Module in Strategic Business Analysis

Lorenzo B. Cabili, CPA, LlB, MPA, MBA

Faculty, College of Business Administration

4 STRATEGY ANALYSIS

“What we think, what we

become.”

-Buddha

Overview

Welcome to Module 4!

Strategy analysis is an important starting point for the analysis of financial

statements. Strategy analysis allows the business analyst to probe the
economics of a firm at a qualitative level so that the subsequent
accounting and financial analysis is grounded in business reality. Strategy
analysis also allows the identification of the firm’s profit drivers and key
risks. This in turn enables the analyst to assess the sustainability of the
firm’s current performance and make realistic forecasts of future
performance. Strategy analysis, therefore, involves industry analysis,
competitive strategy analysis, and corporate strategy analysis.

Learning Objectives

At the end of this module, you should be able to:

Describe a range of techniques for carrying out strategic

analysis and definition
 STRATEGY ANALYSIS

Strategy analysis is an approach to facilitating, researching, analyzing,

an mapping an organization’s abilities to achieve a future envisioned state
based on present reality and often with consideration of the organization’s
processes, technologies, business development and people capabilities.
Part of the whole process is the ability to bridge
gaps that exist between the enterprise,
organizational, operational and project aspects of
organization. This requires a look at the present
state, the future state, risk and financials and the
creation of change requirements to achieve the
desired outcomes

Given the increasing emphasis on early-engagement business analysis,

and the need for this work to align with the business strategy and
objectives, an understanding of strategic analysis techniques is essential
for all BAs. Let us describes a range of techniques for carrying out
strategic analysis and definition, plus techniques to monitor ongoing
performance.

AllStrategy analysis
organisations – external
have business
to address the environment
changes that have arisen, or can be
predicted to arise, within their operating business environment. Such
changes occur constantly, and any organisation that fails to identify and
respond to them runs the risk of encountering business problems or even
the failure of the entire enterprise. There are two techniques that are
used to examine the business environment within which an organisation is
operating: PESTLE analysis and Porter’s Five Forces analysis.

PESTLE analysis provides a framework for

investigating and analysing the external
Technique 1: PESTLE ANALYSIS environment for an organisation. The framework
identifies six key areas that should be considered
when attempting to identify the sources of change.
These six areas are:
 Political (Examples of political factors
could be a potential change of
government, with the corresponding
changes to policies and priorities, or the
introduction of a new government
initiative)
 Economic (Examples of economic factors
could be the level of growth within an
economy, or market confidence in the
economies within which the organisation
operates)
 Socio-cultural (Examples could be
demographic issues such as an increase in
the number of working mothers, or
consumer behaviour patterns such as the
 Technological (This area covers factors arising
from the development of technology. There are
two types of technological change: there can be
developments in IT, and there can be
developments in technology specific to an
industry or market, for example enhancements
to manufacturing technology).
Legal (Legal compliance has become such an
important issue during this period that many
business analysis assignments have been carried
out for the purpose of ensuring

compliancewith particular lawsor

regulations).
Environmental (Examples of factors arising
from concerns about the natural environment, in
other words the ‘green’ issues, include increasing
concerns about packaging and the increase of
pollution).

Using PESTLE analysis

The PESTLE analysis technique is usually used in a meeting or workshop

where several ideas and opinions can be sought. Representatives from a
range of functions should be present so that they can provide specialist
information.

When using the PESTLE technique it is important to recognise that we are

looking for factors that fit two criteria: they are outside the sphere of
influence (i.e. control) of the organisation, and they will have some level
of impact upon it. Another important aspect to recognise when using
PESTLE is that its objective is to identify factors that could affect the
organisation. It is therefore of little benefit to spend time considering
whether a government initiative should be filed under ‘Political’, or
whether ‘Legal’ would be preferable.
Technique 2: PORTER’S FIVE FORCES Porter’s Five Forces analysis is also used to consider
the external business environment, but it has a
FRAMEWORK different focus from that of the PESTLE analysis. This
technique examines the business domain or
industry within which an organisation operates, and
identifies the business pressures that may be
brought to bear upon that organisation. The
analysis derived from using the five forces
framework is usually applied to a suite of products
or services delivered by an enterprise:
 Industry competitors (What is the level of
competition for the products or services in
this industry? Is the organisation in a good
competitive position or is it a minor player?
Are there several competitors that hold the
power in the industry?)
  New entrants (What is the level of
competition for the products or services in
competitors: this industry? Is the
organisation in a good competitive position
or is it a minor player? Are there several
competitors that hold the power in the
industry?)

 Substitutes (What is the range of

substitutes available? What is the position
of the organisation when compared to the
suppliers of these substitutes?)

 Buyers (How much choice do buyers have?

Can they switch suppliers easily? Do they
have the power in the relationship or are
they locked in to the supplier?)

 Suppliers (How many suppliers are

available? Is this a competitive situation
where the organisation has a choice of
suppliers? Do the suppliers have the power
in the relationship because they operate in
an area of limited supply?)

The answers to these questions help to identify the

factors within the industry or business domain that
have the potential to impact upon the organisation,
either positively or negatively.

Using Porter’s Five Forces analysis

The first step in using this technique is to decide which industry or
business domain the organisation operates within; this decision is
extremely important when using the technique, as the results will vary
considerably depending on the industry at the heart of the analysis. Once
the industry has been decided upon, the five categories are examined to
identify the pressures that exist between the organisation and each of
them. Five forces analysis requires knowledge about the industry and the
different organisations or individuals that participate in its work. Areas
such as substitute products can be difficult to analyse, and possible
substitutes can be missed. At one time some industries had high barriers
to entry because of the financial requirements, so new entrants were
considered unlikely. However, the rise of businesses with access to funds,
such as the major supermarkets, has meant that high financial
requirements may not deter new entrants.
 Strategy analysis – internal capability

It is helpful to use a combination of techniques when analysing an

organisation’s internal capability, since just one technique would provide
only limited information. These three techniques help the analyst to
identify areas that are strengths the organisation can harness, and those
that are weaknesses that could undermine it. These strengths and
weaknesses can later be combined with the opportunities and threats
already described to build a SWOT (see previous module) for the
organisation.

Technique 3: MOST ANALYSIS MOST analysis is used to analyse what an

organisation has set out to achieve (the mission and
objectives) and how it aims to achieve this (the
Using MOST Analysis strategy and tactics). A MOST provides a statement
of intent for the organisation, and is usually created
following some strategic analysis activity. It is also
The use of MOST helps the analyst gainused an during
understanding of two aspects:
the strategic analysis, since it can
what the organisation wishes to achieve (its mission and objectives),
demonstrate strength within the organisation andor
how it is going to do this (its strategy and tactics).
expose inherent weaknesses.

When examining the MOST for an organisation, the technique is used to

MOST stands for:
identify strengths and weaknesses. This is done by considering the
following areas: Mission: the rationale and direction
for the organisation.
 Definition: Is there a defined MOST for the Objectives:
organisation?
the goalsIs that
it the
complete and consistent, or are there elements
organisationmissing or out of
aims to achieve.
alignment with each other? Strategy: the medium- to long-term
plans and actions that will enable the
 Clarity: Does the MOST set out a clear direction
organisationand toplanachieve
that willits
enable the organisation’s development and provide
objectives. a focus for the
work carried out? Tactics: the detailed, short-term plans
and actions that will deliver the strategy.
  Communication: Are the staff of the organisation aware of the
MOST, and is it available as a context for the work they do?
 Organisational commitment: Do the staff work to deliver the
MOST? Do they agree with the content of the MOST and are they
supportive of its intent?

If the answer to any of these question is ‘no’, then there is a potential for
weakness in the organisation. For example, the senior management may
have defined the MOST, but the staff might not agree with the direction
and objectives, and as a result might not be motivated to deliver them.

If the answer to any of these questions is ‘yes’, there are potential

strengths in the organisation. For example, the clear definition and
planning as encapsulated in the MOST can help motivate the staff to work
towards an agreed set of objectives.

MOST analysis can be a tricky technique to use when assessing internal

capability. It is important to remember that merely defining and displaying
a coherent MOST does not necessarily result in buy-in and motivation on
the part of staff. The real strength is gained when the MOST provides a
clear focus and direction for the organisation. Where there is no clarity or
agreement, the MOST may mask some fundamental weaknesses.

The Resource Audit is used to analyse key

Technique 4: RESOURCE AUDIT areas of internal capability in order to
identify the resources that will enable
business change and those that will
undermine or prevent such efforts.
Resources can be tangible resources, intangible
resources, and human resources. The five areas
of resource to examine are:

 Financial (The financial resources available

– which may simply be the organisation’s
financial assets, but could also include the
possibility of loans and credit. We need to
consider whether the organisation is
financially stable, and whether it has access
to funds for investment and development)
 Physical (The land, buildings and
equipment available for use by the
organisation, whether owned or leased)
 Human (The people employed by the
organisation, whether on a permanent or a
temporary basis)
 Reputation (The marketplace perception
of the organisation, and the amount of
goodwill, or alternatively, antipathy,
generated by this reputation)
 Know-how (The information held within
the organisation, and the way it is used to
support the organisation’s work)
Using the Resource Audit
The Resource Audit is used to identify areas of strength and of weakness
within an organisation. For each area listed, we need to determine
whether the organisation has access to resources that will enable it to
develop and grow, asking, for example:

 Does the organisation have access to financial resources that

will enable the development of new products or services or is it
in financial difficulty, lacking the ability to invest in new
products or services?
 Does the organisation have access to land and buildings that
will provide a basis for the development of new products or
services, or is there a poor, underfunded infrastructure?
 Are the people working within the organisation motivated to
deliver excellent products and services, or are they demotivated
or complacent?
 Does the organisation have a reputation that will support the
development of the market for its products and services, or is
the brand devalued in a way that will hinder these efforts?
 Is the information held within the organisation used to inform
decisions and operations? Is this information used to build a
knowledge base that will support the organisation? Or is
information used poorly, and accessed with difficulty?

Figure 4.1 Here is an example of Resource Audit for a small consultancy company:

Physical: land: no land owned; buildings: no buildings owned – offices

leased in Oxford and Bath; equipment: each employee has a
company laptop and a personal mobile; supporting equipment:
two printers and two projectors are available for use when
necessary.

Financial: good financial control and stability. Ratios: profit on sales –

30%; liquidity – P1.5 current assets to P1 current liabilities;
gearing ratio – 90%.

Human: staff of 25, including 18 consultants; two joint managing

directors; all staff very motivated and committed to the company;
all consultants highly qualified and skilled.

Reputation: good reputation in local area, and has won local awards; not
known outside customer base and areas of operation.

Know-how: company makes extensive use of ad hoc information systems,

but these are not well integrated.
Technique 5: BOSTON BOX The Boston Box was developed by the Boston
Consulting Group (hence, BCG matrix) to aid
portfolio management. The box is a 2 × 2 matrix
with four quadrants. The axes represent low to high
market growth and low to high market share. The
quadrants represent the following areas:

 Star (These are high-growth business units

or products with a high percentage of
market share. Over time the market
growth will slow down for these products,
and, if they maintain their relative market
share, they will become ‘cash cows)
 Cash cow (These are low-growth business
units or products that have a relatively high
market share. These are mature, successful
products that can be sustained without
large investment. They generate the
income required to develop the new or
problematic products that will become
‘stars’ in the portfolio)
 Wild card or problem child (These are
businesses or products with low market
share, but operating in high-growth
markets. They have potential but may
require substantial investment in order to
develop their market share, typically at the
expense of more powerful competitors.
Management has to decide which ‘problem
children’ to invest in, and which ones to
allow to fail.
 Dog (These are the business units or
products that have low relative share and
are in unattractive, low-growth markets.
Dogs may generate enough cash to break
even, but they do not have good)

Figure 4.2 Boston Box

High
Wild car or Star
Problem child

Market growth

Dog Cash cow

Low

Low High
Market shares
Using the Boston Box
The Boston Box is used to assess an organisation’s products and services
according to their market shares and their market growth prospects. The
portfolio of products and services is examined, and each of them is placed
within the most appropriate quadrant. This helps identify strengths and
weaknesses within the portfolio.

One of the issues with the Boston Box is the level of granularity of the
product assessment. There may be some products that do not fit neatly
into a particular quadrant, but are on the cusp between two. When using
this technique it is important that a commonsense approach is adopted
and that other factors are taken into account. For example, if a product is
assessed as having medium market share and low growth this might not
be because of an inherent problem with the product. It could instead be a
question of timing and market conditions. The action that would improve
the situation might simply be to manage the product carefully until the
market conditions change.

MIND CHALLENGE #1

Frito Lay, a product of Pepsico has a market share of

58.8% in the US.
Even though Pepsi’s share in the market has been
reduced to 8.4%, it’s still a popular product under
Pepsico because of its brand equity.
Other product such as Aquafinathe (biggest selling
mineral brand in the USA), Tropicana, Gatorade and
Mountain Dew are gaining their place in the market as
well.
It’s a mystery whether the diet food and soda industry
will boom in the future and will Pepsico’s products will
find their place or not, such as Diet Pepsi, Pepsi Max,
Quaker.
As of now, Pepsico have seasonal and experimental
products like Pepsi Real Sugar and Merry Mash-up.

Analyze Pepsico’s portfolio using the Boston Box

Matrix.
 INDUSTRY ANALYSIS

In analyzing a firm’s profit potential, an analyst has to

first assess the profit potential of each of the industries
in which the firm is competing. Industry analysis
therefore consists of identifying the economic factors
which drive industry profitability The intensity of
competition determines the potential for creating
abnormal profits by the firms in an industry. Whether or
not the potential profits are kept by the industry is determined by the
relative bargaining power of the firms in the industry and their
customers and suppliers. At the most basic level, the profits in an industry
are a function of the maximum price that customers are willing to pay for
the industry’s product or service. One of the key determinants of the price
is the degree to which there is competition among suppliers of the same
or similar products.

Figure 4.3. Industry Structure and Profitability (Adopting Porter’s Five Forces Analysis)

Rivalry among Existing Threat of New Entrants Threat of Substitute

Firms Products
Scale economies
Industry growth First mover advantage Relative price and
Concentration Distribution access performance
Differentiation Relationships Buyers’ willingness to
Switching costs Scale / Legal barriers switch
Learning economies
Excess capacity Exit
barriers

INDUSTRY PROFITABILITY

Bargaining Power of Bargaining Power of

Buyers Suppliers

Switching costs Switching costs

Differentiation Differentiation
Importance of product for Importance of product
costs and quality Number for costs and quality
of buyers Volume per Number of suppliers
buyer Volume per supplier
 COMPETITIVE STRATEGY
ANALYSIS

The profitability of a firm is influenced not only by its

industry structure but also by the strategic choices it
makes in positioning itself in the industry. While there are
many ways to characterize a firm’s business strategy,
research has traditionally identified two generic
competitive strategies, (1) cost leadership and (2)
differentiation that can potentially allow a firm to build
a
sustainable competitive advantage.

Figure 4.4 Strategies for Creating Competitive Advantage

Cost Leadership Differentiation

Supply same product or service at a lower Supply a unique product or service at a
cost. cost lower than the price premium
customers will pay.
Economies of scale and scope Efficient
production Superior product quality Superior product
Simpler product designs Lower input costs variety Superior customer service More
Low-cost distribution flexible delivery Investment in brand image
Little research and development or brand Investment in research and development
advertising Control system focus on creativity
Tight cost control system and innovation

Competitive Advantage
Match between firm’s core competencies and key success factors to
execute strategy
Match between firm’s value chain and activities required to execute
strategy
Sustainability of competitive advantage
Competitive Strategy 1 : Cost Leadership

Cost leadership is often the clearest way to achieve

competitive advantage. In industries where the basic product
or service is a commodity, cost leadership might be the only
way to achieve superior performance. If a firm can achieve
cost leadership, then it will be able to earn above-average
profitability by merely charging the same price as its rivals.
Conversely, a cost leader can force its competitors to cut
prices and accept lower returns or to exit the industry.

Competitive Strategy 2 : Differentiation

For differentiation to be successful, the firm has to accomplish

three things. First, it needs to identify one or more attributes
of a product or service that customers value. Second, it has to
position itself to meet the chosen customer need in a unique
manner. Finally, the firm has to achieve differentiation at a
cost that is lower than the price the customer is willing to pay
for the differentiated product or service.
 CORPORATE STRATEGY
ANALYSIS

While some companies focus on only one business,

many companies operate in multiple businesses.
When analyzing a multi-business organization, an
analyst has to evaluate not only the industries and
strategies of the individual business units but also
the economic consequences— either positive or
negative—of managing all the different businesses
under one corporate umbrella. Some companies
have viewed this
multi-business structure as a source of strength and have embraced it,
while others have seen it as distracting and value dilutive and have
moved to narrow their business focus.

Corporate Strategy Analysis involves examining whether a company is able

to create value by being in multiple businesses at the same time. A well-
crafted corporate strategy reduces costs or increases revenues from
running several businesses in one firm relative to the same businesses
operating independently and transacting with each other in the
marketplace.

Sources of Value Creation at Corporate level

Economists and strategy researchers have identified several factors that

influence an organization’s ability to create value through a broad
corporate scope. Economic theory suggests that the optimal scope of
activity of a firm depends on the relative transaction cost of performing a
set of activities inside the firm versus using the market mechanism

Transaction costs can arise out of several sources. They may arise if the
production process involves specialized assets such as human capital skills,
proprietary technology, or other organizational know-how that is not easily
available in the marketplace. Transaction costs also may arise from market
imperfections such as information and incentive problems. If buyers and
sellers cannot solve these problems through standard mechanisms such
as enforceable contracts, it will be costly to conduct transactions through
market mechanisms.

Transactions inside an organization may be less costly than market-based

transactions for several reasons.

 First, communication costs inside an organization are reduced

because confidentiality can be protected and credibility can be
assured through internal mechanisms.
 Second, the head office can play a critical role in reducing costs of
enforcing agreements between organizational subunits.
 Third, organizational subunits can share valuable non-tradable
assets (such as organizational skills, systems, and processes) or
non-divisible assets (such as brand names, distribution channels,
and reputation).
Empirical evidence suggests that creating value through a multi-business
corporate strategy is difficult in practice. Studies also show that
acquisitions of one company by another, especially when the two are in
unrelated businesses, often fail to create value for the acquiring
companies. Finally, there is considerable evidence that value is created
when multi-business companies increase corporate focus through
divisional spin-offs and asset sales.

In summary, while companies can theoretically create value through

innovative corporate strategies, there are many ways in which this
potential fails to get realized in practice. Therefore, it pays to be skeptical
when evaluating companies’ corporate strategies.

MIND CHALLENGE
#2
We are now done with Module 4.
ExplainCongratulations!
why you agreeKeepor disagree
that stockwith
of each of the
following statements:
knowledge, you will need it on the
succeeding modules. You may still go back
a. It is better to be
and re-read thisapart
differentiator than athat
if there are lessons cost
leader, are
since
not you can to
yet clear then
you.charge premium prices.

b. It is more profitable to be in a high technology

industry than a low technology one.

c. The reason industries with large investments

have high barriers to entry is that it is costly to raise
capital.
Strategy analysis is an important starting point for the analysis of
financial statements because it allows the analyst to probe the economics
of the firm at a qualitative level. Strategy analysis also allows the
identification of the firm’s profit drivers and key risks, enabling the analyst
to assess the sustainability of the firm’s performance and make realistic
forecasts of future performance. Whether a firm is able to earn a return on
its capital in excess of its cost of capital is determined by its own strategic
choices: (1) the choice of an industry or a set of industries in which the
firm operates (industry choice), (2) the manner in which the firm intends
to compete with other firms in its chosen industry or industries
(competitive positioning), and (3) the way in which the firm expects to
create and exploit synergies across the range of businesses in which it
operates (corporate strategy). Strategy analysis involves analyzing all
three choices.

Industry analysis consists of identifying the economic factors which drive

industry profitability. In general, an industry’s average profit potential is
influenced by the degree of rivalry among existing competitors, the ease
with which new firms can enter the industry, the availability of substitute
products, the power of buyers, and the power of suppliers. To perform
industry analysis, the analyst has to assess the current strength of each of
these forces in an industry and make forecasts of any likely future
changes.

Competitive strategy analysis involves identifying the basis on which the

firm intends to compete in its industry. In general, there are two potential
strategies that could provide a firm with a competitive advantage: cost
leadership and differentiation.

Corporate strategy analysis involves examining whether a company is able to

create value by being in multiple businesses at the same time. A well-
crafted corporate strategy reduces costs or increases revenues from
running several businesses in one firm relative to the same businesses
operating independently and transacting with each other in the
marketplace.
Cadle, J., Debra, P., Turner, P., BUSINESS ANALSYIS TECHNIQUES, 2nd Edition.

Palepu, K., Healy, P., BUSINESS ANALYSIS & VALUATION. South-

Western CENGAGE Learning

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