Dragon Gate Investment Partners LLC. Fifth Ave. #3010 New York, NY USA T: +1 (212) F: +1 (212) E:

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1 a BREIFING PAPER aaa Dragon Gate Investment Partners LLC Fifth Ave. #3010 New York, NY USA T: +1 (212) F: +1 (212) E: Yuquan Rd A-12 Yuquan Building 5201 Haidian District, Beijing China T: C: E: Analyzing & Communicating Corporate Strategy in an IR Context March 2010 Mission: To integrate finance, communication, marketing and securities law compliance to enable the most effective two-way communication between a company and the financial community and other constituencies, which ultimately contributes to a company s securities achieving fair valuation.

2 Analyzing & Communicating Corporate Strategy in an IR Context CONTENTS This briefing paper 1. Introduction 2. Understanding your Markets 3. Defining and Building Strategy 3.1 Defining Strategy 3.2 Building Strategy 4. Models used to Identify and Analyse Strategy 4.1 The BCG Matrix 4.2 The Ansoff Matrix 4.3 Porter s 5 Forces 4.4 SWOT Analysis 4.5 Competitive Strategy Analysis 5. Strategy Statements for IR Audiences

3 Page 3 1. Introduction A compelling investment story describes: The company s markets (the opportunity) The company s strategy (the plan) and Evidence of delivery (performance). The investment story should tackle the 3 key valuation variables growth, quality and risk. It should also deal with the characteristics of the investment, in terms of capital structure and dividend policy. Whether or not a company is able to earn a return on its capital in excess of the cost of capital is determined by its own strategic choices the choice of industries or set of industries in which the company operates and the manner in which the company intends to compete with other firms. This briefing paper focuses on the market ( opportunity ) and on strategy ( the plan ) and explains how investors and analysts assess corporate strategy. 2. Understanding your Markets Your IR audiences will begin by asking what business you are in. It is therefore crucial to have a clear description of what you do and in which industries you do it your business model. What do you do? How do you make money? Which markets do you serve and how are they growing? Who are your customers and suppliers? How do you do what you do better than the competition? The key to understanding the business is often to understand the value chain and in which parts of that chain the company operates ie the extent to which the company is vertically or horizontally integrated.

4 Page 4 PESTLE analysis offers a useful framework for thinking about the external factors that are likely to influence the prospects for your markets. This is a model frequently used by analysts and investors who will have their own views on which external factors are likely to have a major impact and how. Reading sector research will give you an insight into their views. You can then see whether there are misconceptions that you will either have to correct or live with. Either way, this gives you the context for what the analyst will believe about your company. PESTLE If your company does not fit easily into a sector, it will be particularly important to give a clear description of your markets and to supply the investment community with enough information for them to be able to determine the prospects for those markets. This might involve commissioning external market research. 3. Defining and Building Strategy 3.1 Defining Strategy A strategy is a long term plan of action to gain competitive advantage through the achievement of corporate objectives. Strategic planning is about setting an appropriate course and direction for a company which focuses resources to achieve these corporate objectives. Strategy execution is the actions that a company plans in response to or in anticipation of changes in its external environment, its customers and its competitors. Strategy statements therefore need to answer four questions: How are we currently positioned? Where do we want to be (in our market context and compared to competitors)? What do we intend to do to get there? How do we do this better than anyone else (ie how do we beat the competition)?

5 Page Building Strategy Understanding the process for building strategy helps to understand how external audiences will analyse and test your strategy statements and presentations. Set out your vision - what the business will look like in 3 or more year s time? Describe your mission the nature and purpose of the business What the business is and does Primary products/services Key processes & technologies Main customer groups Primary markets/segments Principal channels/outlets What are your values? - describe your relationship with: Society Customers Suppliers Employees Other stakeholders Define your strategies using one or more of the models below (which are defined later): The BCG matrix The Ansoff matrix Porter s 5 Forces SWOT analysis Identify your objectives in terms of: Growth Profitability Technology Offering Markets Set your goals - determine a set of specific time-based measurements to be achieved by implementing strategies. These should be: Quantifiable Consistent Realistic and Achievable

6 Page 6 4. Models used to Identify and Analyse Strategy Your IR audiences are likely to use fairly standard strategy analysis tools. Understanding these tools will help you to present your strategy effectively and speaking to analysts and investors using familiar language will help your strategy to be easily understood. 4.1 The BCG Matrix The Boston Consulting Group s growth/share matrix can be used to consider a portfolio of investments or group companies. The BCG s research found that a high market share correlated with a high return on investment because of learning curve effects. Star Problem Child Business Growth Rate High Cash Cow? Dog Low High Low Relative Market Position Market Share The theory suggests that having a high market share in some businesses enables the funding of others. Stars high growth businesses in strong market positions, finance themselves. Cash cows whilst not offering large growth potential themselves often provide the investment to fund the question marks (sometimes known as the problem child). The problem child is the really interesting area. However, there are risks here as the problem child could either turn into a star or a dog. If the company s strategy is to focus on a problem child area of the business, then strategy communication needs to demonstrate how market share growth will be achieved in a timeframe that exploits the high growth period of the business. Dogs should usually be liquidated.

7 Page The Ansoff Matrix OLD PRODUCT NEW MARKET OLD Market Penetration Expansion (Product Development) NEW Related Diversification (Market Development) Unrelated Diversification This matrix looks at the ways that businesses can grow or develop. The old product in the old market (top left) is a market that the business has already penetrated (the equivalent perhaps of the BCG cash cow). The top right quadrant identifies product development where new products are sold into existing markets (expansion). In the bottom left, old products are sold into new markets and this is termed market development (or related diversification). The bottom right quadrant unrelated diversification - is the area that carries the most risk. Analysts and investors understand expansion and market development, but take some persuading that unrelated diversification is a good strategy. IR audiences tend to take the view that they can diversify their portfolios themselves and do not need companies to do it for them. 4.3 Porter s 5 Forces This is another well-known model frequently used by investment analysts to determine your market position and to analyse your strategy. It is also useful internally for building strategy.

8 Page 8 Competitive Rivalry - This describes the intensity of competition between existing firms. Highly competitive industries generally earn low returns. Competition will be strongest in the following situations: Many players of about the same size, no dominant firm. Little differentiation between competitors products and services. A mature industry with very little growth (companies can only grow by stealing market share). Threat of New Entrants - The easier it is for new companies to enter the industry, the more cutthroat competition there will be. Barriers to entry include: Existing loyalty to major brands or incentives for using a particular buyer High fixed costs or high capital requirements Scarcity of resources or lack of access to distribution Absolute cost advantage or economies of scale Government restrictions or legislation Patents, trademarks or copyrights Bargaining Power of Buyers - Customers can put pressure on prices where: There is a small number of buyers buying large volumes Switching to another (competitive) product is simple The product is undifferentiated or unimportant to the buyer The buyer can backwards integrate (ie produce the product themselves) Bargaining Power of Suppliers- If one supplier can affect a company's margins and volumes, then they hold substantial power. Suppliers will be powerful if: There are very few suppliers of a particular product There are no substitutes or switching to another (competitive) product is very costly The product is differentiated or extremely important to the buyer

9 Page 9 The supplier poses a credible threat of forward integration Threat of Substitutes - If the cost of switching is low, then this poses a serious threat. The main issues are the similarity of substitutes (based on price/performance) and the propensity of customers to switch. 4.4 SWOT Analysis SWOT analysis is very simple to use and very effective. It provides a framework to identify the internal and external factors that are positives or negatives for the company both now and in the future. SWOT enables a company to identify strategies that: Build on strengths Resolve weaknesses Exploit opportunities and Avoid threats. SWOT analysis is frequently used by sell-side analysts both behind the scenes and as a component of research notes to assess a company s potential. SWOT Analysis 4.5 Competitive Strategy Analysis There are two generic competitive strategies which a company might adopt industry-wide: Cost leadership Differentiation

10 Page 10 Both of theses strategies can allow a firm to build a sustainable competitive advantage and can be compelling to analysts and investors: Cost leadership: Supply the same product or service at lower cost Economies of scale Efficient production Simpler product designs Lower input costs Little brand advertising Little R&D Tight cost control Differentiation: Supply a unique product or service Superior product quality Superior product variety Superior customer service More flexible delivery Investment in brand image Investment in R&D Control system focus on creativity & innovation Alternatively, a company s strategy might be one of focus: A company using a focus strategy concentrates on a market area, a market segment or a product. The strength of a focus strategy is derived from knowing the customer and the product category very well. Strategies that do not fall in to these neat categories are inherently much harder for companies to communicate and for the audience to understand. 5. Strategy Statements for IR Audiences Investors and analysts clearly need to understand a company s strategy but they also need to see what s in it for them. Although your strategy might be to provide the best customer experience in your sector and indeed this may be a significant source of competitive advantage, you will need to help your audience make the links back to shareholder value creation. Investors and analysts also like to see evidence that the strategy is being pursued operationally and producing enhanced performance. Linking strategy to your key performance indicators (KPIs) can help to demonstrate how your company plans, promises and delivers.

11 Page 11 Disclaimer Dragon Gate Investment Parnters bases its information on sources it believes to be reliable, but no warranties or conditions, express or implied whether statutory or otherwise are given and such are expressly excluded including in particular any warranty that any information is complete, correct or accurate or that it is fit for a particular purpose or any purpose or any warranties or conditions as to title, quiet possession, satisfactory quality or as to description efficacy usefulness or as to infringement of the intellectual property or other rights of any person. All such warranties are expressly disclaimed and excluded. Details and information are subject to change without notice. Dragon Gate Investment Parnters make no warranty as to the copy right in or any intellectual property rights in any material posted on our web site or in our briefing papers and copy right and all other intellectual property rights which exist in the web site or are posted on the web site or which exist in our briefing papers shall remain the property of Dragon Gate Investment Parnters or other the persons entitled thereto absolutely.