Chapter 2:

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Rate of 5% 10%
Return

Simple rule of thumb valuation

Net cash flow

Buying a house for investment

Option 1 Option 2
Yearly net cash flow $10000 Yearly net cash flow $15000

At 5% return value of house is At 5% return value of house is

$10000/.05 = $200000 $15000/.05 = $300000

At 10% return value of house is At 10% return value of house is

$10000/0.1 = $100000 $15000/0.1 = $150000
Recap on Session 1

4 Steps in Financial Analysis

• Analyse Business Strategies
1

• Analyse Accounting Policies and Choices

2

• Analyse Financial Statements

3

• Forecast Future Financial Statements

4
 Discussion

Think of a BBQ road side business you want to start

near DC. List the factors you need to consider.
text
 Overview of Session 2
Strategy drives organizational actions

Studying a firm’s strategy provides:

1. An understanding of what drives risks,
profitability and competitive advantages.
2. An idea of how to measure the success of a
firm’s actions.
3. A basis on which to forecast future performance.

5
 Learning Outcomes
On successful completion of this session/topic, you
should be able to:

1. Discuss and apply the 5 competitive forces, based on

Porter’s Model.
2. Discuss and apply 2 major competitive strategies.
3. Evaluate the likelihood of achieving and sustaining
competitive advantage [i.e. in the long-run].
LO 1

Industry Analysis
LO 1
Profit Potential
Assess profit potential of industry (or industries) in
which the firm competes
 Systematic differences in profitability across
industries e.g. supermarkets vs automotive
 Profitability can change over time as industries
evolve (from start-up to mature) e.g.
telecommunications
 Average profitability is influenced by the 5 forces in
Porter’s Model
 Industry
Structure and
Profitability

9
LO 1
Competition
Profits depend on the maximum price customers are
willing to pay for products/services
 Depends on the level of competition in the industry
 monopolies can usually set prices
 differs from “perfect” competition (many suppliers
of the same product)
 Compete on non-price dimensions i.e. customer
service, loyalty programmes e.g. airlines
LO 1
CF1 Rivalry among existing firms
Determinants Details and e.g.
Concentration Price competition is more intense in
& Balance of fragmented industries (a lot of players)
Competitors e.g. supermarkets
Industry In low growth industries, firms may
growth rate reduce prices to capture market share
Economies of Firms may reduce price to achieve
Scale & Excess economies of scale and utilize capacity
Capacity e.g. airlines, phone companies
Differentiation Switching fees and product
& Switching differentiation reduce price competition
Costs i.e. compete on other dimensions
LO 1
CF2 Threat of new entrants
Determinants Details and e.g.
Legal Barriers e.g. limited availability of licenses,
other restrictions due to patents etc.
Economies of New entrants may need to invest in
Scale R&D, PP&E and/or advertising
Channels of New entrants may face difficulty in
Distribution & securing contracts with distributors due
Relationships to existing alliances etc.
First Mover First movers may have the opportunity
advantage to set industry standards, secure
limited licenses etc.
LO 1
CF3 Threat of substitute products
Relevant substitutes
 May not have the same form as the existing
product but perform the same function
 e.g. travelling between Suva and Nadi
The degree to which substitutes exist depends on
1. Relative price and performance of competing
products and services; and
2. the willingness of customers to accept the
substitutes
LO 1
CF4 Bargaining Power of Buyers
Price Sensitivity
Determines the extent to which customers care to bargain
on price
 How important is the product to the customer’s
 cost structure (pay less e.g. fuel for airlines)
 product quality (pay more e.g. professional sport)
Relative Bargaining Power
Determines the extent to which customers will succeed in
forcing the price down
 Consider number of buyers in the market, volume of
purchases, threat of backward integration etc.
LO 1
CF5 Bargaining Power of Suppliers
Same factors as CF4 (seller’s perspective)
Suppliers have greater bargaining power when
 They are fewer in number (compared to buyers) e.g.
soft drinks, banks
 Their product or service is critical to buyers
 Threat of forward integration e.g. online sales cut out
the retailer
LO 2

Competitive Positioning
 Strategies
for Creating
Competitive
Advantage

17
LO 2
CS1 Cost Leadership
Goal: To become the lowest-cost provider
 Result: Charge the same price as competitors but
make higher profits
1. Use economies of scale
2. Lower input costs (bargain power)
3. Simpler product design (reduce parts and labour)
4. More efficient organisation processes (lower
overheads)
5. More efficient production e.g. less wastage
LO2
CS1 Cost Leadership
These firms focus on tight cost controls

1. Invest in efficient scale plants

2. Avoid investment in risky R&D
3. Avoid serving marginal customers e.g. rural or
distant communities
LO 2
CS2 Differentiation
Goal: To lead the industry in some dimension of quality
that is highly valued by customers

Need to accomplish 3 things

1. Identify attribute(s) that customers value
2. Position itself to meet the need in a unique manner
3. Achieve differentiation at a cost < price customer is
willing to pay
LO 2
CS2 Differentiation
These firms focus on creativity and innovation
 Requires investment in R&D
 Also requires marketing capabilities, including brand
image (to signal value)

e.g. product quality, bundling of services, delivery

timing etc.
 Discussion Question 1
Explain whether you agree or disagree with each of the
following statements:
1. It is better to be a differentiator than a cost leader,
since you can then charge premium prices.
2. It is more profitable to be in a high technology than
a low technology industry.
3. Industries with large investments have high barriers
to industry because it is costly to raise capital
Acknowledgement
This question is taken from Page 49 of the course text
 Discussion Question 2

There are very few companies that are able to be both

cost leaders and differentiators.
1. Why?
2. Can you think of a company that has been
successful at both?

Acknowledgement
This question is taken from Page 49 of the course text
Corporate Strategy
LO 3
Achieving Competitive Advantage
Choosing a strategy is important

To assess likely achievement of the strategy, consider:

1. What is the customer need that the firm is focusing
on?
2. How does the firm distinguish its customer value
proposition form alternatives available from its
competitors?
3. Does the firm currently have the key capabilities and
processes to deliver its value proposition?
LO 3
Sustaining Competitive Advantage
May be difficult to sustain competitive advantage over
time, because:
1. Successful strategies are copied
2. Change is constant e.g. technology
To assess likely sustainability of the strategy, consider
3. Barriers to imitation in the firm’s strategy
4. Changes that potentially affect the industry and the
firm’s strategic position
5. Actions the firm can take to address (2) and renew
its competitive advantage
 Corporate Strategy Analysis
• Companies with multiple business segments
require an analysis how the separate
segments are managed within the corporate
governance structure.
• Factors to analyse include:
– Transaction costs
– Specific benefits to operating under one corporate
umbrella.
• The case of General Electric.
 Concluding Comments
• The industry analysis approach has notable
strengths and some limitations.
• Porter’s ‘five forces’ framework is valuable in
evaluating the strategy and actions of firms
within an industry.