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Financial Analysis > Week 2 > Flashcards

Week 2 Flashcards

1
Q
A
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2
Q

Three Key Strategic Considerations

A
  1. What business activities is the firm engaged in?

– Industry membership(s)

  1. How does the firm attempt to compete with other industry members?

– Competitive strategy

  1. How does the firm attempt to add value by operating in multiple business areas?

– Corporate strategy

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3
Q

Porter’s 5 Forces Framework

What are the 5 forces

A
  1. Rivalry among existing firms
  2. Threat of new entrants
  3. Threat of substitute products
  4. Bargaining power of buyers
  5. Bargaining power of suppliers
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4
Q

Porter’s 5 Forces Framework

These 5 forces can be further divided into

A

– Forces affecting the degree of actual and potential competition in the industry

– Forces affecting the bargaining power of buyers and suppliers within the industry

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5
Q

A company’s ‘moat’

A

A company’s immunity to competition, and thus its predicted ability to sustain higher growth, higher profit margins etc in the future.

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6
Q

Describe wide moat firms

A

have unique skills or assets allowing them to stay ahead of competition and earn above average profits for many years

Returns exceed cost of capital

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7
Q

Competitive Force 1: Rivalry Among Existing Firms

Higher degrees of competition among existing firms

A

– Push prices towards the marginal cost of production (i.e. down)

– Differentiation is important e.g. perceived product quality

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8
Q

Competitive Force 1: Rivalry Among Existing Firms

What determines intensity of competition within an industry?

A

– Industry growth rate

– Concentration and balance of competing firms

– Level of differentiation and switching costs

– Scale/Learning economies and ratio of fixed to variable costs

– Excess capacity and exit barriers.

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9
Q

Competitive Force 1: Rivalry Among Existing Firms

How Industry Growth Rate can influence competition among firms

If industry is stagnant

A

if industry is stagnant, competition will be fierce, as existing firms fight for ‘slice of the same pie’

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10
Q

Competitive Force 1: Rivalry Among Existing Firms

How Industry Growth Rate can influence competition among firms

If industry is growing rapidly

A

If industry is growing rapidly, there is room for each firm to increase sales, so normally less price pressure.

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11
Q

Competitive Force 1: Rivalry Among Existing Firms

How Concentration and Balance of Competitors can influence competition among firms

A

– How many firms in industry?

– Are there a couple of really big players?

• If a small number of firms hold considerable market share, competition may be less severe (or may have less severe implications for profit margins)

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12
Q

Competitive Force 1: Rivalry Among Existing Firms

Product Differentiation Determine intensity of competition?

A

if products sold are almost identical >>>>higher competition

– If products sold differ in actual or perceived quality, the extent to which a competitor’s product is a potential substitute for your product decreases

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13
Q

Competitive Force 1: Rivalry Among Existing Firms

Switching Costs Determine intensity of competition?

what is Switching costs

A

costs imposed on the customer if the customer changes suppliers

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14
Q

Competitive Force 1: Rivalry Among Existing Firms

Switching Costs Determine intensity of competition?

Low switching costs

A

Low switching costs increase competition

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15
Q

Competitive Force 1: Rivalry Among Existing Firms

Switching Costs Determine intensity of competition?

High switching costs

A

High switching costs decrease competition

• E.g. Payroll outsourcing firms

– Expensive for customer to have to set up their own payroll department

• Microsoft

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16
Q

Competitive Force 1: Rivalry Among Existing Firms

Scale/Learning Economies and Cost Structure Determine intensity of competition?

Economies of Scale exist where

A

Economies of Scale exist where the average cost per unit of production declines as output increases

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17
Q

Competitive Force 1: Rivalry Among Existing Firms

Scale/Learning Economies and Cost Structure Determine intensity of competition?

If scale economies are very important in an industry,

A

there will be high competition among existing firms, because changes in market share will have a larger relative effect on profit margins

18
Q

Competitive Force 1: Rivalry Among Existing Firms

Scale/Learning Economies and Cost Structure Determine intensity of competition?

Scale economies also sometimes

A

impose barriers to entry, which affects the level of competition from newcomers

19
Q

Competitive Force 1: Rivalry Among Existing Firms

Excess Capacity and Exit Barriers:Determine intensity of competition?

– If competitors have excess production

A

If competitors have excess production capacity, they may have incentive to expand output and sell at a price just above incremental cost, driving prices down

20
Q

Competitive Force 1: Rivalry Among Existing Firms

Excess Capacity and Exit Barriers:Determine intensity of competition?

Exit barriers also increase competition

A

and include the existence of specialised assets:

• Assets for which the next best use is relatively low (e.g. Machinery specialised to the manufacture of a particular product). These assets will not be worth much on the open market if their current mode of use becomes economically unattractive.

21
Q

Competitive Force 2: Threat of New Entrants

A

The ease with which a new (or outside) firm can enter an industry will affect the profitability of firms already operating in the industry.

22
Q

Competitive Force 2: Threat of New Entrants

Factors affecting the barriers to entry include

A

– Economies of scale
– First mover advantage
– Relationships with suppliers and customers

– Legal barriers.

23
Q

Competitive Force 2: Threat of New Entrants

Factors affecting the barriers to entry include

Economies of Scale

If economies of scale are high:

A
  • a new competitor, operating at low volume will struggle to be profitable
  • To achieve minimum optimal scale, competitors need to access to lots of $$$$ of finance, which may be hard to obtain from external sources (e.g. banks, equity investors)
24
Q

Competitive Force 2: Threat of New Entrants

Factors affecting the barriers to entry include

Economies of Scale

If economies of scale are high:

A
  • a new competitor, operating at low volume will struggle to be profitable
  • To achieve minimum optimal scale, competitors need to access to lots of $$$$ of finance, which may be hard to obtain from external sources (e.g. banks, equity investors)
25
Q

Competitive Force 2: Threat of New Entrants

Factors affecting the barriers to entry include

Economies of Scale normally have 2 effects

A

1) Greater economies of scale normally increase competition among firms already in an industry
2) Greater economies of scale normally decrease the threat of entry of new firms to an industry

Greater number of existing competitors usually causes 1) to dominate, and vice versa.

26
Q

Competitive Force 2: Threat of New Entrants

First Mover Advantage

A

Successful first movers may discourage competition

• being the first to bring a specific product or service to market.

enables a company to establish strong brand recognition and customer loyalty before other entrants to the market arise. Another advantage is the additional time a first mover business has to perfect or improve its product or service.

– Advantage is higher when switching costs are high (high cost for customers to switch brands)

• E.g. Computer operating systems

27
Q

Competitive force 2 Threat of New Entrants contd.

• Relationships with Suppliers and Customers

suppliers?

A

Access to distribution channels (shelf space)

arrangements with retailers

28
Q

Competitive force 2 Threat of New Entrants contd.

• Relationships with Suppliers and Customers

Access to necessary inputs

A

requirements for highly skilled labour, specialised materials may deter entry, because those inputs may be very difficult or costly for an outsider to acquire

29
Q

Competitive force 2 Threat of New Entrants contd.

Legal Barriers

A

Regulation may directly impair ability of potential competitors to enter

30
Q

Competitive Force 3: Threat of Substitute Products

A

Referring to the threat of products which satisfy a similar consumer demand E.g. Laptop computers v smart phones v tablets • Considerable overlap in functionality

31
Q

Competitive Force 3: Threat of Substitute Products

The degree to which substitute products or services exist

A

affects the industry’s bargaining power with suppliers and customers, and ultimately profitability, depends upon:

– the relative price and performance of competing products or services

– the willingness of customers to accept substitutes/ to switch

32
Q

Competitive Force 4:Bargaining Power of Buyers

A

Buyer bargaining power can exert downward pressure on prices

33
Q

Competitive Force 4:Bargaining Power of Buyers

Factors that can affect this bargaining power are

A
  • Switching cost
  • Differentiation

– Buyer price sensitivity to product or service

– How many buyers are there, volume of buyers

• If your firm’s only product is an electronic component only useable in Apple computers, there will be v. strong downward price pressure.

34
Q

Competitive Force 5:Bargaining Power of Suppliers

A

Suppliers have bargaining power when there are few substitutes and/or few suppliers relative to the number of customers demanding a product or service.

  • Ownership of telecommunications infrastructure
  • Suppliers with control of scarce natural resources
35
Q

Competitive Strategy Analysis

Competitive strategy: Cost leadership

A

supply same product at lower cost

economies of scale and scope, simpler product design, efficient production, lower input cost, low cost distribution, tight cost control system

36
Q

Competitive Strategy Analysis

Competitive strategy: Differenctiation

A

supply unique product at cost less than price premium customers are willing to pay

superior quality, customer service, investment in brand image, investment in r&d control system focus on creativity and innovation

37
Q

The likelihood of achieving and sustaining competitive advantage must be evaluated.

• Factors to evaluate include:

A
  1. Resources and capabilities available to implement strategies
  2. Whether the firm’s activities, infrastructure, and other operating elements consistent with its competitive strategy.
38
Q

The likelihood of achieving and sustaining competitive advantage must be evaluated.

• Factors to evaluate include:

Resources & Capabilities Needed

Cost-leader

A

– Sustained access to finance
– Engineering and human process mgmt skills – Low-cost distribution system

39
Q

The likelihood of achieving and sustaining competitive advantage must be evaluated.

• Factors to evaluate include:

Resources & Capabilities Needed

Differentiated Firm

A

– Marketing Skills/Awareness

– Access to finance to fund investment in Brand Name

– Product engineering skills

– Reputation for quality or leadership

40
Q

Corporate Strategy

The Downside of Combination

A

More expensive to control the firm’s operations as the range of different activities increases

• Inefficiencies associated with monitoring diverse activities are a type of ‘bureaucratic cost’

41
Q

Corporate Strategy

Benefits of Combination

A

Vertical integration

– more efficient to produce own factor inputs

– May provide more reliable supply chain where timing of supply is crucial

42
Q

Corporate Strategy

Benefits of Combination

Intangibles

A

• Intangibles may be valuable to numerous business lines

– Brand names

– Proprietary knowledge relevant to a number of products

– Economies of scope across production of different goods

Financial Analysis (10 decks)

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