Answer Key Corporate Finance

STRATEGIC MANAGEMENT:

Lecture 1: The Concept of Strategy

Central to the success of a company is the ability to respond to events with flexibility and clarity of goals. In order to implement a solid strategy, we have to pay attention to 4 major points:

• Consistent and long-term goals
• Profound understanding of the competitive environment
• Objective understanding of resource availability
• Effective implementation

Generally strategy focus on two different forces:

• Internal: as goal and values, resource capabilities, structure and system
• External: as competitors, customers and suppliers.

We call strategic fit a strategy that is able to mix properly the internal and external forces that operates on a firm, so that the firm’s goal will be consistency in both the internal and external environment.
This means that there is no a single best way of organizing or managing a firm, but the strategy is determined by the environment and by the forces that acts on the specific firm. This theory is called contingency theory.

Strategy evolved its meaning during years. At first, known as financial budgeting, strategy was only a forecast of the profit and loss of each possible investment.
In the ’60, with the corporate planning, it started to evolve becoming a list of goal and changes that the firm should reach in 5 years.
However, after the oil shock of 1974, macroeconomic instability showed that the best thing for a firm was no longer to focus on a 5-years strategy, but to focus on the competitor in order to find a way to beat them on the market. This new kind of strategy is called strategic management.
During ’90 the focus of strategy shifted from the sources of profit in the external environment to the source of profit within the firm, creating the resource-based view of the firm.
After the 2008 crisis was clear to firms that market was no longer trustable and any kind of forecast of the future would have been inconsistent. For this reason the contemporary strategy focus on the capability of the firm to adapt and survive to turbulence, trying to create a flexible production system.

There are three main rules of strategy:

• Decision support: strategy is a pattern that gives coherence to the decisions of an organization. If all the employee have to attend to a common strategy, the firm can be sure that everybody will work to reach the same goals. Not having a strategy can create misunderstanding about the company’s goal.
• Coordinating device: strategy transport communication through all the company levels.
• Target: Strategy is forward looking, it concerns not only with how the firm compete now, but also how it will compete in the future. Without one the risk is to focus too much on the present without trying to find new business for the future.

In general, strategy have to answer to two different questions:

1. Where to compete        →                Corporate strategy
2. How to compete        →                 Business strategy

The creation of the strategy is not defined. It is a mix between the managers decision and the behaviour of the employee. We can summarize three way in which strategy can born:

• Intended strategy: is the strategy conceived by the leader or the tom management
• Emergent strategy: is the strategy that emerge from the decision and the behaviour that managers and employee have to take every day in order to adapt the original strategy to the circumstances.
• Realized strategy: is the actual strategy implemented is the result of a mix of the other two kind of

 strategy

In order to apply in a case study the strategy analysis, we have to follow 7 steps:

• Identify the current strategy
• Appraise performance: how well the current strategy is performing?
• Diagnose performance: why it is performing like that?
• Industry analysis: how is the environment? How is performing competitors?
• Analysis of resources and capabilities
• Formulate strategy
• Implement strategy

Lecture 2: Industry Analysis

The industry is the group of all the firm that operate in a specific environment. The industry analysis wants to understand the profitability of an industry studying the forces that operate on that specific market.
The most common industry analysis is called “PEST” and analyse the fifth most important external forces: Political, Economic, Social and Technological. PEST analysis and similar can be useful in keeping a firm alert to what it’s happening in the word. However the danger is that a continuous and systematic scanning on all the macroeconomics factor will be costly and my result in an overload of information.
In order to avoid this, the industry analysis has to be done only on the macroeconomics factor that affect directly the suppliers, the costumers or the competitor of our firm. This because the profits earned by the firms are determined by three factors: the value of the product to costumers, the intensity of competition, the power of suppliers.

The most important industry analysis is the Porter’s five forces that vies the profitability of an industry as result of five forces of competitive pressure. These are:

1. Substitutes: the price that costumers are willing to pay depends from the availability of substitute products. The presence of sever substitutes makes costumers more price sensitive and so they will switch to the concurrent if the price are too high
2. Threat of entry: when an industry has positive profits, it will attract new entries, that will take the price down. If, in order to start a business in the industry, there are several threat of entry, new entries will be discouraged and the profit in the industry will stay high.  
   Example of threat can be: capital requirements, economy of scale, absolute cost advantages, product differentiation, access to channels of distribution, legal barriers and retaliation (possibility that competitor, if a new entry comes, star a price war).
3. Competitors: the intensity of competition influence the profitability of the industry. The intensity is the result of interaction between six factors:

1. Concentration: rate between the number and size of the competitor and of the costumers. The lower the better.
2. Diversity of competitors: more are different, more is difficult that costumers will switch easily from one to another (and so higher revenue).
3. Product differentiation
4. Excess capacity or exit barriers: in presence of these two things, competitor will have advantages more from selling product at a lower price than from retiring.
5. Cost conditions: scale economies and ratio between fixed and variable costs: the more flexible the best.

1. Costumers: is the power of buyer. It depends on two factors:

1. Price sensitivity
2. Bargaining power: the realism of the bargaining from costumers depends from:

1. Size and concentration of buyers and suppliers
2. Buyers information
3. Capacity of vertical integration

1. Suppliers: as the costumer, but in an opposite way. In this moment the firm is the costumer.

With this analysis we can try to forecast an industry profitability. But the fifth forces analysis tell us only the present profitability. Because the profitability of an industry is determined from its structure, in order to find the future profitability we have to:

• Examine how the industry’s levels of competition and profitability are a consequence of its present structures.
• Identify the trends that are changing in the industry’s structures
• Identify how these structural changes may affect the five forces competition

Generally, a good profitability can be made thanks to an architectural advantage: this is an advantages that a firm reach thanks to the industry structure. In average, the pioneer of the industry has this advantages because, when he was alone on the market, he had the chance to build the industry on the basis of his internal structures.
Anyway there are some way to change the industry structure – and so to make an architectural advantage.