rrrr -AND ANALY9IS

INTERNAL
DlAGNosls

OBJECTIVES diagnosts
of internalanalysisand
To dcscribethe process illustratehow they affcct
i"tto" u'.'dtt'
To introduceinternal "'uttltt
used lbr
becn dovclopedand
lT.:'"i]::t:::e tcchniqueswhich havc
internalanalYsts internal strengthsand
affcct thc diagnosisof
To considerfactorsthat
weaknesscs

I N T R O D U C T I O[N
1]
n i t o n a n a l to
T h i s c h a p t c r c o m p l e t e s t h e t h r e e - c h a p;tt e r u;;"ironment i s a n d d i a which
l ' s determine gnosis.ChaptcrsJ
unury'i'";;; ;i;""'*
and 4 focuseo on "f i" 'rt" nt- in the future' Chapter 5
ut lignificant
oppoftunitiesuna 'r""ui''t""iJ
descriuestheparallelp,".*,-*'.ninr,olvesdeterminingthestrengthsandweaknesses in order to develop
at present develop' Th;; ;;; d"iagnosed limtt
the firm has
"'"ti'ni or ionsider how they wrll
competitive advantages'"Jnil:'ilt;;*"utn"'*''
'"1""?f
;ffi::i'"fi!i""T"1-"li,lillli,IT,f
H:'j"'il:J:':'#TitJ.ii;#;
ina' itsrunc-
strong
isequa'v
;**:U:ilHl-T::n:iT';'lil,"il"rii: ","
t i o n s . P r o c t o r & G a m b l e w a s k n o w o"*ign'
n r c ' i t " "l-*tican
p " t U t t t t *Telephone k n o w n f ois
g i sTelegraph
i n j ' ' l t a y t aand r
p'ooutliJn una p'oau't of these firms ts
its outstanding potiti"s' Yet each
'"'uit" und p""onn"i
known for its outstanOing 155
 C H A P T E R5

examine thetirm'smatKeilng and

lnternalanalyslsis theprocessby whichthestr-ategists corporate
operations, resources
and
research
distribution, una'i"i"tip^unt, production wherethe lirm has siq-
ti'"'"2"!iiZ"""'l'i'n i"'ors^to determine
and personnet, ls the processby whichstrategists
"dunot"ukn"" s' lnternaldlagnosls ls pre-
nilicantstrengths threats environment
the
determine how to exptoitii"Zii"n'"i'i"'' *{ \:::.thein orderto buitdsustainabie com-
weaknesses
sentingby usingst'"ngti'"'l;iiepai'i'g

' 'acrossthe board''' Within t eachdivision has varying strengths

not strong :o*li:y'in jct enginesand weak rn compurersa
was strong
and weaknessesGcncralElectric
i.ewycarsago.Soafirmnrustdetermincwnatitsdistinctivecompetenciesare-what
r r - r a k e s i t u n i q u c t o t h e c o m p c t i t i v e a r e n ait- l.nust
s o , t hdetermine
atitcanm a k e d eweaknesses
whether cisionsabouthow
in the future. And
to usetheseabilitresno* oni which can bc overcome'
identifyweaknesscs
will iimit strategtcopt'o* or
Exhibit5.lindicates't''o*'*"ngtt'sandweaknosscsatlTTrnayinfluencethat
comPany'sstrategy'

Saramanca'
the 10,000linesinstalledin
in 1gg5to to theunited one quarterof
introduce successful lonversion of
ITT spent$105 million spain, or. *o*inr., The
a prevailing
Statcsits system 12, a sophisticated.telephone^switch stiengthsintt' uouoniog"s was ttr1,1l;<1^by
fiIanc" or marketingareasbutin the
whichhasbeenroutrngcallsanddataabroadrint"'tgai' *"ut'i"*"
rTT,s #;;;i; vehiclefor .r*ki;;;; TTt* organization and managemeni
Sysrem12 is pr.riuct .evelopmentand
,nurt"i-ion inut"o uv a.T&i'ano in the Unitedstatesand
telecommunication,
analystsand cuslomers areas.Three*"** *"tr set'up
^"d'l;;;^; :11"ry
while
NorthernTelecomLtd.
12i';;;vinnouutin' t".^Y;L:n:,:tlht1::lii:-!;*'!:ii
thesvstem
that
agree oiganiza'lion
'lhe
T5ill:l:;l'!;Iu*;':";;;pr"* uno lt was
iffi';,;i;t; l*.:*i:tJ'"i'iS;'lx,:,iTli""?+
12,;;;;; is so complexthat without focusedmanagement
ttran$t uiilion d""*ni"* Srrr.,n
spentmore Thisfaultin thestrategtc
ha'dto dtugn^amajorsystem'"
;;;tt"
tneopinionthatit should.be deliverydelays
from someanalysts the nume^rous
Xi in the Unitedro*r, u-iou"^rt^i""",'0
add 25 centsa planningstageresurted-in
ieading-toot""uJ cuslonrer*ifrd:::t' ln addition'
ti Systeml;;;*;
il. #;;ft;;,,,,.*ev t,lffi*: m$:tHjlfm:f#:,,4,i;;4t**
shareto eamings.u"in.;rir.r'*nd,
tochairm.an
cruciar
!!.
ttl+x**:J!ll;l:riiil1,",ry::::#:'iJi:i l:ff','#r:*#:**x*i:Jil:f",T":;'"
BI
i{ii
tl{[I
terecoJnmunications
the TTJllhlTfiyl'}ill *{il;;;*."of
strategv,ryi:i":,iilT::11
ll:,1il1l.$"i,i"i.il;'il;.'i;"9.;;'**ri-9:t" .,ecommun.
^":i:i*"frT,:ffi?';'JJiii;11;ffi*
st
-*c
&i,
{;.
Hr*k*J:*;;
li;;pfrtrg*hi5i:ffiftgg j:l -'
*t, more.llobrem'
ffi il:?i,ffi'r;;,1; ;;;;;;{
ru;rffi#'ffi
.r*' t^.^'1,
1
:",1*f.lt3,;.,J"';{'"ll;i;**:fu
'S::i

gr:

.i
.,'g!
ff?i"i,f
,,t';:*:,,fi
, 'gi
it:
tf
*
,,ii .!-
 AND DIAGNOSIS 157
ANALYSIS
INTERNAL

unless the executivesare fully aware of their competitiveadvantages,they may

s marketing and not choosethe one opportunityof the many availableat the time that is likely to lead
be
,orale I'esou/ces to the greatestsuccess.Unlessthey regularly analyzetheir weaknesses,they will
'he firm must
has slo- unableto face the environmentalthreatseffectively.In effect, theseassessments
rhlch stralegrslg
;ronment is pr1- be combined with environmentaianalysisso that decisionscan be made about how
tstainable s6m- to use or add strengthsand minimize weaknesses'
This chapterfocuseson how to analyzethe intemal factorsrealistically and diag-
nose their significance.lt is at this point that executivescan develop a -strateg$
aduantap,e.Ilofile(SAP) and match it with an environmentaltllreat and opportunity
prinl" GffiF) to createoptimal conditionsfor adjusting or changing strategiesor
r'arytng strengths
p o li c i e s .
k in computersn
Exhibit 5.2 remindsus of how this processfits into the total strategicmanagement
:ncresare-w[n1
process.And as before, we are interestedin how the internalfactorsrelate to the gap
sions about how
analysis.That is, managernentperforms internal analysisand diagnosisto identify
:ther weaknesses of the firm. Managementalso examlnes
'con]e. clearly the current strengthsand weaknesses
the most probablefuturestrenglhsand weaknesses. On the basisof theseassesslnents,
y influence that goal attainment given the internal and externalcon-
expectations are developed about
ditions. If gapsexist between desiredand cxpected objectives, new strengthsmust be
developedor weaknesses preventinggoal attainmcnt must be overcotne.
Since this chapterparallelsChapters3 and 4, much of what was said there applies
here and wiil not be duplicated.'fhesinrilaritiesincludethc definitionsof analysis
I"l'-*--r
ln Salarnanca, and diagnosis,the purposesofanalysisanddiagnosis,and factorsaffectingdiagnostic
'conversion
of decisions.
by a prevailing This chapteralsoprovidesparallelinformationon the internalfactors.This includes
Areasbut in thO'
nd management
. Strategicfactorsto be analyzedand diagnosed
nited States.and . Techniquesand problemsof internalanalysls
ng to M. Peter . The role of strategistsin internalanalysisand diagnosis
rrk SystemsDi-' . Diagnosisand preparation of a summaryassessment (SAP)
:he organization
agement lt was
in the strategic
INTERNALFACTORSTO BE ANALYZED
f,elivery delays
e. In addition, In the discussionofinternal factors,it is not possibleto considerin depth the material
and personneland laborrelations.
ts resources in 'Some in coursessuchas marketingmanagement
presented
wing other ad- of the leadingbooks on the subject are listed in tbe referencesfor each section.
"s future could All that will be attempted here is a listing of the most crucial ir]ternalfactors and a
' of this single of the competitive advantages (and weaknesses) that
presentationof brief illustrations
are poSsible.The order of discussion does not indicatc importance-it is iust a con-
kog announced
venientorderingof line and staff factorsand follows a fairly typical budgetingformat'
: telecommun-
is rejected,he
But you shouldrememberthat each areainteractswith the others'
ce, leading to
sheet.
Marketingand DistributionFactors [2]
i5; "Behind the
Marketing and distributionmeansmoving goodsor servicesfrom the producerto the
customer. It startswith finding out what customerswant or need and whether the
product and/or servicecan be sold at a profit. This requiresdoing market research'
158 c H A P T E5R

S t r a r e g i cm a n a g e m e n t
e l e m e n t s( C h a p t e r2 )
To determine
missiong , oals
a n d v a l u e so f
the firm and Enterprise l \ 4 i s s i o na n d
key decision objectives
makers

The
general
environment
T o s e a r c ht h e
e n v i r o n m e n at n d
d r a g n o s teh e
rmpaclor tnreats
and opporlUnittes

To eramine
anc dragnose
thc i rm s
s l r c n q t h sa n d
WCAK IESSCS

The
s I r a l e g cr
T o c o n s i d e vr a r r o u s m an a g e m e n t
a l t e r n a t l v easn d process
a s s u r et n a t t h e
6pcroprialestrategy
s chosen

T o m a t c hp l a n s ,
p o l r c i e s ,r e s o u r c e s ,
stru61g19,3n6
a d m i n i s t r a l i v set y l e
wrth the StrategY
lI
l
>r

To ensure
Evalualion
implementation and
will meet control
objectives

EXHIBIT5.2 A model of strategicmanagement.

 L N A L Y S I SA N D D I A G N O S I S 1 5 9
INTERNAA

AND DISTRIBUTION
INTEBNALFACTORS:MARKETING
5'3
EXHIBIT
struclY::andmarketshare:To whalex 8 Ef.ficient and effqctive packaging of products (or the
-tompetifive
;t;r*'ilt firm establisleou,,:lflt marketsharein the equivalentfor services.l.
9 Effcctiue pricing strategyfor productsand sen'ices'
I
iltin*il*rt::*#
#ilffrT':|
?,'i:il* l0 Efficient and efl'ectivesalesforce: close ties-withkey

I i;i.tl;.
,tritui.tt'
t*"ct-service

Ffi4 pfo-du.t-Eervlce
llne.
mix: quality of products
- - ^ ^ ^ r .product-service
completeness of ^ - ^ r . . ^ +^ ^

phaseor lire cvclethemain

and customers. How vulncrableare we in tcrms 01 concen-
traringon salesto a few custotnets?
11 Effective advertising:Hasrit establishedthe compa-
ny's product or branclrtnageto develoployal customers?
;.,rirr*o pr"9i:::::i].'':,mix; nincient and effectivemarketing promotionactivities
i.proOu.ttand servicesare in' ri
'S and new-service lcatlenhip' other than advertising,
I Strongnew-proouct
(or equivalent legal prolection for 13 Efficient and eff'ective service after purchase'
I O pu,.ni protection
14 Elficient and effective channelsof distribution and
'wWe

coverage,including internalefforts'
/'

and and geographic

Positive feelings about the fitm
icesbYthe ultimateconsumer'

identifi,ingthemarket,developingproduct,testingcustomerreaction'workingout
and deciding
productioi and costs,determiningdistributionand servicerequirements,
on advcrtisingand promotion approachet'
in the 1970s
As sirnpleas this sounds,marrycotporationsall but forgot suchbasics
high. But vast economic and social changes have madc
The
when inflation kept revenue
imporlant for most firm6. Thc recession in thc early 1980s
srralegrc marketing strengthsmore
shifts created problems for those who pursued mass
managemenl
process
and demographicand iife_style
as the kcys to marketing SucceSS. Likewise, lntense
marketing and brand loyalty
have created
internationalcompetition,rapid technologicalchange,and dcregulation
in typical marketing approaches. The changing nature of competition,
new weaknesses
at marketing strengths and weaknesses in order to build
then. requiresa close look
fragmented narkets. Exhibit 5.3 is a list of the
competitivcadvantagein increasingly
The strategist is looking to see if the firm is sub-
marketing and distriburionfactors.
stantiallystrongerin marketing and distribution than its competltors'
from a variety of
As ytu looi at the factors,you will seethat strengthcan come
questions of segrnentation, positioning, and
upprou.h"r. The operationalmarketing
distribution) are quite important to the firn,s abiltty
mix (pr<lduct,prlce' promotion.
firms compete on any and all of these factors.
to compete effectively. ol cclurse,
l o w p r i c e s l
. o w e r q u a l i i y . m o r e p r o motion.
S o m ef i r m s p r e f c ra p p r o a c h ei ns v o l v i n g
prefer orientations toward higher prices, higher quality,
and wide distriburion;others
and customdcsign.
An assessment of the weaknesses in relationto marketpotentialalso suggestsareas
where improvementscan be made. For instance,if there appearsto be a gap in the
to fill out the
product line, new-productdevelopmentor acquisitionis called for
gap in distribution might lead to efforts to build
existing line or createnew ones.A
gaps exist, price or promotion can lead to
intensity, exposure,or coverage.lf usage
uses or users (customers) can be found for
increasedfrequencyof purchase,or new
products.
 160 5
CHAPTER

Just as importantas thesequestionsare other areaswhich focus on how the mar.

EXHI
keting organizationfunctions.For instance,the organization n.rayhave the abilitvi
accumulate better knou'ledge about its rnarketsthan the corrpetition has lf properi, f:,.:1
:i:,1
used,this canbecomea majoradvantage with respectto assessingthe needfor change*
i. 1
and detern-rining organization
theirtiming. Similarly,if the n'rarketing maintainsgs.d t,,i

relationshipswith productionoI new-productengineering,the translationof market f::"4

place necds into the tin'rclycreationof goods or servicescan lead to a competitive li

edge.
i:,(
ir :
Finally, the importanceof marketingto the overallsuccess of the companyneeds i_
l."'
evaluation.In somefirrrs. suchas thosewhich supplyto a few customerswho specify
tlicir prcciseneeds(e.g.. defensecontractors), the markctingfunction neednot bl
particularlysil'ong.In otherindustries. lhc greatest shareof internalresourceallocation
ntay go to rnarketing units (e.g., consumer products producers). As compctitiveneedg
relative strenglh of n'rarketing and the way it is ntanagedin relation Ri
are assessed, the
to major contpetitors ntav lead 1o indications ol strength or weakness. Exhibit 5.4
providcs an example of hou' malkcting has bccot'ne a wcakness at Proctor& Gamble
ducto thc w a y i t i s n a n a g e di n a c h a n g i n g
e n v i r o n m e n t

E X H I B I T5 , 4 BYTHENUMBERS
MARKETING

Like all packageci-goods marketers,Proctor & Gamble
operatesin a tougherrvorld than the past, when it had the
midas touch. Thc firm has sturnbledlately. It no ionger
has commandingleadson brandedproductssuch as Crest
and Pampers.And its competltorsare smarter.
P&G's traditional strengths-a massivecommitment
to product reseatchand exhaustivetest marketing-have
not been as potent as in the last. lts ntarkctsare lnoture,
and "the old mdssaudiencedeliveredby massmedia for
the massnarketsisn't working anynore," saysoneP&G
alumnus.
P&G's earlier successes often camefrom a strategyof
acquiring brand names (e.g., Charmin, Duncan Hines,
Folger's); and using rnarketing expertise, it put those
narrcs or'lone product after anotherto doninate its field.
Bu1 the firm has yet to tum recent acquisitionsinto big
profit producers.Proctor has done little more than refor-
mulate sonre new products while competitorshave cap-
tured substantialnew businessby segmentingmarketsand
products. Insiders suggestthat the problemsat P&G rc-
flect a corporateculture which is stifling. Decisionsare
"rnade by the numbers." In an agewhen creativethinkers
often get freedom to try ideas without interferencefrorn,
'
the top, P&G remains bureaucraticand centrally con-
trolled. The president wants to "know whal the factslr
are." Irle is a no-nonsenseanalystwho gets involvedin
nitty-gritty matters, with a fetish fot memorandaand a
burdensomesystemof comnrunication.This slow-moving
perfectionist style worked to P&G's advantageduring
less-competitivetimes. But now this approachis hurting
somekey markel:.
Recently, PresidentSmale has been showing greater
flexibility. P&G js working more closely with retailers;it
has cut down on its memos and livened up its ads. For-
going its usual thoroughness,P&G rolled out half a dozen
products since 1984 with no test marketing. However,
unless its weaknessesresulting from insularity and ad-
hercncetb centralizationare reduced,Proctor'spastmar-
keting gloriesmay not providethe strengthsto accornplish
its goal of doubling unit volume each decade.
As Exhibit 5.tl points out, P&G still faces problems
from cornpetitorswho are beatingthem to the punch,but
this "det'ensive" posturelits thc style of its currentman-
agementpractices.

Source: Adaptedfrom Z. Schiiler and A. Dunkin: "P&G's Rusty Marketing Machine," Bu,sinessWeek, Oct.2l, 1985, pp'
I l 1-r12.

.-
 \

L N A L Y S I SA N D D I A G N O S I S 1 6 1
I N T E R N AA

horv the ry1n1_ ss INTEBNALFACTORS:R&D AND ENGINEERING

EXHlBti
the ability 1s 8 Weli-equipped iaboratories and testing facilities
capabilitieswithin the firm
5 If properly 1 Basic research 9 Trainecland experiencedtechniciansand scientists
capabilitl for product engineering
d for changes Z i.u.fopt.nt l0 Work environmentsuitedto creativity and innovation
i i*cellenccin Product design and
alntalnsgoOd "l design
proccss andimprovenrents 11 Managers who can explain goals to researchers
i,*..11.n.. in
rn o1'ms1(s1- packaging developmcnts beingcreated. researchresultsto higher managers
i lop.tiot 12 Ability ofunit to perform effectivetechnologicalfore-
of old or new materials
I competitive i i.otou.t.nts in the use
dcsigngoals and customerrequire- castlng
i oiiritt to nreet
mpany needs ments
; *'ho specify
need not be
-ceallocation
retitiveneeds Factors[3]
:d in relation F&D and Engineering
(R&D) and er.rgineeringfunctioncati be a compctitive
E x h i b i r5 . 4 The rescarchand developr.pcni
to new or inlprovedproductsfor
tr & Gamble advantagelor two prlme reasons:(1) lt can lead
of improved rnanufacturingor
'ilii'ffi
marketing,and (2) rt can lead to the development

*rntj\*'m]i:?'*il"':r"YJ::lilr
ln Chapter3 we notedthat majortcihnologicalchanges
ofteu occurredor-rtsidethe
can provide significant
mntecliateindustr.y.Hven so, r"searchanci development
ferencefrom strength1orthe ongoing husiness'
lntrally con- TheR&Dprocesstscomm<-rnlyviewedasproceedingthroughthestagesofbasic
rat the facts research,appliedresearch,developnrenlalresearch,andctlmmercialization.Exhibit
or
r involvedin
5.6 graphicallyrepresents the tinle savingsin producinga new product' process'
rranda and a one aris showsthc
re.search. time lapse frOrr
servicewith accelerated dcvelopnrental
;low-moving to conmercializ.ation and the othcr shows the R&I)
a basic rosearchbreakthrough
rtage during conditions'
states.The actualrmprovement in time will vary, but unclerunaccelerated
:h is hurting anclcomrnercializ'ation about 25
is
the normal gap betweena researchbreakthrough
wing greater years-Thefigu,.*u,developedbylookingbackfromconlmercializationtobaslc
applications of basicor developr.nental
h retailers;it research.Accurateiorecastsof the comrl]ercial
individualfirm assessingits own
its acis-For- researchat'erareand dlfficultto produce.But for the
half a dozen R&Dcapabilities,thekeyistoexaminetheabilitytoproduceproductorprocess
:. Hogever, improvementsandthetimirigande{l.cclivenessofitsfutureef|orts.
t0 R&D or pursue defensive
ritrr end ad-
A firm can chooseto puisue an offensivc approach
' ' s p a s tm a r -
Exhibit 5.? describesthe kinds of differ-
,,fast seconcl"or "imitaior" approaches.
, accornplish
encesyou would expectin theseapproaches to R&D. Thc offensiveapproachwould
acceleratetheappliedanddevelopmentalresearclrefforts(BlirrExhibit5.6).The
:s problems .,fast seconcl"approachwould emphasize accelerated research(Bt in
cleveloprnental
: punch.but ..imitator,'wouldwait for commercialdevelopments and follow up
ulTentman- Exhibit 5.6). The
withn'rinorchangesorimprovements(B.inExhibit5.6).Exhibit5.8suggestswhen
to use'
thesevarious approachesmight be more suitable
1 , 1 9 8 5p
, p. and 6efensive R&D work. For exan'rple,TDK cor-
Some firms io Uotftoffeniive
its work as positive negativetechnology,
techncllogy,
poration (japan) characterizes

.-rL-
 162 5
CHAPTEF

Commercializalion ofi
<a-

i'io
Developmenta{ iin
Tesearcn
F.ti
lv
!::.

?b
io
:a
Applied if
r e s e ar c h
it
ir
l'!
Basic i,
research { l

ir
D1 D 2 D.r D4
Tlme

A TYPICAL R&D PROCESS

8 1 . 3 A C C E L E R A T E DD E V E L O P T I I E N T ABLE S E A B C H
C A C C E L E R A T E DA P P L I E DR E S E A R T ] H
, 1 a B A S T CI T E S E A R C HFlNDl|'JGS

E X H I B I T5 . 6 Lookingbackfromsuccessful commercialization:transforming
basicresearchintoviable
products.
(BasedonR.Gold,"Technological
Diflusion
in lndustry:
Fesearch
NeedsandShancomings."
TheJournal
of Industrial
Economics,
val.39lMarch pp.247-269.)
1981),

or nonexistenttcchnology.Positivetcchnologyinvolvesresearchfor the purpose0f

upgradingexistingtechnologies and improvingproducts.Researchon negativetech-
nolog)'is doneon processes. naterials,or technologywhich could presenta threatt0
existinglechnology.While this entailslime, cost,and risk. it cnhancesthe possibiiity
of accumulationo1'new technologyandkecpsa firrn abreastof potentialsubstitutions.
NonexjstcnttechnologyresearchIocuseson new developments which could provide
threator opportunityin the futurc.Withoutthis, delaysin researchof negativetech-
nology would be inevitablc,and new productswould ceaseto be developed.
As with marketing,thc in'rportanceo1'R&D to successin businessis much higher

E X H l B l r5 . 7 A coMpARtsoN oF OFFENStvA
E t \ D D E F E N S I VR
E& D A p p R o A C H E S
Otfensive Defensive

Productsor processes Dramaticallynew ones lmprovement of existingones

Productiondesign Flexibleand responsive Rigid,with efticiencygoals
Volume Lessemphasison costper unil High-volume emphasrs
lmplementation New drvisionsor new firms Existingstructures
Timing Longerterm lmmediateimpact
Environrnent Proacl-Use R&Dto achieve React-AdlustR&D to needs
changesuitedto your torecasted
research
 \

SN D D I A G N O S I S 1 6 3
L N A L Y S TA
I N T E R N AA

tuRtlto 't'-' OtO*

5'8 AN INNOVATOn
glgtBlT
-:1; P&G to fo1low in their footsteps'
unveiledits newestproduct for toothpaste).leaving
Procter& Gamble the managelnentstyle discussed
;*1T.T"i.i^Li,l;::i:"'"l#':Yx
:lililli;,'
innol'ilr,'",''"s Nurses Associationfor helping to maln-
N*" f,"* rhis relatesio
in Exhibit 5.4,
light q1::
The strategypursuedby P&G adcls

I[:.ji*H. ITJ:Tf;"T:iff:::'J:] iliffii cussion of R&D wilh regard to offcnsive

would ,pp-^"ft"r. Altirough thc Uiggestfirnrs
and
1",":t
detenstve
ale,thougll to
to realize that consumers "
ibut:-:',"'*;;n
f"""H;; for
oJ,t,
";
it failcd
bctter-quality diapers Last spring' Kimber- fait seco,.tdr,this
seems
positiotr nology. Reporledlv, P&G iost
to valy with the lcvel
-ol
ground to "nimbler.com-
tech-

i fi;;t"t took thc number one market-share rnarket in the recent past' by.lacking in
re- p"t#t-" in the
,l].,.uit.".ontouredfitting diapers'P&G's comeback the imltator
ofi.nr.--o, innovativeleads' lt has assun.red
:#;;; a $-s00 million revamp of diaper-rrtaking and the pump toothpaste' evsll-
equlpment position in both diapers
l.r*.t, Krmberly is presentlychangingrts market shirre Where techr.rologics
iually making up lost
t J a * . a n e t l u i v a l e nPt r o d r r c l '
'"'i;;;;i"t'to of are relativellisimple'the imitatorposition
may be qtrite
P&G, it is using a provon strategv
nrore lasting and rnuch
take suitable. Changesare slower but
consumcrbencfit' howcver slight' to spol rnore attractivc'
a.rr""Ut"itU prcxlucG less rnodiliable.maklng the imitator
i".r"ttrl., ,itare Other examples of P&C's technology is more complex' the
ateas, where
inclurJcthe addit:ionof tartar con- In other
iiii.r.ntiotiun strategy innovalor or fast-second position is usually more dcstra-
and the introductionol Liquid Tide' a laundry and
o"ii" Ct.t, howeuei, are usually smaller finls
with sttperior cleanil1gpower' Howcver' com- ble. Innovatot's,
a.nrg*, industry
dispenset oi'tenconre from outsidetlie
continuc to innovate (e'g ' the pump
;;;ffi ' Br'isirlcs'r
Wcck' Fcb' 24' 1986'
rrch into viable ''l'rocter
ancl Gamble llanks On a Nerv Baby: Ultra Pampers,
Soarcr: Adaptetl fron
pp.3G37'
rs." TheJournal

he purposeof l.orsonethanforothels.Iiorinslance,con.lputerorplrarnaceuticalfirnlsrcncrally
ncgatlvetech- h a v e m u c h l a r g e r R & I ) b u d g c t s ( 5 o r 6 p e r c e n t o | s a l c s ) t h a r i d o r n a n yinnovate
othcrindustries
cvct] thcrc' s:lmc O-il"S^,:tl:tl:-to
ent a threatto lwhich are rn thc 1 pt"tnirange)Yc1
new applicationsor minor improvcmcnts
the possibility wilh new products,r.vhrleothcri dcvclop
wav to iurpiou"procluctivity in rnanulacturing'
substitutions, 0fequal imporlance,R&D is sccnasa dccadcs of neglect
automatiotr alter two
:ould provide Increasecl iL&l) has lcd to incrcasingiactory
inclustries are recognizingthe need to boost
regativetech- rn the Unitctl States.Irven tho service
investtncntin technologyper workcr avcr-
oped. proclucrivity.In thc UfritcilStatcs.capital
much higher agccllcssthan$450pcrworkerinthelg60sthroughrnid]970s'Bythemid-1980s,
(in constantdolLars)'
this figurejunped to ovcr $i1000per worker
firms havc bcen lagging in long-tcrm
It might bc noted 0rat u,hilc nran1,U.S.
witrr unlinown time andpayofflags' 'lapancsc
commitmentto rnvestnentin riskytab
Now n.ranyof the imitators arebccomingthe tnventors'
.o-funr", havesurgedaheacl.
l]utovcnhere,diflerentlrrtlspursuediflcrentapproachcs.Sonyisanlnnovat0r;
electLotlics arena'
x r s l r n go n e s Matsushitals a copycattn thc consutler

hasis
Productionand OperationsManagementFactors[4]
Exhibit5.gliststheiactorsforanalyzingprodr-rctionandopcrationsmanagement'
D to needs
l f w e w e r e t o i d e n t i l y o n e l . u n c t i o n a l a r c a w h e r e N o r t h A m e r i c a n f iThe
r m s United
havebecome
to overseas conrpetitors, it wouldbe operations
lesscompetitivein r-elation
 164 CHAPTER
5

EXHlBlr5'9 TNTERNAL pRoDUcroN ANDoPERATTONS

FACToRS: MANAGEMENT
I Lower total cost of operations.comparedwilh com_ 7 Efficient and effectiveloffices
pctirors'total costs
;2 Capacityto meet market demands. .
3 Efficient and effective facilities l
4 Raw nraterialsarid subassenrblies costs
5 Aclequaleavailability of raw matgrialsand subassem_ ll Elficienrancleffectivenraintenance policies
blies
"i?tri"i.n, verlicalinlegrarionor supplierrelations
ancleflective equipmenrand machinery l1 ltr :jiy.
13 Flexibilityin operations

Statesusedto be cited as the rcaderin this area.Now it seems

that Japanese, Tai-
wanesc,Korean,or Europeanfirrr-rs arc the readcrs.In pirrticular,the Japanese
pushedhard on factorsl, 6, a'd l0 tliroughthe useof robots(five ffi
timesmoreip ssg
than in the united States,eventhoughrheywcre inventedby
Arncricanrl-a q".riryl
control circlesin a nationaleflbrt to improvepro<Juctiviry.
If we are to be able
colnpete'we cannotcontinueto yicld whole businesses b
suchas televisionuna,uoio
manufacturing and clothingto overseas competil.ion. Steelmay be the nextmalorloss.
Ellbrts are beingmadenow in u.s. i'dustry to improvequaiity. ,,D.rng
rt rightthe
first tirne" rnay providemorc bcnefitto the bottom line than
any realisticboostin
salesvolumc-and liequentlyf.r an inveslmentthat is returned
in lessthan a year.
Considerthe U.S steelfirnrs.Their facilitiesareout of dateand
they haven'tbeen
a b l c t , r a i s c f u n J s r o n r r d e ' n i z c .T h e l l l . e a r a s e r i o u s
cJisadvantage.r.rriii,
Japancseon factorsl and 2, thoughthey are showingsigns
ol makinga turnaround.
with regardto factorsr and6, EasternAirrinesusecrtocompere
witt Derta.Delta,s
cquipmentwas newer and lesscostly to operate.Delta had
a cost advantage.with
lhe newerequipmenttherearefewerbrcakclowns, too, and so Delta had an advantage
o n f a c t o rI l .
with regardto factor 3, considersclmeof the majo'food
chains. Satewayand
Kroger havc largerand ncwerstoresthanA&p. A&p hasha<i
to spendlargesumsto
try to catchup. A&P also has factor-gproblcms,Many of
its stoieswere rocated in
oldcr neighborhoods with no parking.Ancl A&p is inadequately represented in the
faster-growingareas.
consider factors4 ancr5. Ashrandoir does not own its
own crude oil. In the
1973-1914oil crisis, only governmcnrpolicy allowedit to
continuei" trr. g.r"ri*
business.Exxon did not havc thcseproblems.
Your exposureto prclduction and opcrationsmanagement providedyou with tools
to help you decidc how a firm can improve with regard
tL factors 9 to 12. The
developmentof care|ul productionplanningand contiol
systems,productivityim-
provements,supplierrelations,and plant capacityand
locationdeciiionscan leadto
important competitivc advantagesfor a firm. If a firm
can produce at a lower cost,
has the capacityto handrebusinesswhen otherscan't,
or.un g"t raw materialsat
favorableprices,jt has a competitiveadvantage.
F i n a l l y . f a c t o rl 3 s u g g c s trsh a r, p c r a t i o n sf l c x i b i l i t yc o u r d
b e c o m ea c o m p e t i t i v e
advantage.Sincethe beginningof this century,efficiency
througheconomiesof scale
 AND DIAGNOSIS 165
I N T E F N A LA N A L Y S I S

l*ctto'uLE S**'*o'*9:ttoN:]
s''o TnE
,rr1af
-ffiI*onof
;calesis
plantsizeto moremanaee^1ble the producta year lale.
it is eusiet to keep tabs on what is happening at the
A newoffic-cfurniturc
ai Westinghouse
ffi;;;t lts general furniture factory. When Nagel took over' he realized
,nlibruni Rapidsemploys600 people new
least
almost itntnediatelythat it was throwing away at
:JI1il:
;:;:',:,'"','.,;i
#h * il:i'*.il:i $100,000,y.u, ui woocl
"f.futaftaat an enormousdilferencebetwecnman- set up a rask lbrce of
s c
managers
r r p .
and
W i t h
union
i n a f c w w
workers
c c
to
k s 'h c
deal
with:tbe problenr.Within a few monthsthey reducedthe
' his"andsmall Plants
ig'H,bjj;il.::;i ;; flarrt.wcsringhousc wastrving scrap to bfOOOu year. "The bottom-lineefTectqf,bcing
mant'facture an energy-efficientlow-cost able to idcntify goals and comtrunicatethem quickly in
n,futifW a'ncl is clramatic," says Nagel' "Ten
recalls'"For six or eightmonths.we a smaller environment
i*rtnit. Nagel me whether by going to smaller
guvsfronrmarketing ^l'd.*^"f11: years dgo, if you askecl
;Tffi;:;;., the-tev what we were ptuns, gave up a lot of efliciencies,I would have
to talk about lou
t:"r iti. the sameroom 'ves.' Now, I can't think of anY "
givcntirne,manywere outof town said
ltri, * " At any
I*?*t"t on otherprojects introduced
Westinghouse
lvzek, ocl 22, lc)84' pp l52-l5tr
:"ol:,,.,." 'A4antedfrom "Small Is Beautiful Now in Manufacturing," Blr,tir'?'ts
JPU|LE'

hasclominated thc thinkingof productionexecutives. Longerand biggerrllns can cut

econorllicinternational
per-unit costs. But ^, *. noi"d bcforc, technologielland
Becausc of nonunionand lbr-
compctitrVeconditionsare changingthe groundrules
elgncomperirion'itisincreasinglydifliculttorun]algcplantsatcapacity.Andas
plants
technologicat chalgc shortenspri,ductlife cycles(e.g. consurnerelectronics),
with computer-aided design and
becclnreobsoletesoonerthan expectcd.Conrbincd
manul.acturing,productivitycanberaisedbutlargeplantcapaciticsbecomcuncom-
P c it t i v e'
Manufacturingpeoplearc now discussing diseconomics of scale Huge manufac-
plants which are beconllng
turing compl"*., ur. teing replacedwith newer,smaller
in Exhibil 5.10. While some iirms still usc cconomies
rrore automatcd,as suggested
othersare findingthat they have nlore flcxibiiity to shift
of scaleto saln advantage,
rn smallcrplants,achievcgreater productivity, and eliminate
pro6uctionrcqurrements
relations. an cra where
ln
some bureauciacy,which ofren leadsto smoothcrlabor
populationgroupswhich
massmarketinggivesway to a focuson needsof fragnrented
seemto changeiapiclly,flexibilityin operations can vefy well becomea competitivc
designflexibility, as well
strength.Firms can increasep.u.Lr, flexibilityand product
(personnel, training,inventory,qual-
as add flexibilityto the productioninfrastructurc
itycontrol,andplanningandscheduling).Thiscreatesaggregatemanufacturingflex-
ibilirv.

CorporateResourcesand PersonnelFactors[5]
andpersonnel factorswhich can provide
Exhibit 5.11 listsa serof corporateresources
competitivearlvantages for a {rrm. Each of the factorscan add lo the ability of a firm
factors.GeneralElec-
,u u.ti"u" its objectives.Somefirms are well known for these
tric.forexample,hasacivantageswithrcgardtomostofthem.

>_--
 166 C H A P T E5R

E X H I B I T5 , 1 1 L A C T O R SC: O B P O R A T R
I N T E R N AF F E S O U R C EASN D P E R S O N N E L

I Corporateinrage and preslige. 9 Balancedfunctionalexperienceandtrackrecordot

2 Effective organizationstructure,climate, and culture.
3 Cornpany size in relation to the industry (barrier to
4 StrategicrnanatL'lncnt system.
5 Enterprise;srecorclfor reachingob.jectives:
sistent has it been?How weil does it do comparedwith
sirrilar enterprises?
6 lnflucnce with regulatoryand governmentaibodies.
7 Lllective corporrte-stalT supporlsystcrns.
8 l { i g h - q u a l i r cy r n p l ( ) y c c s .
managcrnent:Are replacementstrainedand readyto t
over?Do thetop managers workwell together
asa
,10 Effectiverelationswilh tradeuhions.
ll Eflicient and effective persbnnel relations
How con- staffing.appraisaland pronrolion.trainingand
ment, and compensationand benefits.
12 Lower costs of labor (as measuredby
t u r n o v e r a. n d a b s e n t c e i s n r l .
13 Effective tnanagementinlormation and computer
tems.

Sonrc firms have artractedand held high quality, highly productive,and loyal
entployecsand managers.IBM, Texaslnstrunlents,and other firms arc knownf.r
this. Stncethcsepeoplc nrakethc dccisions1'orall l'unctions,this can be a crucial
advantase.Many {irms havepurchased otherfirntsjust to get thcir top-qualityman-
agcrial, professional,and othcr crrployees.By the same token, an organization's
structurc,clinratc,and culturecan bc a kcy advantage. Disneyis well known for an
overridingcrnphasison a fcu, core principleswhich guide dccisions,enrployee be-
havior, and the operalionsof its busincss.
Beingunionizcdcanbc a con'rpclitive disadvan{age becausco1'thelossof flexibility
or bccauseof thc higherdirectcostsof labor.Somefirns arc unioniz.ed but havehad
good relalionswith efficientand efiectiveunions,leadingttt potentialadvantage.
Many of thesefactorsbecomcparticularlvimportantwhcn managcrstry to deter-
nrine whethera str.atcgv can be irnplenrentcd. Weaknesses in theseareascould lead
1o a dcc:isiorrtl1'not attcmptinga given stratcgybccauseo1'the inabilityto carryit out
clfcclivcly. For exarnplc.an accluisition candidatewhoseorganizationstructureis
incor.npatiblc with thc strllclrrre ol your firrn could be a poor choice.Or a strategy t0
ckrsca plant could be af1'ected by union contracts.
Thus,lactors8 to l2 dealwith the so calledpeopleissues.And managers(whether
labclcclpcrsonnel,industrialrclations.or humanresources rnanagers) who dealwith
thesc issucsarc recognizedat somc leadingcomplnies rs a s()urceof cornpetitive
strcnglh.More of thesemrnaccrsarcreportinsto the CEO andare involvedin making
slrategidc e c i s i o n sI f. c o r l r p a n i easr cc o n s t a n t layc q u i l i n gr. n c r r i n g ,s p i n n i n go f f n e w
divisions,entcringnew businesses, or gettingout ol old oncs, managementmust
consiclerthe hurnanresourceques{ions involved-matchingskills with jobs, keeping
kcy personnelaftcra merger,solvinghumanproblcmsthatarisewith new technology
or the closingof a plant, and so on. Accordingto onc of the new breedof human
resourcemanagers,"Chicf cxecutivcshave finalllr colre 1tt realize that people are
what give you a competitivecdgc,andwe'rc tellingthemhorv1oget the right people."
Finally, with thc adventof management informationsyslemsrieveloprnent. and
usagc,many firms are findingthat they can turn dala and informationpower into a
potent strategicweapon.Exhibit 5.12 suggestsa numberof ways that firms can

l;,
.F--
 L N A L Y S I SA N D D I A G N O S I S 1 6 7
I N T E R N AA

TECHNOLOGY
TEN WAYSTO USE INFORMATION
5'12
ExHtBtT
ber for'consumerquestionsand complaints.you get ideas
**.*'o*.F I n.u.'I nun''u'.,-1.11i:i:it
:.:)::'l:T^
office'and
thetreasurer's :1"
your ::I
bauks' Ior product improvementsand neu products ln-house
nd ready to hk;!i i*i,,iiintt betu'een
1P"*' ^ ^ ^ x r o i . 6 n q n n i a l information elecironicpublishingcan help turn oul productmanuals
f a s t c r - a n d that
i n f n r r n n l i o n faster*and thal
ether as a teami1,, llrr .* obtain financial fasterforspeedier.introductions...
,:,,.. il,i;r", uoot cash
betttr
'r--Customer cashmanagement
managentenl
. i-rneunt tap intoyour 7 Sales. biuing salespeopieportablecomputersso that
tatrons policies: i tr Customer service.
service' By
BY letting
letti customers
they can get messagesfaster anclenter ordeis directly adds
-
-L:--'r^.^+^
and shipments, you Lbuild
,,^.' 'rlli
ig and dgvelop- a"atuiur.to track their orders up to quicker deliveries, bettel cash flow, and less pa-
fotuf,y"nOsmoothrelations'
excluslvcconr- perwork.
/ Compensation, r Locking iu custolners'B)' cteattng
p"utr,ao*tnunications with customers for orderentryand g Selling extra processing power. By using off-peak
servicesfor
data,youcanhelpthwart piocessingpowelto developcompletelynew
d computersys- !r.nung. of productandservice
outsiders,you can transfersone of the bigh costsof build-
competitors.
"i
titu.x.t intelligence.By assembling andmanipulal- ing your inforrnationnelwork.
cold leads by
ingdataon dernographics and competitors' -voucanspot i ielemarketing. Testing .telephone
conputer runs to feret out the best pros-
uniupp.aniches,clevelop newproducts'andavoidinven- first-using
pects-helps slash sales-forceexpensesand boost pro-
:lve, and loyal torycruncnes.
virl'.
are known for < New businesses.Information technologiesmake ducti video-
possible' Foderal Express' for one' 16 Training' Training or retrainingworkers-u.sing
ln De a crucial *iole newoperations speed-and lets you cut
trucksandfa- ditkt 1"tt them leam at their own
p-qualiry man- couldnot work withoutcomputer-equipped
i r a i n i u nc o s t s .
cilities.
organization's providing a toll-free num-
6 Product developmcnt. By
I known for an O o t .1 4 ,i 9 8 5 ,P P .1 0 8 - 1 1 6
Soarce:AdaptedtiomJ'HamiltonandC.L'Hanis,..InfornrationPowel,''BusinessWt:ek'
employeebe-

ss of llexibility developstrengths by usinginfbrmationtechnologyto gain a competitiveedge.Quick

availablc
J but have had accessto up-ro-out.data0n which to basedccisionsand n'rakeplans is now
have instalied a chief
advantage. to strategisisfrom all over the coryoration.ln fact, many films
managers often have
rs try to deterr information officer (clo) in their organizations.These new
eas could lead j t s
s e rc r l l l ' u n c t i o nasn dc h a r a c t e r i s t :
to carry it out
. overseethe conrpany'stechnolog,v, includitigdata proccssing,office systems,
)n structure is
,r a strategyto a n dt c l c c o n t n r u n i c a t i o n s
. Report <Jirectlyto the chairmanor CEO
. Concentralcon long-termstrategicuse of information, ieaving day-to da,voper-
igers (whether
who deal with ationsof the computcrroom to subordinates'
rf competitive
ved in making
Financeand Accounting Factors [61
nning off new The appendix
rgement must Exhibit 5.13 hsts someof the major factorsin {inanceand accounting.
analyses which can be done to help
jobs, keeping to this chapterprovidesa summar) of financial
:w technology you assessthis area.
financially
:ed of human One objectiveof the analysisis to determineif the focal firm is stronger
it hold out longeror compete more
at people are than its competitors(Exhibit5.13, factor 1). can
effectively becauseit has thc financialstrengthto do so?
ight people." to
Analyiis of the comparativelinancial condition of the firms is prirnariiy done
lopment, and particularstrategy, or if it is
determinewhetherthe firn is capableof undertaking a
power into a accountfor their financiai
advisableto do so. For example,many entreplcneurs fail to
rat firms can
 1 68 cHAprER5

E X H I B I T5 . 1 3 INTERNALFACTORS:FINANCEAND ACCOUNTING

I Total financial resourcesand strengrh-liquidiry, 5 Advantageous taxconditions

andinsuranc.
ali)i
leverage,pIofitabi1ity,activity,cashflows.-riskexposure
2 Low costof capitalin relationto theindustryandcom- 6 Efficientandeffectivefinancialplanning,workin,'*l-.
petitorsbecause of stockpriceanddividendpolicy ital, andcapitalbudgeting
procedurei l*,,*O,
3 Effectivecapitalstructure,allowingflexibilityin rais- T,Efficientand effectiveiccountingsystemsto,
ing.additionalcapitalas.needed;financialleverage "^:.i!
budgetandprofitplanning,andauditingpro..our.rll)i,,
4 Amicablerelationswith ownersandstockholders 8 Inventoryvaluationpolicies ".
,,ji

weaknessin their stafi-upphase.Their firms go "belly-up" becauseof the

cash-fl0u,
weaknessif they have not plannedfor it. And many firms have planned.ortru
expansionsonly to find that they are financiallyincapableof paying fo, th.m.' ''*" "i",1
Another purposeof financialanarysisis to help pinpoint strengthsor weaknesses
in other functionalareas,liom operationaland strategicperspectives. The otherfacion
l i s l e da d d e f f i c i o n c y( f a c t o r s2 , 5 , a n d 6 ) o r a s t r a t e g ivca l u e( f a c t o r s : a n d q ) t 0 a
firm. The accountingstaff function (factor 7) is a necessaryone for legal and'manl
agementinformationpurposes.Accountingpoiiciesfor inventory valuation(factoJr
can have strategicvalue when changedin responseto inflation and other externj
changes.
This last point suggeststwo other importantideasto keep in mind as the financial
positiclnof the firm is analyzed.First, the financialvalue of a firm must be carefullv
consideredin terms ol' the basis upon which the valuation is made. Stock market
prices may reflect short-term judgmenrsof analysts.And these
.ludgmentsmaybe
basedon changesin the accountingtreatmentof assetsfor tax purposes,whichmay
make returnsappearbetterthan they are. The book value may be ridiculouslyoutoi
datebasedon long-termhistoricalcostsor the methodof depreciation used.llneither
case, if a firm or subunitis being valueclfor acquisition(or for divestitureor liqui-
dation), the financial valuation processiiself must be assessedin additionto other
factors affecting such decisions.So the assessment of strengthor weaknessdepends
on the analyticalapproachand the interpretationof "hard" numbers.
A secondmajor issue is the working capital needsfor strategicversusongoing
operations.Becauseof past strategicchoices,firms may have tied up so muchcash
that future options are limited. This happenedto Ford and seagrams.on the other
hand, cash-richfirms mustdeterminehow long existingstrengthswill provideacon-
tinuousflow of fundsanddecidehow to investthis wisely.Thus timing questionsare
importantto financial analysis.
The final issue we wish to raise concernsthe processof financial management.
Earlier we suggestedthat the way valuationsare made influencesthe contentof the
financial analysis.Also, other corporateresourcesfactorswere seento be important,
includingthe quality of management. Factors4, 6, and 7 in Exhibit 5.13 hint atthe

rSome analystsnow
suggestthe computationof a Q ratio to aid investmentdecisions.This is theratio
of the marketvalue of physicalassetsto the cost of replacingthoseassets.
 I N T E R N AA AND DIAGNOSIS 169
L NALYSIS

financial
important role of the policies and proceduresestablishedfor performing
--'-----*\ role of the financial executive in providing support for planning
analysis.Thus the
ranceto minirnize can lead to a strategic advantagefor the finn. Too often, the chief financial manager
is seen as important only at budget preparationstagesor for providing "number
the
ing, workingse:, crunching" ur input for decisions.These roles are important. But frequently
financial executives are excluded from real involvement in strategicplanning because
;ystemsfor cost;
it is believed that they have short-termorientations,focus on selectivecomponents
3 procedures rather than on conrprehensive pictures,and value precisionover less tangible issues'
(These remarks often apply to executivesin other functional areas as well') As a
result, decisionprocesses can suffer frorn what has beencalled a "paralysis of anal-
ysis." It is suggestedthat the chief financial officer's tasks of forecasting capital
of the cash-flsw structurc,determiningresource allocation anclcash flows, and raising external funds
med costiy planl are critical functionsin determining the competitive advantageof the firlTr.
for them. Thus a firm at a particular time can be strong (or weak) financially, and this
rs Or weaknesses condition allows it to make (or prevents it from making) strategicchanges'Financia-
The other factors ratio and accountinganalyseshelp measure this strategic advantage.But an analysis
rrs 3 and 4) to n should also be madeof the process of flnancial management, since it too can provide
: legal and rnnn- advantagesfor the finn. Of course, as suggested in the section on corporateresources,
uation (factorg) the quality of managementin any of the functional areas can provide advantagesfor
d other external the firm.
just
ln sum, lrrms can have competitiveadvantageson a number of the factors
l as the financial discussed.Strengthsusually lead to greater "slack"-a cushion of resources which
rust be carefully allows an organizationto be flexible and adaptinternallyor externally.Slack enhances
l. Stock market the ability of a firm to choosefrom a greaternumberof alternativestrategies'Weak-
lgments may be nessesor disadvantages limit the strategicoptionsof a firm. The list of resourcesand
a
rses,which may factors also servesas a checklistof items to analyzeabout a firm (or a case)with
liculouslyout of view to improving its operationsand identilying its distinctivecompetencies. It is not
used.rlneither an exhaustivelist. But it doesprovidea usefulbeginning'
lstiture or liqui-
ddition 1o other
:aknessdepends ANDWEAKNESSES
ANALYSISO F S T R E N G T H S
(or
There are a variety of ways each areaof potentialcompetitiveadvantage disad-
versusongolng vantage)mighr be analyzed.First we will provide some for
prescriptions how analysis
p so much cash should be done. Then we will summarizesomeevidence about whether it is done that
s. On the other way and what is analYzed.
I providea con-
1g questlonsare
Techniquesof lnternalAnalysis [7]
rl management. As suggestedeariier, a number of basic referencesfor each areaof internal analysis
) content of the trauebe.n provided.It is beyondthe scopeof this book to summarizethe techniques
o be important, of analysisfor the areasmost businessschoolcurriculumscoverin detail. For instance,
5.13hint at the a partial but far from comprehensivelist of toois ls identifiedin Exhibit 5'14'
Data for analysisand diagnosisof the factors come from several sources. One
sourceis the data gatheredin the environmentalanalysisand diagnosisstageof stra-
rs.Thisis theratio
tegic management.The other sourceis the internaldata generatedin doing business

,,,;L
 1-i
ttv ui-1AHttH5

E X H I B I T5 , 1 4 A F E WT O O L SF O R I N T E R N AA
LNALYSIS

Finance and aicounting: Capital assetpricing model;

pay-back; accountingreturn; presentvalue; internal rate and market-linesanalysis
of return;financialralios (seeappendixi:fixed and varj-
a b l eb u d g e t s
Hirman resources: Turnover analysis; morale sur-
veys; training budgets; analysisof personnelneeds and
caoabilities
Marketing: Sales forecasts:market-sharcanalysis: ysls

and availablefrom lhe nanagerncntlnformationsystemandthe functionalclepanrnents

(such as marketing).One writer has suggested that thc annualreport, witfr
AL'its
faults, is anothervaluablesourceof infomation. So as before, verbalsources,6q_
cuments,formal studies,or a nanallementinfornation svstemcan provideoutuinput,
lor analysis.
In additionto thesesources,thereare two other analyticalaids you might useh
guidethe internalanalysis.The first is the functional-area profile.This typeof proflle
i s s h o w n i n E x h i b i t 5 l 6 ( p a g e1s1 2 - 1 1 3 T
) .h e i d e a i s t o p r e s e n t a m a t r i x o i f u n c t i o n a i
areaswith charactcrislics comrronto each.
T'henthe strategistpreparesthe functional-area resource,deployment matrix(Ex_
hibit 5.1-5).The llrrn rccordswhcrc it is spendingits dollarsand cunently exertins
its e1'1brts. This infornrationshr-ruld be recordedeach year so that the firm can deterl
mine the relativeimportanceof each hrnctionalarea (cornparedwith competitgrs'
functional arcas)over time. This approachallows the firn to analy'zethe strategic
deploymentol funds anclits strengthsand weaknesses over time as comparedwith
t h o s eo f c o m p e t i t o r s .
we also wish to nrakesomesirggcstions abouthorv you can apply someof these
techniclues for stratcgicanalysis.First, eacharcamust be consideredwith respect to
what its policiesand approaches wcre, are, and will bc. That is, how do cunent
conditionsrelale lo the pasl attainmenlof objectives,futureexpeclations, or internal
requiremenls? This questionis criticalto the overallgap analysis,and the answerwill
hclp you determincwhich arcasare most importantlbr the f uture. As we notedbefore,
what is viewedas a strengthn()wrnaybecomea weakness later.Looking at eacharea
ovcr lime allows you to seeif advantages are bcing developedor are deteriorating.
For inslancc,a dcclinc in the nunbcr o{'patcntsbeing genclatedmay be a signof
polentialproblernsin R&D or new-product developrnent. Increasinggrievances may
suggesllaborproblems.An increase in thecostof goodssoldcouldindicateproduction
difficulties.Incrcases in thc reworkratemay indicatequality-control problerns.A host
of indicatorsin eachareacan be exarninedover time. In finance,the latios notedin
the appendixcan be examinedover severalyears,and pro formascan be prepared for
the future. E,achindicatoralsomustbe analyzedin relationto goalsor requirements.
For instance,are salesquotasbeingmet?Doesthe trendin debt to equity suggest

li
 \

INTERNAA ANDDIAGNOSIS 171

L NALYSIS

MATRIX
RESOURCE.DEPLOYMENT
s't s A FUNCTIONAL-AREA
EXHIBIT
Functional
areas
le and shop-
y1, material;
'ement R&D+
plan- engineering

; valueanal.,
, 1,, % ol strategic
develoPmenl
Manu{aclunng dollars

departments FocusoJ eflorts

u,rrh all its
;ources,do_
: datainputs Marketing

right useto
ie of profile
I functional
Finance
nalrix (Ex-
l1' exerting
can deter-
rmpetitors'
re strategic Management
pared with

re of these
respectto
problemsin meetingany conditionsof loan agreernents with bankers?Are <lurhirrng
do current
procedures meeting the requirernents of the i]qual Opportunity Ernployment Con'r-
or internal
mission So that we can continue t() seuure government contracts? Any o1'lhesearcas
n s ue r w i l l
' e db c l o r e , couldbe Sources of weaknesses or strengtl"ts. For example, yor-rr
firm may be a favorcd
employer if its hiring practices are "bctter" than thosc of competitors.
eacharea
:- r. ,i -r . r. .r,a. .t iDn. s
Second,the analysiscan be dclneon a piccemealbasis,with each area viewed
independently of the others.However,thestrengths andweaknesses musthe comparcd
a s r g no f
in relatiottto one another. f'rade-offs will inevitably result. br"rt
it is betterto considcr
i n c e sm a y Consider
the needsand desires of each area together rather than let each suboptimiz.e.
rroduction a policy ot
Exhibit 5.17 as a case in point. Manufacturing may see strength through
n s .A h o s t policies
long, steadymass production runs of a limited product line. Finance may set
s noted in
which value a low {inished-goods inventoryand high turnoverfor cash-flowimpro're-
:pared for
nent. It may suggest capital budgeting and investmentpolicieswhich minimize the
rirements.
number of factories and warehouses, freight costs,etc. So far so good; thesepolicies
\ suggest
 172 5
CHAPTER

EXHIBIT5,16 PROFILE
TYPICALFUNCTIONAL.AREA

R&D engineering
(conceive/design/develop) Manufacturing
(produce)
------a
Focuso{ financial $ for basicresearch $ rol.pfunt
deployments $ for new product $ lor equipment
development $ lor inventory
$ lor produclimprovemenls $ lor labor
$ lor processimprovements

Physicalresources Size.age, and locationof No.,location,

size,andaqe
R&Dfacilities ot ptants
Size,age,and locationof Degreeof automation
development {acilities Degreeof integration
Typeof equipment

Humanresources Nos.,types,and agesof key Nos.,types,and agesof kev

scientistsand englneers stafl personneland
Turnoverol key personnel loremen
Turnover01key personnel

systems
Organizational Systemto monitor Natureand sophistication
of
technological purchasing system;
developmenls productionschedulingand
Systemto control controlsystem;quality
nnnnonlrral/rlocinn/ conlrolsystem
process
developmenl

T e c h n o l o g i c a lc a p a b i l i t i e s No. of patents Baw materialsavailability

No. of new products Trendsin total constant$
% of salestrom new per-unitcostsfor raw
producls malefials and purchased
Relativeproduclquality parts,directlaborand
equrpment
Productivity
Capacityutilization
Unionization

Source:Feprinfedby permissionlrom StrategyFormulation: AnalyticalCanceptsby CharlesW. Hoferand

g o m p a n yA l i r i g h t sr e s e r v e d
D a n S c h e n d e lc, o p y r i g hOt 1 9 7 8b y W e s l P u b l i s h i nC

could be seenas ways to improveefficiencyand gain a competitiveadvantage' But

and salesefforts are directed toward the exciusive distributionof
supposemalketlng
outputs.The companyhasdeveloped pro-
high-quality,high-priced,custom-designed
motiou policies to tap a market opportunity in this area. Its goal is better customer
service through well-stocked warehouses and a wider produ;t line. Suddenly,the
the
assessment of productionand financestrengthstakeson a different meaning.And
 ANDDIAGNOSIS 173
I N T E F N A LA N A L Y S I S

Marketing Management
'ing (produce) (distribute/sell/service) Finance (finance) (plan/organizelcontrol)

$ for sales and promotion $ for shorl-termcash $ for planningsystem

rent $ {or distribution managemenl $ lor controlsystem
)ry $ for service $ for raisinglong{ermfunds $ for management
$ for market research $ for allocatrnglong-term development
funds
$ for management
development

No. and locationof sales No. of lock boxes Locationof corporate

"t, size, and age offlces No. o{ majorlenders horalnil2riara

No. and locationof n;^^^-^i^^

ut5PvrJrut
^t
I vl
^+^^1,
Jtuun

tutomation warenouses ownership

')legration
No. and locationof service No. and types of computers
ripment facilities

and ages of key Nos.,types,and agesof key Nos..types.and agesof ke, Nos.,types,and ages of key
onnetand sarespeopre financialand accounting managersand corporale
Marketingstaff personnel staff
key personnel Turnoverol key personnel Turnoverof key personnel Turnoverol key personnel

sophistication
of Natureand sophistication oi Type and sophisticatlon
of Natureof organizational
rg syslem; distributionsyslem; cashmanagement cuitureand values
r schedulingand servicesystem: pricrng system;financialmarkets of planning
Sophistication
'stem;quality and credit staff; market forecastingsystem; and nnntrnl c\/etame

'slem researchstaff corporate fjnancial oJauthority

Delegalion
mndolc a^.^r rnlin^ Measurementof reward
system systems

als availability Trendsin totalconstant$ Creditrating Corporateimageprestige

)tal constant$ nar-rrnit .^ei< fn r ealoc Creditavarlability Influenceof regulatoryand
osts for raw and promotion;distrrbution Leverage governmental agencies
and purchased and service ratio
Price-earnings Qualityof corporaiestaff
)ct labor and % retajioutlet coverage Stockprice Organizationalsynergies
It Key accountadvantages Cash fiow
Price competltiveness Dividendpayout
lization Breadthof productilne
1 Brand loyalty
Serviceeffectiveness

rarlesW. Hoferand

types and numbersof personnelto manufacturecustom-designed products,staff ware-

ldvantage.But houses.processand ship orders,etc., becomequite different. Cleariy this is an ex-
distribution of treme example"But the point shouldbe clear that what may be a strengthin each area
developedpro- car result in overalj weaknessif the company is "pushing the cogs" in opposite
)etter customer directions.
Suddenly, the In a simiiar view, weaknessesmust be comparedwith strengths.Weaknessesmay
aning. And the preventus from taking advantageof an opportunity,They can preventus from readily
 174 cHAPTER
s

shifiing strategies. But too many executives put on unneeded"blinders.' bv.*_,

sizing weaknesses insteadof strengthslnsteadof taking a pessimistic
anythingcan go wrong. it will"). successful srrategists "i*'Yll"
oftentake an optimisti",)-[
("we didn't know it couldn't be done, so we did it"). Thus insteador ,rr.,1tu
weaknessesto dominate,it is often more fruitful ro lake advantageof un ooo.,l,l-tl8
-^'qrrrrv
by capitalizingon strengrhs. However,lhis must be done u,ithinthe 'tegltlmate' "
rgi
constralntswhrchmay exisl becauseof the fir'r,s weaknesses.
In additionto being comparedover tinle in relationto goals and r, one anorho,
strenglhsartdweaknesses are colr.rpared in relation1o environmental conditions.
' rij
-'rr
conrp:u-ison is usuallybasedon competitors.but it could includethe'ttrm's position
rclalive to techno)ogical changes.suppliers.or the producrlile c1,,cle.
Most strategistsare concernedu,ith how their fimrs are placeristrateeicallyrelativg
to competibrsin similar businesses. It is vjtal that the propercomparisons bs rnu6r-
For exar.nple . as the PIMS data have shorvn,companieslvith a high ,ieg.eeoi
in-
vestnlenlintensityare often less pro{itablethan thosc with lowcr investment-sales
ratios, Similar differencesexist if thc firrn bcing comparer.l is substantially different
on characteristics otherthaninvestrnent intenslty.Thus a sLatenent aboutthe mission
of thc business as discussed in ChapterI becomesimportantas a basisfor determinins
the relevantcomparison groups.Furthen'nore , asidelrom thegroupitsell, thc.o*ouni
within the group that )/ou comparcyour firrn with makesa cliffcrenccll,itl regaid
to
the interpretation ofstrengthsanclwcakncsscs. Considcrratio analvsis.for example.
Besidesstudyingchangesof vour organization over tirne. shouldyou comparethese
with industry(tverages or with the changeserperienced bv leaders? If low performers
on Rol in the industryhavehigh liquidity.for example,is rhe high liquiclirl'of your
firnr a slrengthor a weakness?That n'ra1, depenclon otherfactorsuniqueto your firm's
own sttualion.In other words, many industriesare composedof clifferentstrategic
groups.Comparingratiosof Anheuser-Busch td lleilenlannor l-oneStaror with beer-
industry averagesmay nol make much sense.llcncc, comparisonswith leadersof
strateglcgroups (or to upper- and lower-quartileperformers)is more likely to reveal
vaiid and meaningfulconclusionstiian using "industry averages"as the basisfor
comparingfinancialratiosor otherdatasuchas markctingourlays.plant size, R&D
expenditures. iabor costs.and so on. Indeed.TWA was criticizedwhen irs former
CEO urged execuliveslo mcasuretheir companyagainstindustryaveragesthan to
shoot for the top. So cautionin the interpret.ation of data is requirecl.
It is also in.rportantto comparefirms which are in the same or simjlar phasesof
the product-service life cycle. If our fim's main productsor servicesare in the
matunt)' stage of the lifc cycle. improper compiursonswould be made with a firm
whosc main productsare in the growth phaseof the cycle. One representationof the
l i f e c y c l ei s g i v e ni n E x h i b i t5 . 1 8 .
Finally. it is importantto comparestrengthsand weaknesses relative to their overall
significanceto rhe strategyof the firm. crisis managerscan get bogged down in
analyzingfine detailsand "lose sight ofthe forestfor the trees." Daily operarional
fluctuationsand problemsmay drive atlcntionaway from aeas of strengthor weakness
that are f:u more importantto overall success.of course,clinjcaljudgmenl is required
 175
INTERNAL ANALYSIS AND DIAGNOSIS

F i n i s h e dg o o d s
i...r., b{ inventory control
nlsuc vrew ".nptu-
(,,if W a r e h o unsgi
r opttmrsticyis*
ead of allowinp
,1.2pspponunil|
tegttimate,reol

to One another,
conoltlons.The
r firm's position

egicallyrelative
:isonsbe mndg.
h degree of in_ \--}
nvestmenl_sales
rtialiy different T r a n s P or t a t Io n
Order processtng
out the mission
Flnance P a c k In g
for determinrng
lf, the company Personnel
lVlarketing
with regardto
;, for example.
comparethese EXH|BIT5'17 "Cogwheels" in a physicaldistributionsystem' 3)
Distribution:ASuitab/e
(R.Ball,,,physical LongRangePlanninglFebruaryl9S0l,p
caseforTreatment,"
ow performers
luidity of your
, to your firm's
'erent
strategic
r or with beer-
/lth leadersof
ikely to reveai
EXHIBIT5.18 A common product-servicelife cycle'
the basis for
rnt size, R&D
..,]

**Hil
Phase l , ., :. .t.
'
ren its former (Devdloomen!]
:'ti
rragesthan to
D e v e l o P m e notf
the produit and/or
ser.vice and/or
iiar phasesof p r o c e sas n d l o r
es are in the
: with a firm
ntationof the
market
characterized
. b y : l n c e P t l o n .;
m i s s i o n a lwYorK;
I l a c ko i . q u s t o m e r
lil;fin::"'',1
I decrearseq{emand,I
l'' andcoripotilqrsI I
I k n o w l e d g em ; uch
' '.",';*'''
r their overail I p e r s o n esl e l l i q g
ged down in I a n ds e r v i c o ;.
I c o r i i l n u e dp r o d u c t
y operational
or weakness
\
rt is required
 176 5
CHAPTER
. :,,,':
1.
._,
,
which areas and indicatorsthese are. (We have '
for determining more to sauo.-
this in the sectionon diagnosis.)The key is to identify areasand indicators*i,^llTt
management shouldfocus on. Four key questionscan be askedas vou.*url.lllp
five areas: What does this firm do particularlywell? Do thesecompetencies ^l.lqe
and il'so, when?What doesthe firm do poorly?Does it matter?nr .o*p.ni.rl}l
' - {ru
casesare analyzed,our adviceis to not worry aboutheadcolds-if pneurnontaseetn*
to be indicated,that requiresmore seriousanalysis.(Nonetheless, if it aPPears
that
the head cold can become pneumonta, it may requtretrealment.)

Descriptionsof InternalAnalysis [8]

The discussionof analysisso far has been prescriptive.There is little descriptive
researchon whetherand how strategistsactuallyperform strategicadvantage ana\srs.
On the basisof a feu, studiestwo things are clear. One is that the processof intemat
analysis is subject to inlernal bias by level and ti'pe of executive. There is often
disagreementamong executivesabout thc distinctivecompetenceof their firm. Sec.
ond. it does not appearthat clear patternsof strengthsot weaknessesemerge.Ercir
firn seemsto be uniquein how it developsand usesits advantages.
But this isn't very'helpful.The questionis, How do you identify and usecompe!
itive advantages'l You identify them on the basisof the diagnosisand analysis of
strengthsand n'eaknesses discussedearliel in the chapter.For exarnple,distinctive
competencecould resultfrom a superiordeliveredlow-costpositionor a differentiated
prodnctoffering. Competitiveadvantages could consistof superiorquality,superior
serviccor technicalassistance, a strongbrandname,a uniqueor innovativeproduct
or service,or the statusof being a full-line producerwith wide distribution.Such
advantages result from the strengthof superiorskills or resources,lower costsof
manufacturingor distribution,lower cost of capital. designexpertise,good trade
relationships, fast and flexibleresponsc capabilities, and so on. ldentification of these
involvescarefulanalysisoi'the variousfaclors identifiedearlier.
One o1 thc factorsdiscussedin the operationsand colporateresollrcessectorswas
whethersize was a strengthor weakness. Thc "advantage"of size deserves special
treatmentsincewe think that too many believe "bigger is better." A larger sizein
relation to the con"rpetitionis normally viewed positively. It can give strength by
allowing greatel economiesof scaleor providing barriers to ently. However, there
are some potentialweaknesses associatecl with a larger size. Diseconomies of scale
e a n r e s u l l l r o m r a p i d i n c r e a s eisn s i z e a s u c discussed e a r l i e r 'T. h e r t r g anization
becomesrnoredifficull 10 manage.This is tltpicalof young, overly aggresslve com'
panies.Furthermore.largefirms olten becomethe targets of regulators, legislators'
consuffleractivists, and conpctitols; lllany equatcsize with the potential for misuse
of power. Moreover,small firms or SBUs areoften thoughtto have an adl'antage of
iiexibility that allowsthem to changeand maneuver,while larger firrns or units find
it more difficult to do thrs.
Another dilemma associated with size is its relationshipto goals. A numberoI
studiessuggestthat size is not necessarilydirectly correlatedwith betterperformance'
 INTERNAA ANDDIAGNOSIS 177
L NALYSIS

be
For instance,expansionmay entail internaldiseconomiesof scale.And there may
e to say about grorvth in a particular business. Under certain circumstances, the
limits to continued
Ltorswhich 16p size of the market share itself is related to returns in a U-shapedfashion where large
u examlne the and small sharesmay be relatedto higherROI than medium market shares.
)tenciescount, For example, the do-it-yourselfretail businesshas long been dominatedby small
lompanlesand (K Mart, Home
mom-and-pophardwarestoresand lumberyards.Severallarge firms
)umoniaseems centers of America, etc.) believed they could jump in, build mammoth stores,offer
It appearsthat discountprices, and attract customers u'ith advertising. Instead of killing off the ltttle
guys, the big chains are fighting each other for market share and sites needed to break
warehouse stores. Ir{assive advertising, cost cutting, and loss leaders to
.u"n on large
cut gross margins tremendously. And the littie guys fought back by'
build traffic have
to
forming alliancesfor buying and advertisingclout and by offering personalsen'ice
tle descriptive the naive new do-it-Yourselfers.
ntageanalysis. Theseand other examplessuggestthat expansionStrategies carr)'with them seeds
ressof internal disadvantage where sheer size creates new managementprob-
of potentialcompetitive
Ihere is often lems. Hence each firm must determine whether it is better to bc a big fish in a iittle
ieir firm. Sec- pond or a litrle fish in the sea. There are advantages in both situations, and strength
energe. Each Lr w.ukn.ss can go along with a large size. Careful thought must go into the diagnosis
of whetherconditionsbeing analyzed are strengths or weaknesses'
d use compet- There are also some descriptionsabout how businesses can strengthentheir cour
-rd analysis
of petitivc position and developdistinctive competence. Ohmae suggeststhat managers
rle, distinctive and weaknesses in ways which iead to compet-
snoutause their analysisof strengths
r differentiated itive advantage.
ality, superior
vative product ccrtain areas
I The first approachis to readjustresourceallocationto strengthen
"ibution.Such resoulces exactly the same way competitors
of the business.If managementallocates
ower costs0f do. there will be no changein competitive position. So this approach suggests that
e, good trade where there are key success factors (KSF)
resourcesshould be concenlratedin areas
:ation of these so the firm can gain a stralegicadvantage.Even though a flrm may have no more
toral resourcesthan competitors,it can achievedistinctionif it focusesthoseresources
35 SeCtOrSWaS
on one crucial Point.
scrves special One typical examplehereis the useof marketsegmentation. A Japanese shipbuilder
larger size in segmentedcustomergroups into seven marketsand ship types into 12 product cate-
e strengthbY g-i.r. After identifying ke.v product market groups, it focused its resources and
owever, there attentionon thesesectorsto gain competitive advantage'
rmics of scale 2 It may be that the KSF struggleis beingwaged.but a firm may exploit diff'crences
: organization betu,eenitself and a competitor.Here the strategisteither (a) makesuse of the tech-
gresslvecom- nology, sales network. and so on. of those of its products which are not directly
's^ legislators,
competingwith the productsof competitorsor (b) makesuse of other differencesin
ia1 for misuse the iomposition of assets.Thus reiative superiorityis used to avoid head-oncompe-
advantage of
tition.
I or units find Ohmaeprovidesan exampleof a Japanesefl1m producerwho could not compcte
with Fuji on ttre basis of an image problem associatedwith its name. Advenising
A number of could not overcomethe negativeconnotations.However. it had a relative advantage
perfbrmance'

t
I
.l
'. .1
 178 C H A P T E R5
{:

in its costsof production;hence,it loweredprices ;r artu startedto

and \)rorrwu ru uu
do battle
udtllson econ0llic
issueswhere rt possessed superiority.
3 A competitorin a well-established stagnantindustrymay be hard to dislodp"
Here an unconventional approach may be neededto upsetthe keV factorsio, su..i*,
that the conrpetitor has used to build an advantage The startingpoint is to challenol
acccptedassurnptions about the waY business is done, or the natureof ptoOu.tsi, $rategists
processes, and gait'r a novel advantage by creattng new success lactors.
too fl6fld9
can.rera manuf'acturer wondered wh-v photographs have 1s g. I
n-^roorate
For example, a
stage before being printcd, or why a camera couldn't hxys'i l"rto otai
-consuttant
throughthe negative
users thc trouble of finding and fixing an attachment. Federat
built-in flash to spare
polnt lnsteadof funneled
Expresswonderedwhy packageswere delivercdpoint to
facility. Challenging basic assumptions with questions canlead
throueha centralized
t o n o v e lL o e a s .
4 Finally,a con'rpetitivc aclvanlagc may bc obtainedby meansof innovations which
to new products. Innovation olien involves finding new DIAGNC
open ncw markefsor lcad
wa1"sof satisffing the custotner's utilitY function'
,Supp..,r. that you nanufaclurccolfoc and determinethat the utility functionof
targctcustor.pcrs is supcriortastc.What cleternrines col'l'eetastc'lKind and qualityof
beins, typc of roast, fineness o1'grind, time bctu'een grtndingand brewing,watet
hardnessand tet.npcrarure, stylc of brewing. and so on. Some of thesearebeyondthe
nranulacturcr's control.Br.rtolhers involve degrees of 1'reedom: Waterhardness could
probablybe overcott'tc bl incorporatitlg u rcgenerable lilter in the machine The ap-
proachhere is to think crearively iir innovations tlhich expand degrees of freedom
t i l l r t c r r n t f i l t s hg r r r l s l t t d d c v c l t ' p t t c w s t t c n g l h > '

In eachof thescapproaches rheprincipalpoint is to avoid doing the samethingas

on the samebattlegrouncl.
the competiti<-rn So thc analystn.rustdecidewhich of these
tctclevelopa sustainable
opf,.ur.h", nrighrbc pursuecl distinctivecompetence.

T h e R o l e o f S t r a t e g i s t si n A n a l y s i sa n d D i a g n o s i s
Exhibit-5.19 showshow eachof thegroupsof strategists is involvedin internalanalysis
a n dd i a g n o s t s .
the role performances
lf'yi comparcthis exhibitwirh Exhibit 3.9 you'11notethat
what the research tells us, lirms perform internalanalysis
are siritilar,exceptthat liom
which is why tl.rere are differences betweenthe
less frequetrtly ancl lcss forrnally,
and distorted'
exhibits.Given sone iin<tingstliar rnrernalanal,;sisis time-consuming
are reluctant to perform intcrnal analysis them-
we might unclerstand *hy ,iu,]oc.rs
howevcr.An investment
selves.Outsideconsulta;tsare iot 'ecessarilya panacea,
inject a bias for cmphasizing financial
firm's rcport, for instance, may ,:p:t:l,t^t-
areprobably useful with top management ciiscusston
Irrescriptively,severalapproaches
on pointsof disagreement.
o| course,in a single.SBUfirm, advantages ale analyzedand diagnosedat.the
at the SBU level and then
corporalelevel. In rnutiipt.-SnU firms, the.vare analyzed
rcevaluatedat the colporatelevel and comparedacrossSBUs'

.lil
 ANDDIAGNOSIS
I N T E R N A LA N A L Y S I S 179

IN INTER*O'N
on ecolorlic T H E R O L EO F S T R A T E G I S T S
tftl1tl Analysis
1o-dislodgg.
Verbal Docu-
, rut SUCCOSS Formal Diagnosisand
searchand mentarY
to chailenee studies MIS decision making
interviews search
producrs Strategists Perlorms
;r Rarely Rarely RarelY
OccasionallY Advisesas requested
f^6 1nanaOers Rarely OccasionallY Rarely
Itave to o^ OccasionallY OccasionallYadvlses
Pt-n"tt RarelY Rarely RarelY
Cohotutt OccasionallY hired1oadvise
on'tnauJa Rarely NA OccasionallY
Rarely Rarely
_n-t.-Federal
or tunneled
)nscan lead

tronswhich ANDWEAKNESSES [9]

OF STBENGTHS
inding new DIAGNOSIS process
As indicatedearlier,the diagnostic proccsslirr internall'aclorsparallelsthal
such as tl'restrategist's thc
charactelistics'
function of 1or environmental1a.lors.Similarfactors Irocustng on
job, and the Stl.ltctsiSt'scnvironttlcnlaflect tlre decrsion.
1 qualiryof Strategist,s as
on the onvironlcntal.dra[nttsis
/ing, water cliagnosisof internalI'actorsis similarto 1'ocusing
beyondthe oescribcdir.rChaptcr4.H<lwever,wewilladr]somcotherfactol's,slllccwealc
inesscould d i s c u s s i n g t h c l n \ ) O r l a n c e o l . s u b u n i t s t o t h c o r q a n i z - a t i o n a n d l t"tcchnical
sstrategy
thosein ti'rc
'Ihe organiz-ation theonstssuggestihatthe mostcriticalunitsarc
e. ap- pcrfonnthc basiclransfornlalioll of lnputs
rf freedom .ur".i Essentially,rhcs"or""il. unitswhich necessarily
Notc that this nced rrr'rl
rnto olrtputscallccltor by the missiondcllnirion.
i n c l u d e n i a s s p r o c l u c t , n n i t h o u g h i t c o u l d ) , b c c a u s e o t h c r t y p c s orcal
f r - nestato
issitlnsdonotcal]
wholesalers, retailels,and
ne thingas itlr'tl'riskirrd o1 tlanslorlnation'H.n.. barrks,
:h of these
nlt*iii;:l:l; :TlffJ:lJ]';ll
H*iil*fl;:':,liJ',,1';l"ilil,lJ'"Xfiil:l' of slrcngtlisand wcaknesses'
the prinraf ateasf<lrthc initial diagnosis
}lowever.cltlrcrunttsnotintherechnicalcolcattclnpttobui]dthcirpowerand
b e c o t n e i r n p o r t a n t t ( ) t h e o r g a n i Z a t i o n s o t h a t t h e y n a y i t l c r e a sdiagnosis
c t h c i r s h aoir e o f r e s o u r c e
the
allocation.l<lcntii,ving rhe;e units is also inportant for nanowing
al analysis
s t r e r r g t h s a n c l w e a k n e s s e s . ' I h c s c u n i t s c a n b e i < l c n t i h e d b i ' d e t con r nthe
rininghowmany
other units thcv are inlerconnectcd with, whethcrthcy have a dilcct impact
formances
ai analvsis t e c l r n i c a l c ( ) I e u l l l t s , a n d w h e t h e r t h e y a r c s p c c i a l i z c c l i r r s u c processlllg
hawaythatthgycan
exar.nple. Supposethat a.data
t\\ een the nJf ,.au.. unccrtainty.Let's considcran
L ,.-.- ^i
ut:t(rl rgu, unitbuildsafflanagcll)entinformatioriSyStemwhiclrprovidesusefu]dataforesttnates
,slsthem- o | s a l e s a n c i p r o d u c t r o r ' r s c h c d u l i n g a s w e l l a s f o r t r a c k i n g t h e p e r f o ralrd
rrranceofwarc
to.dealwith importantuncertainties. its
n\cstnent houseoperationslt haspositioneiitsetf
by severalcore units' we can expectthat
specifics. work flow is trnporlantinput for decisions
iiscussion i t s l l o t e r r t i a l p o w e r i n t l r e o r g a n i z a t i o n m a y l e a d i t t o b e c o n l c a n i r r . r pare
o r lde-
anlunitfor
To the extentthat othel subunits
the diagnosisof strengths,,r,i *"okn.s.cs-
requiresanalysisby top management'
ied at the p"",f""i"" a givenunit, it is morepowerfuland
and then O | c o u r s e , t h i s d i s c u s s i o n r e l a t e s c s s e n t i a l l y t o f u n c t i o n s w i t h i n SBut
BUs.Atthc
are made.
comoratelevel of u,.,uryri, ln a multiple-SBUfirm, similarsuggestions

:-L
 180 c H A p r E5R

here one is analyzingthe importanceof entire strategicbusinessunits to

ovgl,ll
corporateperformanceand strategy.That is, how dependentis the cofporotlorl
6n^
given sBU? At this level, moreglobalassessments of sBU strengthsano w.atness;
are olten made and are basedon relativecompetitiveposition and e'rrron6g11r1
opportunity. chapter 7 exan.rineshow these factors can be conrbined to urriri'ln
strategicdecisionmaking.
c)nce the key areasfor diagnosishave been anaryzed,it is useful to prepare
strategicadvantageprofile(SAP) for the firm being analyzed.Similar to the ETopl a
this is a tool for providinga pictureof the rnorecritical areas,which .an have
relationshipto the stratcgicpostureoi'the hrn in the future. 3
Exhibjt 5.20 presentsan exarnpleof an SAP for a hypotheticalfirnt. Nore that
this
lirm has wcaknesscs in channelso1 distribution,facilities,and R&D un.r ir.*p.i.
encingunion difficultics.This may precludeccrtainstrategies. suchas n'rork.r.xpan_
sronin the soulhwest.on the otherhand,it rnaysuggestto managersthar a consciogg
choiceto correctthi.sweaknessis ilnponant.The final conclusions<lcpendon.nui_
ronmentalfactors,objectives,and thc patternol othcrstrengths arrdweaknesses iden-
tified.Fbr exarnple,the linancialstrengths couldlcadto a decisionto invcstin updated
facilitiesor build a salesforcein thc southwest iI'the environmcntshow
there. chapter 8 clescribes in more detail how the SAp is combined,"t,,ru,lJ:;::l;i{
to lcad to strategicdecisionntaking.
I1'lirst-eeneration planningis used,this cliagnosis is bascdon thc most probable
1'uture.If second-generation planningis uscd, severalscenariosof' the future are
draftcd-with best-case,rnost-probable, and worst-cascassumpttons. Then several
diacnoscsare made.
As in the preparationof an Ll'oP, scveralstagcsmay be requireclbeforc the final
S A l ' }i s d i s p l a y e dT. h a t i s , e a c ho f t h e s u b f a c l o risd e n t i l i e cr nl E x h i b i t s5 . 3 , 5 - 5 ,5 . 9 ,
5 . 1I , a n d5 . I 3 s h o u l db e s u b j e c t ctdo t h ec o m p a r a l i vaen a i y s i<s i i s c u s s er ncoi u r s o c h o n

E X H I B I T5 , 2 0 STBATEGIC
A D V A N T A GP
ER O F I L E

lnternalarea Competitivestrengthor weakness

Marketing Productlineis extensive,

and serviceis excellenl.
Channelsof distribution
are weakin lhe southwest
R&D No R&D performed.
Operations Excellentsourcingfor raw materials.
Facrlities
are old and becomingouldated.
Corporateresources 0 Companysizeis aboutaveragefor the industry
0 Profitshavebeenconsistent but average.
- Unionemployees complarn
lrequenily.
Finance + Balancesheelshowsabilityto obtainneededcapital;low debl_
equityratio,highworkingcapitalpositron,
and favorablestock
price.

Note: + indicatesstrength;0 jndicatesneutral; indicatesweakness

_ , , iL
 \

181
L N A L Y S I SA N D D I A G N O S I S
INTERNAA

ontechniquesforanalysis'Forexample'asetoffinancia lratios(seetheappendix)
11isto overall SAP' Then a diagnosisof the most important
can be exhibitedu, u 'upftt-ent to the
in the fina1SAP'
Totuttgnonu on., fo. the organizationis summanzed the
ro weakngg5gg the most crucial and most difficult' In effect'
This latter stage ls probably and time sl-
-.nutaonaantrl ytu to considerthe environmental factors
comparariveanalysesfi;";
o ro assist
in multaneously.Let's clanfy this statement- with
high quick ratio for the firm compared
Supposethat your unuly'i' shows a there is a potential
ro prepare assessment could be that
a rhe ratio of 1'6ut*ujo' to*p"titor' One
to the ETOP,
cashmanagementweakness.ButSupposeyouaisoidentifiedintheETOPathreatof
n can hnygu
insufficientcapitalavat]ab]etotheindustryforneededinvestment.Nowyourpercep_
t i o n o f t h e c a s h p o s i t r o n o f t h i s f i r m m a y t u r n o u t t o i n d i c a t eweakness
s t r e n g t hcould
s . S i mbe
ilarly'a
Note that this otherwisebe viewed as a
high inventory positron which might
rnd is experi_ appearto be growing or if a strike appears
considereda strengthi1'demandconditions
narket expan-
tt*tJrr,n. threatscan be
rt a conscious
sametoken, assessments of environmentaropportunitiesand
rend on envi- the internalfactors. Let,s say that 1'ourenr'i-
iiltered dependrngon your diagnosisof of rarv materials
knessesiden_ of supplies
ronmentalanaly.sis indrcatedalhreat of the exit of sources
purchasing agent
:st in updated you' i"t"*at analysis'however'showsthat your
for your industry' is assured of a
s opportunity remaining suppliers;your firm
has developedclose contactswith the is one of
other factors the p.r.Jp,ion'or the supplier threat
steadystreamof neededinputs. Now strength
advantage;ueto your firm's particular
an opportunily to galn a competitive
rost probable
in thrs area.
tc future are
Intheseexamplesnotethatdiagnosisinvolvestheperception()fthreatsandop'
Ihen several
p o r t u n i t i e s a n d s t r e n g t h s o r * e a l i n e s s e s i n r e l a t i o n t o o n e a n o t h e r .thal Theanalysisof
But diagnosis^requ-1res. you
data and information can be done independently.
fore the final
i 55 5a
considerintegratingtherelativeinformationtodrawconclusions.onefufiherSteplS
needed,however.
n our sectlon You shouldrecognizethat eventscan
We have discussedthis as a staticprocess.
change.Thusdragnostsalsoinvolvesestimatingscenariosoflikelyfutureconditions
to reflect dYnamicrealities' threat
strengthof supply contactsoffsetsa
Considerthe examplewhereyour firm's
o f t h e e x i t o f s u p p h e r s ' H o w l o n g w i ] l t h a t S t r e n g t h e x i s t ? W i ]competitors
l t h e s u p p l ialter
erslemaln
your firm's competitors?will the
loyal or bend to pressureto suppti
t h e i r S t r a t e g y ? F o I 1 n s t a n c . , . o . n " m a , v l e a v e t h e b u s i n e s s . S o mor e m a y i n t e gto
rateback
Othersmay try new methods materials
ward to make thelr own raw materials'
suppliers'Each of thesealternat*"t-if-nl
reducetheir dependenceon the remaining
beconsideredbyyourcompetitors.They'too,arelookingtobuildacompetltlve
advantage if
n of how long a strengthwrll remain
Another issuerelatedto time is the questto
itisre]iedon"^..n,iu.tyo.ou..,"o.Forinstance,theKSFapproachprescribes
b u i l d i n g a u n i q u e S t r e n g t h b y c o n c e n t r a t l n g l e s o u r c e s i nto a s i n g l e a rball'
eaorinafew
rely on a single superstar carry the
low debl-
areas.For lnstance.u rJotuuit team may
bie stock S e v e r a l c o n d i t i o n s m a y r e s u l t o v e r t i m e ' F i r s t , c o m p e t i t o r s m a y SIft athe
r t . tstrength
o..keyon''the
or copy you' fittn's strength'
factor-they may try io attackit, steal'
happenstobetechno]"gi."r,itcanbecomeousot"t..Ifthestrengthlies,inpersonnel,
 182 CHAPTER
5

key people mav resign, retire. or die. Finaily,

if one area receives
tt
resources,
orherareas
wherenewcomperitive
advanrages ExHll
mighrbe,.*:.Ti;lll:
deveiop their potential_Suppose.for example,_ {:
rhat tou hui," un"iyr"o your
rvork force and found that it is made up or finn,s lloon
lignty suiteo and trainei personnerTL.-
coujd be a competitiveadvantage,but you obse.ue ['phor
that the facilities, ;;l;;;'r:li'
and materiarsthat they nced ro do their work
effectively are
Ii.in,
inefficiencies.Thus 1'our firm cannot ase its "r, "r
or,.'"r'i..T,l I kel
vantageunless resourcesare allocatedto correct
strengthas a potential competrtiven6- F:ofI
the weatrlness. Some ol the other 130
approaches suggested earlierma1,be necessarr,. I hol'
of course'the obverseproblemshouldbc iecognized. no
If resourcesare spread
thinly acrossmanlr areas'thereis a dangerthat 16s the
the fim will not developa distinctive
comperenceFimrs (and individuars)havebeen ani
kno,,l,nto seizean opportunltywithout
commensurate abirity.As Chrisrensen et al. suggesl,',opportunismq,ithoui."il-.
rencers a path to fairyland." This is p'rtrcurarll'a ear
oung.. when managersbelieve tar
thal they havesuperiorabilitv andcan succeed
at almostalnything on rhe basisclfpast pe(
success.And as we menlionedbefore, if the
strengtt,,oi int.icependenlunits
actuallv u'orking againsrone another(Exhibir are
5.1f , rhe resultingsuboptimization
may lead 1cla competitivedisadvantage .
The weaknesses ol an.organtzatron maf inhibit or preciudecertainstrategies
being consideredas capabreof impremeniation. from
fjor examprc.a fimr wrth an abnor_
mally high debr-equityrario may {incrit is unabre
ro purru. a mergerbecauseit has
reachedits debt "iirnits." Nonetheress, the roreof peiception....pl ,n herein terms
of the diagnosisof this u,eakness. That is, the debtweaklcssmight be corrected
an lssuanccof equitv, assumingother financial with
factorsiue reasJnableand the equity i. nt
markels (en"'ironmentalfactor) are favorable. I
So it is with other u,eaknesses. More lce
than one entrepreneur hasbeenhe;*d to remarkthat ..we didn't knou,rt
couldn,tbe i,w
done. so we wcnt aheacland did it." '.r
In effect. a firm shourddeveropa slrategyover
1 .f distinctivecompetence.with this approacn
rime which revorvesaroundan area ivl
the firm can developslack resources I
thar can cvorve in10new areasof rt..ogih when
old ones farter lani tt inevitably
do). At the sametime. the weakresses which are identifiedas potentlaily "y
important
to the future shou.rdrecer'e lranagementattention. p
This may require a sirare-qyt0
acquircpersonnelor otherstrengthswhich are
currenllylackin-g.ifthe firm rs rncapable
of developingthem becauseol'internalresource
wea_hnesses.
Many U.s companiesare nl'ing t'be more
_ competltlvetheseciayswith the kind
fi of strategicthinking we have identrfiedhere.
Many firms are planning to lnvest rn
t, more efficrent plants ancrequipmenl.invest in
more researchand development,im-
p r o t e q u a l i t r o f s e r ' i c el o c u \ t o m e r sa. d o p t
m o r ea g g r e s s i vm
e a r J < c t i nt agc t i c s a
, nd
i. trv to reduce labor costs in an effort to deverop
sustainabiecompetilive advantage.
Exhibit -5.21showsa firm in this process.
As you may have noriced,the discussion has begunto addressthe pros and cons
of alternativestrategies.The Boston Consulting
Group suggeststhat the number of
competitiveadvantages and the size of the advantages lead to differentkinds of strate-
gies Exhibit 5.22 expiainsthis. For exan'rple,
if thereare many.uuy. a createad-
vantagessuch as in the fast food business
but the size of thor. uduuntugesis small,
then the firm should probabll,seekto stabilize.

..lL
 \

L N A L Y S I SA N D D I A G N O S I S 1 8 3
INTERNAA

rulk of the s'zt A STRATEGICADVANTAGE

DEVELOPING
ilt[tB,tT with away
ed will not in particuiar.provides Continental
AT&:, GTE' andIBI\4'ContinentalTele anoroach,
iour nnX'S {Corpur"aylth the resourcesto ente.rareasthat it could not
lirnitecl
by mostasa fiim with iJ'or. itt
rnnel. T[6 !^nonewouldnarqlyDevrewed
ilri, r srrensrhs"...*o1l_eili:::,::li: :,::i:i 3l:
on .itsown.
- .'-Of-"ourr.,
enter
ex-
1nes,tools, cations' In the amal gam some observers.are skeptical'A GTE
;tting- datacommuni recenl acquisitions (but
or lead to i li',i.t,tt.t
exchanges spread over.37statcs' ..u,iu. ,"., little synergy in the
::^r1800ruraltelefhone executives see thetn as complementary)'And
retitivead- lllr of the subscritrers still sharepanylines' The Continental
'the and if* i.rt of integratingthe pieces ipto a singlenetwork is
other ; ".r.*, haslittle research and:development
AT&T, GTE' IBN4' and
i;d;;;;*y witlt oiiiif"ft to accJmplish. Further,
1..'runufu.turingcapabilityof its own Compared it's a game for giants'
in assets is minuscule' Xerox are not standing still' lf
;preadtoo iii" ^trttt of ,qt&t, its $3 billion doesn.rt ycr qualit5'
listinctive revenucof $1'1 biilion wasjust ovei 2 per- Conlincntai
i |ro tir-into The'price- The perccption at Contincntal,though' is that it has a
ty without i.^-^t nf the revenueor rts giant competitor' getsbefore its
' standard tor resltat{-11]i']:: hcad stait, uni it oon keep the customersit
It compe_ .*,rt, ratio is ahout ::t competitors are allowed to enter the fray' Fur-
fo*"t tlian the ratiosof the computerconpanlesex- regulated
iiu, advantageEven
rs believe
maiorrole '." ftt thirrnore, Continentalseesits size as an
I'p..t.O to plav a of the market' that will rep-
;is of past
i However,a key strength is an aggre ssivemanagementif it captureson1y,5pcrcent
Tlll"ll.
lt can
of alniost 700 percent
unrts are of regulated tciophone resent a revenuelncrease
imization i t.at atypi.ulof the managemcnt beltevcs turn its business arouncl faster and has already started
thefouncler andchairman
i,."*p*1it, At age70, A carefully pultirlgthe Piecestogethcr
is a good offense '-
ilitor'ttt. best defcnse nl-. *"okn.rr., lt bclieves require long{erm
devel-
lres from andjoint ventures hasbeen
I ri^t*o seriesof acquisitions for aggressive markeling and the need
in abnor- i.li*t.u so lhal lhe conrPany candevclopthe strcngths opmentarethe need integrate high
who can manage ancl
anrlvotce fc'x skilled personnel
r s er t h a s , it ne"dsto becontea nraiorsupplierol data joint venturesare
technology'ACditionalacquisitionsand
in tenns communicationservices'
(Am Sat) gives Contr- plannedto correctthesewcaknesses
: t c d* i t h A joint venture with Fairchild discussedin
A satellite re- You rnight note that severalof the points
rc equitv nental strength in satellite transmission brought together here' Perceptions of rcla-
10 percent ofthecost of this chapter'are
's. \lore l.iuing rtution can be set up for and weakness, relevant companson grol"lps'
lay out comparable grouud lrrtcs tive strength
*ttu, if&f needs to the relationship
r l d n ' tb e a PBX markcting firm' pro- long-term developnrentof resources,and
The purchase of Executone, and environmental threats
in intelligent betieen con-rpetitive advantage
vided a basefrom which to build a business a1l helped determine the.way 1n
i an area which will bc- and opportunitieshave
terminalsand digital telephoneswitches' has chosen to orient itself strategically
rsources of{ice' The joint-venture wtrictLihis flrm
come the hub of the automated
evitably B t i s l n e s sw e e k ' F e b 9 ' 1981'
T a k i n g o n t h e G i a n t si n T e l e c o m n u n i c a t i o n s " '
rportant s o u r c e rA c l a p t e df r o m " C o n t i n e n t a lT e l e p h o n e :
pp,50-56
Itegy to
capable

hc kind
the environmentall'actorsdescribed
r v e S lt n However.we think that this ignoressomeof
nt. im- inourearltcrchaptels.Anditishopedthatyoucanfindwaystoincreaseeitlrerthe
sizeor numberof advantages to incrcascyour options Thus, diagnosisof corl-rbining
-'s. and
wi<lelvarietyof strategyalternatives
t n t 3q e . thc ETOP andthe SAi' shouldleadto cxamininga
here, which is the subjectof Chapters6 and'7'
than is suggested
d cons
Lber of
SUMMARY
strate-
diagnosisplocessparallelingthe en-
rte ad- The chapterdescribedthe intcrnalanalysisand
3 and4. lnternalanalysisand dtag-
small, vironmentalanalyslsprocesscoveredin chapters
nosisistheprocessbywhichthestrategistsexaminethefirm'sinternalfactorsto
 184 c H A p r E Rs

S i z e o f t h e c o m p e t i t i v e a d v a n l a g ew h i c h c a n b e
achieved
Small Large
l ( e y c o m p e t i t i v e f e a t u r e: Key competitivefeature:
. :
l , 4 a n yw a y s t o g a i n a n e d g e ,b u t A s p e c . a ' ; z e da D p r o a c ht o
t h e s i z eo f t h e e d g ec o u n t s f o r the h
m a r k e l s e g m e n t si r . r . . n i i . i ' l " l . n y
litrlein the marketplace, i s c r e a r i n ga n d F r o r e c l ; n j so
f,,.""q
a d v a n t a g er n s e r v i n gt h e s e
segments.
Strategyprescriptions:
. C a r u eo u t a p o s i t i o n a n d S t r a t e g yp r e s c r i p t i 6 n g
hotd ir,
lManY r E m p h a s i z ep r o f i t s n o w . r S e e ka n i c h e ,

r l \ 4i n i m i z e i n v e s t m e n t . . Get ,r pos tion 10 serve

selected
. B e c a u t ; o u sa b o u r e x p a n s i o n . sl'lo, heav
irY1q6,;16
::n;'-:l:;
a nd lort.ly the chosen
advantage.
c S l a v J h c € d o f r i v a l sw h o
asprre
r o g a r r h e s a m ea d v a n t a g e .
. Walch out fo. change.
Ditferent ways
a compelI ve
aovanlage can
be createcl
Key competitive featurel K e y c o m p e t i t i v ef e a t u r e :

Almost a pure cost-pricegame; Olll w h o s e r a n d k e e po n e

]!"* oi the
o n o t h e r f a c t o r s ,a l l f l r m s a r e l a r g ec o m p e t r t r v ea d v a n t a g ew
s ill SUrViVe.
i n a b o u t e q u a lp o s i t i o n .I n t h e u s u a l l Vl o w c o s t i s t h e p , : m a r y a O v a n i ^ " 1
a b s e n c eo f p r i c e -c o s r d i f f e r e n c e s , rhar is availaoleOften. tne nrra o{
th."
there is a virtual competitive q a m ei s v o . l m e .
s t al e m a t e ,
S t r a t e g yp r e s c r i p t i o n s :
Fcw Strategyprescriptions:
r P u r s u ee c o n o m i e so f s c a i e .
. U s e a g g r e s s i v ceo s t
. R i d e t h € e x p e r i e n c ec u r v ed o w n w a r d
reouc|on strategtes.
b y g e t l r n gv o l u m e u p .
r E m p h a s i z ew a y s t o i m p r o v e
. Go after the customers of weakfhms,
e f f i c i en c y .
. l f w e a k , g e t o u t o r l o o k f o r n e ww a y s
. l\4anage
t o i n c r e a s ec a s h f l o w .
10 COmpete.
r Look lor diversification
opportu nitles.

EXHIBIT5.22 Strategiesbased on competitiveadvantages.

(Adapted
framan approach
suggestedby AlanZakon,BastonCansulttng
Group,in an address
to the
Academy of Management, 1982.)

d e t e r m i n ew h e r et h e f i r m h a ss i g n i f i c a nstt r e n . s t hasn d w e a k n e s s e fsh. i s i s n e e d e d s o

the firnr can exploit opporlunities. mcel threats.and corrcctweaknesses inhibitins a
desiredstrategyor puttingtire iirnt at a compclitiveclisadvantage.
The areascoveredin tl.rechaptcrincludeinternalfactorsto bc analyzedanddiag-
nosed-techniquesof internalanalysis.the reality of intcrnalanalysis,the roleof
s t r a t e g r s itn\ t h i sp r o e c s sa. n d t h e d i a g n o s ios1 ' t h ei n t c r n afl a c t g r s .
The internalfactorsthat management analyzesand diagnosesare marketingand
distribution.R&D andengineering. productionandoperations managentent, corporate
resources andpclsunnei.artdfinanceandaccounting. Eachof thesefactorswasbroken
down and rlachsubcategory was illustrated to help you digesttireinternalanalysis and
diagnosisprocess.It was suggested that strengthsare neededto builcjslackto give
firms greaterstrategicoptions,and weaknesses must be overcomewherepossible.

..1
L
 \

185
L N A L Y S I SA N D D I A G N O S I S
I N T E R N AA

various
described'Data and indicators of
Techniquesof internal analysiswere
SubfactorsshouldbegatheredSothalreiati|ecomparisonscanb€made.,Comparisons
arenecessaryinthefo]lowingareastogetaclearerpictureofstrengthsandweak-
n e S S e S : p a s t , p r e s e n t , a n d f u t u r e c o n d i t i o n s ; i n t e r n a l g o a l sand
a n denvironmental
externalrequilements;
to other functional areas;
the wa1,that each functronalarearelates
and the productlife cycle Two anal-vtical
factors:competitors't"itnotog-v' suppliers' key questionswere
tools were suggesred as usef; guiies for the analysis,and four
well? Dcr
competencies-Whatdoesthe firm do
suggestedto help identify distinctive it matter?
do poorly? Does
thesecompetencles count?What doesthe firm
e selected R e s e a r c h o n i n t e r n a l a n a l ) , s i s i n d i c a t e s t h a t r h i s p r o c e s s i s nindicate
otsclen tific.Butvery
that
subject.The studieswhich exist
ly to build
little researchhas been JonL on this
advantage.
ro aspire
exccutivesperceiveStrengthsandweaknessesdifferent]1'andthatfirmsseemtobe
tage. uniqueintheirparticular"patternofcompetitir,eadvanlages.Thatuniquenesscanbe
in a varietyof ways'
developedinto competltiveadvantages
in ihe inrernal analysis and diagnosis
A brief sectlon on the role of ;traregists
processsuggeststhencec]toformalizetheprocessofintemalanai-vsisforbetter
s t r a t e c in
clalla!(mcnt'
t s f o r p e r l o r m l l l gl n l e r n a ld i a g n o s i s '
lp one of the The chapterconcludeswith our suggestlol
r sw i l l s u r v i v e ; F o c u s i n g t h e d i a g n o s r s i s a f f e c t e d b y f a c t o r s o u t l i n e d i n C h a p tperformance:
erl|l.inaddition'
ary aovantage
shoulddererminethe area.s of greatestimportanceto strategic
nare of the the anal1,.st
t e c h n i c a ] c o l e u n l t s a n c l u n i t s w h i c h a r e p e r v a s i v e a(SAP)
n d c a nisr edefined
d u c e u nand
c e rits
tainty.once
advantageprofile
the diagnosisis focused,the strategic
tleveloPment is outlined'
EC
r\ e COlvnward

oi vieakfirms,
T h e s t r a t e g i c a d v a n n g e p r o f i | e i s a t o o l f o r m a k i n g a s yin
slematlceva|uationof.theenter-
l for new way5 for the company its environment'
prise'sinternal factarswntchatre significant

W h a t t h i s p r o f i l e d o e s i s g i v e a v i s u a l r e p r e s e n t a t i o n o f w henvironment'
atthecompanylSaSa
decisionsandinteractionwith its
resultof developingtrom pusl strategic
an internalanalysis'
Sugg.rtion, ut. offer"A for interpreting
Insum'thechapterl.ocusedonhn*.oarralyzetheinternalfactorsrealisticallyand
l r o w t o d i a g n o s e t h e r r s r g n i f i c a n c e . T h e n t h e e x e c u t i v e c a n d e v eorl op.licies'
panSAPandmatch
s neededs0 adjustingor changingstrategies
ir with the E'fOp to creite conditionsfor
i n h i b i t i n ga form as fbllows:
The processis summarizedin proposition
d and diag-
the role of
Proposition5.1
rkcting and Afirmwhosestrategyfitsitsenvironment,consideringltscompetitiveadvantages,wil|be
not
more effectivethan one whasestrategydoes
t. corporate
\\ as broken Proposition5.2
n a i \s i s a n d Afirmwhichdeve|opssta}kresourcesthroughdistinctivecompetencewillbemoreeffec.
lck to give tive than one which does not'
lossibie.
 186 C H A P T5
EF

This chaptercompletesthe analysisand diagnosisdiscussion.Chapter6

begin*u^
three-chapterdiscussionof the choicephaseof the strategicmanagementpro.Jrr'i}e

H::J,",:;::i;::'.#:fl jj;il:
ffi:'!;:H:i:#;*'i:111"]L';:T:11
waysin whichthe gapmay be reduced,by examiningstrategy
,'hoice of a slrategy. "tn*",iri*Tffll- qrt

Appendix:UsingFinancial
Analysis*

:",""::Hffi
lll"ilil::tl:li;"'i.":'::i'.T:T:trT:T,i,#::T
as the beginningpoint for their financialdecisionmaking. lnvestorsuse financialunutvr.*ll
makingdccisionsaboulwhetherto buy or sell stock,andcreditorsusethemin Oeciding whetne,
or nor ro lcnd. Thcy providenanagorswith a measuremenr o1'how the companyis doingii
comparisonwith its performancein past yearsand with the perlormancgof competitorsi;the
industry.
Althoughfinancialanalysisis usefulfol decisionmaking,therearc somc weaknesses
1lx1
shoulcl[rc notcd. Any picture that it providesof the companyis basedon past data. Although
trends may be noteworthy, this picture shouldnot automaticallybe assumedto be applicabie
to the future. In addition,the analvsisis only as good as thc accountingprocedures thathave
providedthc inforrlalion-When nrakingcomparisons bctweencompanies,one shouldkeepin
nrind the variabrlityof accountingproceduresfrom lirm to firm.
Therc are lbur basicgroupsof llnancialratios:licluidity,levcrage,activity, and profitability.
Depicted jn Exhibit 5.23 arc the specific ratroscalculatedlor each of the basic groups.
Licluidity and leverageratios representan assessmenL of the risk of the iirm. Activityand
profitability ratiosare mcasuresof thc returngeneratedby the assctsof the firrn. The interaction
betwcencerlarngroups of ratios is indicatedby arrows.
Typicallytwo commonfinancialstatements areusedin {inancialanalyses: thc balance sheet
and tlreincomeslatement. Exhibit-5.24is a baianceshcetandExhibit5.25 an incomestatemenl
for thc ABC Company.Thesestatements wili be usedto illustratethe financialanalyses.

Liquidity Ratios

Liquidity ratros arc used as indicatorsof a firnr's ability to meet its short-termobligations,
Theseobligationsincludeany currentliabilities,includingcurrentlymaturinglong-termdebt.
Currentassetsmove througha normal cashcyclc of inventories-sales-accounts receivable-
cash,The llrm thenuscscashto pay off or reduceits currentliabilities.The best-knownliquidity
ratio is the currcnt ratio: currenl assetsdivided by current liabilities. For the ABC Company
the cufenl ratio is calcu]ated as follows:

Current assets $ 4 , 1 2 - 5 , 0_0 0

1 6 40 9 8 8 )
Currentliabilities 52.512.500

- $ 3 ' 6 1 8 ' o:q qi . 6 l ( r e 8 7 )

s1 lJ. 2_5()

*Preparedby Ijlizabeth Gatewood,University of Georgia.

 \

T N T E R N AALN A L Y S I sA N D D l A G N o s l s 187

Aclrv ty ProtrlabriltV
L q u i dr 1 y Leverage

,Tif.liSj}:$:
reatea gxp
L

;il;..'];Iffi

'rthrn
its industry
1 sf analysi5
.this
tctal analyses
in
leciding whether
ran)' rs doingin
rntpetttors in hs

,,re:rknesses
$31
. dara.Although
Irt be applicable
:duresthathave
' shouidkeep
in

nd profimbility.
e basic groups,
n. Acrivity and Relurn
measurSs I
The interaction I Net income

i sates I
re balancesheet
rcom€ StatO[l0nt
I analyses.

f--.-rta-".-*. I
I N e tw o r t h
rm obligations,
long-termdebt.
Its receivable- E X H I B I T5 . 2 3 F i n a n c i arl a t i o s .
inou n liquidity
{B(' (.ompany
i s n o t n c c e s s a r i lay
M o - q at n a l y s t s u g g c sal c u n e n lr a t i 0o 1 ' l t o 3 . A l a r g cc u i l c l l t r a t i ( )
tilat an organiz-ation iS not n-iaking. tlre most eiltcicnt usc oi assct's' Thc
gooclsign. it rnav rnean
the more volatilc industr-ies
optimum currentratio will var.vfronr industr) to inclustry."vith
r c q u i r i n gh i g h c lr a t i o s .
Sinccslow ntovtngor obsolescct.tt inventories couldoverstatca llrnl's abllity to lnect Short-
term dcnran(is.thc qurcK ratio is sonretinles prelcreci to assessa fir]n's liquiditl' The quick
ratio is currentassetsnrinusinventories. drvrdedbv curenl iiabilities.The quick ratio for the
A B C C o m p a n yi s c a l c u l a t eads f o l l o w s :

j
 188 C H A P T E5F

Currentassets- inventories $ 1 . 9 5 0 . 0 0 0
Curent liabilities $ra"iat:078(1988)
s1.618.000
- O 7a rlqx'7'
$:.:1:.:50

A qurckratio of approxinrately I would he tl pical for Americrninductries.Although

there
is lessvariabilitl,in the qurckratio than in thc currcntralio. \laLilcinduslries*outObeaUie
ti
salelyoperatervith a lorverratio.

E X H I B I T5 . 2 4 A B C C O M P A N YB A L A N C ES H E E TA S O F D E C E M B E R
31

1987

Assets
Currenlassets:
Cash $ 140,000 $ 115,000
Accountsreceivable 1,760,000 1,440,000
lnventory 2,175,000 2,000,000
Prepaidexpenses 50.000 63,000
Totalcurrenlassets $4,12s,000 $3,618,000
Fixedassets.
| ^n^-torm roeoirrahlec s1,255,000 $1,090,000
Propertyand planl $2,037,000 $2,015,000
I ess A n n rr m r r l a l F d r i p D r e c t a l t o n 862,000 860,000
Nel propertyand plant 1, 17 5 , 0 0 0 1,155,000
Otherfixedassets 550,000 530,000
TotalJixedassets $2,980,000 $2,775,000
Totalassets _q!_ar_q9g _46,99!pA
Liabilitiesand Stockholders'Equity
C u r r e nlti a b i l i t i e s :
Accountspayable 91,325,000 $1,225,000
Eank loanspayable 475,000 550,000
Accrued{ederaltaxes 675,000 425,000
Currenlmaturities (long-term
debt) 17,500 26,000
flirrirlonrlc n2v2hlo 16,250
Tolalcurrentliabilities $2,s12,500 $2,242,250
Long-termliabilities 1,350,000 1,425,000
Totalliabiiities $3,862,500 $3,667,250
Stockholders'equity:
Commonstock(104,046shares
o u t s t a n d i ni n
g 1 9 8 3 ;1 0 1 , 2 0 4
shares
o u t s t a n d i ni n
g 1982) $ 44,s00 $ 43,300
Additionaipaid-incapital 568,000 372,450
Retainedearnrngs 2,630,000 2.310,000
Totalstockholders' equity $3,242,500 $2,725,750
equity
and stockholders'
Totalliabilities 05,000
$7,'1 -qq9l9!4

I
,tL
 T N T E R N AALN A L Y S I SA N D D I A G N O S I S 1 8 9

FOR THE Y E A R S ENDINGDECEMBER31

5'25 ABC COMPANYINCOMESTATEMENT
EXHIBIT
19BB 1987

$B'250'000 $8,000,000
Net sales
$ 5 , 10 0 , 0 0 0 $5,000,000
Less:Costof goodssold
1,750,000 1,680,000
exPenses
Admrnistrative
420,000 390.000
OtherexPenses
tlhoughthere 7,270,000 7,070,000
-ld be able Total
1q $ 980'000 $ 930,000
Earningsbeloreinterestand laxes 210,000
210,000
Less;InlerestexPense
$ 770,000 $ 720,000
Earningsbetoretaxes 325,000
360,000
Less:Federalincometaxes
Earningsa{tertaxes(netincome) jg $_!99p99
cashdividends $ 9o,0oo $ B4,ooo
Common-stock $ 311,000
Additionto retainedearnings $ 320,000
$ 3940 $ 390
EarningsPercommonshare $ 083
$ 0865
s 11 5 , 0 0 0 DividendsPercommonshare
1,440,000
2,000,000
63,000
s3,618,000 LeverageRatios .I.lte
capitiil-ownersor or.]tsidc credilrlrs, |crtlt
LeveragcraLrios idenrilythe s()urceo1.:rfirrr-r,s "amplifi/l'
s1,090,000 ,,leverage"rcl'orsto the fact that using capitalwirh a fixcd intcrestchalgc will
'f
to theequityof holderso1'coltlmon
in rclzrtion stock' hc nlostcoltlmonly
eithcrprolitsor lOsses
Total dcbt includescurrcntliabiliticsand long-
usedrario is toral debt a,uiJcdny total asseis.
t e r n r l i a b i l i r i e s . T h i s r a t r o i s a m e a s u r e O f t h e p c | c e n t a g e o l t o t a l l .firns
u n d sinp stablc
rwidcdbydebt.A
rs usuallyconsidered sa1'eonly for
total dcbt-totalassetsratrohrghcrthan 0.5
s2775,000
s6.393,000 industries.

'lot:-rl i'.\.8b1.li10 ,, </ , ruk!\

dubt
s1.225,000 'l'otal $7. 105,000
asscts
550,000
('1 nL7 ?50
425,000 .- tr <f
\,..,
r IOQ?\
\r,!,,/
26,000 sr6.393,000
16,250
$2,242,250
1,425,000 of the extentto which sourcesof long-
Thc raticrof long tcrnrdcbt to equrtyls a mcasurc
$3,667,250 is computcdby dividing long-termdcbt by thc
tcrnr financingare providcdby crcdrtors.It
stockholders'equr{Y.

$ 43,300
372,450 L o n g - t e r md c b t _ $ 1 , 3 5 0 . 0 0 0: 0 . 4 2 ( 1 9 g g )
2,310.000 Equity $3,242'500
s2,725,750
_ S 1 . 4 2 5 . 0 0_0. ( ) 5 2 ( t q 8 7 J
q9!99!00
, 75 0
$2 . 7 2 5
 190 c H A P T E5F

Activity Batios
Activitl' ratiosindicatehow cffectivelya firm is using its resources.By .o.purilg,,uan,,*
rvith the resourcesusecl1o generalethem, it is pgssibleto establishan efficiency o1
ono,^..-,!
T h c a s : r ' tl u l n u \ c l r e t i . i n i l i r a r e hs u u e f l i c i e n t l )t n a n a F e n t ei n
s rc m p k , 1i n g t o r i l u r r . L " t u j t * .
turnoveris calculatcdby divrdingsalesby total assets.For the ABC Company,urr.,i,,Jrt,t
'-'ttuVtl
is r'alrulalcdl. f,'l lou s:

. Salcs 1,8.150.000
/\S5Ct lUI ll('Vel
Tlrllrssctr $7.l{}l.O{)0

The rati. o1'salcst. lixcd asselsis a rreasurcof thc r r Ltturnovcr

urrr(rvL r ' tplanl
on Pr r d r rd
and
t l t oce q u r p m e n] tti s
c a l c u l a t ehd' d i ' i c l i n gs. a l e sb y n e t f i x e da s s e t s .

Salcs $8.250,000
Ijixed asscl lurnover -
2.11
N e t { i x c dr s s e t s $2,980.000
ri
$8,000.000
t
, .lr,u, 2 8 8 r l q k T )
.brr ,-/ r/ ;) -, u
I

.:
lnrlustryfigurcs1orassctlumovcrwrll vary u,ithcapital-intcnsive
indrrstrres,
andthose
.l
requirinr: large inl'cntories will havc ntuch sntaller ratros.
:i A t t r r l l 1 , 'i1r - t r \ t l \ r : r l i r ri r l 1 1 y g n 1 o rl u) n l { ) \ C r .t . : t i t n a l r . ,hl v d i v r d r n g s : i l c s b i
a v e l . a g ien v e n -
t o r l ' . 1 ' h c n o r t n 1 o r A n r c r i o a n i r r d u s t r i e si s 9 . b u t w h e t h c r r h c r a t i o f o r a p a r t i c u l a r -
i firm is higher
o r l o r ' v e rn o r m a l l t ' d e p e n d s u p o n t h c p r o d u c ( s o l d . S n a l l , i n e x p e n s i v o i t e n r s u s u a l l y
turnover
at a llluch highcr rate than larccr', expcnsive oncs. Sincc invcntorics arc normally
ii c a n i e da t
l1
It c o s l ' t t r ' r ' o u ] cbl e n l o t e a c c u r a i e l o u s c t h e c o s t o f g o o d s s o l d i n p l a c e o f s a l c s i n t h e
numerator
lt
ti o f t h l s r a t i o . I j s t a b l i s h c d c o m p i l e r s o 1 'r n d u s t r y r a l i o s s u c h a s D u n a n d B r a d s t r e e i ,
It
nowever,
ir u s e t h c r a t i o o l s a l c sl o i n v c n t o r y .
t1 ,'
ll

. S:rles $ 8 . t . 5 U . 0 -0 0
ln\ Cnlor) tUtI,)\Cr l- 3 . 7 4t l 9 B E t
I ltvcnt0ry v, [.rrL,o
$8.000.000
- 4 (1981)
$r{,0r1000

l-he accountsreccivabictLrrnover is a measurcof thc averagecollectionperiodon sales.If

the avcrascnumbcrof davsvarieswidely lront thc industr-y of
nornr,i1 may bc an indication
poor nlanagemcnt. A too low ratrocould indicatcthc lossof salesbecauseof a too restrictive
crcdit policy. If the ratio is too high, too muchcapitalis beingtied up in accountsreceivable,
and management may be increasing thc chanceol baddebts.Becauscof varyingindustrycredit
policies,a cotrparison1orthc firm ovcr timc or within an industryis the only usefulanalysis.
Becauseinl-ormation on credrtsalesfbr otherfirmsis gcncrallyunavailable,total salesmustbe
used. Since not all firms have the sarre percentagcof credit sales,there is only approximate
c ( ) t n f r r a b i l i ta) r r r u l rfgi r n r s .
 -!

A N A L Y S I SA N D D I A G N O S I S 1 9 1
INTEFNAL

:
rumover : : 4.6e(1e88)
receivable
Accounls A;*#*ffiG *#ffi
parlng revenues
!). ul oper?tig1_ - $ 8 , o o o , o o=o 5 . 5 6( 1 9 8 7 )
tal assets.
Asset $ I ,440,000
,, assettumover
360
AveragecoilectionPeriod = Accounts tufilover
receivable
360 -
? 7 d a v s( 1 9 8 8 )
469
16n

556

,qulpment.
It is

Ratios
ProfitabilitY chosenby an organl-
)88) profitability is thc nct rcsult of a large number of policies and dccisions
Zation,smanagement.Profitabilityra.tioslndicatehoweffectivelythetotalfirmtsbeingman-
,87) aged.Theprofitmarginloralirmiscalculatedbydividingnelearningsb ysales.Thereiswidc
Amcrican firms is approximatcly5 percent'
variation antong industnes,but the averagcfor

N e t e a r n i n g s- $410,000 -
ies, and those 0 . 0 4 9 7( 1 9 8 8 )
Saies $8,250'000

tvcrage inven- - xi395'ooo

: o.o'+94
(19tJ7)
-firm is
higher $8,000
'000
rally turn over
ally carriedat the re'turnon investment--or ROI' as it
A seconcluseful ratio 1or evaluatingprofilability is
the numerator by total assets The ABC Company's ROI
'ect, however, is frequenrlycalled-fbund by dividin! net earnings
is calculatedas follows:

N c t e a r n i n g s- $ 4 1 0 ' 0 0 0 - 0 . U 5 7 7( 1 9 8 8 )
T o t a la s s e t s $ 7 ' 1 0 5 ' 0 0 0

: f f$i 3: 9o5o, 060 0i 8 ( 1 e 8 7 )

of the rate ol retunl or profitability of

l.he ratio ol net earnrngsto net worth is a measure
by dividingnerearnings by networth' the common-
d on sales.If the stockholders, investme;t.It is calculated
indicationof stockequityandretatned-earningsaccount.ABCCclmpany,sleturnonnetworth.alsocalied
oo restrictive ROE, is calculatedas follows:
ls receivable,
rdustrycredit N e te a r n i n g_s $ 4 1 0 , 0 0 0: 0 . 1 2 6 4( 1 9 8 8 )
:ful analysis. Net worth $3,242'500
;alesmust be
approximate - $395'ooo: 0.r449
(r987)
s2;125,150
 192 cHAprER5

It is often difficult to determinecausesfor lack of profitability. The Du pont

svst"
financialanalvsisprovidesmanagementwith cluesro rhe lack of a firm. ill; ,fti
"11.:.:,
tool bringstogetheractivitv,profitability,and leveragemeasures and showshow,h;;.;ut^,
theoverallprofitability
of thefirm.A depicrion
of thesystem
i, ,.,'tonr,
ilgfflo; l:j:*"""
The right sideof the fieuledeveJops theturnoverratio.This sectionbreaksdown tohl
lnto currentassets(cash,n-rafkelable assetr
securities,accountsreccrvable,and inventorierl
unO'n*aO
assets.Salesdividedbv theselotal assetsgivesthe turnoveron assers.
Thc left sideof the figuredevelopsthe profitnrarginon sales The individual
expense rtems
plus inconielaxesare subtractedfrom salesto producenet profits
after taxes.N.t pronrriin,ora
b1"salesgives the profit margin on sales.When the assetrurnoverratio
on tr-,..iglri ,io.
Exhibit 5.26 is multrpliedbv the profitmarginon salesdeveloped oi
on rhe lefr siaeoittre ngurc,
thc producris rhe rerurnon assers(ROI) for thc firm. l.his can be shown
br,h;"i;1.
"'u rurlOwlng
formu]a.

Salcs Net earnrngs Nct earninqs

;-,-.-+-R()J
totrl assets Sajes Totiil assers

EXHIBIT5.26 Du Pont's linancialanalvsis.

I t 4 u l t r p l i ebdy otal assets/equit\i

$ 7 , 10 5 , 0 0 0 /
$ 3 , 2 4 2 , 5 0=0
2.19
Profitmargin
0.05

t ) i vi d e d Net income Total assets D i vi d e d

In10 $ 4 10 , 0 0 0 $7,'r05,000 inlo

T o t a l c c s t s S ub 1r a c l e d F i x e da s s e t s C ur r e n l
$7,840,000 lrorn Plus assetS
$2,980,000
$4,r25,000

Cost of A d mi ni s t r aitv e
goods sold € xp e n s e s
$ 5 , 10 0 , 0 0 0 $1,750.000

Accounts
r e c ei v a bl e
$ 1,760,000
 \

L N A L Y S I SA N D D I A G N O S I S 1 9 3
I N T E R N AA

the rate of return on assets(ROI) by the

)nt system The lasr step in rhe Du Pont analysisis to multiply ^f -^1,.-- ^-
nf tocommon
theratioof assets
fnis financiai *"io "'"ii'ot':',;;;; "o"ttJ:l?,i.l,tl]1t::i::;',"i.,':::i:'::
v tnese ratios ffii ffi'il.
egurt-r ir'*
\'\vsl'
rate
o.'.*,.te ofreturn:"*'"-t':'l::;::-'it^':':::i:'j:';y.-:1#i:iil:
: .-, 1L^ n,, D ,
Pont anaiysrsdemonstrateshl o w t h e r e t u r n
* rs set forth net income by common equity Flowever,the Du
the return on equlty'
on assetsand the use of debt interactto determine
andimprovetheperformance
o" usedto analyze of a firm' on the
ffiilil;tr""-,
rrrtr vu I urrl r - l n r v r r r v.-q !
total a55gts 1 - ^^.-lJ L^ :-r,acflnetpd
could be investigated
1n left, or profit, side of thc figure, attemPts to lncreasl : p r o f i t s a n d s a l e s
res)and fi1g6 .,nlrrme) c
il (orlou'e"y
.^"t"* o?itt'tn i"'i'out profits
;#;i';*
"i courd lt':t^'-:"-:T:::,:,:Ttl,::
o"'*"1:-t::1"i":::1T:'::t"t,::
:i:iil;.;:;il;;;";;-.i', r,,,I-^*pre'
'xpenseitern5
;"ffi ,inut"igut"
-" '-":-- wavs to rcducc costson 'ltil.""l]lll"]""1,"t'itl.
^ r , ' - - 1 ,^ , - - r , , . ; . , investment!e
Juutlurr trrrErrrv
rofirs divided ""t"i*"".""il
financial ,,fi,.aru could anall"ze the eflect
of reducing ln varlous asrs e t s a s w e l l a s
right sideof
of the figure, the effccl of altcmattvefinanctalstructures'
he following Therearetwobaslcapprtlachcstousing|rnancialratios.()neapproachistoevaluatethe
Frnanctalratiosare computedfor diflerent -vears'
corporation,sperforrlanccovcr severaiycars.
or deterioration
and then an assessmenr rs made aboutri,hethcrthere has beenan improvement
andstatements
orprororma'
'o'nu'"ororprojected'
::ilJffi:ilT:I*:::.;l'*J:
'l;i',il:ff:]"f'
Theothcrapproachlstoe\,aluateafirm,sfinancialconditionandcompareitwilhthelinanciai
:::":iJ::
* ; ;llJi::[J.l:r.[
il$':'ri'Jthllrf ":#'T':;1::'
Dun and Ilradstrect'and varioustradc assoclatlon
,r. pr""io"a by Robcrt Morris Associates.
are listedin the Encyclopediaof Asso(iatktns
and their addresses
publications.(Associations

;;,'.Tf#i*'yli:i:'li;;::,iT:,"il:'J:;'"il,i",Tlilll*:i:i::';:::
lroldeis,and rhc najor brokeragehouscs
I assets/equity different conrpaniesmust be standardizedstl
t,105,000/ To the extent possib}e,,..o,unting data {.rom
),242,50=0 t h a t C o l n p a n l e s c a n b e C o n l P a r . d n , . , o t h a r a s p e c i l i c c ( ) l l l p a n y c a n b e c o m p a r oot
dwithindustry
of financialstatements, sitlccvariousaccountinp
2.15 dara.It is irnportantt0 reaclan1"footnotes
financialpicturcoI the company ljor example'
maragcmcntpracticcscan han. an effccton thc
ftrnlsusingsa]c-leasebackmethtrdsrrrayhavclcveragepicturcsthatalcquitcdiffercntfronl
shcrt
. h a t i s s h o w nu r sd c b l st r r a \ \ c l \ o n l l t e b a l a n c c

Funds
Analysis of the Sources and Uses of
.I.hepurposcofthisanalysisistodetcrminchtlwthcconrpanyisusingitsfinancialrcsotlrccs
lrclmone yeart0 the next, one may determinc
lrolrr year tO year.By comparintbalancesheets ycar'
which thcsefundswere employcdduring thc
how fundswerc obtaincd^"a ui. way in (1) classifybalance
and
of the sou.ces uscs of lundsit ts necessaryto
To prcparea statcrrenr
cashand changesthat decrease cash,(2) classifyfrom thc lncomc
shcetchangcsthal rncrease
and (3) consolidatethis informationon a sources
statemenlfactorsthat increascor dccrcasecash,
In v e n t o r y
i2,175,000 and usesof funds statenlentlonr'
as follows'
Sourcesof funds that increasecashare
deprecrablefixed asset
P r e p iad
I A net dccreascin any assetother than a
fixed asset
expenses 2 A gros decteasein a depleciable
$50,000 3 A net increasein anYliabilitY
4 Proceedsfrom the saleof stock
and depreciationif the cornpanyis profitable)
5 The operatrono1 the company(net income.

Usesof lunds include

194 5
cHAPTEF

I A net increasein any assetother than a depreciablefixed asset

2 A gtoss increasein depreciablefixed assets
3 A net decreasein any liabiliry
4 A retiremenlor purchaseof stock
5 Paymentof cashdividends

\\'e compute gross changesto depreciablefixed asselsby adding depreciationfrom the

income stalementfor the period to net fixed assetsat the end ol the period and then subtracting
representsthe
fron the rotal the net fired assersat the beglnningof the period. The resrdual
changein depreciablefixed assctsfor the period.
For the ABC Companl' the follo\\'ing changewouJdbc caiculated:
Net propertyand plant (1988i !;1.175.000
Depreciationfor 1988 - 80.000
l;1,25-5.000
-1.r55.000
Net property'andplant (1987)
s 100.000

T6 aveid doublecounting,thc changein retainedearningsis not shou'ndirectly in the funds

statement.When the funds statementis preparecl,this accountis replacedbv the earnrngsafter
taxes. or net income, as a sourceof funds and dividendspaid during the year as a use ot funds.
The differencebetweenner income and the changern the retained-earnings accountwill equal
the amount of dividends paid during rhe year. The accomparyingsourcesand uses of funds
statementwas preparedfor the ABC Companv.
A funds analysisrs useful for dcterminingtrendsin working-capitalpositionsand for dem-
onstratinghow the firm has acquiredand emplovedits funds during some period-

A N D U S E SO F F U N D SS T A T E M E N T
A B C C O . ' SS O U R C E S
FOB 19BB

Sorrces
Prepaidexpenses $ 13,000
AccountsPayable 100,000
Accruedfederaltaxes 250,000
Dividendspayable 3,750
CommonstocK 1,200
Additionalpaid-incaPital 195,500
Earningsaftertaxes(netincome) 410,000
Depreciation 80.000
Toialsources $1,0s3,450

Cash $ 25,000
Accountsreceivable 320,000
Inventory 175,000
.165,000
Long{ermreceivables
Propedyand plant 100,000
Other fixed assets 20,000
Bank loanspayable 75,000
Currentmaturities debt
oi long-term 8,500
Long-termliabilities 75,000
Dividendspaid 90,000
Totaiuses $1,053,450

-
 SN DD I A G N O S I S 1 9 5
I N T E R N AAL N A L Y S I A

Fatios and
workrng
capital

L i qui di t y :
C ur r e n l

0uick
the
Leverage
ins
the
( e t c .)

\ /orkIng
capitai
posilion

E X H I B I T5 . 2 7 A summaryof the financialposition of a firm

(.'onclusion
E r h i b i t 5 2 7 s o t h a t Y O Uc a l l c l e v c l t ) l )a
nds I t i s r . c ( ) n r n l c t l d c - ct lh a t \ ' ( ) l l p r e p e r c a c h a r l s L l c ha s
c h a r t a l l o u s a t l i s p l a Vo 1 ' l l t c r a l t U st ' r c t L i t t l t
iter u s c l r r lp o r t r a ! a l 0 l l l t c s c i r n a n c r a la n a 1 l ' s t ' sl '.l t c
'fhi: 'l "favorablc" ( 'l )' "ncutral" (-- )' ancl
ds. r e n c ic o l u n r r r c O u i t l i t l c l u d c a r r o w s t o ' l i c a t c
i n t i
. c o l u l n n c O u l d i r l c l u r l ct h c d c s t r c ' d
ual r . r n f a V 0 r a b l c(" l l l 0 f t h c r l t i o s o v c r t l n l e. h c S t e n d a l c l
-l'hc lnclrllln!tti the rattCls
rds ( O r r c t l u r r c c lrl a l i o . l n t e r p r c t a f i O cno l u t t l nc a n b c t r s t t i l o d c s e l i b ct h c
rarios a s o n c a s p e c r o
t i thc firnl's financiai
{ i r r t h i s l r r r r r .l ' h c c h a r t r . r " c s a b i , s i c t i i s p l : r v o i t l t e
condltlotl.

REFERENCES
tl I StrategicAdvantageFactors
I'he Intcnrlil Analvsis.'' Long Rdtt'Qe l ' l r t r r r i t r l , qv o l
C r o o n . l ' . . " A i d s r n D e t e r n r i r l i n !S t l a t e9 \
il. no. 4 (August.19791P ' P 65 73
unl Crntltclitttr'r (Neu'
P o r t c r ' .\ 4 . F . . . C o n t l t c t i t i t e S / r r t l t ' , q r "7 c L h t t r t l u a s . l r t tA n r i t : i t t g l n d u ' s l r i t s
Y o r k . l j r e cP r e s s .l 9 i r ( ) ) '
(Ncu YOrk:Irinlncr:LlIlxCCUtiYe-q Rcscarch
Stcincr.(1.:"!lrrrtt,!ir'l.at'lrn"sitt rgtts'i(sssll.rr:.ss
ljountlatron,1965).
' ' A R c s o u r c c - B a sV Jovt'rln1' vol
\ \ ' i r n e r l e l tR
. .. e ide u ' o l t h c I " i r t t r ' S t r r r t c g i r 'l \ l a n a g e n t c t t l
5 ( 1 9 8 ' 1 )p.p . l 7 l - l f i O

and Distribution
12) Analyzing Marketing
Mttrkt'tPlonnit?q(EnglcwoLrdcliifs' N l : Ptenltcc
Abell. t). Ir.. andJ. S. Harnnrontl:Srratc:g.ic
llall. 1979).
(EnglewoodClil'l''r'N i : PLentice-}lall'l9E0l
ting Md11{)8(it1(ttt
Kotlcr. l).: iv4arke
"N{arketing.The New I'rioriry." IJuriirc's'sll'crlt Nov ll ' 1981"pp 96-106'

l3l AnalYzing F&D and Engineering

l &D (Lex-
o f I n d u s r r l oR
B o s e m a nB. . . N I . C r o w . a n d A . L i n k ( e d s . 1s: r r a l r g i t M a n a g , e m e n t
i n g t o n .N l a s s .L: e x i n g t o nB o o k s .1 9 8 4 ) .