LECTURE NOTES

Chapter 6 - Internal Analysis

Content of Chapter 6

1. Performance measurement includes a description of shareholder value in addition to sales and

profits.

2. The effort to find surrogates for long term prospects drives us to 6 other performance measures—
brand loyalty, quality, image, cost, new products, employee performance, and heritage/values. An
interesting matrix with quality against cost provides some proscriptive suggestions in Figure 6.2.

3. Threats and opportunities, two key strategy concepts, are elaborated.

4. Figure 6.3 on page 109 on structuring strategic decisions suggests that a successful strategy will
assess strengths and weaknesses, competitor strengths and weaknesses and market needs
attractiveness and key success factors. The idea is to leverage your strengths, neutralize your
weaknesses and your competitor’s strengths in a favorable market context.

Shareholder value

What is the theory behind shareholder value (that maximizing shareholder value is what matters
and other financial measures like ROI or ROS are not on target)? What are the assumptions of
shareholder value (that the profit stream from an investment can be estimated accurately, that the asset
value is known, that the cost of equity is known)? What are the problems of implementing shareholder
value (as a practical matter, it is hard to forecast future cash flows so the short term cash flows become
an important signal of the future—as a result the process tends to drive mangers to make short term
profits even though that is not the theory)?

Shareholder value holds that the flow of profits emanating from an investment should exceed
the cost of capital (which is the weighted average of the cost of equity and cost of debt). Routes to
achieving shareholder value – such as downsizing, reducing assets employed, and outsourcing – can
be risky when they undercut assets and competencies.

Shareholder value analysis provides a method to make investment decision more quantifiable.
Long term investments may be abandoned. Time horizons and hurdle rates are critical.

One danger of shareholder value analysis is that it reduces the priority given to other
stakeholders such as employees, suppliers, and customers, each of whom represents assets that can
form the basis for long-term success.

Beyond Profitability

© 2010John Wiley & Sons Lecture Notes Chapter 6–page 1

 Why go beyond profitability? That should be the bottom line. The reason is that we need
surrogates for long term cash flow, for the creation of assets and competences that will create future
profits.

What measures would you consider important? The seven noted on page 1029 should come up
but so should others. Which ones to select? It should depend on the strategy and the firm. How? See
question 3 about applying this question to McDonald’s and Chevrolet.

How would you measure new product activity (and maybe some of the others)? This is a
nontrivial question.

Threats and Opportunities

What is the difference between strategic problems (events or trends adversely affecting
strategy) and strategic liabilities (the absence of needed assets or competences)? - both can be threats.
Can you think of examples of each?

How would you evaluate threats and opportunities? The immediacy and impact dimensions
introduced in the last chapter can be employed. Can you think of examples for a business like General
Mills cereal?

From Analysis to Strategy

What are the critical inputs to strategy? The figure 6.3 on page 109 provides a simplified view.
Each of the three components is definitely important. Ask the class to name a successful business
strategy (Dell, Pantene, B of A, etc.). How would you evaluate the strategy with respect to these three
dimensions?

For Discussion:

1. Explain shareholder value analysis. Why might it help firms? Why might it result in bad decisions?
See the discussion above.

2. Look at the quotations that begin Chapter 2 through 6. Which ones do you find the most insightful?
Why? Under what circumstances would its implications not hold?

Chapter 6 – “The fish is the last to know if it swims in water.” (Chinese proverb: It is easy to drift
along and not realize a threat until it is too late. But if you keep on top of competitors and trends you
can get in front of disasters before they happen—when there is still time to respond.

Chapter 3 - “There is nothing more exhilarating than to be shot at without result.” - Winston
Churchill. The goal is to obtain a market position supported by assets and competences that is not
vulnerable to competitive moves.

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 Chapter 3 – “Induce your competitors not to invest in those products, markets, and services where
you expect to invest the most... that is the fundamental rule of strategy.” - Bruce Henderson, BCG.
An interesting premise! How can you do that? Is it possible in today’s world of information flow?

Chapter 2 – “Before you build a better mousetrap, it helps to know if there are any mice out there.”
- Mortimer Zuckerman.

Strategy should be driven by the market and not by an R&D project or by an executive that thinks
the firm should enter some product market. It should be driven by a market need for a value
proposition that the firm can deliver.

3. What performance measure would you consider most important for McDonald’s? For Chevrolet?

The overall measures might be similar but the detailed ones will be different. Quality is key for both
but the way you determine quality will be very different. McDonalds is about consistency,
cleanliness, fast service, and personal while Chevrolet is about reliability, styling, etc.

4. Conduct a strengths, weaknesses, opportunities, and threats (S.W.O.T.) analysis for Ford. For Frito-
Lay?

The class should not get hung up with the lack of knowledge—they should freely make
assumptions. The emphasis should be on developing one or two in each category and then
discussing them. Even with that proviso, the exercise will demonstrate that the list is long and it is
tough to nail down some concepts. A strength for Ford could be the connection with Mazda. But its
impact will depend on how it is used.

For Frito-Lay the whole health and sustainability is both a threat and an opportunity. Strengths are
the brand and distribution. Weakness is the size and scale that make it hard to try new items.

© 2010John Wiley & Sons Lecture Notes Chapter 6–page 3