Financial Management Chapter 3

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Education.

Assessing the Internal Environment of the Firm

chapter 3

Learning Objectives

After reading this chapter, you should have a good understanding of:

LO3.1 The benefits and limitations of SWOT analysis in conducting an internal analysis of the firm.

LO3.2 The primary and support activities of a firm’s value chain.

LO3.3 How value-chain analysis can help managers create value by investigating relationships among activities within the firm and between the firm and its customers and suppliers.

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Learning Objectives

LO3.4 The resource-based view of the firm and the different types of tangible and intangible resources, as well as organizational capabilities.

LO3.5 The four criteria that a firm’s resources must possess to maintain a sustainable advantage and how value created can be appropriated by employees and managers.

LO3.6 The usefulness of financial ratio analysis, its inherent limitations, and how to make meaningful comparisons of performance across firms.

LO3.7 The value of the “balanced scorecard” in recognizing how the interests of a variety of stakeholders can be interrelated.

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The Importance of the Internal Environment

Consider…

Which activities must a firm effectively manage and integrate in order to attain competitive advantages in the marketplace?

Which resources and capabilities must a firm create and nurture in order to sustain a competitive advantage?

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The Limitations of SWOT Analysis

Strengths may not lead to an advantage SWOT’s focus on the external

environment is too narrow SWOT gives a one-shot view of a moving

target SWOT overemphasizes a single

dimension of strategy

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Value-Chain Analysis

Value-chain analysis looks at the sequential process of value-creating activities Value is the amount buyers are willing to

pay for what a firm provides How is value created within the organization? How is value created for other organizations

in the overall supply chain or distribution channel?

The value received must exceed the costs of production

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Example: Streamlining the Value Chain

IBM & SAP have teamed up to help firms reduce value chain inefficiencies & improve operational effectiveness

Benefits of value chain streamlining: Commonality between parts & suppliers Integration of sales forecasting & inventory

management Lowered transaction, infrastructure &

operating costs Deliver products to market faster

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Value-Chain Analysis

Primary activities contribute to the physical creation of the product or service; the sale & transfer to the buyer; and service after the sale: Inbound logistics Operations Outbound logistics Marketing & sales Service

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Question?

In assessing its primary activities, an airline would examine:

A. Employee training programs

B. Baggage handling

C. Criteria for lease versus purchase decisions

D. The effectiveness of its lobbying activities

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Value-Chain Analysis

Support activities either add value by themselves or add value through important relationships with both primary activities & other support activities: Procurement Technology development Human resource management General administration

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The Value Chain

Exhibit 3.1 The Value Chain: Primary and Support ActivitiesSource: Reprinted with permission of The Free Press, a division of Simon & Schuster Inc., from Competitive Advantage: Creating and Sustaining Superior Performance by Michael E. Porter. Copyright © 1985, 1998 by The Free Press. All rights reserved.

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Primary Activity: Inbound Logistics

Inbound logistics is primarily associated with receiving, storing & distributing inputs to the product: Material handling Warehousing Inventory control Vehicle scheduling Returns to suppliers

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Primary Activity: Operations

Operations include all activities associated with transforming inputs in to the final product form: Machining Packaging Assembly Testing or quality control Printing Facility operations

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Primary Activity: Outbound Logistics

Outbound logistics includes collecting, storing, & distributing the product or service to buyers: Finished goods Warehousing Material handling Delivery vehicle operation Order processing Scheduling & distribution

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Primary Activity: Marketing & Sales

Marketing & sales activities involve purchases of products & services by end users and includes how to induce buyers to make those purchases: Advertising Promotion Sales force management Pricing & price quoting Channel selection Channel relations

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Primary Activity: Service

Service includes all actions associated with providing service to enhance or maintain the value of the product: Installation Repair Training Parts supply Product adjustment

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Support Activity: Procurement

Procurement involves how the firm purchases inputs used in its value chain: Procurement of raw material inputs

Optimizing quality & speed Minimizing associated costs

Development of collaborative win-win relationships with suppliers

Analysis & selection of alternative sources of inputs to minimize dependence on one supplier

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Support Activity: Technology Development

Technology development is related to a wide range of activities: Effective R&D activities for process &

product initiatives Collaborative relationships between R&D

and other departments State-of-the-art facilities & equipment Excellent professional qualifications of

personnel Organizational culture to enhance creativity

& innovation

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Support Activity: Human Resource Management

Human resource management consists of activities involved in recruitment, hiring, training & development, & compensation of all types of personnel: Effective employee retention mechanisms Quality relations with trade unions Reward & incentive programs to motivate

all employees

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Support Activity: General Administration

General administration involves Effective planning systems to attain overall

goals & objectives Excellent relations with diverse stakeholder

groups Effective information technology to

coordinate & integrate value-creating activities across the value chain

Ability of top management to anticipate & act on key environmental trends & events, create strong values, culture & reputation

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Interrelationships Among Value-Chain Activities

Interrelationships among activities within the firm

Relationships among activities within the firm and with other stakeholders such as customers & suppliers

Managers must not ignore the importance of interrelationships among value-chain activities

Expand the

value chain

by

exchanging

resources

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Example: The Value Chain in Service Organizations

Exhibit 3.4 Some Examples of Value Chains in Service Industries

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Resource-Based View of the Firm

The resource-based view of the firm (RBV) Combines an internal analysis of phenomena

within a company With an external analysis of the industry & its

competitive environment Resources can lead to a competitive

advantage If they are valuable, rare, hard to duplicate When tangible resources, intangible resources, &

organizational capabilities are combined

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Types of Firm Resources

Tangible resources are assets that are relatively easy to identify: Physical assets: plant & facilities, location,

machinery & equipment Financial assets: cash & cash equivalents,

borrowing capacity, capacity to raise equity Technological resources: trade secrets,

patents, copyrights, trademarks, innovative production processes

Organizational resources: effective planning processes & control systems

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Types of Firm Resources

Intangible resources are difficult for competitors to account for or imitate – are embedded in unique routines & practices: Human resources: trust, experience &

capabilities of employees; managerial skills & effectiveness of work teams

Innovation resources: technical & scientific expertise & ideas; innovation capabilities

Reputation resources: brand names, reputation for fairness with suppliers; reliability & product quality with customers

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Types of Firm Resources

Organizational capabilities are competencies or skills that a firm employs to transform inputs into outputs; the capacity to combine tangible & intangible resources to attain desired ends Outstanding customer service Excellent product development capabilities Superb innovation processes & flexibility in

manufacturing processes Ability to hire, motivate, & retain human

capital

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Question?

Gillette combines several technologies to attain unparalleled success in the wet shaving industry. This is an example of their

A. tangible resources.B. intangible resources.C.organizational capabilities.D.strong primary activities.

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Firm Resources and Sustainable Competitive Advantages

Strategic resources have four attributes: Valuable in formulating & implementing

strategies to improve efficiency or effectiveness

Rare or uncommon; difficult to exploit Difficult to imitate or copy due to

physical uniqueness, path dependency, causal ambiguity, or social complexity

Difficult to substitute with strategically equivalent resources or capabilities

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Sources of Inimitability

Physical uniqueness: resources that are physically unique

Path dependency: scarce because of all that has happened along the path followed in a resource’s development and/or accumulation

Causal ambiguity: impossible to explain what caused it to exist or how to re-create it

Social complexity: a result of social engineering such as interpersonal relations

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Criteria for Sustainable Competitive Advantage

Exhibit 3.7 Criteria for Sustainable Competitive Advantage and Strategic ImplicationsSource: Adapted from Barney, J.B. 1991. Firm Resources and Sustained Competitive Advantage. Journal of Management, 17:99 – 120.

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The Generation and Distribution of the Firm’s

Profits Four factors help explain the extent to

which employees and managers will be able to obtain a proportionately high level of the profits that they generate: Employee bargaining power Employee replacement cost Employee exit costs Manager bargaining power

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Evaluating Firm Performance

Balance sheet Income statement Market valuation Historical comparison Comparison with

industry norms Comparison with key

competitors

Employees Owners Customer satisfaction Internal processes Innovation, learning &

improvement activities Financial perspectives

Financial Ratio Analysis

Balanced Scorecard Stakeholder Perspective

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Financial Ratio Analysis

Five types of financial ratios Short-term solvency or liquidity Long-term solvency measures Asset management or turnover Profitability Market value

Meaningful ratio analysis must include: Analysis of how ratios change over time How ratios are interrelated

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Five Types of Financial Ratios

Exhibit 3.9 A Summary of Five Types of Financial Ratios

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The Balanced Scorecard

A meaningful integration of many issues that come into evaluating performance

Four key perspectives: How do customers see us? (customer

perspective) What must we excel at? (internal

perspective) Can we continue to improve and create

value? (innovation & learning perspective) How do we look to shareholders? (financial

perspective)

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Customer Perspective

Managers must articulate goals for four key categories of customer concerns: Time Quality Performance and service Cost

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Internal Business Perspective

Managers must focus on those critical internal operations that enable them to satisfy customer needs: Business processes

Cycle time, quality, employee skills, productivity

Decisions Coordinated actions Key resources and capabilities

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Innovation and Learning Perspective

Managers must make frequent changes to existing products & services as well as introduce entirely new products with extended capabilities. This requires: Human capital (skills, talent, knowledge) Information capital (information systems,

networks) Organization capital (culture, leadership)

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Financial Perspective

Managers must measure how the firm’s strategy, implementation, and execution are indeed contributing to bottom line improvement. Financial goals include: Profitability, growth, shareholder value Improved sales Increased market share Reduced operating expenses Higher asset turnover

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Limitations of the Balanced Scorecard

Not a “quick fix” – needs proper execution

Needs a commitment to learning Needs employee involvement in

continuous process improvement Needs cultural change Needs a focus on nonfinancial rather

than financial measures Needs data on actual performance

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