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Chapter 4 - The Internal Assessment

Overview
Chapter 4 explains how to conduct an internal strategic management audit to
provide an excellent foundation for formulating strategies. Key aspects of the basic
business functions (management, marketing, finance, production/operations, R&D, and
MIS) are reviewed along with value chain analysis, benchmarking, breakeven analysis,
and cost/benefit analysis. This chapter reveals how to identify and prioritize internal
strengths and weaknesses that provide a basis for strategies formulated. Chapter 4
explains how to develop an Internal Factor Evaluation (IFE) Matrix, an important
strategic planning tool.
It is vital for companies and organizations to identify and prioritize the relative
importance of key internal strengths and weaknesses that characterize the firm, so the
firm can deploy assets/resources to capitalize on the strengths and improve upon the
threats. Survival of the firm can hinge on this part of strategic planning being done well,
so Chapter 4 is very important. This part of strategic planning requires that an
engineering hunt for the facts be conducted, to avoid a strategic plan being based on
vague generalities, which is detrimental both to companies and students performing case
analysis.

Learning Objectives
The Chapter 4 Learning Objectives presented in the textbook are reiterated below:

1. Describe the nature and role of an internal assessment in formulating strategies.


2. Discuss why organizational culture is so important in formulating strategies.
3. Identify the basic functions (activities) that make up management and their relevance
in formulating strategies.
4. Identify the basic functions of marketing and their relevance in formulating strategies.
5. Discuss the nature and role of finance and accounting in formulating strategies.
6. Discuss the nature and role of production/operations in formulating strategies.
7. Discuss the nature and role of research and development (R&D) in formulating
strategies.
8. Discuss the nature and role of management information systems (MIS) in formulating
strategies.
9. Explain value chain analysis and its relevance in formulating strategies.
10. Develop and use an Internal Factor Evaluation (IFE) Matrix.

Teaching Tips
1. Ask by show of hands (although you have the information recorded on a class roster
sheet), who in the class is a Management major, and then ask the same for each BBA
major. Why? Because this chapter offers a quick synopsis of key material in those
majors. Ask students to capitalize on their area of expertise in performing their strategic
management case analysis. Emphasize to students that strategies are based on a
prioritized list of strengths and weaknesses in the functional areas of business. No firm
can do everything beneficial, so prioritization is a key in strategic planning.

2. Show the author videos about Chapter 4 at the www.strategyclub.com website. Also
at that website, show the IFEM portion of the Excel student template. Also, show a
sample case presentation at that website, with special emphasis on the Internal
Assessment part.

3. Regarding the financial ratios presented, show students where they can retrieve those
ratios on the Internet, i.e., at the websites presented in the chapter, especially the sources
given in Table 4-10. Note: Table 4-10 is brand new to this textbook and is worthy of
spending some time on because the underlying numbers of key internal and external
factors come from sources such as those given, plus students need to get familiar with
what their college library does and does not offer in terms of business online databases.

4. Breakeven analysis has become an increasingly important strategic planning concept,


especially for thousands of start-up businesses and entrepreneurs. Therefore, definitely
go through the end-of-chapter review questions and exercises that deal with breakeven.
This edition gives a formula and example problems that can be utilized in class to apply
breakeven.

5. The IFE Matrix in Table 4-8 for a retail computer store will serve as a running
example in other chapters to come, so definitely go over that example. Point out the use
of $s, #s, %s in the factor list, as well as the Ratings, which (remind students) are 4 or
3 for strengths and 2 or 1 for weaknesses (in contrast to the Ratings in an EFEM).

6. At the end of Chapter 4, direct student attention to the Implications for Students
because this is important information as the team prepares and ultimately delivers their
oral case analysis presentation later in the course.

7. Regarding the end-of-chapter review questions, consider assigning them all one day in
class, giving each student a question or two, and letting them tell the class the answer,
with you commenting on their answers. I have found this to be a fun day in class and it
goes pretty quickly.

8. Several of the end-of-chapter Assurance of Learning Exercises make excellent


homework or classwork assignments to be completed as an individual or as a group of
students. Several exercises focus on the Hershey Company Cohesion Case, and several
focus on your college/university. I usually select one from each venue.
Answers to End-of-Chapter 4 Review Questions
4-1. The primary means for gaining and sustaining competitive advantages for most
companies are shifting downstream. Explain and discuss this statement.

Answer: The primary means for gaining and sustaining competitive advantages for most
companies are shifting downstream. Recent research by Dawar reveals that in most
industries today, upstream activities such as supply chain management, production, and
logistics, are being commoditized or outsourced by firms, while downstream activities
related to consumer behavior are becoming the primary means for gaining and sustaining
competitive advantage. Dawar reports that the sources of competitive advantage are
shifting away from production processes inside the firm, to customers and markets
outside the firm. Businesses are increasingly gaining competitive advantage by
proactively shaping customers point of purchase behavior, rather than firms using focus
groups, surveys, and social media to determine what customers want.

4-2. In analyzing big data, there is a shift from focusing largely on aggregates or
averages to focusing, in addition, on outliers, because outliers oftentimes reveal
(predict) critical innovations, trends, disruptions, and revolutions on the horizon.
Explain and discuss this statement.

Answer: In analyzing big data, there is a shift from focusing largely on aggregates or
averages to focusing, in addition, on outliers, because outliers oftentimes reveal (predict)
critical innovations, trends, disruptions, and revolutions on the horizon. In essence,
knowing more about who is not your customer and why may be as (or more) important
than knowing about your customer. Perceptual mapping and multidimensional scaling
are being more widely used to explore outlier patterns. Also, the typical statistical
approach of relying on p values to establish the significance of a finding is becoming less
trusted, since with extremely high sample sizes almost everything becomes significant.
In contrast, the focus of analysis is shifting more to the size and variance explained, i.e.,
examining for example R-squared. Stepwise regression and cluster analysis are
becoming more widely used to supplement traditional p-value analyses.

4-3. What are some limitations of financial ratio analysis?

Answer: 1) Financial ratios are based on accounting data, and firms differ in their
treatment of such items as depreciation, inventory valuation, R&D expenditures, pension
plan costs, mergers, and taxes. 2) Seasonal factors can influence comparative ratios. 3)
Conformity to industry composite ratios does not establish with certainty that a firm is
performing normally or that it is well managed; likewise, departures from industry
averages do not always indicate that a firm is doing especially well or badly. For
example, a high inventory turnover ratio could indicate efficient inventory management
and a strong working capital position, but it also could indicate a serious inventory
shortage and a weak working capital position. 4) Financial ratios are not very
actionable in terms of revealing potential strategies needed, i.e., since they generally
are based on performance of the overall firm; selecting actionable key factors, both
externally and internally, upon which to formulate strategies is important. 5) All ratios
are not significant for all industries and companies. For example, accounts receivable
turnover and average collection period are not meaningful to a company that takes only
cash receipts.

4-4. Does RBV theory determine diversification targets? Explain and discuss this
statement.

Answer: Recent research by Neffke and Henning basically says the answer is YES.
Their empirical evidence reveals that it is the nature of a firms human capital more than
any other variable in the firms value chain that impacts that firms choice of
diversification targets. Specifically, firms select acquisition targets that offer
opportunities to leverage existing human resources. Neffke and Henning report that
firms are far more likely to diversify into industries that have ties to the firms core RBV
activities in terms of their existing workforce, rather than into industries without such
ties. In fact, Neffke and Henning report that firms are over 100 times more likely to
diversify into industries to which the firms internal human assets are strongly
complementary, rather than into industries for which such skill-relatedness linkages are
weak. (Source: Based on: Neffke, Frank and Martin Henning (2013), Skill
Relatedness and Firm Diversification, Strategic Management Journal, 34, 297-316).

4-5. True or False: Recent research reveals that the most effective marketing
methods for firms with fewer than 500 employees is the company website (50%).
Explain.

Answer: TRUE. There has been a dramatic shift away from advertising on television,
newspaper, radio, and magazine to advertising on social media, especially through the
companys website.

4-6. What are collaborative machines?

Answer: Increasingly in production settings, a new breed of robots, called collaborative


machines, are working alongside people. The robots, priced as low as $20,000 and
becoming widely used even in small businesses, do not take lunch breaks or sick days or
require health insurance, and they can work nonstop all night tirelessly if needed. Unlike
larger robots that cost much more, collaborative machines are more flexible, oftentimes
doing one task one day and a different task the next day. At Panek Precision Inc., a
Northbrook, Illinois-based machine shop, Mr. Panek says: Having robots has allowed
us to move our existing workers into more useful tasks, such as monitoring more-
advanced machines that require human tending. Workers are generally quite receptive
to collaborative machines, even giving them names, such as Fred at Stuller Inc., a
jewelry factory in Lafayette, Louisiana, and Baxter at KNEX Brands, a toy maker in
Hatfield, Pennsylvania.

4-7. Identify some excellent online resources for finding financial ratio information.
Answer: See Table 4-10. The authors favorite, however, is www.finance.yahoo.com. It is free and
immensely informative with financial comparative metrics for any publicly-held firm.

4-8. Marketing is becoming much more technical as are the duties and responsibilities of
chief marketing officers (CMOs). Give four examples of increasing technical aspects of
marketing.

Answer: a) Managing the firms website. b) Performing data mining (business analytics) to
facilitate decision making. c) Developing, administering, and analyzing surveys to assess
customer tendencies and desires. d) Adjusting prices across countries in conjunction with
changes in the value of the dollar.

4-9. Is a capacity utilization rate of 50 percent good? Why?

Answer: A rate of 50% would be terrible because that would indicate that the production
machinery in a manufacturing plant would be running/operating only 50% of the time. This
would be like an airplane staying grounded 50% of the time = not good for business.

4-10. If Netflix increases its advertising expenses by 30 percent while keeping its price and
variable costs the same, does that mean the companys breakeven point will increase 30
percent? Show this calculation for a hypothetical firm.

Answer: YES, on rare occasions. NO, unless the only fixed cost is advertising, which is rarely
the case, so the answer is almost always NO.
Before: After:
BE = TFC/ (P VC) BE = TFC/ (P VC)
BE = 100/ (10 5) BE = 130 / (10 5)
BE = 20 BE = 26
Conclusion: 26 20 = 6 6/20 = 30%

4-11. What are the limitations of breakeven analysis?


Answer: Wikipedia gives a good answer, as follows:

BE is only a supply side (i.e., costs only) analysis, as it tells you nothing about
what sales are actually likely to be for the product at various prices.
BE assumes that fixed costs (FC) are constant. Although this is true in the short
run, an increase in the scale of production is likely to cause fixed costs to rise.
BE assumes average variable costs are constant per unit of output, at least in the
range of likely quantities of sales (i.e., linearity).
BE assumes that the quantity of goods produced is equal to the quantity of goods
sold (i.e., there is no change in the quantity of goods held in inventory at the
beginning of the period and the quantity of goods held in inventory at the end of
the period).
In multi-product companies, BE assumes that the relative proportions of each
product sold and produced are constant (i.e., the sales mix is constant).
4-12. In the Joys Daycare BE example in the chapter, how would a $1,000 annual
advertising expenditure impact the business break-even point?

Answer: It would raise the BE point from 8 children to 20 children.


BE = 1,600/4 = 400 units (children in June). Since there are 20 days in June, Joy must watch 400/20
= 20 children every day to break even, up from 8 children. See Table 4-7 in the chapter.

Table 4-5 Applying Breakeven Analysis for Joys Day Care

Seeing a need for childcare in her town, Joy is considering opening her own daycare
service. Joys Day Care needs to be affordable, so Joy would like to care for each child
for $12 a day. But Joy also wants to make money. Joy needs to know how many
children she will have to watch per day to make money. Joy gathered the following
information about potential new business.

a. The month of June has 20 workdays, Monday through Friday for four weeks.
b. Insurance and rent on her business will be $200 and $400, respectively, per month.
c. Expenses per student per day will be snacks (2 @ $1.00) + meals (2 @ $3.00).

Joys Analysis
Breakeven = Operating Expenses ($12.00 - $8.00)
Break-even = $600 $4.00 Break-even = 150 units (children) in June.
Since there are 20 days in June, Joy must watch 150 20 = 7.5 kids, or 8 children every
day to make a profit.

4-13. Explain Cost/Benefit analysis.

Answer: Cost/benefit analysis involves assessing the costs, benefits, and risks associated with
marketing decisions. The three steps required to perform a cost/benefit analysis are: (1) compute
the total costs associated with a decision, (2) estimate the total benefits from the decision, and
(3) compare the total costs with the total benefits. An opportunity becomes more attractive to
the extent that expected benefits exceed total costs.

4-14. Explain why communication may be the most important word in Management.
What do you think is the most important word in Marketing? In Finance? In Accounting?

Answer: The process of performing an internal audit provides significant opportunity for
participants to understand how their jobs, departments, and divisions fit into the whole
organization. Performing an internal audit thus is an excellent vehicle or forum for improving
the process of communication in the organization. Excellent communication leads to excellent
understanding of what the firm is doing and why, and what is in it for employees and managers.
This leads to excellent commitment, a vital ingredient for strategy implementation. Student
answers will vary on the most important words for Marketing, Finance, and Accounting.
Examples may include pricing for Marketing, financing for Finance, and ethics for
Accounting.
4-15. Discuss how the nature of advertisements have changed in the last few years.

Answer: Growth of traditional advertising outlets such as newspapers, magazines, television,


and radio have slowed dramatically, and there has been significant growth in Internet
advertising. Advertising on social media sites such as Facebook, Twitter, YouTube, and
LinkedIn has become important for many companies. Companies are even beginning to
advertise to readers of e-books. Ads in general are also shorter in length, and targeted more
effectively to customers. Companies increasingly are utilizing business analytics (data mining)
to link the price being charged for ads to tangible, measurable results in sales.

4-16. Explain why it is best not to have more than 30 percent of the factors in an IFE
Matrix be financial ratios.

Answer: In developing an IFE Matrix, it is important to not have more than 30 percent of the
key factors be financial ratios, because financial ratios are the result of many factors, so it is
difficult to know what particular strategies should be considered based on a financial ratio. For
example, a firm would have no insight on whether to sell in India or China to take advantage of
a high ROI ratio. A much better factor is that the firms sales in India increased 14% vs. 4% in
China.

4-17. List three firms you are familiar with and give a distinctive competence for each firm.

Answer: Answers will vary for each student. Examples of firms with distinctive competencies
include Maytag, which is known for excellent product quality; Procter & Gamble, known for
superb marketing; and 3M, known for innovative research & development.

4-18. Give some key reasons why prioritizing strengths and weaknesses is essential.

Answer: Prioritization is key throughout the strategic planning process, because no firm has
sufficient resources to do everything that can benefit the firm. Key internal factors must be
prioritized so that the firms most important strengths and weaknesses can be determined
collectively as needed to decide among numerous beneficial strategies. Performing an internal
audit provides great opportunity for participants to understand how their jobs, departments, and
divisions fit into the whole organization.

4-19. Why may it be easier in performing an internal assessment to develop a list of 80


strengths/weaknesses than to decide on the top 20 to use in formulating strategies.

Answer: Developing a list of 20 strengths and weaknesses can be difficult when it involves
managers representing various organizational interests and points of view. The judgments
required to compile such a list will impact strategy formulation, implementation, and
evaluation. Simply put, some departments and divisions/segments will receive greater
resources than others based on the factors selected, and more specifically the prioritization of
factors. Eighty random factors would be easy to develop since managers from all areas would
have their interests covered. It is essential to include managers from all areas of the business in
the prioritization of internal factors since formulation of selection of strategies will be based on
the most important factors.

4-20. Think of an organization you are very familiar with. List three resources of that entity
that are empirical indicators.

Answer: Empirical indicators are resources that are rare, hard to imitate, and not easily
substitutable. Student examples should encompass at least one of these three characteristics
when identifying resources that enable a firm to implement strategies that lead to a sustainable
competitive advantage. For example for ExxonMobil Corp., ownership of oil wells, ownership
of drilling rights, and contractual agreements with various distributors could all be empirical
indicator resources.

4-21. Think of an organization you are very familiar with. Rate that entitys organizational
culture on the 15 example dimensions listed in Table 4-2.

Answer: Organizations selected will vary by student. Some example cultural products listed in
Table 4-2 include: strong work ethic, high ethical beliefs, formal/informal dress, socializing
outside of work, and being health-conscious or having a wellness program. These and other
cultural aspects can be rated on a 1-5 scale, where 1 is a weak component of the firms culture
and 5 is a strong component of the firms culture.

4-22. If you and a partner were going to visit a foreign country where you have never been
before, how much planning would you do ahead of time? What benefit would you expect that
planning to provide?

Answer: I would do extensive planning, so that we could use our time wisely in the country,
seeing and doing all that we could while there. Potential benefits from planning for the trip may
include anticipating and preparing for potential issues related to weather and travel, establishing
objectives on what to do and see, devising strategies to make the trip cost effective, developing
policies and guidelines on behavior and activities, and setting goals (priorities) that are
important to the student. Some students may indicate that extensive planning is not necessary
and may curb spontaneity.

4-23. Even though planning is considered the foundation of management, why do you think it
is commonly the task that managers neglect most?

Answer: Various reasons listed and described back in Chapter 1 include:


Lack of knowledge or experience in planning. Poor reward structures. Firefighting. Considered to be
a waste of time. Too expensive. Laziness. Content with success. Fear of failure. Overconfidence.
Prior bad experience. Self-interest. Fear of the unknown. Honest difference of opinion. Suspicion.

4-24. Are you more organized than the person sitting beside you in class? If not, what
problems could that present in terms of your performance and rank in the class? How
analogous is this situation to rival companies?
Answer: Being well-organized means that you utilize time efficiently and effectively, rather
than wasting time. Being well organized in class thus usually translates into excellent
performance in the course. When rival firms are in close proximity to each other, as your fellow
students are in the class, being well organized becomes even more important. Regarding
teamwork in class or in a business, the purpose of organizing is to achieve coordinated effort by
defining task and authority relationships. The three activities within the organizing function can
be applied to business as well as the classroom: 1) work specialization, 2) combining jobs to
form departments, and 3) delegating authority.

4-25. List the three ways that financial ratios should be compared/utilized. Which of the three
comparisons do you feel is most important? Why?

Answer: Three questions that should be raised when conducting a financial ratio analysis are:
(1) How has each ratio changed over time? (2) How does each ratio compare to industry
norms? (3) How does each ratio compare with key competitors? Financial ratio analysis should
be conducted on three separate fronts to get the full picture, so no one area is more important
than the others.

4-26. Illustrate how value chain activities can become core competencies and eventually
distinctive competencies. Give an example for an organization you are familiar with.

Answer: Identify where low-cost advantages or disadvantages exist anywhere along the value
chain from raw material to customer service activities. Identify your firms own strengths and
weaknesses as compared to competitors value chain analyses. Take action to strengthen
competitive advantages turning them into distinctive competencies, and improve competitive
disadvantages in an effort to turn them into core competencies. An example of this is Wal-Mart,
which has built powerful value advantages by focusing on exceptionally tight inventory control,
volume purchasing, and low pricing.

4-27. In an IFEM, would it be advantageous to list your strengths, and then your weaknesses,
in order of increasing weight? Why?

Answer: Yes. Arranging factors according to importance would help the firm organize,
evaluate and utilize internal factors in the strategic planning process. It is not essential that the
IFEM be structured in this manner, but it definitely would be helpful for an analyst.

4-28. In an IFEM, a critic may say there is no significant difference between a weight of 0.08
and 0.06. How would you respond?

Answer: On the surface, the weight of an IFEM factor may appear to be insignificant.
However, a factors weight can become significant when it is combined with a rating and
converted into a weighted score. For example, the 0.08 factor may receive a rating of 4 (major
strength), whereas the 0.06 factor may receive a rating of 1 (major weakness). The weighted
score of the 0.08 factor will be 0.32, whereas the weighted score of the 0.06 factor will be a
much lower 0.06. In addition, it is important to note that 0.08 is 33% higher (more important)
than 0.06.
4-29. Why are so many firms raising their dividend payout amounts?

Answer: Companies are making money and stock prices are high, so the thought is to reward
their shareholders by raising the dividend. Firms in 2012 especially raised dividends since the
federal government anticipated increasing taxes on dividends in 2013.

4-30. When someone says dividends paid are double taxed, what are they referring to?

Answer: Dividends are subject to corporate taxation followed by private income taxation. The
company first pays corporate tax on its revenue, before the dividend is paid out to the
shareholder. Once the shareholder receives the dividend, he/she pays taxes on that dollar
amount. So in essence that dollar amount was taxed at the corporate level and the individual
level.

4-31. Draw a breakeven chart to illustrate a drop in labor costs.

Answer: A drop in labor costs constitutes a decrease in variable costs, which would result in a
decrease in a firms breakeven point. See the diagram below for an illustration:
TR TR

TC
Before After

VC
TC

$
VC
$

FC FC

Q Q

4-32. Draw a breakeven chart to illustrate an increase in advertising expenses.

Answer: An increase in advertising expenses constitutes an increase in fixed costs, which would
result in an increase in a firms breakeven point. See the diagram below for an illustration:
TR TR

TC
Before TC After

VC $
VC
$

FC
FC

Q Q

4-33. Draw a breakeven chart to illustrate closing stores.

Answer: Closing stores constitutes a decrease in fixed costs, which would result in a decrease in
a firms breakeven point. See the diagram below for an illustration:

TR TR

TC
Before TC After

VC
VC
$

FC
FC

Q Q

4-34. Draw a breakeven chart to illustrate lowering price.

Answer: Lowering price constitutes a decrease in total revenue, which would result in an
increase in a firms breakeven point. See the diagram below for an illustration:
TR
TR
Before TC After
TC

VC VC
$
$

FC F
C

Q Q

4-35. Explain why prioritizing the relative importance of strengths and weaknesses to include
in an IFE Matrix is an important strategic-management activity.

Answer: No firm has sufficient resources to do everything that can benefit the firm, so
prioritization is vital at all stages of strategic management. No more than 20 factors should be
included in an IFE Matrix because too many strategies cannot be effectively pursued
simultaneously. Including more than 20 factors dilutes the importance of the most significant
factors.

4-36. How can delegation of authority contribute to effective strategic management?

Answer: Delegation of authority is an effective way to involve lower-level and middle-level


managers in the strategy-formulation process. Delegation can also be important in strategy
implementation to help motivate managers, because those persons being delegated to may actually be
closer to customers/suppliers/distributors and thus can make more effective decisions.

4-37. Which of the three basic functions of finance/accounting do you feel is most important in
a small electronics manufacturing concern? Justify your position.

Answer: According to James Van Horne, the three basic functions of finance are the investment
decision, the financing decision, and the dividend decision. In a small electronics manufacturing
concern, the investment decision would be most important, because the firm probably does not pay
dividends, and likely does not have common stock, but does have to allocate available resources
among projects/regions.

4-38. Explain how you would motivate managers and employees to implement a major new
strategy.

Answer: There is a need to demonstrate clearly how the new strategy will benefit managers and
employees of the organization. Articulate effectively why the new strategy is needed, given
competitors strategies, products, and services. Involve employees and managers in formulating
strategies to the extent possible. Involve as many managers as possible in discussions about how to
effectively implement the strategy. The process is more important than the plan.

4-39. Why do you think production/operations managers are often not directly involved in
strategy-formulation activities? Why can this be a major organizational weakness?

Answer: There is an unfortunate stigma in many organizations that production/operations


managers do not need to be involved in strategy-formulation decisions; they only implement
strategies. This attitude can represent a major weakness in any organization, because more than
80 percent of company assets are generally tied up in production/operations facilities, materials,
plants, equipment, inventory, and machines. Production managers input into strategy-
formulation activities can help assure that cost-effective strategies are selected for
implementation.

4-40. Give two examples of staffing strengths and weaknesses of an organization with which
you are familiar.

Answer: Staffing activities include hiring, training, testing, wage and salary administration,
employee benefits, union/management relations, and employee development. The Brown
Company has high employee morale and an excellent ESOP plan, but the firm also has too few
women in upper management and too few minorities as well.

4-41. Would you always pay out dividends if your firms annual net profit increases
ten percent or more? Why or why not? What effect could this have on a firms
strategies?

Answer: The answer is NO. You may pay out dividends, but you certainly would not
always pay out the dividends. Reason is that there are pros and cons of reinvesting
earnings, as opposed to paying dividends, as follows:

Pros of reinvesting earnings:


1. Can spur growth of the company
2. Can enable the firm to acquire other firms
3. Can enable the firm to fund multiple strategies
Pros of paying out dividends:
1. Can keep shareholders happy
2. Can attract more shareholders
3. Can raise a firms stock price

4-42. If a firm has zero debt in its capital structure, is that always an organizational strength?
Why or why not?

Answer: Whenever an organizations return on investment or profit margin exceeds the cost of debt,
it may be advisable to use debt to finance growth and expansion. Thus, it is not always an
organizational strength to have zero debt in a firms capital structure. As an individual, if you were
sure you could make 15 percent on monies invested, then you would probably obtain a substantial
amount of debt at 4 percent to invest at that higher level.

4-43. After conducting an internal audit, a firm discovers a total of 100 strengths and 100
weaknesses. What procedures could be then used to determine the most important of these?
Why is it important to reduce the total number of key factors?

Answer: Let a group of knowledgeable individuals in the organization evaluate the relative
importance of each factor by assigning a 1 = not important, 2 = somewhat important, and 3 = very
important. Then add the ratings each factor receives. The 20 factors with the highest sum score
should be included in the IFE Matrix. Another way is to ask those individuals to simply put a check
mark by their top 20 factors; then take up the responses and add the check marks to determine the
prioritization.

4-44. Why do you believe cultural products affect all the functions of business?

Answer: Cultural products permeate every activity in an organization. People become attached
to cultural products and often resist changes in rites, rituals, values, beliefs, and norms.
Whether people work in marketing, manufacturing, personnel, or finance/accounting, they
likely feel strongly about a firms culture.

4-45. Do you think cultural products affect strategy formulation, implementation, or


evaluation the most? Why?

Answer: Cultural products likely affect strategy implementation most, but, too often,
consideration of cultural products is limited in formulation and evaluation activities.

4-46. Explain the difference between data and information in terms of each being useful to
strategists.

Answer: Data becomes information when it is assimilated and used by individuals for some purpose.

4-47. What are the most important characteristics of an effective management information
system (MIS)?

Answer: An MIS utilizes hardware, software, models for analysis, and one or more databases. The
system must be economical, widely understood, practical, and updated regularly.

4-48. Do you agree or disagree with RBV theorists that internal resources are more important
than external factors for a firm in achieving and sustaining competitive advantage? Explain
your and their position.

Answer: While internal factors are certainly important, one cannot say with any degree of certainty
that either internal or external factors will always or even consistently be more important than the
other in seeking competitive advantage. Strategists must understand that both internal and external
factors, and the relationships between them, are important. The RBV suggests that the mix, type,
amount, and nature of a firms internal resources should be considered first and foremost in devising
strategies that lead to sustainable competitive advantage. The RBV recognizes that a firm should
identify and exploit its unique resources and capabilities. While this is certainly true, external factors
will also play a key role in a firms success. Firms should utilize internal strengths to take advantage
of external opportunities.

4-49. Define and discuss empirical indicators.

Answer: Empirical indicators refer to the characteristics of resources that enable a firm to implement
strategies that improve its efficiency and effectiveness and ultimately lead to a sustainable
competitive advantage. The three empirical indicators for a resource to be valuable are that the
resource should be 1) rare, 2) hard to imitate, and 3) not easily substitutable.

4-50. Define and explain value chain analysis (VCA).

Answer: Value chain analysis refers to the process whereby a firm determines the costs associated
with organizational activities from purchasing raw materials to manufacturing products to marketing
those products. The analysis seeks to identify where advantages and disadvantages exist along the
value chain from raw material to customer service as compared to rival firms. VCA can enable a
firm to gain and sustain competitive advantages.

4-51. List five financial ratios that may be used by your university to monitor operations.

Answer: Different type organizations have unique ratios that they monitor in addition to
traditional ratios. For example, universities may monitor #faculty/#students, $tuition
revenues/#students, and #online courses/total # courses. Universities can also monitor current
ratio, quick ratio, debt-to-total assets ratio, accounts receivable turnover, average collection
period, and operating profit margin.

4-52. Explain benchmarking.

Answer: Benchmarking is an analytical tool used to determine whether a firms value-chain


activities are competitive compared to rivals. It entails measuring costs of value chain activities
across an industry to determine best practices among competing firms for the purpose of
duplicating or improving upon those best practices.

4-53. Define, compare, and contrast weights vs. ratings in an EFE Matrix vs. an IFE
Matrix.

Answer: Weights in both matrices reveal the relative importance of the factors to being successful in
the industry and must sum to 1.0. Ratings in both matrices reveal how well the company is
performing on the given factor and range from 1 to 4. However, in an EFEM the ratings can be 1, 2,
3, or 4 anywhere on the column, whereas in an IFEM the ratings must be 4 or 3 for the strengths and
1 or 2 for the weaknesses.
4-54. Would you ever pay out dividends when your firms annual net profit is negative? Why?
What effect could this have on a firms strategies?

Answer: YES. It may be a one-year accounting anomaly that caused the negative profit rather
than a projected trend of poor performance. For the following reasons, dividends are sometimes
paid even when a firms annual net profit is negative:

Paying cash dividends is customary. Failure to do so could trigger a huge stock price drop.
Dividends represent a sales point for investment bankers. Some institutions can only buy
dividend-paying stocks.
Shareholders often demand dividends, even in companies with great opportunities for
reinvesting all available funds.

Answers to the End-of-Chapter 4 Assurance of


Learning Exercises
ASSURANCE OF LEARNING EXERCISE 4A:
APPLY BREAKEVEN ANALYSIS

ANSWER:
Breakeven Quantity = Total Fixed Costs (TFC) / Price per unit (P) - Variable Costs per unit
(VC)

Total Fixed Costs (TFC): $100 million


Price per unit (P): $3 million
Variable costs per unit (VC): $2 million

1. Breakeven Quantity = $100 million / ($3 million - $2 million) = 100 planes


2. Since the company makes $1 million on each plane (P VC), after the FC are covered at
100 planes, then the company needs to produce 99 more planes to make a $99 million profit,
so the answer is 199 planes.
3. Since the company makes $1 million on each plane (P VC), after the FC are covered at
100 planes, then if the company produces 200 planes, it will make a profit of $100 million.

Note: This problem assumes that capacity utilization is sufficiently low for the additional
planes to be produced with no corresponding increase in fixed costs. Obviously at some point
of producing additional airplanes, fixed costs must be increased.

ASSURANCE OF LEARNING EXERCISE 4B:


COMPARE NETFLIX WITH REDBOX

ANSWER: Which of the two companies websites reveal most effectively the best
movies for the week? What are the best movies being rented this week?
www.netflix.com versus www.redbox.com. The Netflix website is best but only after
you pay the $7.99 per month fee or sign up for the free first month. The Redbox site is
non-subscription (free) and reveals instantly the best movies, etc.

ASSURANCE OF LEARNING EXERCISE 4C:


PERFORM A FINANCIAL RATIO ANALYSIS FOR HERSHEY

ANSWER:

Financial Ratios for Hershey Company (2014)

Liquidity Ratios:
Current ratio: Current assets/Current liabilities = 2,247 / 1,935 = 1.16

Quick ratio: Current assets minus inventory/Current liabilities = (2,247 - 801) / 1,935 = 0.747

Leverage Ratios:
Debt-to-total-assets ratio: Total debt/Total assets = 1,548 / 5,629 = 0.275

Debt-to-equity ratio: Total debt/Total stockholders equity = 1,548 / 1,455 = 1.06

Long-term debt-to-equity ratio: (Total liabilities Total current liabilities)/Total Equity =


(4,109 1,935) / 1,519 = 1.43

Times-earned-interest ratio: Profits before interest and taxes/Total interest charges =


1,389 / 83.5 = 16.63

Activity Ratios:

Inventory turnover: Sales/Inventory of finished goods = 7,421 / 801 = 9.26

Fixed assets turnover: Sales/Fixed assets = (let Fixed Assets = PP&E) = 7,421 / 2,151 = 3.45

Total assets turnover: Sales/Total assets = 7,421 / 5,629 = 1.32

Accounts receivable turnover: Annual credit sales/Accounts receivable = 7,421 / 596 = 12.45

Average collection period: Accounts receivable/(Total credit sales / 365 days) =


596 / (7,421 / 365) = 29.32 days

Profitability Ratios:

Gross profit margin: (Sales minus costs of goods sold)/Sales = (7,421 4,085) / 7,421 = 0.45

Operating profit margin: Earnings before interest & taxes (EBIT)/Sales = 1,389 / 7,421 = 0.19
Net profit margin: Net income/Sales = 846 / 7,421 = 0.114

Return on total assets (ROA): Net income/Total assets = 846 / 5,629 = 0.15

Return on SEquity (ROE): Net Income/Total stockholders equity = 846 / 1,519 = 0.557

Earnings per share (EPS): Net Income/ # of shares of common stock outstanding =
846,912 / 299,281 = 2.82

Price-earnings ratio: Stock Price/EPS = 90 / 2.82 = 31.91

Growth Ratios:
Sales Annual % growth in total sales
2014 revenue 2013 revenue = 7,421 7,146 = 0.038
2013 revenue 7,146

Net income Annual % growth in profits


2014 net income 2013 net income = 846 820 = 0.0317
2013 net income 820

Earnings per share Annual % growth in EPS


2014 EPS 2013 EPS = 846 - 820 divided by 820 =
2013 EPS (299 + 60) (299 + 60) (299 + 60)

(2.35 2.28) / 2.28 = 0.031

2014 RE 2013 RE = xxxx invested into company vs. NI of xxxx, so $ div paid =
5,860 5,454 = 406 vs. 846 earned, so $ 440 dividends paid

2014 dividends per share = $ 440 / (299 + 60) = 440/359 =$ 1.22

ASSURANCE OF LEARNING EXERCISE 4D:


CONSTRUCTING AN IFE MATRIX FOR HERSHEY COMPANY

ANSWER:

Key Internal Factors Weight Rating WScore

Strengths

1. Hershey sells products in 70 countries under more than 80 brands. 0.07 4 0.28
2. Hershey has an exemplary philanthropic & sustainability record. 0.05 3 0.15
3. Hershey is the leader in the USA in dark & premium chocolate 0.07 4 0.28
(44% market share).
4. Hershey is the leader in chocolate production in the USA 0.08 4 0.32
(34% market share).
5. Hershey has 20.3% market share for candy production in USA. 0.07 4 0.28
6. Hershey sales in 2014 increased 2.4% to $7.4 billion. 0.04 3 0.12
7. Hershey has Chocolate World Stores in Shanghai & Singapore. 0.02 4 0.08
8. Hershey just acquired Krave Pure Foods Inc. 0.03 3 0.09
9. Hersheys sales outside the USA are growing 3% annually. 0.08 4 0.32
10. The Milton Hershey School for Orphans is the largest of its kind. 0.02 3 0.06

Weaknesses
1. Sales are seasonal, lowest outside of holidays. 0.05 2 0.10
2. Hersheys uses a functional design with no divisional presidents. 0.04 1 0.04
3. High debt makes Hershey financially vulnerable. 0.04 1 0.04
4. Hershey spends 1% of revenue on advertising vs. rivals spending 4%. 0.04 1 0.04
5. Only 15% of Hersheys revenues are from outside the USA. 0.07 1 0.07
6. Only 3% of Hersheys profits come from outside the USA. 0.06 1 0.06
7. Nearly 40% of Hershey sales are generated from mass merchandisers. 0.05 2 0.10
8. There is only one female among Hersheys top mgt., and no minorities. 0.03 2 0.06
9. Nearly 30% of Hersheys sales come from supermarkets. 0.03 2 0.06
10. Hershey profits largely are aimed at supporting the Hershey School. 0.03 2 0.06

Total 1.00 2.61

ASSURANCE OF LEARNING EXERCISE 4E:


CONSTRUCT AN IFE MATRIX FOR YOUR UNIVERSITY

ANSWER:
An example is given below. Note that the most highly weighted factor, i.e., the most
important in the industry, is the demand for nursing and business students, and the university
is doing pretty well as indicated by a rating of 3. But note also that the university has some
major weaknesses, especially in terms of crime on campus and old athletic facilities.

Weight Rating WScore


Strengths:
1. Location in a state capital with several Fortune 500 firms .05 4 .20
2. $200 million technology donation for high-tech facilities .07 3 .21
3. Diverse (28%) student body and faculty, up from 21% .09 4 .36
4. Visionary presidential leadership .04 4 .16
5. Nationally-ranked programs in nursing and business .11 3 .33
6. Athletic teams performing excellent, raising visibility .05 3 .15
7. Tuition 15% lower than peer institutions .04 3 .12
8. Our engineering and life sciences buildings are new .03 4 .12
9. We operate at full capacity (100%) in our dorms .05 4 .20
Weaknesses:
1. Urban campus with limited space for expanding .05 2 .10
2. Police arrests on campus rising 5% annually .07 1 .07
3. Gyms and athletic facilities 30 years old .05 1 .05
4. Food service complaints up 11% vs. prior year .03 1 .03
5. 30% of faculty are near retirement age and high paid .04 2 .08
6. Student activity surveys indicate 14% drop in .06 2 .12
satisfaction
7. Alumni giving declining 10% annually .05 1 .05
8. 30% of classes taught by adjunct faculty .04 2 .08
9. Student/faculty ratio of 51 to 1 is high .08 1 .08

TOTAL 1.00 2.51

Conclusion: The university has many areas for improvement, as indicated by the five ratings
of 1 and the overall score of 2.51 on a 1 to 4 scale.

ASSURANCE OF LEARNING EXERCISE 4F: Applying RBV Theory

ANSWER:

Resources Rare Non-imitatable Non-substitutable

1. Executive talent
2. Employee talent
3. Land owned
4. Equipment owned
5. Patents on technology
6. Copyrights on documents
7. Alliances with partners
8. Customer email base
9. Supplier agreements
10. Leases on properties

Answers to End-of-Chapter 4 Mini-Case Questions


1. From a management perspective, do you think the college football
expenditures by BWW are warranted? Why?

Yes. ESPN is Walt Disney Companys most profitable division or segment.


College football has grown in popularity every year, and the 8-team playoff
system in 2014-2015 was a huge success. Managers of restaurant chains look for
same-store-growth year-over-year and BWWs expenditures during college
football season are likely to produce more profits than costs for the company.
Customers also support firms that give back to communities, and BWW has found
a highly visible way to promote its giving-back efforts.

2. From a marketing perspective, do you think the college football expenditures


by BWW are warranted? Why?

Yes. Marketers strive to devise an effective theme that can be used throughout
the year to promote its brand. College athletics is a hugely popular pastime in the
USA. BWWs expenditures on advertising, especially during the Division 1
College Football playoffs, garners millions of customers. BWW could likely
even carry their support of college athletics to the next level by supporting
Division 1 (especially) basketball and baseball, and even by becoming active in
womens athletic events.

3. From a finance perspective, do you think the college football expenditures by


BWW are warranted? Why?

Yes. Chapter 4 talks about breakeven analysis. Marketing expenditures are a


fixed cost that drive up a companys breakeven point. The question is whether
the expenditures can in addition drive revenue up sufficiently to surpass those
additional fixed costs. BWW continues to use this marketing approach year after
year, so the presumption is that the strategy is worthwhile, because shareholders
expect continually increasing profitability and growth leaving little room for
ineffectiveness.

4. Management, marketing, and finance executives do not always agree, so how


could differences in opinion be resolved?

Focus on shared goals and objectives, derived from collective input in the
strategic planning process, and collective decisions made about policies,
strategies, and resource allocation. Top executives typically all own large blocks
of the firms common stock, and all desire to see the firms stock price increase,
so there is a vested interest among the executives in being mutually supportive of
the firms vision and mission.

5. As BWW spends more on advertising, does its breakeven point go up or


down? Illustrate.

The breakeven goes up. See the breakeven diagram in the chapter that illustrates
the impact of raising fixed costs on the breakeven quantity (of chicken wings,
etc.) that must be sold to at least make a profit.

6. How does BWWs approach to marketing compare to recent trends


regarding how to best spend advertising dollars?
BWWs television approach is a bit old but old may be effective for BWW because
their customers are all talking about BWW on social media. Recent research reveals that
the most effective marketing methods for firms with fewer than 500 employees is the
company website (50%), Facebook and/or other social media sites such as Twitter (27%),
print yellow pages (25%), and Internet yellow pages (15%). Nearly two million firms of
all sizes now pay to advertise on Facebook, up from about one million 18 months ago.
Spending on online advertisements globally is increasing about 25 percent annually,
according to eMarketer, and represents about 39 percent of total advertising spending in
the USA. Advertising on television is on a downward spiral, according to Time Warner,
Discovery Communications, and Comcast. Upfront ads for the 2014-2015 TV season
declined about 6 percent. Heavy marketers such as Allstate and Mondelez International
now openly speak about shifting TV ad dollars to digital platforms. Allstate shifted 20
percent of its TV ad dollars to digital from 2013 to 2015.

NOTE THE FOLLOWING IS AN EXCELLENT, FUN, NOT-IN-THE-BOOK,


ADDITIONAL ASSURANCE OF LEARNING EXERCISE FOR CHAPTER 4

EXERCISE TITLE: What Internal Functional Areas Are Most Important To Examine
In Strategic Planning?

Purpose

A prioritized list of internal factors is needed for effective strategic planning. Oftentimes
the process entails all managers individually ranking the factors identified, from 1 (most
important) to 20 (least important). Prioritization is absolutely essential in strategic
planning because no organization can do everything that would benefit the firm; tough
choices among good choices have to be made.
Internal functional areas that yield strengths/weaknesses can be divided into six
broad categories or areas: (1) Management; (2) Marketing; (3) Finance/Accounting; (4)
Production/Operations; (5) R&D; and (6) MIS. For some companies or organizations at
various times, some areas are more important than others. This exercise reveals the authors
ranking of the relative importance of six functional areas for inclusion in a strategic planning
internal assessment.
The purpose of this exercise is to examine more closely the functional areas of
business. In addition, the purpose of this exercise is to examine whether individual
decision making is better than group decision making. Academic research suggests that
groups make better decisions than individuals about eighty percent of the time.

Instructions

Rank the six internal areas as to their relative importance (1 = most important, 5 = least
important) in doing strategic planning. First, rank the areas as an individual. Then, rank
the areas as part of a group of three. Thus, determine what person(s) and what group(s)
here today can come closest to the expert ranking. This exercise enables examination of the
relative effectiveness of individual versus group decision making in strategic planning.

The Steps

1. Fill in Column 1 in Table 1 to reveal your individual ranking of the relative


importance of the six areas (1 = most important, 2 = next most important, etc.).
For example, if you feel management is the 3rd most important functional area in
doing strategic planning, then enter a 3 in Table 1 in Column 1 beside
Management.
2. Fill in Column 2 in Table 1 to reveal your groups ranking of the relative
importance of the six areas (1 = most important, 2 = next most important, etc.).
3. Fill in Column 3 in Table 1 to reveal the experts ranking of the relative
importance of the six functional areas.
4. Fill in Column 4 in Table 1 to reveal the absolute difference between Column 1
and Column 3 to reveal how well you performed as an individual in this exercise.
(Note: For absolute difference, disregard negative numbers.)
5. Fill in Column 5 in Table 1 to reveal the absolute difference between Column 2
and Column 3 to reveal how well your group performed in this exercise.
6. Sum Column 4. Sum Column 5.
7. Compare the Column 4 sum with the Column 5 sum. If your Column 4 sum is less
than your Column 5 sum, then you performed better as an individual than as a
group. Normally, group decision making is superior to individual decision
making, so if you did better than your group, you did excellent.
8. The Individual Winner(s): The individual(s) with the lowest Column 4 sum is the
WINNER.
9. The Group Winners(s): The group(s) with the lowest Column 5 score is the
WINNER.

Table 1 Internal Functional Area Analysis: Comparing Individual versus


Group Decision Making

Internal Functional Areas Column 1 Column 2 Column 3 Column 4 Column 5

1. Management
2. Marketing
3. Finance/Accounting
4. Production/Operations
5. R&D
6. MIS

Sums

Answer: The Expert Ranking

Internal Functional Areas Authors Ranking


(1 = most important; 6 = least important)

1. Management 1
2. Marketing 3
3. Finance/Accounting 2
4. Production/Operations 4
5. R&D 6
6. MIS 5

Rationale

The authors have developed hundreds of IFE Matrices for organizations over three
decades. The expert rankings given above are based on their experience and reading the
reference articles given at the end of Chapter 4. First, management is typically the most
important internal functional area because it includes strategic planning, as well as employee
morale, organizational structure, and executive competence in leading. Next, the second most
important functional area is financial/accounting, because all firms, even nonprofits and small
businesses, must manage their limited finances effectively, and all firms have an income
statement top and bottom line and a balance sheet that needs to balance. Third most important
generally is marketing because this function includes first and foremost customers and no
organization can survive, much less prosper, without a loyal customer base. Fourth most
important generally is production/operations because oftentimes as much as 80 percent of a
firms assets are tied up in plant/equipment/land, coupled with this function including effective
supply chain operations. Fifth most important generally is MIS because effective decisions
are best made when accurate/reliable/timely information is continuously gathered and used,
although many firms are too informal in managing this function. Lastly, although for some
firms this function may be number one in importance, is R&D. Even many high-tech firms
will minimize R&D expenditures by pursuing a follow-the-leader rather than first-mover
strategy to develop new and improved products.