PRODUCT / LINE MIX. Understand the product mix and features -- variety, design, packaging, substitutes, product crosselasticities.

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1 PRICING Estimate demand (pricing is largely demand driven) Analyze customer s willingness to pay for company s product / service Target customer segment(s) Price elasticity Price of substitute products / services Value-added of company s product / service (either real or perceived) Consider costs, but don t let costs dictate the outcome. Adjust for anticipated competitor response. Analyze company s strategy: Premium vs. value product / service Niche vs. large market share Capabilities in positioning product / service Consider various pricing strategies: Price discrimination Two-part tariff Bundling Warranties

2 PRODUCT / LINE MIX Understand the product mix and features -- variety, design, packaging, substitutes, product crosselasticities. Identify the size of the product portfolio mix -- could the company be spreading its resources too thin across a large product portfolio? Analyze product profitability mix: Profit margin of each product line Product breakdown as a % of revenues, cost, profits, growth rates, etc. Consider discontinuing unprofitable products in the mix Explore possibility of introducing new products Consider issues of cannibalization and effect on brand equity Evaluate pricing strategy -- premium vs. value products (see PRICING card) Examine company s core competencies, ability to leverage economies of scope and scale, potential issues of capacity constraints. Analyze market direction and threat of new entrants

3 GENERAL CASE TIPS Repeat the question State your hypothesis / key decision criteria Explain the framework to be used Walk the interviewer through your analysis Draw visuals if possible -- charts (e.g., waterfalls, bubbles) 2x2 matrices, pies, etc. Summarize conclusions and explain what additional analyses may be relevant Generate options and alternatives If you get stuck, restate what facts you know REMEMBER: Try and make the interview an interactive dialogue between you and the interviewer. The interviewer is not an adversary; you are working together to solve the client s problem. Relax and have fun!

4 ECONOMICS GNP = C + I + G + X C = personal consumption I = corporate investment G = government purchases X = net (exports - imports) Market equilibrium: Price -- Quantity point where demand equals supply (does not change unless demand or supply shifts). Marginal Costs < Average Costs implies economies of scale Marginal Costs = Average Costs implies constant returns to scale Marginal Costs > Average Costs implies dis-economies of scale Price elasticity of demand = (% change in Quantity / % change in Price) if > 1 implies elastic if < 1 implies inelastic Consider diminishing marginal utility and diminishing returns

5 CUSTOMERS Conduct segmentation of customer base -- who is the target customer? Existing customers (company s or competitors) New customers Profitability of target customer segments vs. other potential segments Identify what the customers needs are and what they value Commodity vs. premium products Assess needs and perceptions against company s product mix Market trends Analyze relative buying power -- most powerful when: few customers exist and they purchase in large volumes products are standardized and represent high % of final product s total costs profits of buyer are low buyers present credible threat of backward integration Consider other key issues: Product substitutes / complements and switching costs Demand elasticity Cost of retaining and acquiring a customer (e.g., use of loyalty programs because it s cheaper to retain customers than to acquire new customers)

6 COMPANY ANALYSIS Consider the company s vision / mission / stakeholders Examine the company s capabilities: Firm resources (people, capital, technology, etc.) Core competencies (economies of scope) Capacity issues (e.g., manufacturing, distribution, human resources) -- how flexible are facilities / labor? Understand the company s cost structure: e.g., how is the marginal cost impacted by building new capacity (i.e., marginal costs will increase if new capacity is not fully utilized OR marginal costs increase if capacity is greater than minimum efficient size) Economies of scale Analyze the company s financing options: Access to capital / financing capabilities Alternatives to internal financing NPV of alternative options Consider the impact of external factors (e.g., technology, regulation, competitors, likely competitive responses, etc.)

7 DISTRIBUTION Understand current structure -- is it overly complex? Draw a map (e.g., show plants, distributors, customers) Outline the value chain (suppliers, manufacturers, distributors, wholesalers, retailers, customers, etc. -- break down each as a percentage of total costs) Analyze the objectives of distribution chain for specific case Channels Coverage Flexibility Speed Barriers to Entry Consider various tradeoffs: Cost vs. proximity Service vs. product implications JIT vs. inventory Internal vs. external distribution issues Evaluate impact of trends (IT, deconstruction of value chain) Consider cost-benefit analysis of alternative distribution methods

8 Analyze segments (who, what, where, how, value) PROMOTION Understand audience needs / perceptions (conjoint surveys, trends, etc.) Benchmark with other industries Estimate potential per segment Demand Price Profitability Growth Competition Consider various issues in company s advertising and PR strategy including: Differentiation and sustainability of promotion Dilution of message Use of specials, discounts, etc. Sales force effectiveness Identify opportunities to differentiate product (based on dimensions of quality, design, location, service, advertising, price, etc.) in order to: Expand feasible set of strategies (not limited to 1 dimension / product attribute) Make demand less elastic Avoid price warfare REMEMBER: The goal is to send the right message to the right people in the right way!

9 REGULATORY Understand key regulatory issues: Pricing guidelines (e.g., as % of costs) --> no monopoly pricing Tariffs Anti-trust Patent infringement, intellectual property rights Assess regulation as a barrier to entry (through procurement, as well as environmental and safety standards Prohibitive costs of compliance for new entrants Control of licenses by a public authority ( approved supplier status) Trade barriers Analyze impact on the company as well as the competitors Leverage regulatory asymmetries (in your own market, other countries, etc.) Look to the past for precedents

10 FRAGMENTED MARKET Understand why the market is fragmented low barriers to entry and / or high barriers to exit absence of economies of scale or learning curve effect high transportation costs high inventory costs or erratic sales fluctuations diverse market needs (i.e., need for customized offering) high product differentiation government prohibition of concentration / local regulations newness of industry Examine whether or not fragmentation can be overcome (Is consolidation feasible? See CONSOLIDATION card) Determine if overcoming fragmentation is profitable for the company If fragmentation is inevitable, identify best alternatives for coping with it tightly managed decentralization increased value added specialization by product type, product segment, customer type, region, etc. backward integration

11 GLOBAL ISSUES Consider key issues in developing a global competitive strategy: Factor cost differences among countries Differing circumstances in foreign markets (i.e., 4 P s) Different roles of foreign governments Differences in goals, resources, and ability to monitor foreign competitors Evaluate various mechanisms for participation in global activities: Licensing Private labeling Mergers and acquisitions Exporting Joint ventures Foreign direct investment Assess market conditions National, economic, social, and political conditions and circumstances Competitive landscape and competitive reaction (signaling?) Analyze cost - benefit of participation (does it add shareholder value?) Economies of scale Transportation or storage costs and cost of labor, energy, raw materials, etc. Access to established distribution channels Ability to leverage value chain asymmetries Consider management structure (i.e., multinational, centralized, transnational)

12 BUSINESS ESTIMATION STATISTICS Outline your overall logic, identify key assumption drivers, use round numbers, show your work and write it down! (be careful not to get too detailed) United States US population million US households million World population -- 6 billion Key cities North America million South America million Europe million Asia billion Tokyo, Japan million New York City million Los Angeles million Buenos Aires, Argentina million Beijing, China million

13 VALUE CHAIN Compare value chain to that of competitors and identify sources of differentiation Construct value chain for the firm and the customer and identify drivers of uniqueness in each activity Support : Infrastructure, IT, HR, procurement Primary : Suppliers, inbound logistics, operations, manufacturing, outbound logistics, marketing and sales, support Identify primary activities such as: Outbound logistics: activities needed to convert inputs to outputs OR outputs to final destination Sales and marketing: activities necessary to inform / persuade customers to but outputs and order-taking processes necessary to complete sales (e.g., sales force effectiveness, customer satisfaction, use of ads to enhance brand image) Rate relative importance of each activity Analyze cost drivers and cost interactions Identify possible outsourcing opportunities Select attributes that promise high differentiation between cost and price premium Break down each activity as a % (i.e., as % of every incoming dollar) Locate linkages between value chain and customers

14 NEW MARKET ENTRY Ask if this fits the company s mission / culture -- e.g., why does the company want to expand? Invest excess cash flow Increase market share Decline in existing market (shrinking sales, higher costs, lower margins) Assess the firm s resources and capabilities: Economies of scope and scale Ability to leverage current value chain components (infrastructure needed) Capital, labor, and capacity constraints (see CAPACITY card) Evaluate market conditions Size and growth rate of new target market Competitive profile / trends and likely competitive responses Barriers to entry (and how to overcome them) and regulatory considerations Consider complements with current product / markets, potential issues of cannibalization, and market cross-elasticities Analyze cost - benefit of new market entry Niche vs. large market share Consider methods of entry (e.g., JV, direct investment, exporting, acquisition)

15 INFORMATION TECHNOLOGY Evaluate cost - benefits of IT investment Is the project a strategic necessity? If so, don t evaluate IT investment based on current project evaluation methods (i.e., 5 year payback, ROI criteria, etc.) Outsource vs. develop in-house Understand that IT infrastructure determines what a company will be able to do and not do in the future Defines a company s organizational capability Must have close link between strategic planning and IT infrastructure planning Assess competitor strategies with respect to IT investments Consider impact of current IT issues (e.g., the Year 2000 problem) on the company s costs and profitability Avoid over-investing Make sure that employees are prepared to learn and adopt new system Identify the impact of IT infrastructure on redefining the value chain

16 FORMULAS TOTAL ASSETS = Current assets + PPE + Investments + Other Assets BALANCE SHEET = Assets = Liabilities + Stockholder s Equity STOCKHOLDER S EQUITY = Shareholder s Equity + Common Stock + Retained Earnings REAL INTEREST RATE = Nominal Interest Rate - Inflation PROFIT BEFORE TAXES = Gross Revenue - Returns & Allowances - COGS - SG&A - Depreciation - Interest Expense GROSS MARGIN = Gross Revenue - Returns & Allowances - COGS NET WORKING CAPITAL = Current Assets - Current Liabilities BREAKEVEN VOLUME = Fixed Costs / (Price - Variable Costs)

17 Consider changing market characteristics: MARKET SHARE Long-term growth rate of existing markets and new segments not currently being served Customers and how they use the product Product, process, and market innovation Entry or exit of major firms Diffusion of proprietary knowledge Regulatory changes Changes in cost structure If the market is growing, the number of entrants increases and it s easier for all players to achieve improved performance (non-zero sum game); therefore it s easier and cheaper to take market share. Strategies include: Maintain prices as costs and achieve high profitability (price effect) Drop prices as costs to increase market share (market share effect) Note: in a growing market you want to increase market share over the long-run If the market is slowing, one firm s gain is another firm s loss (zero-sum game) Price competition increases especially when there are large economies of scale, low marginal costs, and learning curve effects Check that market share is not from turnover of most profitable customers

18 COSTS Analyze main cost components as a % of Total Costs (and % of Total Sales): Direct Labor (union vs. non-union), Direct Material, Allocated Overhead (including SG&A and Depreciation), Distribution Costs, Financing Costs Consider potential flaws in the company s cost accounting method Break down total costs into fixed and variable cost components Fixed Cost Issues: Variable Cost Issues: - Capacity utilization (if it s low, identify - Suppliers (consolidate?) cause, e.g., demand vs. efficiency) - Cost control - Break-even analysis mechanisms and (BE volume = FC / (Price - VC)) incentives in place? - Economies of scope and scale - Outsourcing alternatives - NPV of fixed cost investment with - Impact of horizontal or sensitivity analysis vertical integration Determine slope of industry cost curve Compare cost structure to that of competitors Identify and leverage potential cost advantages (e.g., raw materials, labor, energy sources, infrastructure, patents, location)

19 MERGERS & ACQUISITIONS Assess goals and objectives for such consideration Increase market access Diversify horizontally or vertically Pre-empt competition Achieve operating synergies (e.g., economies of scope or scale) Achieve financial synergies (e.g., lower cost of capital) Realize tax gains (e.g., acquirer transfers tax losses of target to offset income) Consider impact on acquirer s financial condition Comparison of margins Ability to finance the acquisition Issues of accretion / dilution on EPS Tax issues Evaluate impact on competitive environment Competitive trends and likely competitive responses Legal and regulatory implications (anti-trust) Consider post-merger integration issues Strategic fit Exit strategies Culture implications Discuss M&A alternatives (e.g., outsourcing, JV, corporate restructuring, etc.)

20 Understand common methods of valuation: VALUATION Discounted Cash Flow (DCF) - projection of future earnings and selection of appropriate discount rate (be prepared to estimate revenues and costs!) Comparable Multiples - apply multiples of income or revenues of comparable companies to establish purchase price Asset-oriented Approaches - fair market value, fair value, book value, liquidation value Consider the following factors in valuing a closely-held or private company: nature and history of the business economic and industry conditions book value of target company and it s financial conditions earnings capacity of the company dividend-paying capacity evidence of goodwill or other intangibles other sales of stock prices of comparable stocks Assess means of financing the transaction

21 COMPETITION Analyze the competitors strengths, weaknesses, opportunities and threats (SWOT analysis) Firm resources Management profile and style Product line (i.e., substitutes) Clout and leverage with buyers and suppliers Industry trends Determine if there are any Barriers to Entry? Economies of scale Existence of learning curve effects Access to distribution channels Product differentiation Capital requirements Governmental actions Examine the cost structure of competitors (especially as it relates to the client s cost structure) -- cost differences may be based on the degree of vertical integration (see COSTS card) Consider likely competitive responses to the client s actions and potential cooperative strategic options

22 COMPETITOR INTENSIFICATION Consider various responses in an intensified competitive environment: Use resource advantages to raise barriers to entry Raise switching costs for customers Step up marketing effort Increase promotional efforts (e.g., implement customer loyalty programs) Consider price signaling (e.g., lower your price in a smaller market) Leverage customer information to identify and steal most profitable customers away from competitors ( cream-skimming ); likewise, protect your most profitable customers Grow market share through mergers or acquisitions Avoid price wars and other irrational behavior; remember that accommodating your competition sometimes makes the most sense Establish long-term contracts to lock in customers

23 PROFITS AND MARGINS GROSS PROFITS = REVENUES - COSTS Identify root causes of decline in profitability (e.g., margins vs. quantity) Break down Revenue component (see REVENUE card): Price Quantity Break down Cost component (see COST card): Fixed Costs vs. Variable Costs Direct Labor, Direct Material, Allocated Overhead (including SG&A and Depreciation), Distribution Costs, Financing Costs -- all as a % of Total Costs and Total Sales Analyze product profitability and product mix (I.e., look at volume shifts) Identify mix of customer segments and associated segment profitability Explore trends in overall industry profitability (competitors profitability?) Examine the impact of any unusual charges (e.g., one-time capital outlays, contingent liabilities, litigation charges, environmental charges, etc.) Consider changing market factors (demographics, tastes, economy, changes in technology, regulatory actions)

24 REVENUES = PRICE x QUANTITY REVENUE Break down factors which influence Price (see PRICING card): Analyze customer s willingness to pay for company s product / service Target customer segment(s) Price elasticity Price of substitute products / services Value-added of company s product / service (either real or perceived) Evaluate product mix and ability to differentiate product (based on dimensions of quality, design, location, service, advertising, price) Consider competitors pricing strategies and relative market pricing power Break down factors which influence Quantity (see MARKET SHARE card): Consider market share vs. market demand (and growth patterns) Explore inability to meet market demand based on capacity constraints (demand vs. capacity utilization vs. throughput) Analyze types of customers gained / lost (protect most profitable customers) Evaluate impact of product substitutes vs. complements Consider the cyclical or seasonal nature of the business, if applicable

25 CONSOLIDATION Examine feasibility and objectives of industry consolidation create economies of scale or learning curve effects standardize diverse market needs make acquisitions for critical mass recognize industry trends early Evaluate impact of consolidation achieve operational and financial synergies capacity utilization vs. demand cultural fit Assess implications of vertical vs. horizontal consolidation Understand regulatory issues Analyze cost - benefit to the company

26 OUTSOURCING Analyze the make vs. buy decision Ignore fixed and other sunk costs, only consider variable costs Examine the company s cost allocation method Assess benefits of outsourcing: lowers cost increases flexibility and access to external capabilities benefit from economies of scale and specialization of third-party provider may reduce new product development cycle Assess costs of outsourcing: loss of control over manufacturing process, quality, turnaround time, etc. increased difficulty associated with integrating different technologies and knowledge bases (may diffuse the concept of core competencies which results in loss of a company s ability to innovate and develop) costs of monitoring the contractor and contract specifications may outweigh lower unit costs

27 OPERATIONS EFFICIENCY Consider three components when evaluating plant efficiency: Utilization: percent of total available time that plant is actually running Identify causes of loss (e.g., lack of demand, labor problems, line breakdown) Throughput rate: compare actual production rate to maximum potential rate Identify causes of loss (e.g., calibration, labor performance, poor maintenance, other plant functions) Waste: measure what percentage of raw material inputs is lost in producing output Identify causes of loss (e.g., calibration, quality of inputs, machinery breakdowns) REMEMBER: When asked to analyze capacity utilization of a plant, consider ALL three of the above points!

28 SUPPLIERS Segment suppliers on basis of client s needs (e.g., quality, cost, value-added, timeliness, JIT, service, etc.) Identify key decision criteria in evaluating suppliers (e.g., low cost, high quality control, low defect rates, quick turnaround times, etc.) Evaluate company s relative bargaining power with suppliers based on % of supplier s total sales Analyze supplier power -- greatest when: dominated by a few suppliers product is differentiated (high switching costs, few substitutes) supplier poses credible threat of forward integration Examine ways to lower overall supply costs: consolidation of suppliers increases capacity utilization of suppliers which lowers suppliers costs and thereby could lower the company s costs and prices (however, be careful of supplier concentration) economies of scope among suppliers inventory vs. JIT

29 ALLIANCES & JOINT VENTURES Assess benefits of such a strategy: Ability to exploit critical internal resources and gain access to resources of partner quicker, at lower cost, and with less uncertainty Gain access to markets and technology in much shorter time than would result from firm going at it alone Share management responsibility Assess potential problems and costs: Agreement on the value of each partner s contribution to the JV / alliance Ability to achieve cooperation between firms that are also competitors Conflicting objectives / divergent management styles Disputes over quality and labor practices Potential lack of control Recognize that the sharing of benefits will depend on: Strategic intent of the partners Ability of each partner to capture and appropriate the skills of the other Company s receptiveness to the partnership Identify alternative strategies (e.g., outsourcing, M&A, etc.) -- explore as needed

30 DIVESTITURES & SPIN-OFFS Evaluate reasons for a divestiture: Poor strategic fit and/or poor performance of a division Parts of a company are worth more than the whole (reverse synergy) Capital market factors (greater access to capital markets post-divestiture) Immediate infusion of cash from the sale Evaluate reasons for a spin-off: Redefinition of core business Parts of a company are worth more than the whole (reverse synergy) Capital market factors (greater access to capital markets post-divestiture) Impact on cost of capital Assess market conditions Is timing right to sell? Competitive response (i.e., lead to price or quality ) Conduct cost - benefit analysis Can subsidiary inefficiency / high costs be turned around? Effect on quality of product / service Impact on economies of scale and scope Current / future cost breakdown (fixed costs vs. variable costs, transition costs)

31 DIVERSIFICATION Examine existing business situation and understand motivation behind diversification (invest free cash flow?) Avoid diversification strategy solely to smooth earnings Analyze different types of diversification Expand geographically (local, regional, national, international) Integrate vertically (offsets power of suppliers, smoother production flow, better accessibility to markets, distribution cost advantage) Expand into related markets (product, business, distribution, managerial skill) Expand into unrelated markets ( risk, benefits from economies of scale, acts as informal market when external markets e.g., labor or capital, are weak) Evaluate ability to leverage existing resources, value chain, infrastructure and economies of scope and scale Consider competition and likely competitor response (e.g., impact on pricing) Conduct cost - benefit analysis of diversification strategy Economic conditions Market supply / demand Regulatory issues

32 CAPACITY Assess overall fixed asset effectiveness (see OPERATIONS EFFICIENCY card) Utilization Throughput against its theoretical potential Product acceptance and waste levels Compare to industry averages and recent trends Identify causes of utilization loss Lack of demand Plant breakdowns Staffing issues Issues to consider in adding new capacity Demand considerations Ties up capital and may result in excess capacity Evaluate company s minimum efficient plant size (MES) relative to total market output (it s easier to enter if MES as % of total market is smaller) Estimate slope of industry cost curve -- it s easier to bring a new plant on-line below capacity if the cost curve is flat REMEMBER: Importance of utilization as fixed costs as a % of total costs