Strategy analysis

Class 2: Chapter 2

Krishna G. Palepu, Paul M. Healy and Erik Peek, Business Analysis and Valuation: 4th IFRS Edition
© Copyright Cengage Learning EMEA 2016
 LAST WEEK CLASS: A REVIEW

• All tools (industry analysis, corporate strategy analysis, accounting

analysis, financial analysis, and valuation) are equally important to
forecasting and valuing a company.
• Who prepares the Financial Statements? Management/ Auditor? Auditor's
role is to provide assurance whether there is a material misstatements or
not in the financial statements.
• For the financial analysts, they have to be aware of the differences of the
Accounting principles of companies to be compared or analysed. The
differences should be adjusted to make it an apple to aple comparison.
• Also, they must be aware of the possibilities of fraud/mistatements of
financial statements. See China Husle at Netflix.

Krishna G. Palepu, Paul M. Healy and Erik Peek, Business Analysis and Valuation: 4th IFRS Edition
© Copyright Cengage Learning EMEA 2016
 BASIC IDEAS OF TODAY'S CLASS: FROM STORY TO NUMBERS
SHOULD BE INLINE OR CONSISTENT

• Industry Analysis (from your Strategy class) is the qualitative factor that is SO
important that we can understand the historical and future performance.
• The Strategy Analysis is the key to say that your numbers in forecasted
financial numbers can be achieved or NOT. CASE: Growth of Gojek Revenue
in 2019 was 10%. Is it still possible if the growth for 2020/21 stays the same?
– Industry Analysis: What are happening in the industry in 2020/21? what are
the effect of the events on the competition and profitability of the industry?
Remember SMKO: when competition is tight, profitability is low (this is bad
for business).
– Competitive Strategy of Gojek vs Grab: play cheap (cost leadership) or
dare to be different? Please consider Go Life, Go Play, etc.
– Corporate Strategy: What are the most important key value drivers of
Revenues? See Porter Value Chain Analysis. For the Revenue, is the Price
(P) or the Quantity (Q) that is increasing in the upcoming years?
• So, the idea is to be sustainable, the company's works should be in line from
industry analysis, corporate strategy analysis and financial numbers.

Krishna G. Palepu, Paul M. Healy and Erik Peek, Business Analysis and Valuation: 4th IFRS Edition
© Copyright Cengage Learning EMEA 2016
INDUSTRY STRUCTURE AND PROFITABILITY

In Class Discussion:

Krishna G. Palepu, Paul M. Healy and Erik Peek, Business Analysis and Valuation: 4th IFRS Edition
© Copyright Cengage Learning EMEA 2016
COMPETITIVE FORCE 1: RIVALRY AMONG EXISTING FIRMS

• Higher degrees of competition among firms:

– Push prices towards the marginal cost of production.

– Make non-price dimensions of products or services more important.

• Determinants of the intensity of competition among firms:

– Industry growth rate.

– Concentration and balance of competitors.

Krishna G. Palepu, Paul M. Healy and Erik Peek, Business Analysis and Valuation: 4th IFRS Edition
© Copyright Cengage Learning EMEA 2016
RIVALRY AMONG EXISTING FIRMS, CONTINUED

• Determinants of the intensity of competition among firms:

– Degree of differentiation in products and services and switching

costs.

– Scale/Learning economies and ratio of fixed to variable costs.

– Excess capacity and exit barriers.

Krishna G. Palepu, Paul M. Healy and Erik Peek, Business Analysis and Valuation: 4th IFRS Edition
© Copyright Cengage Learning EMEA 2016
COMPETITIVE FORCE 2: THREAT OF NEW ENTRANTS

• The ease with which a new firm can enter an industry will affect the
profitability of other firms within the industry.

• Factors affecting the barriers to entry are:

– Economies of scale
– First mover advantage
– Relationships with suppliers and customers
– Legal barriers

Krishna G. Palepu, Paul M. Healy and Erik Peek, Business Analysis and Valuation: 4th IFRS Edition
© Copyright Cengage Learning EMEA 2016
COMPETITIVE FORCE 3: THREAT OF SUBSTITUTE PRODUCTS

• The degree to which substitute products or services exist affects the

industry’s bargaining power with suppliers and customers, and
ultimately profitability.

• The degree to which substitutes exist depends upon the relative price
and performance of competing products or services, and the
willingness of customers to accept substitutes.

Krishna G. Palepu, Paul M. Healy and Erik Peek, Business Analysis and Valuation: 4th IFRS Edition
© Copyright Cengage Learning EMEA 2016
COMPETITIVE FORCE 4: BARGAINING POWER OF BUYERS

• Buyer bargaining power can exert downward pressure on prices.

• Factors that can affect this bargaining power are:

– Buyer price sensitivity to product or service
– Relative bargaining power of buyers

Krishna G. Palepu, Paul M. Healy and Erik Peek, Business Analysis and Valuation: 4th IFRS Edition
© Copyright Cengage Learning EMEA 2016
COMPETITIVE FORCE 5: BARGAINING POWER OF SUPPLIERS

• A mirror image of the bargaining power of buyers.

– Suppliers have bargaining power when there are few substitutes

and/or few suppliers relative to the number of customers
demanding a product or service.

Krishna G. Palepu, Paul M. Healy and Erik Peek, Business Analysis and Valuation: 4th IFRS Edition
© Copyright Cengage Learning EMEA 2016
APPLYING INDUSTRY ANALYSIS TO THE EUROPEAN AIRLINE
INDUSTRY

• During the early 2000s, profitability in the industry was low.

– Competitive forces:
• Moderate industry growth
• Fragmented industry
• Few opportunities to differentiate; low switching costs
• High excess capacity

– Threat of new entrants: Budget airlines

– Bargaining power of suppliers and buyers

• Suppliers: aircraft, oil, ground handling
• Buyers: high price transparency

Krishna G. Palepu, Paul M. Healy and Erik Peek, Business Analysis and Valuation: 4th IFRS Edition
© Copyright Cengage Learning EMEA 2016
COMPETITIVE STRATEGY ANALYSIS

• Individual firms must choose appropriate strategies to succeed within

their industry segment.

• Two basic competitive strategies are:

– Cost leadership
– Product / service differentiation

• Figure 2.3 conveniently summarizes aspects of cost leadership and

differentiation.

Krishna G. Palepu, Paul M. Healy and Erik Peek, Business Analysis and Valuation: 4th IFRS Edition
© Copyright Cengage Learning EMEA 2016
STRATEGIES FOR CREATING COMPETITIVE ADVANTAGE

Krishna G. Palepu, Paul M. Healy and Erik Peek, Business Analysis and Valuation: 4th IFRS Edition
© Copyright Cengage Learning EMEA 2016
ACHIEVING AND SUSTAINING COMPETITIVE ADVANTAGE

• Choice of strategy is an important first step for a firm. The likelihood of

achieving and sustaining competitive advantage must be evaluated.

• Factors to evaluate include:

– Unique core competencies

– A system of activities that fits with the strategy and potentially

reinforce each other

– Strategic positioning

Krishna G. Palepu, Paul M. Healy and Erik Peek, Business Analysis and Valuation: 4th IFRS Edition
© Copyright Cengage Learning EMEA 2016
APPLYING COMPETITIVE STRATEGY ANALYSIS TO THE IKEA
GROUP

• What was IKEA’s superior performance based on?

– Low-cost competitive strategy

– Global strategy
– Sourcing of production
– Economic designs
– Logistics
– Sales

Krishna G. Palepu, Paul M. Healy and Erik Peek, Business Analysis and Valuation: 4th IFRS Edition
© Copyright Cengage Learning EMEA 2016
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.

Krishna G. Palepu, Paul M. Healy and Erik Peek, Business Analysis and Valuation: 4th IFRS Edition
© Copyright Cengage Learning EMEA 2016