ACCT3013 Lec 1 Intro and Business Strategy Analysis

Question 1

What is the PRIMARY ROLE of financial statements and accounting?

Answer 1

To measure and convey the monetary effect of business FUNDAMENTALS to external stakeholders.

Question 2

What does FIRM FUNDAMENTALS mean?

Answer 2

“Raison d’etre” reason for being for a firm.

e.g. product quality, customer base, pricing, technological base, capacity to innovate, intellectual property, supply chain efficiency, market share, human capital etc.

Question 3

What are the strengths of ACCRUAL ACCOUNTING? (2)

Answer 3

1. Necessary for timely allocation of resource exchange.

2. Thus reflects real expectations of economic performance.

Question 4

What are the problems of accrual accounting?

Answer 4

1. Largely subjective process, many assumptions, measurement is highly controversial.
2. Underlying flexibility gives opportunity for (intentionally incentivized / unintentional) misrepresentation. (e.g. ask 5 accountants to value the same IP).
3. Allows management to be selective of which information to report in accordance to their interpretation of what is reliable and relevant info.

Question 5

What is RELIABILITY and RELEVANCE?

Answer 5

• The extent to which info is verifiable, representationally faithful, neutral (e.g. historical cost).
• extent to which info has an impact on timely decision making, and possess predictive value (e.g. mark-to-market).

Question 6

What is the SIGNALLING PROBLEM?

Answer 6

Management must also find balance between conveying enough value-relevant info BUT without giving away too much proprietary data.

Question 7

What is the conflict between reliability and relevance? Give an example.

Answer 7

• Many info may be relevant and impact decision making when provided sooner than later, however early release of info may be under great UNCERTAINTY and risks being unreliable.
• Info is reliable when it is accurate and truthful, but waiting to learn more about it accuracy risks losing its relevance.
  e. g. Retail company suspects increase in bad debts because of credit crunch period (too lenient in borrowing) but no idea extent of the damage, only historical estimates.

Question 8

What is the key to understanding competitive forces and the risk / return profile of a business in terms of fundaments?

Answer 8

Its relative standing within the industry… …

which can be analysed by PORTER’s 5 FORCES.

Question 9

What is the highest level classification of industry? (5)

Answer 9

1. Primary - Extraction
2. Secondary - Manufacturing
3. Tertiary - Services
4. Quaternary - Knowledge
5. Quinary - Culture and research

Question 10

What is the HIERARCHY of industry? (6)

Answer 10

Economic activities - industries - divisions - branches - line of business - even finer specialisations.

Question 11

Why is defining industry classification important?

Answer 11

to COMPARE companies! Performance is relative!

• Industry classification lets us understand the pressures and challenges faced by businesses, in terms of access to resources, supply chain, customer base, and above all COMPETITION .

Question 12

Main demand for goose meat is festive occasions. Can also produce down and feathers which are in constant demand for quilts and cushions.

Which competitors would you compare performance of a SINGLE geese producer?

Answer 12

Turkey - similar characteristics, turkey down and feathers, consumed at similar times.

Question 13

How should industry be defined? Why?

Answer 13

In terms of COMPETITION!

Degree of INDUSTRY CONCENTRATION determines the aggregate ECONOMIC RENTS (overall market profit).

Monopoly (max eco rent, disincentive to produce) - duopoly (incentive to drop price) - oligopoly - perfect competition (0 eco rent, profit = marginal cost of production).

Question 14

What are the 2 important questions in business strategy analysis?

Answer 14

1. What creates competition within this industry?

2. How is the economic rent shared?

Question 15

What is the 1st critical factor that determines the degree of RIVALRY AMONGST COMPETITORS?

• How can companies differentiate themselves when core products are the same?
• What should non-differentiable retailers invest in?
• What is the impact of internet aggregators?

Answer 15

1. PRODUCT DIFFERENTIATION
   * by-products / services surrounding the core product become a critical factor for differentiation. (e.g. Airlines which compete for same flight route differentiate on the basis of in-flight entertainment, loyalty reward programs.)
   * Non-differentiable retailers should have competitive prices and invest to enable LOW SWITCHING COSTS. (e.g. Coles + WW always in same location).
   * Internet aggregators (e.g. trivago.com) have made it easy to switch on the basis of cost, everything else held equal.

Question 16

What is the 2nd critical factor that determines the degree of RIVALRY AMONGST COMPETITORS?

Answer 16

2. INDUSTRY GROWTH RATE
   * The bigger the market potential the more there is to SHARE. Greater the attraction of NEW ENTRANTS.
   e. g. Fast growing industries like technology, rivals not only compete on existing market shares but also focus on attracting new customers from UNTAPPED DEMOGRAPHICS.

Question 17

How do companies justify scaling up?

Answer 17

Companies can only justify scaling up by economies of scale, otherwise you are becoming double as risky.

Economies of scale determine the COST ADVANTAGE of growing.

Question 18

What is UNTAPPED CAPACITY in an industry?

Answer 18

The excess available demand volume of an industry.

• Suggests that firms are currently underproducing below their capacity.
• The greater the excess capacity the more incentive there is for competition leading to reduced prices. Greater the attraction NEW ENTRANTS.
  e. g. Why China shuts down steel companies to maintain higher prices.

Question 19

Alot of the rivalry factors also determine the extent of potential threat from new entries (e.g. industry growth, excess capacity).

What is the main barrier to entry relevant to the THREAT OF NEW ENTRANTS?

Answer 19

The lower the scale and the lower the ratio of fixed to variable assets will attract more new entries and would be quicker for them to become competitive.

e.g. Energy production industry extremely hard to build competition from scratch, hence preferred to enter through M&A’s.

Question 20

What is FIRST MOVERS ADVANTAGE?

Answer 20

First movers create markets / industries, so they have the advantage of determining the “rules of the game” such as professional and technological standards. Also enjoy long-term brand awareness.

e.g. QWERTY keyboard, Apple, Jeep.

Question 21

What determines the BARGAINING POWER OF BUYERS?

Answer 21

Buyers have strong bargaining power when SWITCHING COSTS are low, and they can see through COST STRUCTURE of a product.

Which is why most of consumables today focus their strategy on MARKETING AND PACKAGING.

Marketing is value-relevant! e.g. Panadol neck = normal panadol.

Question 22

What determines BARGAINING POWER OF SUPPLIERS.

Answer 22

Suppliers have strong bargaining power when they have access to a UNIQUE NODE in the SUPPLY CHAIN.

e.g. Vertical combinations eliminate supply chain costs and INFO ASYMMETRIES, and makes supply chain INACCESSIBLE to competitors.