Business Analysis & Valuation

Module-2
Industry - Strategy and
Competitive Analysis 1
 Industry Strategy Analysis

Organization’s profit potential is determined by its own

strategic choices such as:

1. choice of an industry or a set of industries in which

the organization operates (industry choice).
2. manner in which it intends to compete with other
organizations of its chosen industry or industries
(competitive positioning) and
3. way in which it expects to create and exploit
synergies across the range of businesses in which it
operates’(corporate strategy).
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 Strategy Industry Analysis: Cont…

Strategy analysis, therefore, involves

industry analysis [Five forces that determine

the intensity of competition determines] ,

competitive strategy analysis [cost

leadership and differentiation], and

corporate strategy analysis

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INDUSTRY ANALYSIS

Analyzing organization’s profit potential, an

analyst has to first assess the profit
(Revenue & Cost) potential of each of
the organization / industry in which the
organization is competing.

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Strategy literature suggests that the average
profitability of an industry is influenced by the
“five forces”.
According to this framework, the intensity
of competition determines the
potential for creating abnormal profits
by the firms in an industry.

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 Industry competitiveness:
Sources of Competition

There are five potential sources of competition

in an industry:
(1) rivalry between existing firms,
(2) threat of entry of new firms, and
(3) threat of substitute product or services
(4) Bargaining Power of Buyers
(5) Bargaining Power of Suppliers
These five forces determines industry profitability
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 Competitive Force 1:
Rivalry Among Existing Firms

Pushing prices close to (and sometimes

below) the marginal cost / compete on
non-price dimensions such as innovation
or brand image

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Rivalry Among Existing Firms -
Intensity of Competition

Factors determine Rivalry Among Existing Firms - intensity of

competition:

Industry Growth Rate

Concentration and Balance of Competitors – Number

and relative size.
(When companies are relatively balanced in strength, they are more likely to engage
in competitive battles and attack and retaliate as they strive for market leadership.

If a particular industry has a very high number of firms offering identical goods or
services, this will lead to more competitive intensity. However, in a monopoly or
oligopoly market structure that is dominated by just one or a few firms, there will be
less rivalry.)
Rivalry Among Existing Firms -
Intensity of Competition

Low Differentiation and Switching Costs will have

high intensity of competition

High Economies of scale and the Ratio of Fixed to

Variable Costs will have high intensity of competition

Excess Capacity and High Exit Barriers

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 Competitive Force 2:
Threat of New Entrants - barriers to entry

The potential for earning abnormal

profits will attract new entrants to an
industry and threat of new firms
entering an industry potentially
constrains the pricing of existing firms
within it.

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 Threat of New Entrants – (barriers to entry)

Factors determine the Threat of New Entrants –

(barriers to entry): A: Economies of Scale

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.

Either way, new entrants will at least initially suffer

from a cost disadvantage in competing with existing
firms.
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 Threat of New Entrants – (barriers to entry)

Factors determine the height of barriers to entry in

an industry:

Sources of Economies of scale: large

investments in research and development (the
pharmaceutical or jet engine industries), in
brand advertising (soft-drink industry), or in
physical plant and equipment
(telecommunications industry).
Threat of New Entrants – (barriers to entry)

Factors determine the height of barriers to entry in

an industry: B: First Mover Advantage:

able to set industry standards, or enter into

exclusive arrangements with suppliers of cheap
raw materials.

acquire scarce government licenses to

operate in regulated industries.

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 learning economies i.e. early firms will have
an absolute Cost advantage over new
entrants.
 First mover advantages are also likely to be
large when there are significant switching
costs for customers once they start using
existing products.

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Threat of New Entrants – (barriers to entry)

Factors determine the height of barriers to entry in

an industry:

For example, switching costs faced by the users

of Microsoft’s DOS operating system make it
difficult for software companies to market a
new operating system.
Threat of New Entrants – (barriers to entry)
Factors determine the height of barriers to entry in
an industry: C: Access to Channels of Distribution
and Relationships

 Limited capacity in the existing distribution channels

and high costs of developing new channels can, act as
powerful barriers to entry.

For example, a new entrant into the domestic auto

industry in the U.S. is likely to face formidable barriers
because of the difficulty of developing a dealer network.

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Threat of New Entrants – (barriers to entry)

Factors determine the height of barriers to entry in

an industry:

 Similarly, new consumer goods manufacturers find it

difficult to obtain supermarket shelf space for their
products.

 Existing relationships between firms and customers in

an industry also make it difficult for new firms to
enter an industry. Industry examples of this include
auditing, investment banking, and advertising.

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 Threat of New Entrants – (barriers to entry)

Factors determine the height of barriers to entry in

an industry: D: Legal Barriers

 There are many industries in which legal

barriers such as patents and copyrights in
research-intensive industries limit entry.

Similarly, licensing regulation limit entry into taxi

services, medical services, broadcasting, and
telecommunications industries.

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 Competitive Force 3:
Threat of Substitute Products
Relevant substitutes are not necessarily those
that have the same form as the existing products
but those that perform the same function.
For example, airlines and car rental services
might be substitutes for each other when it
comes to travel over short distances.

Similarly, plastic bottles and metal cans

substitute for each other as packaging in the
beverage industry.
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Threat of Substitute Products – Conti…

The threat of substitutes depends on the

relative price and performance of the
competing products or services and on
customers’ willingness to substitute.
Example ….next

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Threat of Substitute Products – Conti…

For example, even when tap water and bottled

water serve the same function, many customers
may be unwilling to substitute the former for the
latter, enabling bottlers to charge a price
premium.
Similarly, designer label clothing commands price
premium even if it is not superior in terms of
basic functionality because customers place a
value on the image offered by designer labels.

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 Competitive Force 4:
Bargaining Power of Buyers

Two factors determine the power of buyers:

price sensitivity and relative bargaining power.

Price sensitivity determines the extent to

which buyers care to bargain on price and
relative bargaining power determines the
extent to which they will succeed in forcing the
price down.

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Bargaining Power of Buyers – Conti…

A: Price Sensitivity: When buyer can be more

price sensitive?

Buyers are more price sensitive when the

product is undifferentiated and there are few
switching costs.
Bargaining Power of Buyers – Conti…

Attribute to Price Sensitivity

The sensitivity of buyers to price also depends

on the importance of the product to their own
cost structure.

When the product represents a large fraction of

the buyers’ cost (for example, the packaging
material for soft-drink producers), the buyer is
likely to spend the resources necessary to shop
for a lower cost alternative
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Industry Analysis: Cont…

Competitive Force 4: Bargaining Power of Buyers – Conti…

B: Relative Bargaining Power

Even if buyers are price sensitive, they may not
be able to achieve low prices unless they have a
strong bargaining position.

Relative bargaining power in a transaction

depends, ultimately, on the cost to each party of
not doing business with the other party.
Industry Analysis: Cont…

The buyers’ bargaining power is determined by the

number of buyers relative to the number of
suppliers,
volume of purchases by a single buyer,

number of alternative products available to the

buyer,

 buyers’ costs of switching from one product to

another, and
the threat of backward integration by the buyers.
Industry Analysis: Cont…

Competitive Force 4: Bargaining Power of Buyers – Conti…

For example, in the automobile industry, car

manufacturers have considerable power over
component manufacturers because auto
companies are large buyers with several
alternative suppliers to choose from, and
switching costs are relatively low.

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In contrast, in the personal computer industry,
computer makers have low bargaining power
relative to the operating system software
producers because of high switching costs.

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Industry Analysis: Cont…

Competitive Force 5:
Bargaining Power of Suppliers

In an industry, suppliers are powerful when

there are only a few companies and few
substitutes available to their customers.

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Industry Analysis: Cont…

Competitive Force 5: Bargaining Power of Suppliers – Conti…

For example, in the soft-drink industry, Coke

and Pepsi are very powerful relative to the
bottlers.
In contrast, metal cane suppliers to the soft
drink industry are not very powerful because of
intense competition among cane producers and
the threat of substitution of cans by plastic
bottles.
Industry Analysis: Cont…

Competitive Force 5: Bargaining Power of Suppliers – Conti…

Suppliers also have a lot of power over

buyers when the suppliers’ product or
service is critical to buyers’ business.

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Industry Analysis: Cont…

Competitive Force 5: Bargaining Power of Suppliers – Conti…

For example, airline pilots have a strong bargaining

power in the airline industry.

Suppliers also tend to be powerful when they pose a

credible threat of forward integration.
For example, IBM is powerful relative to mainframe
computer leasing companies because of its unique
position as a mainframe supplier and its own presence
in the computer leasing business.

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 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. There are two
generic competitive (1)
strategies: cost
leadership and (2) differentiation.

Both these strategies can potentially allow a firm to

build a sustainable competitive advantage

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 Competitive Strategy Analysis: Conti…

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.

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How can we achieve Cost Leadership?

Ways to achieve cost leadership-

economies of scale and scope,
economies of learning, efficient
production, simpler product design,
lower input costs, and efficient
organizational processes.

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Competitive Strategy Analysis: Conti…

Benefits of being cost leader

earn above-average profitability by merely

charging the same price as its rivals.

Force competitors to cut prices and accept

lower returns, or to exit the industry.

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Competitive Strategy Analysis: Conti…

Competitive-Strategy 1: Cost Leadership – Conti…

Firms that achieve cost leadership focus on tight cost
reductions. How do they achieve it?
investments in efficient scale plants (aligned supply with
demand),
focus on product designs that reduce mfg costs,
minimize overhead costs (explore outsourcing secondary
activities),
make little investment in risky research and development (star
and questionable product or services), and
avoid serving marginal customers except for star and
questionable product.
They have organizational structures and control systems that
focus on cost reduction.
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Competitive Strategy Analysis: Conti…

Competitive Strategy 2: Differentiation

A firm following the differentiation strategy seeks to

be unique in its industry along some dimension that is

highly valued by customers.

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Feature of 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.

Example: KBL considered Handle of Mini-Monoblock Pump as unique

but customer did not attach much value

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Second, it has to position itself (effective communication) 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.

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Competitive Strategy Analysis: Conti…

Competitive Strategy 2: Differentiation –Conti….

How Differentiation can be achieved ?

providing superior intrinsic value via. product quality, product

variety, bundled services, or delivery timing.

investing in signals of value such as brand image, product

appearance, or reputation.

investments in research and development, engineering skills,

and marketing capabilities.

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Competitive Strategy Analysis: Conti…

Competitive Strategy 2: Differentiation –Conti….

While successful firms choose between cost leadership and

differentiation, they cannot completely ignore the dimension on
which they are not primarily competing.

Firms that target differentiation still need to focus on costs so

that the differentiation can be achieved at an acceptable cost.

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Similarly, cost leaders cannot compete unless they

achieve at least a minimum level on key dimensions

on which competitors might differentiate, such as

quality and service.

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Competitive Strategy Analysis: Conti…

Competitive Strategy 2: Differentiation –Conti….

How to Achieve and Sustain Competitive Advantage ?

Firm has to have the capabilities needed (make the necessary

commitments to acquire the core competencies needed and
structure its value chain in an appropriate way) to implement and
sustain the chosen strategy (Cost leadership / Differentiation).
Strategy – a plan of action to gain and sustain competitive
advantage

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Competitive Strategy Analysis: Conti…

Competitive Strategy 2: Differentiation –Conti….

What is Core competency and Value Chain ?

Core competencies are the economic assets that the firm

possesses, whereas the value chain is the set of activities that
the firm performs to convert inputs into outputs.

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The uniqueness of a firm i.e. core competency and its value

chain and the extent to which it is difficult for competitors to

imitate them determines the sustainability of a firm’s

competitive advantage.

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Competitive Strategy Analysis: Conti…

Competitive Strategy 2: Differentiation –Conti….

To evaluate whether a firm is likely to achieve its intended

competitive advantage, the analyst should ask the following
questions:

What are the key success factors and risks associated with the
firm’s chosen competitive strategy?

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Does the firm currently have the resources and capabilities to
deal with the key success factors and risks?

Has the firm made irreversible commitments to bridge the gap

between its current capabilities and the requirements to achieve
its competitive advantage?

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Competitive Strategy Analysis: Conti…

Competitive Strategy 2: Differentiation –Conti….

Has the firm structured its activities (such as research and

development, design. manufacturing. marketing and
distribution, and support activities) in a way that is consistent
with its competitive strategy?

Is the company’s competitive advantage sustainable? Are there

any barriers that make imitation of the firm’s strategy difficult?

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Competitive Strategy Analysis: Conti…

Competitive Strategy 2: Differentiation –Conti….

Are there any potential changes in the firm’s industry structure

(such as new technologies, foreign competition, changes in

regulation, changes in customer requirements) that might

dissipate the firm’s competitive advantage? Is the company

flexible enough to address these changes?

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Elements That Should be Covered in a
Company Analysis.

A thorough company analysis, particularly as presented in a

research report, should
 provide an overview of the company (corporate profile),
including a basic understanding of its businesses, investment
activities, corporate governance, and perceived strengths and
weaknesses;
 explain relevant industry characteristics;
 analyze the demand for the company’s products and services;
 analyze the supply of products and services, which includes an
analysis of costs;
 explain the company’s pricing environment; and
 present and interpret relevant financial ratios, including
comparisons over time and comparisons with competitors.
A Checklist for Company Analysis:
Corporate Profile
Identity of company’s major products and services, current
position in industry, and history
 Composition of sales
 Product life-cycle stages/experience curve effects
 Research & development activities
 Past and planned capital expenditures
 Board structure, composition, electoral system, anti-takeover
provisions, and other corporate governance issues
 Management strengths, weaknesses, compensation, turnover,
and corporate culture
 Benefits, retirement plans, and their influence on shareholder
value.
 Labor relations
 Insider ownership levels and changes
 Legal actions and the company’s state of preparedness
 Other special strengths or weaknesses
A Checklist for Company Analysis:
Industry Characteristics
 Stage in its life cycle
 Business-cycle sensitivity or economic characteristics
 Typical product life cycles in the industry (short and marked by
technological obsolescence or long, such as pharmaceuticals protected by
patents)
 Brand loyalty, customer switching costs, and intensity of competition
 Entry and exit barriers
 Industry supplier considerations (concentration of sources, ability to
switch suppliers or enter suppliers’ business)
 Number of companies in the industry and whether it is, as determined by
market shares, fragmented or concentrated
 Opportunity to differentiate product/service and relative product/service
price, cost, and quality advantages/disadvantages
 Technologies used
 Government regulation
 State and history of labor relations
 Other industry problems/opportunities
A Checklist for Company Analysis:
Analysis of Demand for Products/Services

 Sources of demand
 Product differentiation
 Past record, sensitivities, and correlations with social, demographic,
economic, and other variables
 Outlook—short, medium, and long term, including new product and
business opportunities Analysis of Supply of Products/Services
 Sources (concentration, competition, and substitutes)
 Industry capacity outlook—short, medium, and long term
 Company’s capacity and cost structure
 Import/export considerations
 Proprietary products or trademarks Analysis of Pricing
 Past relationships among demand, supply, and prices
 Significance of raw material and labor costs and the outlook for their cost
and availability
 Outlook for selling prices, demand, and profitability based on current and
anticipated future trends.
A Checklist for Company Analysis:
Financial Ratios and Measures (in multi-year
spreadsheets with historical and forecast data)

I. Activity ratios, measuring how efficiently a company performs

such functions as the collection of receivables and inventory
management:
• Days of sales outstanding (DSO)
• Days of inventory on hand (DOH)
• Days of payables outstanding (DPO)

II. Liquidity ratios, measuring a company’s ability to meet its

short-term obligations:
• Current ratio
• Quick ratio
• Cash ratio
• Cash conversion cycle (DOH + DSO – DPO)
A Checklist for Company Analysis:
Financial Ratios and Measures (in multi-year
spreadsheets with historical and forecast data)

III. Solvency ratios, measuring a company’s ability to meet its

debt obligations. (In the following, “net debt” is the amount of
interest-bearing liabilities after subtracting cash and cash
equivalents.)
 Net debt to EBITDA (earnings before interest, taxes,
depreciation, and amortization)
 Net debt to capital
 Debt to assets
 Debt to capital (at book and market values)
 Financial leverage ratio (Average total assets/Average total
equity)
 Cash flow to debt
 Interest coverage ratio
 Off-balance-sheet liabilities and contingent liabilities
 Non-arm’s-length financial dealings
A Checklist for Company Analysis:
Financial Ratios and Measures (in multi-year
spreadsheets with historical and forecast data)

IV. Profitability ratios, measuring a company’s ability to generate

profitable sales from its resources (assets).
 Gross profit margin
 Operating profit margin
 Pretax profit margin
 Net profit margin
 Return on invested capital or ROIC (Net operating profits after
tax/Average invested capital)
 Return on assets or ROA (Net income/Average total assets)
 Return on equity or ROE (Net income/Average total equity)
A Checklist for Company Analysis:
Financial Ratios and Measures (in multi-year
spreadsheets with historical and forecast data)

V. Financial Statistics and Related Considerations, quantities and facts

about a company’s finances that an analyst should understand.
 Growth rate of net sales
 Growth rate of gross profit
 EBITDA
 Net income
 Operating cash flow
 EPS
 Operating cash flow per share
 Operating cash flow in relation to maintenance and total capital
expenditures
 Expected rate of return on retained cash flow
 Debt maturities and ability of company to refinance and/or repay debt
 Dividend payout ratio (Common dividends/Net income available to
common shareholders)
 Off-balance-sheet liabilities and contingent liabilities
 Non-arm’s-length financial dealings
To evaluate a company’s performance, the key measures should be
compared over time and between companies (particularly peer
companies). The following formula can be used to analyze how and
why a company’s ROE differs from that of other companies or its
own ROE in other periods by tracing the differences to changes in
its profit margin, the productivity of its assets, or its financial
leverage:

ROE = (Net profit margin: Net earnings/Net sales) ×

(Asset turnover: Net sales/Average total assets) ×
(Financial leverage: Average total assets/Average common equity)
 Strategic Position and
Action Evaluation( SPACE) Analysis
BCG Matrix
Blindspots Analysis - Strategic Significance of
Competitive Analysis.
CORPORATE BUSINESS:
FINANCIAL STATEMENT

STRATEGIC POSITION
AND
ACTION EVALUATION
( SPACE)
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The Strategic Position and Action Evaluation or the
SPACE Matrix is a four-quadrant framework which
indicates whether aggressive, conservative, defensive,
or competitive strategies are most appropriate for a
given company. The SPACE Matrix Analysis is most often
employed during market analysis of a firm.

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The axes of the SPACE Matrix represent the two internal
dimensions of a competitive firm which are its financial
strength [FS] and its competitive advantage or [CA] and
two external dimensions which are environmental stability
[ES] and industry attractiveness or IA.

These four factors are the most important determinants of

an enterprise's overall strategic position in the
marketplace.
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A generic SPACE Matrix is detailed below:

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 Factors Determining
Factors Determining
Competitive Advantage. Financial Health.

STRATEGIC
POSITION
AND ACTION
EVALUATION
( SPACE)
Factors Determining Factors Determining
Industry Strength. Environmental Stability.

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 9.Economies of 1. Return on
Scale. Investment.
Leverage.

Inventory
Turnover. FACTORS
DETERMINING Liquidity.
FINANCIAL
Risk Involved
In Business. STRENGTH: Capital Reqd.
vs.
Capital Avalbe
Ease Of Exit
From Market Cash Flow.
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 1.Market Share. Product Quality.

Customer Loyalty.

9. Speed of
New Product
FACTORS
Introductions. DETERMINING
Technological
COMPETITIVE Know-How.
Competition’s ADVANTAGE (Generic
Capacity
Utilization.
Strategy).
Vertical
Integration.
Product
Replacement Product
Cycle. Life Cycle.
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 1. Growth
Potential.
Profit
8. Productivity/
Potential.
Capacity
Utilization. FACTORS
DETERMINING
INDUSTRY Financial
Stability.
Easy Of Entry STRENGTH (Five
Into Market. Competitive
Forces):
Technological
Capital Know-How.
Intensity.
Resource
Utilization.
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 FACTORS DETERMINING
ENVIRONMENTAL STABILITY.

1. Technological 5.Barriers To Entry

Into Market.
Changes.

2. Rate of Inflation. 6.Competitive Pressure.

3. Demand Variability. 7. Price Elasticity

Of Demand.

4. Price Range of 8. Pressure From

Competitive Products. Substitute Products.
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The SPACE Matrix should be completely customized to
the particular firm / company being studied and based
on factual information derived from industry and market
data.

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The steps required to develop a SPACE Matrix are
listed below:
1. Select a set of variables to define financial
strength (FS), competitive advantage (CA),
environmental stability (ES), and industry
attractiveness (IA)

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2. Assign a numerical value ranging from +1
(worst) to +6 (best) to each of the variables that
make up the FS and IS dimensions.

Assign a numerical value ranging from -1 (best)

to -6 (worst) to each of the variables that make
up the ES and CA dimensions. 72
3. Compute an average score for FS, CA, IS, and ES by
summing the values given to the variables of each
dimension and dividing by the number of variables
included in the respective dimension.

4. Plot the average scores for FS, IA, ES, and CA on the
appropriate axis in the SPACE Matrix.

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5. Add the two scores on the x-axis and plot the
resultant point on X. Add the two scores on they-
axis and plot the resultant point on Y. Plot the
intersection of the new xy point.

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6. Draw a directional vector from the origin of
the SPACE Matrix through the new intersection
point. This vector reveals the type of strategies
recommended for the organization: aggressive,
competitive, defensive, or conservative.

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This diagram shows that the firm is in a very favourable position
and is able to take an aggressive growth strategy. It is operating in
an attractive and stable industry and has major competitive
advantages backed up by significant financial strength.

Aggressive

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Competitive Strategy The Competitive posture arises when a firm
has strong advantages in an attractive
industry but its financial strength is
insufficient to compensate for
environmental instability.

The immediate strategy is to improve its

financial strength (raising capital, improving
profitability, merging with a cash rich
parent) whilst maintaining its competitive
position.

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Conservative Strategy
The Conservative posture arises when the
firm is financially strong but is unlikely to
make significant returns from the
business.

The strategy is to look for diversification

opportunities in more attractive
competitive situations.

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Defensive Strategy The Defensive posture in the SPACE
matrix occurs when all the dimensions
are scored poorly. Firms in this position
are very weak and heading for failure
unless the external environment
becomes more favourable.

The firm will need to retreat from all but

its strongest segments so that it can
concentrate its limited resources on a
turnaround.

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 BCG Matrix

Boston Consulting Group (BCG) developed its

“experience curve” in 1965-66 as an attempt to
explain why some competitors outperform
others. What are the “rules” for success?
 BCG Matrix

According to BCG, success depends largely on the “impact

of accumulated experience.”
For each cumulative doubling of experience, says BCG,
total costs decline by about 20 to 30%, thanks to
“economies of scale, organizational learning and
technological innovation.”
 BCG Matrix

From BCG’s experience curve came the “Growth-Share

Matrix,” a portfolio analysis tool that allows diversified
companies to plot each of their business units on a grid.
Using the grid, companies can compare each area’s
relative potential for investment.
 BCG Matrix

Companies can thus maintain a balance between “cash

cows” and “stars,” while identifying “question marks”
(potential stars) for further observation and “dogs” to be
put down.
 Boston Consulting Group’s
Growth-Share Matrix
G Relative Market Share
r
o
w
t
h
M
a
r
k
e
t
 BCG Matrix
Hence, Boston Consulting Group (BCG) developed a
model for managing a portfolio of different strategic
business units (SBUs) or major product lines.

The BCG Growth-Share Matrix is a four-cell (2 by 2)

matrix used to perform business portfolio analysis as a
step in the strategic planning process.
 BCG Matrix

The BCG matrix provides a framework to compare many

SBUs/product lines at a glance and for allocating

resources between the different SBUs or product

lines.
 BCG Matrix

·SBUs/Product Lines with a relative high market share

in a high growth market are designated as Stars.

·SBUs/Product Lines with a relative high market share in

a low growth market are designated as Cash Cows.

 BCG Matrix

· SBUs/Product Lines with a relative low market share in a

high growth market are designated as Question

Marks or Problem Children.

•SBUs/Product Lines with a relative low market share in a

low growth market are designated as Dogs.

Thank You

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