Learning MBA Master Degree

TEACHER: Hi, Student. Let’s continue our discussion on Company Situation Analysis. Do you recall what we were discussing at the end of last Module?

STUDENT: We were talking about value chain analysis and how useful it is for evaluating a company’s cost effectiveness compared with its rivals.

TEACHER: True. However, there's more to strategic cost analysis and a company's cost competitiveness than just comparing the costs of activities comprising rivals' value chains. Competing companies often differ in their degrees of vertical integration. Comparing the value chain for a partially integrated rival against a fully integrated rival requires adjusting for differences in scope of activities performed. Can you think of other factors that may explain cost differences?

STUDENT: Nowadays it is very common to outsource activities. Maybe uncompetitive prices can have their origins in activities performed by suppliers or by forward channel allies involved in getting the product to end-users.

TEACHER: Correct. Suppliers or forward channel allies may have excessively high cost structures or profit margins that jeopardize a company's cost competitiveness even though its costs for internally performed activities are competitive. For example, when determining Michelin's cost competitiveness vis-à-vis Goodyear and Bridgestone in supplying replacement tires to vehicle owners, one has to look at more than whether Michelin's tire manufacturing costs are above or below Goodyear's and Bridgestone's.

If a buyer has to pay $400 for a set of Michelin tires and only $350 for comparable sets of Goodyear or Bridgestone tires, Michelin's $50 price disadvantage in the replacement tire marketplace can stem not only from a higher manufacturing costs (reflecting, perhaps, the added costs of Michelin's strategic efforts to build a better quality tire with more performance features) but also from (1) differences in what the three tire makers pay their suppliers for materials and tire-making components and (2) differences in the operating efficiencies, costs, and markups of Michelin's wholesale-retail dealer outlets versus those of Goodyear and Bridgestone.
STUDENT: Good example, Teacher. But let me add that knowing what happened with the tires Bridgestone / Firestone supplied to Ford for the Explorer, we can assume that the lower prices of Bridgestone also reflected a lower manufacturing quality or quality control procedures.

TEACHER: True. Obviously if Bridgestone knowingly realized "cost savings" in this way, it was not a wise policy, since the end result was not good at all. Apart from the human suffering caused by Firestone tires failing and causing accidents, the economic damage to Bridgestone was substantial.

STUDENT: Can we then advise managers not to let their need to lower costs tempt them into lowering quality or quality control procedures?

TEACHER: Yes, that would be very good advice, Student. Anyway, accurately assessing a company's competitiveness in end-use markets requires that company managers understand the entire value delivery system, not just the company's own value chain; at the very least, this means considering the value chains of suppliers and forward channel allies (if any).

Suppliers' value chains are relevant because suppliers perform activities and incur costs in creating and delivering the purchased inputs used in a company's own value chain; the cost and quality of these inputs influence the company's cost and/or differentiation capabilities. Anything a company can do to reduce its suppliers' costs or improve suppliers' effectiveness can enhance its own competitiveness. Forward channel value chains are relevant because (1) the costs and margins of downstream companies are part of the price the ultimate end-user pays and (2) the activities forward channel allies perform affect the end-user's satisfaction. Furthermore, a company can often enhance its competitiveness by undertaking activities that have a beneficial impact on its customers' value chains.

For instance, some aluminum can producers constructed plants next to beer breweries and delivered cans on overhead conveyors directly to brewers' can-filling lines. This resulted in significant savings in production scheduling, shipping, and inventory costs for both container producers and breweries.

STUDENT: We have see a typical example of a value chain, but I assume there are many differences between industries, right?

TEACHER: Yes, of course. The value chain for the pulp and paper industry (timber farming, logging, pulp mills, papermaking, printing, and publishing) differs from the chain for the home appliance industry (parts and components manufacture, assembly, wholesale distribution, retail sales). And we can think of many more examples. Now, the work load involved in developing a value chain should not be underestimated as we shall see right now.

Developing the Data for Strategic Cost Analysis

The data requirements for value chain analysis can be formidable. Typically, the analyst must break down a firm's departmental cost accounting data into the costs of performing specific activities.

The appropriate degree of disaggregation depends on the economics of the activities and how valuable it is to develop cross-company cost comparisons for narrow1y defined activities as opposed to broad1y defined activities.

STUDENT: It occurs to me that an obvious good guideline is to develop detailed cost estimates for activities representing a significant or growing proportion of cost.

TEACHER: Good advice, again. Top management must prevent lower level managers to spend excessive time computing costs for activities that are not really significant. Now, let me elaborate about the differences between traditional cost accounting and activity-based costing.

Traditional accounting identifies costs according to broad categories of expenses-wages and salaries, employee benefits, supplies, travel, depreciation, R&D, and other fixed charges.

Activity-based costing entails assigning these broad categories of costs to the specific tasks and activities being performed.

STUDENT: And what about suppliers and distributors?

TEACHER: Surely it is necessary to develop cost estimates for activities performed in the competitively relevant portions of suppliers' and downstream customers' value chains.

STUDENT: While it is certainly hard work, any company should be able to develop its own activity-based costs. But how about getting information about suppliers, customers and rival firms?

TEACHER: To benchmark the firm's cost position against rivals, costs for the same activities for each rival must be estimated -an advanced art in competitive intelligence.

STUDENT: Are you talking about spying on competitors?

TEACHER: Not necessarily. It is possible to get information form many sources, such as common suppliers or customers, data published by government, etc. I’ll give you a few more examples later on.

My point is that despite the tediousness of developing cost estimates activity by activity and the imprecision of some of the estimates, the payoff in exposing the costs of particular internal tasks and functions and the cost competitiveness of ones position vis-à-vis rivals makes activity-based costing a valuable strategic management tool.

Student, according to our discussion can you tell me what the most important application of value chain analysis is?

STUDENT: The most important application of value chain analysis is to expose how a particular firm's cost position compares with the cost positions of its rivals.

TEACHER: Correct. And what is needed to reach this end?

STUDENT: I guess that what is needed is competitor versus competitor cost estimates for supplying a product or service to a well-defined customer group or market segment.

TEACHER: Again, very well, Student. The last part of your comments is especially important and let me quote you, "to a well-defined customer group or market segment". The size of a company’s cost advantage / disadvantage can vary from item to item in the product line, from customer group to customer group (if different distribution channels are used), and from geographic market to geographic market (if cost factors vary across geographic regions).

Benchmarking The Costs Of Key Activities

Many companies today are benchmarking the costs of performing a given activity against competitors' costs (and/or against the costs of a noncompetitor in another industry that efficiently and effectively performs much the same activity or business process). Benchmarking focuses on cross-company comparisons of how well basic functions and processes in the value chain are performed -how materials are purchased, how suppliers are paid, how inventories are managed, how employees are trained, how payrolls are processed, how fast the company can get new products to market, how the quality control function is performed, how customer orders are filled and shipped, and how maintenance is performed.

The ultimate objective is to understand the best practices in performing an activity, to learn how lower costs are actually achieved, and to take action to improve a company's cost competitiveness whenever benchmarking reveals that the costs of performing an activity are out of line with what other companies (competitors or noncompetitors) have been able to achieve successfully.

STUDENT: I read that Xerox was an early pioneer in the use of benchmarking. Is this so?

TEACHER: Yes. In 1979, Japanese manufacturers began selling mid-size copiers in the U.S. for $9,600 each -less than Xerox's production costs. Although Xerox management suspected its Japanese competitors were dumping, it sent a team of line managers to Japan, including the head of manufacturing, to study competitors' business processes and costs.

STUDENT: Don’t tell me the Japanese willingly opened their doors to the Xerox people.!

TEACHER: Not really. Xerox's joint venture partner in Japan, Fuji-Xerox, knew the competitors well. The team found that Xerox's costs were excessive due to gross inefficiencies in its manufacturing processes and business practices; the study proved instrumental in Xerox's efforts to become cost competitive and prompted Xerox to embark on a long-term program to benchmark 67 of its key work processes against companies identified as having the "best practices" in performing these processes. Xerox quickly decided not to restrict its benchmarking efforts to its office equipment rivals but to extend them to any company regarded as "world class" in performing an activity relevant to Xerox's business.

STUDENT: OK, Teacher, you promised to elaborate on ways to get information for benchmarking.

TEACHER: I did not forget. Sometimes cost benchmarking can be accomplished by collecting information from published reports, trade groups, and industry research firms and by talking to knowledgeable industry analysts, customers, and suppliers (customers, suppliers, and joint-venture partners often make willing benchmarking allies).

Usually, though, benchmarking requires field trips to the facilities of competing or noncompeting companies to observe how things are done, ask questions, compare practices and processes, and perhaps exchange data on productivity, staffing levels, time requirements, and other cost components.

STUDENT: Benchmarking involves competitively sensitive information about how lower costs are achieved, and close rivals can't be expected to be completely open, even if they agree to host facilities tours and answer questions. How is this problem overcome?

TEACHER: The explosive interest of companies in benchmarking costs and identifying best practices has prompted consulting organizations (for example, Andersen Consulting, A. T. Kearney, Best Practices Benchmarking & Consulting, and Towers Perrin) and several newly formed councils and associations (the International Benchmarking Clearinghouse and the Strategic Planning Institute's Council on Benchmarking) to gather benchmarking data, do benchmarking studies, and distribute information about best practices and the costs of performing activities to clients/members without identifying the sources. Over 80 percent of Fortune 500 companies now engage in some form of benchmarking.

STUDENT: Do you have some specific personal experience in benchmarking?

TEACHER: A giant food processing company I used to work for operated dozens of plants all over the world, and they performed "internal benchmarking" by comparing costs and processes of these different plants.

Strategic Options For Achieving Cost Competitiveness

There are three main areas in a company's overall value chain where important differences in the costs of competing firms can occur:

1. in the suppliers' part of the industry value chain,
2. in a company's own activity segments, and/or
3. in the forward channel portion of the industry chain.


If a firm's lack of cost competitiveness lies either in the backward (upstream) or forward (downstream) sections of the value chain, then reestablishing cost competitiveness may have to extend beyond the firm's own in-house operations.

When a firm's cost disadvantage is principally associated with the costs of items purchased from suppliers (the upstream end of the industry chain), company managers can pursue any of several strategic actions to correct the problem:

* Negotiate more favorable prices with suppliers.
* Work with suppliers to he1p them achieve lower costs.
* Integrate backward to gain control over the costs of purchased items.
* Try to use lower-priced substitute inputs.


Student, do you have any ideas on a company's strategic options for eliminating cost disadvantages in the forward end of the value chain system?

STUDENT: Let me think. Well, an obvious one would be pushing distributors and other forward channel allies to reduce their markups.

TEACHER: Right, and this procedure is used a lot, but of course there is a limit to it. A company can also work closely with forward channel allies/customers to identify win-win opportunities to reduce costs. And actually there is no limit to improvement that can be attained in this was. The food processing company I worked for learned that by receiving the eggs for mayonnaise production in liquid form in cooled tank trucks, it saved a bundle in comparison with receiving fresh eggs and processing them in-house.

STUDENT: And what was the advantage to the egg suppliers? I assume they had to make a substantial investment in equipment for the processing and delivering of the eggs in liquid form.

TEACHER: Right. But this "partnership" arrangement assured the egg company the status of "preferred supplier" in the form of a long term contract.

Now, when the source of a firm's cost disadvantage is internal, managers can use any of nine strategic approaches to restore cost parity:

1. Initiate internal budget reductions and streamline operations.

2. Reengineer business processes and work practices (to boost employee productivity, improve the efficiency of key activities, increase the utilization of company assets, and otherwise do a better job of managing the cost drivers).

3. Try to eliminate some cost-producing activities altogether by revamping the value chain system (for example, shifting to a radically different technological approach or maybe bypassing the value chains of forward channel allies and marketing directly to end-users).

4. Relocate high-cost activities to geographic areas where, they can be performed more cheaply.

5. See if certain activities can be outsourced from vendors or performed by contractors more cheaply than they can be done internally.

6. Invest in cost-saving technological improvements (automation, robotics, flexible manufacturing techniques, computerized controls).

7. Innovate around the troublesome cost components as new investments are made in plant and equipment.

8. Simplify the product design so that it can be manufactured more economically.

9. Try to make up the internal cost disadvantage by achieving savings in the, backward and forward portions of the value chain system.

Question 4: How Strong Is The Company’s Competitive Position?

Using value chain concepts and the other tools of strategic cost analysis to determine a company's cost competitiveness is necessary but not sufficient. A more broad-ranging assessment needs to, be made of a company's competitive position and competitive strength. Particular elements to single out for evaluation are (1) how strongly the firm holds its present competitive position, (2) whether the firm's position can be expected to improve or deteriorate if the present strategy is continued (allowing for fine-tuning), (3) how the firm ranks relative to key rivals on each important measure of competitive strength and industry key success factors, (4) whether the firm enjoys a competitive advantage or is currently at a disadvantage, and (5) the firm's ability to defend its position in light of industry driving forces, competitive pressures, and the anticipated moves of rivals.

COMPETITIVE STRENGTH ASSESSMENTS

The best to determine a company's competitive position is to find out -in a systematic and measurable way- whether the company is stronger or weaker than close rivals on each key indicator of competitive strength.

The procedure:

1) Make a list of the industry's key success factors (7 to 10 are enough).

2) Rate the firm and its key rivals on each factor. A numerical scale from 1 to 10 can be used, o ratings of stronger (+), weaker (-), and about equal (=) may be appropriate.

3) Sum the individual strength ratings to get an overall measure of competitive strength for each competitor. 4) Determine the size and extent of the company's net competitive advantage or disadvantage.

Question 5: What Strategic Issues Does The Company Face?

The final analytical task is to home in on the strategic issues management needs to address in forming an effective strategic action plan. Here, managers need to draw upon all the prior analysis, put the company's overall situation into perspective, and get a lock on exact1y where they need to focus their strategic attention. This step should not be taken light1y. Without a precise fix on what the issues are, managers are not prepared to start crafting a strategy-a good strategy must offer a plan for dealing with all the strategic issues that need to be addressed.

STUDENT: Very clear as a principle. In practice, what is it that managers can do?

TEACHER: To pinpoint issues for the company's strategic action agenda, managers ought to consider the following:

• Whether the present strategy is adequate in light of driving forces at work in the industry.

• How closely the present strategy matches the industry's future key success factors.

• How good a defense the present strategy offers against the five competitive forces-particularly those that are expected to intensify in strength.

• In what ways the present strategy may not adequately protect the company against external threats and internal weaknesses.

• Where and how the company may be vulnerable to the competitive efforts of one or more rivals.

• Whether the company has competitive advantage or must work to offset competitive disadvantage.

• Where the strong spots and weak spots are in the present strategy.

• Whether additional actions are needed to improve the company's cost position, capitalize on emerging opportunities, and strengthen the company's competitive position.

These considerations should indicate whether the company can continue the same basic strategy with minor adjustments or whether major overhaul is called for.

Key Points

There are five key questions to consider in performing company situation analysis:

1. How well is the present strategy working? This involves evaluating the strategy from a qualitative standpoint (completeness, internal consistency, rationale, and suitability to the situation) and also from a quantitative standpoint (the strategic and financial results the strategy is producing

2. What are the company's strengths, weaknesses, opportunities, and threats?
A SWOT analysis provides an overview of a firm's situation and is an essential component of crafting a strategy tight1y matched to the company's situation. A company's strengths, especially its core competencies, are important because they can serve as major building blocks for strategy; company weaknesses are important because they may represent vulnerabilities that need correction. External opportunities and threats come into play because a good strategy necessarily aims at capturing attractive opportunities and at defending against threats to the company's well-being.

3. Are the company's prices and costs competitive? One telling sign of whether a company's situation is strong or precarious is whether its prices and costs are competitive with industry rivals.

4. How strong is the company’s competitive position? The key appraisals here involve whether the company's position is likely to improve or deteriorate if the present strategy is continued, how the company matches up against key rivals on industry KSFs and other chief determinants of competitive success, and whether and why the company has a competitive advantage or disadvantage.

5. What strategic issues does the company face? The purpose of this analytical step is to develop a complete strategy-making agenda using the results of both company situation analysis and industry and competitive analysis. The emphasis here is on drawing conclusions about the strengths and weaknesses of a company's strategy and framing the issues that strategy-makers need to consider.
STUDENT: I sense we are reaching the end of this Module, right, Teacher?

TEACHER: Yes. I will summarize by stating that good company situation analysis, like good industry and competitive analysis, is crucial to good strategy-making. A competently done company situation analysis exposes strong and weak points in the present strategy, company capabilities and vulnerabilities, and the company's ability to protect or improve its competitive position in light of driving forces, competitive pressures, and the competitive strength of rivals. Managers need such understanding to craft a strategy that tits the company's situation well.