Strategic Business Analysis Textbook PDF

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              !! " #  $  %& !'!( ) * + !!, - *.$ # !!,  "    - / ". /  0  % %  1 & $   2 $   "    - / ". /  0  % %   +          /  +         - *.$  $     & '3 4 *   * +   . + *    .     5 $ *  *.$   $  .   +.          .   .       * +  6      *     *.$   *       *     - *.$  $     & '3          +.  - *.$ $ &$.   3! 2  -  #     $ "'2 , 1 &**       *.$  7   *  *   . *   * +     +   * +   . +  $  .   7 8  2  $. #$  *     90: * : 5‡ ,,6 5!6 ';< ,((!= : 5‡ ,,6 5!6 ';< 1 1 /1 ? .   * .  @       *$ 5 *:AA 11 6 +.  $ B-   8 **  7   B+ $  7 British Library Cataloguing-in-Publication Data &   $       + /  +      +. Library of Congress Cataloguing-in-Publication Data 8  $ $  +  .A "  *1 1 & * +.  -#%  *   $    $ .  *     **  1 8.  @  : 8.  @      *.$ -#%: * $ 8.     %    3C   *+   $  5  3C6  *  5  3C61 D  ++ $*   1 '1 8  $ *$1 1  *$1 (1   *E    1 ,1   *E   E-  1 D1 "   '3  or team skills the organization  $   ?   Employee know-how, Perception of high quality standards,   "   Distributor know-how, The organization's ability to:        Supplier know-how, and Manage change, innovate work as teams,     " groupings of the above. Respond to challenge -  @".   Tradition of Customer Service, etc.      ?  , (  
$"! *$  Weighted key Regulatory Positional Functional Cultural    product attributes capability capability capability capability C 2        .     1 Price Value chain Employee    2   configuration know-how  !    2 Availability Distributor  "    "  know-how !)***, >   3 Value for money Licences $   ?     "   4 Rapid response Operating Ability to        system manage change     " 5 Image Trademarks Reputation Perception -  @".   of products of quality      ?  , The strategic issue of how these intangible resources can be developed for competitive and market advantage can now be addressed. This involves consideration of how intangible resources can be protected, sustained, enhanced and exploited. For example, does management recognize and value the intangible resources of the organization and do they appreciate the length of time it took to acquire them? How safe are these resources and can they be protected in law? From a competitive advantage perspective, are the resources increasing or decreasing, and what can we do to ensure that they continue to increase? An example of the types of actions that can be undertaken to protect and develop the key intangible resources are shown in Figure 9.10. By progressively narrowing down and ranking these capabilities we can more clearly identify a company's strengths, and this is pivotal for a strategy that seeks The key Protecting Sustaining Enhancing Leveraging intangibles 1 Employee Reward in Widen know-how salary and training bonus structure opportunities 2 Distribution Include know-how in strategic alliance    decisions >      3 Licences Protect sole  (   2 licence     agreements  !    in courts  "    "  4 Operating Integrate !)***, >   System with $   ?   distributors   "   5 Quality Do not        tamper with     " organization -  @".   culture      ?  ,   !! !" #$! !%& to maintain or expand the market share of a company. It is also crucial that management understand the potential consequences of a strategic move that undermines or abandons the capabilities that sustain existing competitive advantage, as this can result in a loss of market share and company failure. From a strategic perspective, capabilities can be inputted into investment decisions, portfolio analysis, value chain analysis and decisions regarding strategic acquisitions, alliances and disposals. This information can also be used to more effectively gauge the competitive position of a company and the actions it might reasonably undertake.  !! " We have defined resources as consisting of assets and competences. This led to an outlining of techniques for analysing the activities and resources of an organization at a business level. It also involved a discussion of the relation- ship between inimitable resources as distinctive competences and unique assets, and competitive advantage. The role of management as a resource in making links between units in corporate portfolios was discussed. In multi- divisional firms, the role of the centre in recognizing opportunities for synergy between business units and its role in contributing to effectiveness of unit value chains was outlined. Bottom-up and top-down techniques for auditing resources have also been discussed. Top-down techniques are important because they emphasize the primacy of the customer. The Hall and Andriani approach for making links between resources, product features, product benefits and competitive advantage was outlined to show how organizations might go about the task. '  C H A P T E R 10 Financial performance and investment appraisal          The ability to financially analyse a company is central to any strategic investigation, and a better understanding of financial performance can be achieved if we apply certain analytical tools. Indeed, the use of financial performance indicators are a key analytical tool for many investors and management consultants, especially when the emphasis is on evaluating past and current performance, and where projections on future perform- ance are being made. Access to financial information is obviously necessary if you are to finan- cially evaluate a company, and this information is most likely to be contained within profit and loss and balance sheet statements. These statements provide a `snapshot' on the financial health and standing of a company at a specific point in time. They are particularly important within strategic analysis because they provide the information for the calculation of financial ratios, which enable comparisons to be made with other companies in the same industry or sector. The ratios can be used to measure profitability, liquidity, corporate activity, the efficiency with which the company uses the assets that it has at its disposal, and how the stock market values the company. It is important that the data collected from the financial statements spans a time frame that enables a meaningful comparison to be made between companies and for financial projections to be made (e.g. 5 years). The collection of this financial data can be time consuming, especially so when it involves the dissection of the financial statements of competitors ± although this is time well spent if it provides insight into the strategic decision-making processes of the key players within the industry or sector.       ! "   #$              It is important to remember that financial statements contain data that is normally 12 months out of date. This is likely to be the most up-to-date information because companies have to produce, by law, annual operating statements of their preceding 12 months activities. The information that these statements contain is particularly useful because all companies have to pro- vide equivalent types of information, which means that we can make quite robust comparisons between companies. Financial statements can be used for the following: & To support and underpin the data and information that is inputted into strategic models (e.g. SPACE, Life Cycle Matrix SWOT analy- sis). & To analyse competitors who may pose a strategic threat by identify- ing their financial strengths and weaknesses, and how these might influence their strategic intent. & To support strategic acquisitions and mergers through a detailed financial analysis of potential candidates. & To analyse key customers and suppliers in order to anticipate demand and potential strategic activity. & To compare internal cost centres with comparable cost centres with- in competitors, to identify significant variances, and to incorporate remedial action into the strategic planning process. & To identify the growth potential and borrowing power of the organ- ization. & To assess if the company is vulnerable to decreases in revenue and possible corporate failure.      Corporate reports also contain a written statement by the Chairman or Chief Executive Officer, and these provide a valuable resume of the company's activity and accomplishments over the previous 12 months, together with an insight into current business strategies and their expected impact on future corporate financial performance. These reports can also be `economical' with the truth when performance is poor. If results are worse than expected and the interpretation of the Chairman or Chief Executive Officer looks overly optimistic, care needs to be exercised. In these circumstances additional research may be required to see if the projections and expectations are justified. Written statements provide a useful context for considering the following questions: & Has senior management identified any specific challenges or under- lying trends facing the organization, and has corrective action been incorporated into their overall strategy? %    ,  # -,.   !  /  --# & Does the report provide any insight into managements ability (and track record) to identify and implement strategic change? & Are the strategic objectives within the report being achieved, and if not, is the current management capable of achieving them? & Does the report contain a clear view of the business and does it state where the business is headed? &         '    A financial ratio is a relationship, at a given point in time, between items on a financial statement. If the ratio is to have any meaning then the items must be synergistic (i.e. when put together they say something about the perform- ance of the company). It is important to resist the temptation of calculating all possible ratios, because like strategic analysis in general, it should be a selective process where the emphasis is on the selection of ratios to identify and illustrate specific strategic issues and trends. It is also important that we do not generalize too broadly from ratios, as it does not automatically follow that weak ratios are a precursor to corporate failure. Although powerful, many other factors need to be dovetailed into ratio analysis if we are to arrive at a meaningful insight into present and future performance. When ratios are used to compare industries or sectors then it is important that the companies should be of a similar size and sell similar products or services to similar markets. Although it is always difficult to project into the future, ratios can be calculated over several years and then plotted graphically in a time series to highlight changes over that period, and by extending the trend, potential future performance. (  ' ) *  *  +  Comparisons between trading years and other companies in the industry or sector can be made difficult in the following situations: & Changes in accounting standards and methods ± such changes can result in material changes to ratios calculated. These changes should be quantified if possible and their impact on the analysis explained. & Accounting for exceptional items can create anomalies, and an assessment needs to be made as to whether they are a `one off'. Companies frequently use this technique to cover a multitude of sins (including poor performance). & Restructuring costs ± like exceptional items these reduce margins and profits. Explanations for such costs very often lack detail and care needs to be exercised when assessing their strategic implica- tions. & The sale or acquisition of subsidiaries can make a material difference when assessing group structures. 0      ! "   #$ These factors and situations need to be taken into account, and possibly compensated for, when comparing companies using ratios. If these types of situations are taken into account then they can only improve and enhance the insight that financial ratios provide. Ratio analysis can be divided into five key areas: profitability, liquidity, leverage or gearing, activity analysis, and stock market valuations.       -  1   These ratios indicate the degree of competence with which the company allocates the resources available to the resulting income generated. The main item used in profitability analysis is the profit and loss account, and this can give rise to confusion because two profit figures are given; one after interest and tax and the other before interest and tax. In general, using profit before interest and tax is useful because it enables us to compare the trading performance of similar companies irrespective of borrowings that may have been used to finance those activities. Taking profit after interest and tax charges provides a more thorough analysis of a com- pany's competitive strength, as there is a direct relationship to gearing (leverage), and this can be important in assessing whether the company is financially over-stretched. Profit after interest will fluctuate in line with vari- ations in interest rates assuming profits before interest remain constant. The seven most commonly used profitability ratios are shown in Figure 10.1.  #2'*   Liquidity ratios can show whether a company can meet its short-term liabil- ities, which usually revolve around the ability of a company to manage its stocks and inventories, and the flow of cash coming into the company. This can be critically important because a company that fails to pay its bills (for its stock) is likely to cease to function. If a company is unable to generate sufficient cash itself, then it should have set up and put in place the financial facilities to cover its position. Poor liquidity and the inability to manage cash flow can lead to a loss in confidence from both creditors and financial provi- ders, and if such problems are not addressed quickly, exposure to take-over or company failure may be a reality. Conversely, too much liquidity can reduce profitability as short-term assets usually infer that the company is failing to fully utilize its cash to produce higher levels of return. Indeed, the maintenance of the fine balance of keeping liquidity low whilst meeting all short-term obligations can be a key success factor. When the ratios are shown as trends over time they can be used as a comparative barometer of overall performance. In general, low liquidity ratios are associated with a stable and predictable industry and sector environment, whilst high ratios can relate to unpredictable, 3  Ratio Method of calculation Analytical value 1 Gross profit Sales  Cost of goods sold The total margin available to cover operating Sales costs and give a profit 2 Operating profit Profit before interest and tax A measure of the firm’s profitability margin (return on Sales irrespective of interest and tax charges sales) 3 Net profit margin Profit after tax and interest Indicates the percentage of profit available (net return on sales) Sales for distribution and reinvestment 4 Return on total Profit after tax þ Interest Measures the return on total assets assets Total assets 5 Return on shareholders Profit after tax Measures the rate of return on the equity (net on net worth) Shareholders equity shareholders investment 6 Return on common Profit after tax  Dividends on preference shares Measures the return to common or equity Total stockholders equity  Partial value of preference shares ordinary shares 7 Earnings per share Profit after tax  Dividends on preference shares Gives the value of earnings for each Number of common or ordinary shares issued ordinary or common share Figure 10.1 Profitability ratios. 10  FINANCIAL PERFORMANCE AND INVESTMENT APPRAISAL 119      ! "   #$                                                                                                                                                            Liquidity ratios. volatile and cyclical environments. Likewise, companies having high levels of stock may be subject to increased risks, whilst a downward trend of stock values in relation to sales may indicate improved management practices (e.g. JIT stock management systems). There are three key liquidity ratios, and these are shown in Figure 10.2. &    )    Gearing ratios provide insights into how much of a company's assets are financed by external sources of funding. The higher the ratios the greater the risk to the company, as large borrowings will be prone to interest rate changes that are beyond the control of management. Funds that are provided by ordinary shareholders can have a reduced dividend payment when times are difficult, whereas borrowed funds attract a market rate of interest that cannot be deferred or defaulted upon. Figure 10.3 shows the five most used gearing ratios. (  )   These ratios are useful for comparing individual companies to industry or sector standards. Figure 10.4 shows five activity ratios, and when used sensible they can indicate how efficient a company is in managing and gen- erating a return from its assets.   7  7   Stock markets use a myriad of techniques to assess the value of companies, and the four ratios outlined in Figure 10.5 are used extensively within such evaluations.     ,  # -,.   !  /  --#                   !                                      !      "                          #  !                     "     "         $ %                                 &              '    * + ,      -                       Gearing or leverage               ratios.             .   !                        "  ,     + ,  !       /           !      %    !          /  0                   $ !  "                      "      &      ' * !  "   .                                   #$% Activity ratios.       ! "   #$              8    &  9           "    &               :                        "    &                     &          "    & .              "    &            $     "  &   '&   !          (                         , Stock market ratios.                 Ratio analysis can be integrated into, and be a valuable part of, the following strategic models: S.W.O.T. analysis Ratios can be used to identify strengths and weaknesses. This can be integrated into future scenarios by trending the ratios forward. S.P.A.C.E. analysis The `industry strength' axis can be measured using ratios that gauge profit potential, financial stability and capital intensity. Likewise, the axis `financial strength' can be measured using return on investment, gearing (leverage), liquidity, capital required, cash flow, and inventory turnover ratios. The `competitive advantage' axis can also be inferred from the position of the company's products within the overall life cycle (see product life cycle below). Industry attractiveness/business strength matrix Ratios can be used to weight and rate market size and potential growth, capital requirements, and industry profitability so that a composite measure can be arrived at for `industry attractiveness'. The areas for measurement within `business strength' are market share, relative profit margins and cost differences. Life cycle matrix A company's competitive position can be gauged using the five types of ratios outlined above (i.e. profitability, liquidity, gearing [lever- age], activity and stock market), whilst the industry stage in the evolutionary life cycle can be estimated by incorporating estimates of product life cycles (see product life cycle below). B.C.G. matrix The industry growth rate and relative market share can be inferred from profitability, liquidity, gearing (leverage) and stock market ratios, as each of the four `ideal' positions within the matrix can be compared to each other using these ratios.     ,  # -,.   !  /  --# &      +*'       As products progress through their respective life cycles distinct links can be made with financial performance. Product revenue will continue to increase until the product reaches maturity, sales will then decrease until the product is obsolete. Profitability will also decrease at this point as margins are under pressure from both competitor products and the need to invest in R&D to create new products. The stages of a product's life cycle and the types of strategies associated with each stage are shown in Figure 10.6. Ratio analysis can provide insight on the relative position of a product, and through for- ward trend projections of the ratios strategic positions can be anticipated and catered for.  !       "# !$% All of the ratios outlined in Chapter 10 can be calculated automatically on the CD. By selecting `Ratio' from the menu, ratios can be calculated and graphed for a 5-year period, and then trended forward for a further 2 years. Analysis is supported through help menus and on-screen buttons, with detailed information being provided on how to use and interpret the ratios. We would encourage you to use the ratio analysis package, as it is a powerful investigative tool that can enhance and extend your strategic analysis of a company.  &     Investment appraisal or capital budgeting can be defined as `the analysis of a proposed investment that is a long-term asset used by the business to yield a return over a period of time that is greater than one year.' Examples include the purchase of a warehouse or a fleet of delivery vehicles.           9     ;  .  "    ,  /   & '          0     0                       /          ' # .        <     =,    Product life cycle stages &  '            and associated     strategies. &      ! "   #$ Capital budgeting assumes that funds are limited and that a decision has to be made between several investment alternatives. To simplify the analysis we make the following assumptions: & The project's cash flows are known with certainty. & The cost of capital is given and is the same for all projects. & The expected net cash flows for the project will be realized at the end of the time periods in which they are expected to occur. With these assumptions in place we can divide the capital budgeting process into five stages: 1 Search and identification. 2 Estimating cash flows (including discount rate selection). 3 Evaluating projects. 4 Selecting projects. 5 Post acceptance analysis. ' (    The five most used techniques for evaluating investment projects are outlined in the following list (tutorial and exercises for each of the appraisal methods can be accessed on the CD): 1 Payback. 2 Discounted payback. 3 Average rate of return. 4 Net present value. 5 Internal rate of return and modified internal rate of return. The process of calculation has been eased significantly as most spreadsheet software packages have in-built functions that can be used in each of the five areas. Choosing the most appropriate appraisal method depends on a num- ber of factors, and these, together with a brief outline of the appraisal method, are outlined in the following sections. % - 1 7 This is the simplest method of calculation, and it involves selecting projects on the basis of repaying the investment amount in the shortest possible (or company stated) time period. In addition to its simplicity, the main advantage of payback appraisal method is the built-in safeguard against risk, because it always looks for projects that will repay capital in the shortest (or stated) time period. The main disadvantage is that it makes no allowance for taxation or capital allowances, and this is important because different allowances and tax benefits can be attributable to different types of projects. It also disregards the profit streams from projects once the payback period is over. This means that (    ,  # -,.   !  /  --# payback-based funding decisions could lead to under investment, which could have a very negative impact on long-term competitive advantage. % ! ' * + 1 7 Discounted payback uses a discount rate to discount down the net inflows to the project, with the cumulative value of these being used to determine the point at which payback occurs. This is considered to be more realistic because the value of monetary inflows decreases over time (due to inflation), and it is only by `discounting' these can the original investment be properly recouped. The choice of the discounting rate is clearly important, for too high a rate will increase the payback period and make the project look unviable. %& )     ' The average rate of return calculates the profitability of an investment by relating the initial investment to the future annual average net cash flows. The method takes account of profits over the whole of the project's life, and its average profit is expressed as the rate of return on the initial investment. This calculation should be done after tax and capital allowances so that a more accurate profit figure is used. Payback, discounted payback and average rate of return are the most traditional discounting methods, yet they all suffer from a lack of sensitivity with respect to reinvestment issues, differing project lengths and varying profit flows and patterns. They also suffer from the previously mentioned time value of money problem ± money today is of more value than money tomorrow, so we should not treat the value of money in year one as the same as that accrued in future years. Issues like these can be more effectively accommodated in the net present value and internal rate of return appraisal methods. %(  +  ) ' Net present value calculates the benefit of an investment project in terms of current money assuming that a rate of return must be earned. To calculate the NPV of an investment a discount rate is used on future payments and income. %       ' The internal rate of return of an investment project is the break-even return level that equates to the project's present value of net cash flows against the projects initial investment. %% * *       ' This is a more sophisticated form of IRR and the calculation takes into account the re-investment of net flows. Two rates are required for this calculation, a finance rate and a re-investment rate.       ! "   #$ %0 +    * -/ Although there is little difference between the two techniques, the IRR method has the advantage that it provides a better estimate of project risk. It is also preferred by many businesses because it focuses on the rate of return rather and not NPV values. The IRR and NPV appraisal methods are both robust, yet neither should be used as a panacea within investment appraisal, as many other factors and analysis tools can be used alongside them to make the strategic decision- making more effective. ) *  Financial analysis is an essential ingredient within strategic analysis. Import- antly, the ease with which the tools and techniques that have been outlined can be used in strategic analysis is significantly enhanced if the CD is used. Indeed, the ability to carry out sophisticated financial analysis is only likely to be hampered by the availability of relevant financial data within consolidated corporate accounts and the unpredictability that inherently exists when extrapolating into the future. %         11 Models for aiding strategic selection            A diversified company can have several businesses within its corporate port- folio, which increases complexity and necessitates that we look at: & How attractive the portfolio is from different stakeholder positions (shareholders, bankers, etc.). & The projected performance of the present portfolio. & The enhancements that could be made to the portfolio to improve synergy and strategic fit (e.g. divest units to provide finance to improve overall performance and/or to finance acquisitions that would improve specific value chains). The analysis of a portfolio uses all the analysis techniques for a single business company, and then builds on these by mapping and assessing the interaction and performance contribution of each portfolio member to the group as a whole. A procedure for carrying out these tasks is likely to include: & The identification of existing portfolio strategies. & The use of the strategic models described in this chapter to map and analyse the current position of the companies within the corporate portfolio. & The analysis of the industries within which portfolio companies operate in so that future performance and potential can be evalu- ated. & The benchmarking of individual company performance against the rest of the industry.     ! "# & The assessment of the interrelationships of portfolio members in respect of synergy and strategic fit. & The assessment of whether individual portfolio companies fit with current and future corporate strategy. & The analysis of the capital requirements of the portfolio (this should be quantified to give a ranking to strategic options and their invest- ment strategies). & The crafting of new strategies to improve portfolio performance (this may include acquisitions, divestments, investments in existing businesses, and the creation of synergy between businesses in the portfolio, such as shared distribution channels and other services to provide overall cost reductions and benefits).      A business portfolio matrix is a two dimensional array that graphically dis- plays the strategic positions of the various businesses within a diversified company. The types of factors that influence and shape the strategic position of a company include: & the industry growth rate. & the amount of market share achieved by the company. & the long-term projections for the industry. & the competitive strength of the business. & the stage in the product life cycle. & the stage in the industry life cycle. The three most widely used strategic models for analysing a diversified portfolio of companies are the BCG (or Growth Share) matrix, the Industry Attractiveness ± Business Strength (or GE) matrix and the Industry Life Cycle (or Hoffer, A.D. Little) matrix (Hofer and Schendel, 1978).              The BCG matrix shown in Figure 11.1 compares the industry growth rate on the X-axis and the relative market share of the company on the Y-axis, with each business being plotted as a circle that is positioned according to its X Y location. The circle size equates to the revenue contribution made by the business to the total revenue of the portfolio. Figure 11.1 shows the data that was inputted to determine the position and size of the circles so that we can compare the companies within the portfolio against the industry growth rate and their relative market share. The position of each company on the BCG matrix in Figure 11.2 is deemed to have implications with respect to how the corporate group invests in each of the portfolio companies, and the types of strategies that they will then develop and execute. $  Portfolio Market Largest rival Relative Economic Industry Growth % Revenue company share % share market share growth (%) growth differential contrib. (%) A 15 12 1.3 2 3 1 20 B 60 70 0.9 2 5 3 15 C 40 30 1.3 2 6 4 30 D 10 50 0.2 2 1 1 10 E 15 10 1.5 2 1 3 11 F 35 60 0.6 2 2 0 14 Figure 11.1 BCG data table. 11
MODELS FOR AIDING STRATEGIC SELECTION 129    ! "# High relative market share Low relative market share BCG growth share matrix STARS QUESTION MARKS High C B A F Industry growth rate D E      Low     Source     !" #$" CASH COWS DOGS The growth rate in Figure 11.2 is arrived at by taking the difference between the industry growth rate and the economic growth rate, with the resultant rate being either higher or lower than the economy as a whole. Relative market share (R.M.S.) is calculated by dividing the businesses percentage share of the total industry volume by the percentage share of its largest rival. For example, if a business has 30 per cent of the market by volume and its nearest rival has a 60 per cent share, its R.M.S. is 0.5. It therefore follows that only market leaders have an R.M.S. greater than 1. Many portfolio analysts feel that the axis for relative market share should be divided at 0.75 or 0.8 rather than 1 so that businesses with strong market shares that are not market leaders can be positioned in the two left-hand quadrants of the matrix. There are four generic categories within the BCG matrix, and the char- acteristics of each generic type are outlined below: 1 Question mark characteristics: & The business is in an industry growing faster than the economy. & The business has a low relative market share. & There is a low experience curve effect and the firm cannot exploit economies of scale. & The business may not have the ability to compete against a larger rival. & Investing large amounts of cash is needed to increase relative market share. & Investment may not overcome the experience curve effect that rivals with a large relative market share possess. %&  
+ " ,+    " + & The parent company may invest in order to capture the rapid growth in the industry. & The parent may divest if there are more attactive alternative investments. 2 Star characteristics: & The industry growth rate is high and superior to that of the economy as a whole. & High profitability and cash flow generation potential. & High investment needed to maximize the benefit from the high industry growth rate. & The business can take advantage of its experience curve and economies of scale. & Such businesses can significantly boost the overall financial performance of the portfolio. 3 Cash cow characteristics: & They have high relative market share in an industry with a low growth rate. & They have the ability to generate large cash surpluses. & As the industry is mature the investment needs are lower for sustaining market share. & The business is likely to be an industry leader with high relative market share and experience curve benefits. & The business will need to fortify and defend strategy to main- tain its position. & If a `Cash Cow' becomes weak they can be divested so that cash can be invested in other portfolio companies. 4 Dog characteristics: & Low growth rate and relative market share. & Low profit margins through poor economies of scale and experience curve benefits. & Poor generation of cash may prevent action to redress the situation. & Divesting or liquidating the company may be the only feasible option.     ' ( )   )* The BCG Matrix can be a useful strategic tool for highlighting businesses that provide strong cash flows and/or require an investment strategy. It raises aware- ness of the need to allocate financial resources correctly in order to optimize the performance of the overall portfolio. Perhaps more importantly, it sheds light on the sources of potential funding and where such funding should be spent, and provides a basis for strategies that effect movements within the matrix for the overall benefit of the portfolio. Investment and divestment strategies can be assessed, even though the matrix does not measure profitability directly. %    ! "# Looking at the BCG matrix positively, it can: & Assist strategic decision-making, especially on investment expansion and divestment. & Help identify cash providing companies and companies that need cash injections. & Facilitate a better understanding of financial relationships between portfolio companies. & Be a useful tool when used in conjunction with investment appraisal techniques such as NPV and IRR. Looking at the BCG matrix negatively, it can: & Artificially categorize businesses in high and low categories for rela- tive market shares and growth rates when the reality is that many businesses have average classifications. & Be too simplistic to place a business in one of four cells (e.g. a market leader may be less profitable than a smaller rival). It may be more meaningful to analyse the movement of a portfolio company over a period of time to assess its general direction within the matrix. & Fail to determine which portfolio company provides the best return on an investment assuming finite resources are available. & Provide a blinkered perspective because relative market share and industry growth rates are too limiting in terms of their ability to capture the dynamics of strategic positions (e.g. a high relative market share does not guarantee high profitability because it assumes that there will be experience curve benefits and economies of scale). %  '  *  ( -) )   The industry attractiveness matrix is a nine cell model that quantifies long- term industry attractiveness on the vertical axis and competitive strength on the horizontal axis. As Figure 11.3 shows, long-term industry attractiveness is divided into high, medium and low attractiveness while competitive strength is divided into strong, average and weak strength. The two axes are derived from several factors that are individually weighted and rated, and once the factors have been given values and weighted a circle is placed on the matrix where the co-ordinates intersect, with the size of the circle being directly proportionate to the individual company's revenue contribution to the whole portfolio. . -     '  *  ( -) ) Industry attractiveness is an important factor within strategic analysis because attractive industries are seen to provide long-term growth opportunities and profit streams within the portfolio. The types of factors that impinge on industry attractiveness are: %  
+ " ,+    " + Business strength / competitive position G.E. industry Strong Average Weak    business strength 9 %&'   ()&    "" *'&+ 60 High &'   &   $ Source ,  Strategy 6 Formulation, Analytical Concepts   & Long term Medium 56 45 *   " ã  -" industry attractiveness ! &  ! / 3  &  0 '/1 &  ) &    & Low – High priority for investment 20 2 &&  – Medium priority for investment "  &  "( " 0 , -33 43 ##5$" – Low priority for investment 9 6 3 0 & Market size and predicted growth rates High rates of growth and large market shares are highly positive factors. & The intensity of competition A lack of competition will result in higher profit margins. & Emerging opportunities and threats Low threat levels and promising opportunities provide competitive advantages. & Capital requirements Can the company finance high-level capital programmes and will the return on capital be acceptable to shareholders? & Strategic fit Synergy with other members in the portfolio can pro- vide combinatory competitive advantages. & Profitability Margins and return on investment are directly affected by profits. & Social, political, environmental and regulatory factors Industries are affected by some or all of these factors and they can increase pres- sure on margins and profitability. & Risk and uncertainty High risk and uncertainty can result in busi- ness failure. & Cyclical and seasonal factors These factors can affect stability and cash flow. These types of industry attractiveness factors will then require weighting with the total weights being equal to 1. They are then rated with each factor having a value between 1 and 10. / -    ()  -)  )  0 Competitive strength factors are important because they influence a com- pany's ability to gain competitive advantage. By assessing the competitive strength of a company we can compare it to other companies in the same industry. The types of factors that affect competitive strength are: %%    ! "# & Relative Market Share This is the ratio of a company's market share by volume to its nearest rival (e.g. if a company has a 25 per cent share and its nearest rival has 50 per cent the R.M.S. is 0.5), and the higher the R.M.S. the greater its competitive strength compared to its rivals. & Ability to compete on cost This provides a strong competitive advan- tage over rivals. If competitors can achieve cost parity, then the time involved in achieving cost parity must be allowed for. & Ability to match rivals on key product and/or service attributes Quality, technology, reputation, etc., can affect customer demand and competi- tive advantage. & Influence and bargaining power over buyers and suppliers This can lower competition in the market place and provide competitive advantage. & Technology and innovation Being first to market with technologically advanced and innovative products can lead to competitive advan- tage (assuming resources are available to realize the advantage). & Branded image Strong brand names can command premium prices. & Matching the company's resources to key success factors in the industry When a company's strengths match industry key success factors a competitive advantage can be gained. & Profit margins relative to competitors Normally a direct result of suc- cessful cost competition. The weighting and rating of these factors can be applied in the same way as those for industry attractiveness. 3  ))     )  The correspondence of the industry attractiveness and competitive strength positions to the size of the consolidated scores are shown in the following table: Industry attractiveness Scores Competitive strength High Greater than 6.7 Strong Medium Between 3.3 and 6.7 Average Low Below 3.3 Weak Businesses that are positioned in the three top left cells of the nine cell matrix represent the greatest investment opportunities, with the top left cell (High± Strong) being the most attractive for the allocation of funds. The three cells running diagonally bottom left to top right have the next priority for investment, for they need a steady investment stream to maintain industry position and cash flows. The three cells in the bottom right section of the matrix have a low investment priority and may necessitate that the businesses be divested unless a specific investment opportunity can bring about a turnaround situation. %.  
+ " ,+    " +  "4) (*( )   A life cycle matrix places businesses within a 15 cell matrix with the intention of highlighting the position of each portfolio member within their respective industry life cycle. The horizontal axis rates the company's competitive posi- tion (strong, average, or weak) while the vertical axis in Figure 11.4 shows the stages in the industry life cycle from early development at the top of the matrix to stagnation and decline at the bottom. The numbers against each circle (portfolio company) denotes the industry size by value. Once the companies have been positioned on the matrix the information can be used to support strategic decision-making, especially for investment decisions. The matrix can be used in conjunction with other models and measures, which is important because it does not take into account the profitability of the portfolio companies. This would also support the analysis of strategic fit between portfolio members since the matrix only provides limited information for determining business strategies. The three matrices that have been outlined should be used to support strategic analysis and not as prescriptive and deterministic models. It is clearly important that the matrices use the most appropriate and up-to-date data. When used carefully, each of the matrices has strategic value, although the greatest benefit is gained when they are used together as this provides a broader picture of the strengths and weaknesses within the corporate portfolio. MEMBER'S COMPETITIVE POSITION STRONG AVERAGE WEAK Early development 12 Industry takeoff Rapid growth 58 THE LIFE-CYCLE    PORTFOLIO MATRIX %&'   ((   POSITION OF THE Competitive INDUSTRY IN THE shake-out Source ,  Strategy EVOLUTIONARY Formulation, Analytical LIFECYCLE Maturity 6 Concepts   & *   " ã  -" Market ! &  ! / saturation  &  0 '/1 &  ) &    & Stagnation / 2 &&  industry decline 23 "  &  "( " , -33 43 ##5$" %/    ! "#       !"  #   $ !"#% The appropriateness of product development and market development stra- tegies can be analysed using a four dimensional matrix that has the acronym SPACE (Rowe et al., 1994). It is a conceptual device for understanding the strategic posture of a business and the strategic options associated with such a posture. The usefulness of SPACE lies in its ability to position a business against four strategic dimensions, these being the financial strength of the business, the strength of the industry it operates in, the degree of stability within the general business environment, and the level of competitive advantage the business has compared to its rivals. Examples of how a business can score on the four dimensions are shown in Figure 11.5, and as can be seen, the profile of the business will be determined by its relative position on the four axes. Financial strength is deemed to be important because a business can better withstand adverse environmental conditions, such as high interest rates, if it has access to financial reserves. It also means that a business is in a better position, compared to a financially weak company, if it wants to diversify into more attractive industries or competitively undercut existing industry players. Industry strength focuses upon the attractiveness of the industry in terms of its growth potential and profitability. In an expanding industry, such as that Financial strength Financial strength 5 5 Conservative Aggressive posture 4 4 posture 3 3 2 2 1 1 Competitive Industry Competitive Industry advantage –5 –4 –3 –2 –1 1 2 3 4 5 strength advantage –5 –4 –3 –2 –1 1 2 3 4 5 strength –1 –1 –2 –2 –3 –3 –4 –4 –5 –5 Environmental stability Environmental stability   & Financial strength Financial strength , '   ( 0 5 5 ! '  4 4 Source   "6" 3 3 7 & "8" 9(: ;"" 2 2 7&& " " & 7 (:  Competitive 1 1 Industry Competitive Industry "6"