From Financial Statement to Business Analysis

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From Financial Statementto Business Analysis

Financial Statement Distortion and noiseTrue information

Intermediaries rely on their knowledge of the firm’s industry and its competitive strategy

Step 1: Business strategy analysis

Step 2: Accounting analysis

Step 3: Financial analysis

Step 4: Prospective analysis

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Business strategy analysis(step 1)

Key profit drivers SustainabilityKey risks

Key Drivers

Cellular phones

Internet commerce

Pharmaceuticals

Retail

Fashion clothing

Non-fashion clothing

Beverages

Population coverage and churn rates

Hits per hour

Research and development

Retail space and sales per square foot

Brand management and design

Production efficiency

Brand management and production innovation

KEY ECONOMIC FACTORSINDUSTRY

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Business strategy analysis

Profit in excess of the cost of capital

own strategic choices

Industry analysis

Competitive strategyanalysis

Corporate strategyanalysis

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Business strategy analysis:Industry analysis

Degree of actual and potential competition

Bargaining power in input and output markets

Bargaining power of buyers(4)

Bargaining power of suppliers(5)

Rivarly among existing firms(1)

Threat of new entrants(2)

Threat of substitute products(3)

Industry profitability“FIVE FORCES”

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• Industry growth rate• Concentration and balance of competitors• Degree of differentiation and switching costs• Scale/learning economies and the ratio of fixed to variables costs• Excess capacity and exit barriers

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• Economies of scale• First mover advantage• Access to channels of distribution and relationship• Legal barriers


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• Perform the same function• Technologies that allow to use less of existing product• Customer’s willingness to substitute (brand, design…)


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• Price sensitivity : Switching costs Differentiation Importance of product to the cost structure

• Relative bargaining power: Number of buyers relative to the number of suppliers Volume per buyer Threat of backward integration by the buyers


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• Price sensitivity : Switching costs Differentiation Importance of product to the cost structure

• Relative bargaining power: Number of buyers relative to the number of suppliers Volume per suppliers Threat of forward integration by the suppliers


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The European Airline Industry

• In the early 1980s: highly regulated (routes and fares);• From 1987 to 1997: EU liberalized the industry, reduced government intervention;• In 1980: the four largest European airlines carried 54 million passengers;• In 2000: the same airlines carried 147 million passengers;• … the industry exhibited steady growth;• In the early 2000’s: many of the largest European airlines reported poor performance;• … other national carriers went bankrupt…

WHY?

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• Growth: annual average 5% between 1995 and 2004. Negative growth after 11/09/01;• Concentration: fragmented industry; liberalization of the market; State subsidies;• Differentation and switching cost: virtually identical flights;• Structural excess capacity problem: the annual passenger load factor was 72% (1995-2004).

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• 1993: Change in system used to allocate time slots among the airlines;• Use of smaller airports in order to enter the market;• Easy access to capital. Second-hand aircraft;• After 1997: no legal barriers. Possibility to freely operate on any route within the EU;• Substitute products: High-speed rail network.


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• 90% of aircraft came from two commercial aircraft manufacturers (Airbus, Boeing);• Fluctuations in fuel market price;• Significant power of airline employees (threat of strike…);• Web booking systems made market prices transparent



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The memory chip industry

One of the fastest growing industies in the last twenty years is the memory chip industry.

Yet the average profitability has been very low.

What are the potential factor that might explain this apparent contradiction?

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The memory chip industry• Low concentration;• Few barrier to entry; • Low differentation;• Low switching costs;• High fixed costs and low variable costs;• Presence of scale and learning economies;• Excess capacity;• No access needed for distribution;•High importance of product for cost






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Business strategy analysis:Competitive strategy analysis

Two generic competitive strategies

Sustainablecompetitive advantage

COST LEADERSHIP DIFFERENTIATION

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COST LEADERSHIP

• Economies of scale and scope• Efficient production• Simpler product design• Lower input costs• Low-cost distribution• Little research and development or brand advertising• Tight cost control system

Supply same product or service at a lower cost

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• Superior product quality• Superior product variety• Superior customer service• More flexible delivery• Investment in brand image• Investment in research and development• Control system focus on creativity and innovation

DIFFERENTIATION

Supply a unique product or service at a cost lower than the price premium customers will pay

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Core competencies Value chain

… the extent to which it is difficult for competitors to imitate them…

The sustainability of a

firm’s competitive advantage

• What are the key success factors and risk associated with the firm’s chosen competitive strategy?• Does the firm currently have the resources and capabilities to deal with the key success factors and risks?• Are there any barriers that make imitation of the firm’s strategy difficult?• Are there any potential changes in the firm’s industry structure that might dissipate the firm’s competitive advantage?• Is the company flexible enough to adress these changes?

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The sustainability of a firm’s competitive advantageIn the early 1980s, United, Delta and American Airlines each started frequent flier programs

as a way to differentiate themselves in response to excess capacity in the industry.

What happened?

• Airlines anticipated that the programs would fill seats that would otherwise have been empty and hence would have had a low marginal cost;

• However, because the costs of implementing a program were low, there were few barriers to other airlines starting their own frequent flier programs;

• Before long, every airline had a frequent flier program with the same requirements for earning free air travel;

• Simply having a frequent flier program no longer differentiated airlines!

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IKEA

• 1953: founded by Ingvar Kamprad as a mail-order company;• 1960s: started to develop its operating concept: selling flat-packed furniture through large warehouse store;• 1960s: started to expand internationally;• IKEA’s average growth rate between 1999 and 2005 was approximately 11%;• For the 2005 fiscal year IKEA achieved € 15.2 billion in revenues;• Its profit margin was well above those of some of IKEA’s larger competitors;• One of the world’s largest forniture retailers.

How did IKEA achieve such performance?

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Low-cost competitive strategy

GLOBAL STRATEGYIn 33 countries it targetsthe same customer group

(young families and couples)

SOURCING OF PRODUCTIONA network of 1,300 suppliers in 53 country.Often it is a manufacturer’s sole customer

ECONOMIC DESIGNSIts designers find the most economic

design solution

LOGISTICSLarge warehouse stores outside

the city centers.Forniture in flat-pack format.

SALESCustomers need little assistance.

Limited after-sales service.Minimum personnel expenses.

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competitive advantage

forniture design store design logistics

Over the years, IKEA had made large investments in knowledge of low-cost

the business model was very difficult to replicate

No competitors has been able to replicate the business model on a similar scale

sustainable

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IKEA’s strategy exhibits somecharacteristics of a differentiation strategy

In 2005, IKEA’s brand was estimated at € 7.8 billion.It’s a cult brand.

Strength of retailer’s brand name

Diversityin its assortment

Distinctivenessof its design

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Business strategy analysis:Corporate strategy analysis

Multibusiness organizations

evaluate the industries and strategies of the individual business units

evaluate the economic consequences of managing all the businesses under

one corporate umbrella

Organization’s ability to create value through a broad corporate scope

… the transaction cost of performing a set of activities inside the firm versus using the market mechanism

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Transaction inside an organization may be less costly than market-based transaction

Nontradable or nondivisible asset

Critical role of theHeadquarters office

Empirical evidence suggests…

Communication costs

… it’s difficult to create value through a multibusiness corporate strategy

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EASYGROUP

• 1995: easyJet started operations as a low-fare short-haul airline company;

• 2000: 28% of its share was placed on the LSE at an amount of £ 224 million;

• From 1997 to 2005: EasyJet’s revenues increased from £ 46 to £ 1,341 million;

• Stelios Haji-Ioannou , the founder of EasyJet, streched the “easy” brand name to other industries;

• Competitive strategy: web-booking in advance, no-frills services, bypass intermediaries, tight control over costs.;

• Following this strategy, EasyGropu expanded into car rental, pizza delivery bus transport, cinemas, hotels.

How could EasyGroup create value through its broad corporate?

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Business strategy analysis: Corporate strategy analysis

Diversification

Established reputation in offering no-frills services at low prices

Expertise in flexible pricing and online selling

Revenues from licensingthe “easy” brand

Brand-stretching can help to economize on advertising

There were also signs that EasyGroup was expanding too rapidly and thatits diversification beyond air travel was likely to fail.

Documents

From Financial Statement to Business Analysis