forces that


determine the degree of competition
- Rivalry among existing firms
- Threat of new entrants
- Threat of Substitute products

7
COMPETITIVE FORCE 1: RIVALRY AMONG
EXISTING FIRM
In most cases average profitability depend
on the rivalry among firms in industry
- Aggressive competition pushes prices close
to or below marginal cost
- Some industries find the way to coordinate
their pricing or compete on non-price
dimensions – Innovation, brand image etc.

8
COMPETITIVE FORCE 1: RIVALRY AMONG
EXISTING FIRM
 Several factors influence on the intensity of
competition among players
 Industry growth – new firm can find a space

 Concentration and balance of competition –


Number of players and their relative size

 Degree of differentiation and switching costs:


Extent to which firm can avoid head on competition

 Economies of Scale and the ratio of fixed to


variable costs
9
COMPETITIVE FORCE 1: RIVALRY AMONG
EXISTING FIRM
 Excess capacity and Exit Barriers:
 Tend to use excess capacity in he industry
by reducing prices
 Exit barriers would exacerbate the excess
capacity problem
Exit barriers are high when the assets are
specialized, or if there are regulations which
make exit costly.

10
COMPETITIVE FORCE 2: THREAT OF NEW
ENTRANTS
 Threat of new entrants potentially constraint
the pricing of the exiting firms
There are several factors influence on this
 Economies of sale : When there are large
economies of scale, new entrants face the choice of
having either to invest in a large capacity which
might not be utilized right away, or to enter with less
than the optimum capacity. initially suffer from a
cost disadvantage in competing with existing firms.

11
COMPETITIVE FORCE 2: THREAT OF NEW
ENTRANTS
 Threat of new entrants potentially constraint
the pricing of the exiting firms and the factors
influence on this (cont.…)
 First mover advantage : May set the industry
standards, Exclusive arrangements with suppliers,
Important government licensing for regulated
industries, Advantage of Learning economies,
Switching cost for users – Computer operating
system
 Access to channels of distribution and
relationship. Limited capacity in existing channels and high cost of
developing new channels
 LEGAL BARRIERS. 12

Telecom, Broadcasting and medical


COMPETITIVE FORCE 3 : THREAT OF
SUBSTITUTE PRODUCTS
 Both similar products as well as products
that performs similar functions; Ex. Plastic
Bottles and Metal Cans; University Degree and
Professional programmes, There are a lot of
substitutes in Food and Beverage products
 Customers willingness to switch to substitute
is an important factor – Brand loyalty, Discount etc.
 It may depend on
 Relative price of competing products
 Functionality of such products – whether they perform
the same function
 Value place for the image
13
COMPETITIVE FORCE 4: BARGAINING
POWER OF THE BUYER
 Price sensitivity and relative bargaining
power are important factors;
 Sensitive to price depends on what fraction of
buyers cost has to be spent on the product and
the importance of the product to the buyers
own product quality
 Relative bargaining power depends on the cost
to each party of not doing business with the
other party.

14
COMPETITIVE FORCE 4: BARGAINING
POWER OF THE BUYER
For a product relative bargaining power
depend on:
 Number of buyers relative to the number of suppliers
 volume of purchases by a single buyer
 Number of alternative products available to
the buyer
 Threat of backward integration by the buyer

Ex. Automobile industry car manufacturers has


considerable power over component manufacturers

15
COMPETITIVE FORCE 5 : BARGAINING
POWER OF SUPPLIER
 Analysis of the relative power of supplier is
a mirror image of the buyers power in an
industry.
Ex. Super market – imports through intermediates
 Suppliers are powerful when there are only
a few companies and few substitute
available to their customers
Ex. Coke is very powerful relative to bottlers
 Suppliers are also have a lot of power over
buyers when the suppliers product or
service is critical to buyers business 16
Priyantha Hearth
B.Sc., MBA, FCA, ACMA

Email: [email protected]
Phone: 077304772

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