Other Strategic Issues

Discussion Question 1  APA format no plagiarism (see attachments also).

Briefly answer each of the following questions.

(A 2-page response is required.)

a. What is the relationship between the case analysis and the financial analysis? 

b. What is the value of the financial statement to the case analysis? 

c. How are financial statements calculated? 

Discussion Question 2 

Assess and elaborate on the following elements of a strategic audit.  

(A 2-page response is required.)

a. The advantages of a strategic audit 

b. The need that is filled by a strategic audit 

c. The advantage of a continuous strategic audit

d. The source of the effectiveness of a strategic audit 

e. What a strategic audit provides

Lecture Notes

You will receive the greatest benefit from the following Lecture and Research Update if you first read this narrative, review the lesson, study the Required Readings, then come back to this section and carefully re-read this Lecture and Research Update. The “lecture” portion of this narrative focuses on issues from the textbook that need further explanation, while the “research update” portion integrates supportive information from recent professional academic and trade articles with the textbook information.

At this point, we have devoted most of our effort to the assessment of internal and external conditions affecting a firm and its strategy. Now as we turn our focus to the firm’s financial performance, we will attempt to understand which financial policies and financial conditions are conducive to which strategy. This is essential because it enables us as future managers to make sound decisions that move us towards our goal of value maximization. We have explored external analysis, both in general terms as well as from the firm’s perspective, using Porter’s Five Forces model. From that technique, we know that if we understand threats posed by the environment, we can position ourselves better to overcome those threats. Then, we focused on the firm’s internal strengths and on gaining and sustaining a competitive advantage. In order for a firm to outperform its competitors, it must hold unique and valuable resources that cannot be immediately replicated by others.

Resource-Based View and the VRIO Approach

The Resource-Based View of the firm and the VRIO approach provided us with the theoretical and practical tools to identify a firm’s competitive advantage. At this point, you should understand the complementarities of external and internal analysis. It would be of little benefit to a firm to have a firm grasp of the overall economy, its industry, and its competitive environment, but possess little understanding of how its own resources and capabilities can be employed toward a competitive advantage. For example, a firm may develop a strategy to become the largest producer of its product, but that strategy is meaningless unless that firm possesses the financial strength and capability to raise the capital necessary to attain and retain that size. Likewise, a firm may hold valuable, rare, and inimitable resources, but it may not be able to employ them effectively if it fails to understand its environment or if it lacks the requisite financial capability.

Effectiveness of Strategy

Once you have determined a strategy for a firm based on its competitive position and its resources, you must monitor the effectiveness of that strategy. While t

here

are several methods to measure the performance and financial condition of a firm, analysis of financial statements is a logical place to begin in assessing a corporation’s overall financial position and competitiveness, as manifested in its financial performance. Financial statements are used by the corporation’s directors as one tool for evaluating management and for decision-making, by taxation authorities to determine the firm’s tax liability, and by investors to determine the quality of the firm’s securities. Publicly held firms, in addition to sending periodic reports to their stockholders, also are required to submit audited financial statements in a specified format, as well as other information about their operations and strategy, to the Securities and Exchange Commission (SEC). The SEC requirements are to protect existing and prospective investors and to gain and maintain confidence in publicly-issued securities, and, consequently, the financial markets.

By studying SEC reports, investors are able to make informed decisions about their investments. Earlier, we saw how internal governance can sometimes create problems with the transparency of the reporting process. The regulatory system, while flawed, still enabled such cases as Enron and Global Crossing to be exposed and allowed both the government and the accounting profession to take action. We have already covered governance issues, a discussion that we do not need to duplicate here, but it is essential to understand the reporting obligations imposed on traded firms as part of the system to protect investors and maintain the integrity of financial markets.

Managers and directors must be aware of the SEC regulations and reporting requirements for public firms and fully comply with them. The passage of the Sarbanes-Oxley Act in 2002, charging directors and management with more direct responsibility for financial controls and for the accuracy of financial reports, has added another costly burden to businesses. In addition, the accounting profession has established the Public Company Accounting Oversight Board (PCAOB), subjecting firms to more rigorous scrutiny. Awareness and understanding of the more stringent requirements is an integral part of the operating environment of all firms in the contemporary environment.

Balance Sheet and Income Statement

Two major accounting statements report the financial position of a company: the balance sheet and the income statement. The balance sheet reports the assets and liabilities of the firm as of a given date. The income statement (once called profit and loss statement) reports all revenues and expenses for the firm for a given accounting period, resulting in a bottom line of net income or loss for that period. While this information is useful, analysis of these statements enables greater insight to be gained on the financial performance and on the broader financial and competitive position of a company.

Statement of Cash Flows

An important step is to determine the sources and applications of cash for the firm for a particular period by constructing the statement of cash flows, sometimes called the summary of net changes in financial position. As you will learn, the balance sheet reports, among other accounts, the cash on hand as of a certain date, but does not trace how that cash position changed or came about since the previous reporting period. The importance of cash inflows and outflows of the firm is that it enables decision makers to detect possible problems in both the finances and operations of the firm. If you need a review of the various accounts in financial statements, consult a basic accounting textbook.

Financial and Nonfinancial Ratios

Another way the balance sheet and income statement can be analyzed is by the calculation of financial ratios. Financial ratios help to evaluate a firm’s performance because they provide a normalized indication of the company’s financial condition and current operating results. Possibly more important, however, is analysis over several periods to determine trends, either favorable or unfavorable, and to enable comparisons with competing or comparable firms, or even with the entire industry.

Financial Ratio Analysis consists of:

1. Liquidity Ratio

2. Profitability Ratios

3. Activity Ratios

4. Leverage Ratios

5. Other Ratios

Ratios for most firms and industries are publicly available. As one example, let us say we have calculated the Inventory Turnover Ratio (ITR) for BestBuy and find that their average turnover is 20 days in 2015 (The ITR provides a measure of the effectiveness of the company’s logistics, as each extra day of inventory can add significantly to the firm’s costs.). That number means little in isolation, but if we calculate the same ratio for the previous five years and find that the ITR had improved from 60 days to 20 days, we will be inclined to think positively about the current figure. Now, let us say we determine the ITRs for BestBuy’s competitors and find that their average ratio was 35 days. At this point, we might begin to believe that BestBuy holds a competitive advantage in its inventory management operations, which in turn may provide some indicators about BestBuy’s strategy.

Every time a question arises or a trend is indicated, you should attempt to dig further into these ratios so that you understand the reasons for your observation. Equally important, you will learn that mastery of financial analysis techniques enables you to make realistic projections about future operations.

Finally, there are nonfinancial indicators that also influence a firm’s long-term profitability and ultimately its competitiveness. These include such factors as customer loyalty, brand recognition, and employee satisfaction (low employee turnover). Such measures have a major influence on a company’s strategy and must be considered in addition to those techniques used for assessing financial strength. Again, a caution is offered for thought: no single factor can be used to draw a conclusion about the firm’s overall condition. All ratios and indicators must be integrated into a whole.

Financial Analysis

From this background and with the mastery of ratio techniques, it becomes possible to employ financial analysis in the determination of a firm’s strategy and in the assessment of the firm’s ability to support its strategy. The key point about the field of financial analysis is that it must be undertaken for a purpose. No analyst can conduct a meaningful ratio analysis without being told what the purpose is. Accordingly, there must be some indication of how much that strategy will require in financial resources, integrated with the other, nonfinancial indicators listed above. While objective financial calculations are useful, it should be understood that human judgment is also essential. You should feel free to incorporate your own judgments into any analysis to implement and support a strategy.

Lecture and Research Update Bibliography

Wheelen, T. L., Hunger, J. D., Hoffman, A. N. And Bamford, C. E. (2016). Strategic Management and Business Policy (14th ed.). NJ: Prentice Hall.

PowerPoint Lecture Notes

Use the lecture notes available in PowerPoint as you study this chapter by CLICKING THE LINK BELOW. These notes will help you identify main concepts and ideas presented in this chapter.

If you do not have PowerPoint on your computer, you can download a free viewer from Microsoft by clicking here.

Chapter 7

Strategy Formulation:
Corporate Strategy

Chapter 7

Learning Objectives
Understand the three aspects of corporate strategy
Apply the directional strategies of growth, stability and retrenchment
Understand the differences between vertical and horizontal growth as well as concentric and conglomerate diversification
Identify strategic options to enter a foreign country
Apply portfolio analysis to guide decisions in companies with multiple products and businesses
Develop a parenting strategy for a multiple-business corporation
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After reading this chapter, you should be able to:
Understand the three aspects of corporate strategy
Apply the directional strategies of growth, stability and retrenchment
Understand the differences between vertical and horizontal growth as well as concentric and conglomerate diversification
Identify strategic options to enter a foreign country
Apply portfolio analysis to guide decisions in companies with multiple products and businesses
Develop a parenting strategy for a multiple-business corporation
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Corporate Strategy
Corporate strategy
the choice of direction of the firm as a whole and the management of its business or product portfolio and concerns

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Corporate strategy is primarily about the choice of direction for a firm as a whole and the management of its business or product portfolio.

Corporate Strategy
Directional strategy
the firm’s overall orientation toward growth, stability or retrenchment
Portfolio analysis
industries or markets in which the firm competes through its products and business units
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Corporate strategy addresses three key issues facing the corporation as a whole:
1. The firm’s overall orientation toward growth, stability or retrenchment (directional strategy).
2. The industries or markets in which the firm competes through its products and business units (portfolio analysis).

Corporate Strategy
Parenting strategy
the manner in which management coordinates activities and transfers resources and cultivates capabilities among product lines and business units
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3. The manner in which management coordinates activities and transfers resources and cultivates capabilities among product lines and business units (parenting strategy).

Corporate Directional Strategies
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Figure 7-1

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Having chosen the general orientation (such as growth), a company’s managers can select from several more specific corporate strategies such as concentration within one product line/industry or diversification into other products/industries. (See Figure 7–1.)

Directional Strategy
Growth strategies
expand the company’s activities
Stability strategies
make no change to the company’s current activities
Retrenchment strategies
reduce the company’s level of activities
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A corporation’s directional strategy is composed of three general orientations (sometimes called grand strategies):
■ Growth strategies expand the company’s activities.
■ Stability strategies make no change to the company’s current activities.
■ Retrenchment strategies reduce the company’s level of activities.
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Growth Strategies
Merger
a transaction involving two or more corporations in which stock is exchanged but in which only one corporation survives
Acquisition
100% purchase of another company
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A merger is a transaction involving two or more corporations in which both companies exchange stock in order to create one new corporation. An acquisition is a 100% purchase of another company.

Concentration Strategies
Vertical growth
achieved by taking over a function previously provided by a supplier or distributor
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Vertical growth can be achieved by taking over a function previously provided by a supplier or distributor.

Concentration Strategies
Vertical integration
the degree to which a firm operates vertically in multiple locations on an industry’s value chain from extracting raw materials to manufacturing to retailing
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Vertical growth results in vertical integration—the degree to which a firm operates vertically in multiple locations on an industry’s value chain from extracting raw materials to manufacturing to retailing.
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Vertical Integration
Backward integration
assuming a function previously provided by a supplier
Forward integration
assuming a function previously provided by a distributor
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More specifically, assuming a function previously provided by a supplier is called backward integration (going backward on an industry’s value chain). Assuming a function previously provided by a distributor is labeled forward integration (going forward on an industry’s value chain).
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Vertical Integration
Transaction cost economies
vertical integration is more efficient than contracting for goods and services in the marketplace when the transaction costs of buying on the open market become too great
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Transaction cost economics proposes that vertical integration is more efficient than contracting for goods and services in the marketplace when the transaction costs of buying goods on the open market become too great.

Vertical Integration Continuum
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Harrigan proposes that a company’s degree of vertical integration can range from total ownership of the value chain needed to make and sell a product to no ownership at all. (See Figure 7–2.)

Vertical Integration
Full integration
a firm internally makes 100% of its key supplies and completely controls its distributors
Taper integration
a firm internally produces less than half of its own requirements and buys the rest from outside suppliers
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Under full integration, a firm internally makes 100% of its key supplies and completely controls its distributors.
With taper integration (also called concurrent sourcing), a firm internally produces less than half of its own requirements and buys the rest from outside suppliers (backward taper integration).

Vertical Integration
Quasi-integration
a company does not make any of its key supplies but purchases most of its requirements from outside suppliers that are under its partial control
Long-term contracts
agreements between two firms to provide agreed-upon goods and services to each other for a specific period of time
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With quasi-integration, a company does not make any of its key supplies but purchases most of its requirements from outside suppliers that are under its partial control (backward quasi-integration).
Long-term contracts are agreements between two firms to provide agreed-upon goods and services to each other for a specified period of time.

Concentration Strategies
Horizontal growth
expansion of operations into other geographic locations and/or increasing the range of products and services offered to current markets
Horizontal integration
the degree to which a firm operates in multiple geographic locations at the same point on an industry’s value chain
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A firm can achieve horizontal growth by expanding its operations into other geographic locations and/or by increasing the range of products and services
offered to current markets.
Horizontal growth results in horizontal integration—the degree to which a firm operates in multiple geographic locations at the same point on an industry’s value chain

International Entry Options for Horizontal Growth
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Some of the most popular options for international entry are as follows:
Exporting
Licensing
Franchising
Joint Venture
Acquisitions
Green-Field Development
Production Sharing
Turn-Key Operations
BOT Concept
Management Contracts

Exporting

Licensing

Franchising

Joint Venture

Acquisitions

Green-Field Development

Production Sharing

Turn-Key Operations

BOT Concept

Management Contracts

Diversification Strategies
Concentric (Related) diversification
growth into a related industry when a firm has a strong competitive position but attractiveness is low
Synergy
the concept that two businesses will generate more profits together than they could separately

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Growth through concentric diversification into a related industry may be a very appropriate corporate strategy when a firm has a strong competitive position but industry attractiveness is low.
The search is for synergy, the concept that two businesses will generate more profits together than they could separately.

Diversification Strategies
Conglomerate (Unrelated) diversification
diversifying into an industry unrelated to its current one
Management realizes that the current industry is unattractive.
Firm lacks outstanding abilities or skills that it could easily transfer to related products or services in other industries.
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When management realizes that the current industry is unattractive and that the firm lacks outstanding abilities or skills that it could easily transfer to related products or services in other industries, the most likely strategy is conglomerate diversification—diversifying into an industry unrelated to its current one.

Controversies in
Directional Strategies
Is vertical growth better than horizontal growth?
Is concentration better than diversification?
Is concentric diversification better than conglomerate diversification?
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Is vertical growth better than horizontal growth? Is concentration better than diversification? Is concentric diversification better than conglomerate diversification?

Stability Strategies
Pause/Proceed with caution strategy
an opportunity to rest before continuing a growth or retrenchment strategy
No-change strategy
decision to do nothing new—a choice to continue current operations and policies for the foreseeable future
Profit strategies
decision to do nothing new in a worsening situation but instead to act as though the company’s problems are only temporary

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A pause/proceed-with-caution strategy is, in effect, a timeout—an opportunity to rest before continuing a growth or retrenchment strategy.
A no-change strategy is a decision to do nothing new—a choice to continue current operations and policies for the foreseeable future.
A profit strategy is a decision to do nothing new in a worsening situation but instead to act as though the company’s problems are only temporary.

Retrenchment Strategies
Retrenchment strategies
used when the firm has a weak competitive position in some or all of its product lines from poor performance
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A company may pursue retrenchment strategies when it has a weak competitive position in some or all of its product lines resulting in poor performance—sales are down and profits are becoming losses.

Retrenchment Strategies
Turnaround strategy
emphasizes the improvement of operational efficiency when the corporation’s problems are pervasive but not critical
Contraction
effort to quickly “stop the bleeding” across the board but in size and costs
Consolidation
stabilization of the new leaner corporation
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Turnaround strategy emphasizes the improvement of operational efficiency and is probably most appropriate when a corporation’s problems are pervasive but not yet critical.
Contraction is the initial effort to quickly “stop the bleeding” with a general, across-the-board cutback in size and costs.
The second phase, consolidation, implements a program to stabilize the now-leaner corporation.

Retrenchment Strategies
Captive company strategy
company gives up independence in exchange for security
Sell-out strategy
management can still obtain a good price for its shareholders and the employees can keep their jobs by selling the company to another firm
Divestment
sale of a division with low growth potential
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A captive company strategy involves giving up independence in exchange for security. The sell-out strategy makes sense if management can still obtain
a good price for its shareholders and the employees can keep their jobs by selling the entire company to another firm. If the corporation has multiple business lines and it chooses to sell off a division with low growth potential, this is called divestment.

Retrenchment Strategies
Bankruptcy
company gives up management of the firm to the courts in return for some settlement of the corporation’s obligations
Liquidation
management terminates the firm
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Bankruptcy involves giving up management of the firm to the courts in return for some settlement of the corporation’s obligations. In contrast to bankruptcy, which seeks to perpetuate a corporation, liquidation is the termination of the firm.

Portfolio Analysis
Portfolio analysis
management views its product lines and business units as a series of investments from which it expects a profitable return
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In portfolio analysis, top management views its product lines and business units as a series of investments from which it expects a profitable return

BCG Growth—Share Matrix
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Figure 7-3

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Using the BCG (Boston Consulting Group) Growth-Share Matrix depicted in Figure 7–3 is the simplest way to portray a corporation’s portfolio of investments. Each of the corporation’s product lines or business units is plotted on the matrix according to both the growth rate of the industry in which it competes and its relative market share.

BCG Matrix
Question marks
new products with the potential for success but need a lot of cash for development
Stars
market leaders that are typically at or nearing the peak of their product life cycle and are able to generate enough cash to maintain their high share of the market and usually contribute to the company’s profits
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Question marks (sometimes called “problem children” or “wildcats”) are new products with the potential for success, but they need a lot of cash for development.
Stars are market leaders that are typically at or nearing the peak of their product life cycle and are able to generate enough cash to maintain their high share of the market and usually contribute to the company’s profits.

BCG Matrix
Cash cows
products that bring in far more money than is needed to maintain their market share
Dogs
products with low market share and do not have the potential to bring in much cash
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Cash cows typically bring in far more money than is needed to maintain their market share.
Dogs have low market share and do not have the potential (because they are in an unattractive industry) to bring in much cash.

BCG Matrix—Limitations
Use of highs and lows to form categories is too simplistic.
Link between market share and profitability is questionable.
Growth rate is only one aspect of industry attractiveness.
Product lines or business units are considered only in relation to one competitor.
Market share is only one aspect of overall competitive position.
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Unfortunately, the BCG Growth-Share Matrix also has some serious limitations:
■ The use of highs and lows to form four categories is too simplistic.
■ The link between market share and profitability is questionable
■ Growth rate is only one aspect of industry attractiveness.
■ Product lines or business units are considered only in relation to one competitor: the market leader. Small competitors with fast-growing market shares are ignored.
■ Market share is only one aspect of overall competitive position.

Advantages and Limitations of Portfolio Analysis
Advantages
Encourages top management to evaluate each of the corporation’s businesses individually and to set objectives and allocate resources for each
Stimulates the use of externally oriented data to supplement management’s judgment
Raises the issue of cash flow availability to use in expansion and growth
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Portfolio analysis is commonly used in strategy formulation because it offers certain advantages:
■ It encourages top management to evaluate each of the corporation’s businesses individually and to set objectives and allocate resources for each.
■ It stimulates the use of externally oriented data to supplement management’s judgment.
■ It raises the issue of cash-flow availability for use in expansion and growth.
■ Its graphic depiction facilitates communication.

Advantages and Limitations of Portfolio Analysis
Limitations
Defining product/market segments is difficult
Suggest the use of standard strategies that can miss opportunities or be impractical
Value-laden terms such as cash cow and dog can lead to self-fulfilling prophecies
Lack of clarity on what makes an industry attractive or where a product is in its life cycle
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Portfolio analysis does, however, have some very real limitations that have caused some companies to reduce their use of this approach:
Defining product/market segments is difficult.
It suggests the use of standard strategies that can miss opportunities or be impractical.
It provides an illusion of scientific rigor, when in reality positions are based on subjective judgments.
Its value-laden terms such as cash cow and dog can lead to self-fulfilling prophecies.
It is not always clear what makes an industry attractive or where a product is in its life cycle.
Naively following the prescriptions of a portfolio model may actually reduce corporate profits if they are used inappropriately.

Tasks Necessary for Managing a Strategic Alliance Portfolio
Developing and implementing a portfolio strategy for each business unit and a corporate policy for managing all the alliances of the entire company
Monitoring the alliance portfolio in terms of implementing business units’ strategies and corporate strategy and policies
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A study of 25 leading European corporations found four tasks of multi-alliance management that are necessary for successful alliance portfolio management:
Developing and implementing a portfolio strategy for each business unit and a corporate policy for managing all the alliances of the entire company
Monitoring the alliance portfolio in terms of implementing business units’ strategies and corporate strategy and policies

Tasks Necessary for Managing a Strategic Alliance Portfolio
Coordinating the portfolio to obtain synergies and avoid conflicts among alliances
Establishing an alliance management system to support other tasks of multi-alliance management
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Also necessary are:
Coordinating the portfolio to obtain synergies and avoid conflicts among alliances
Establishing an alliance management system to support other tasks of multi-alliance management

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Corporate Parenting
Corporate parenting
views a corporation in terms of resources and capabilities that can be used to build business unit value as well as generate synergies across business units
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Corporate parenting, or parenting strategy, in contrast, views a corporation in terms of resources and capabilities that can be used to build business unit value as well as generate synergies across business units.

Corporate Parenting
Generates corporate strategy by focusing on the core competencies of the parent corporation and the value created from the relationship between the parent and its businesses
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Corporate parenting generates corporate strategy by focusing on the core competencies of the parent corporation and on the value created from the relationship between the parent and its businesses
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Developing a Corporate
Parenting Strategy
Examine each business unit in terms of its strategic factors
Examine each business unit in terms of areas in which performance can be improved
Analyze how well the parent corporation fits with the business unit
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The search for appropriate corporate strategy involves three analytical steps:
Examine each business unit in terms of its strategic factors
Examine each business unit in terms of areas in which performance can be improved
Analyze how well the parent corporation fits with the business unit

Horizontal Strategy and
Multipoint Competition
Horizontal strategy
cuts across business unit boundaries to build synergy across business units and to improve competitive position in one of more business units

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A horizontal strategy is a corporate strategy that cuts across business unit boundaries to build synergy between business units and to improve the competitive position of one or more business units

Horizontal Strategy and
Multipoint Competition
Multipoint competition
large multi-business corporations compete against other large multi-business firms in a number of markets
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In multipoint competition, large multi-business corporations compete against other large multi-business firms in a number of markets. These multipoint
competitors are firms that compete with each other not only in one business unit, but also in a number of business units.
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