Company Overview
SAP, established in 1972 by a group of five German software engineers, has emerged as the third world-largest software provider in collaborative business solutions for all types of industries and for every major market. SAP began with P/1, software of accounting transaction processing program, is now call Enterprise Resource Planning System or ERP. Before 1999, it focused of developing a powerful ERP system for the largest multinational companies and outsourced consulting service to external consultants for marketing, installation and implementation. It used to sell the whole ERP package and wanted to provide a superior software system. However, under the threats of changing technology and intense competition, SAP changed its business model and strategy in 1999 to become more responsive to customers’ needs by creating new business solutions to large, medium and small firms, breaking ERP package into separate modules and making them easier to use and maintain. The strategy move and organizational restructure, together with mySAP solution, have marked a great leap forward in SAP’s growth journey. Now SAP continues to add new solutions and customize mySAP to meet the needs of every customer in all industries.
By applying Five-force model and PEST, I analyze the external environment and determine threats and opportunities that SAP is and will face. Going deeply inside the company, I analyze SAP’s business model, strategies at all levels, resources, capabilities and value chain to determine SAP’s strengths and weaknesses. Then, I come to the conclusion with problems that SAP is and will face. Finally, I suggest some alternatives, analyze the costs and benefits of these alternatives and come up with some recommendations and their implementation plans. I suggest the use of Balanced Scorecard to measure our solution with described criteria.
I. Situational Analysis and Problems Identification
A. External Analysis
1. Five Forces (Appendix 1)
· Potential Competitor – High. Microsoft is now focusing on PC software but may become competitor in ERP software market because it has bought 2 companies that compete with SAP in small and medium size markets and it has competencies in a wide range of software products and resources and capacity to develop quickly and easily an ERP system with web-based solution.
· Power of Supplier – High but decreasing. Before 1999 SAP depended heavily of consulting companies to market and promote its ERP system to both local and overseas markets. After changing strategy in 1999, SAP focused more on developing in-house consultants and has became stronger in consulting service related to ERP solutions.
· Power of Buyer – Low because the switching cost is very high but this power is increasing due to complementors.
· Power of Substitute – High. Here substitute means modules or parts of ERP package because customers do not usually buy the whole ERP package but tend to buy some modules of ERP that fit exactly their needs.
· Rivalry – High because: 1) competitors catch up SAP technology in developing ERP by exploiting weaknesses of SAP software; 2) Oracle has became main competitor who can offer product nearly the same as SAP products; 3) Niche players (Siebel, Ariba, Marcum…) emerge as main players; 4) Competition in niche market is very intense; 5) IMB has changed its strategy to provide customized software that customers want.
· Threat of Complement – High. Sun has provided Java Platform and Free Linux Platform that enable computers to work with any software systems. This will decrease switching costs and buyers can buy ERP modules from any providers to run in their current system. Therefore, the power of buyers will increase.
Environment Analysis
· Political, demographic, social environment is favorable.
· Macroeconomic environment: in early 2000s, firms tend to spend less on IT system due to economic downturns in 1990s.
· Technology environment: fats growing web and internet technologies and software development capacity in the U.S and abroad may become a threat to SAP if it can not change its technology ahead of time.
Threats
· Oracle developed its own ERP that have features that SAP does not have.
· Competitors exploit weakness of SAP software and offer products more customized and less expensive.
· Development of the internet and broadband technology may make SAP’s P/3 be outdated.
· Development of new web-based software technology puts SAP under the threat of losing product advantages.
· Threat from compilementors like products of Sun.
· Niche competitors get stronger and more aggressive in competing with SAP.
· Microsoft may become a competitor in the future.
Opportunities
· Large market segments of small and medium-sized firms.
· Large untapped overseas markets.
· Large market segments for new industries such as insurance, food, logistics, public sector.
· Opportunities in current markets if SAP can customize ERP to customers’ needs and make it easier to implement and use.
· Large market segments for new solutions in ERP package that SAP has not yet develop like corporate governance, risk management, finance, compliance.
· Opportunities for consulting and maintenance service that comes along with ERP solutions.
5. Conclusion
SAP is vulnerable and risks losing market shares due to intense competition from Oracle and niche players and threats from fast changing technology and complimentors. Potential competitors might come from both red and blue oceans to challenge SAP technology. But SAP has many opportunities in all markets and industries. The question is that how SAP uses its competencies to develop its technology and create new solutions to offer such large markets.
B. Internal Analysis
1. Business model (Appendix 2)
Before 1999, old model
- Applied focused strategy to largest international firms
- Focused only on software development
- Outsourced marketing, installation, implementation and software maintenance
After1999, new model
- Pursued differentiation strategy to serve all customers
- Focused on software development, consulting service and software maintenance
- Outsourced implementation and maintenance
- Developed consulting and maintenance capabilities to reduce outsource
The old business model worked well because customers do not require sophisticated and customized products and competition was very low. However, this model was not sufficient for the new environment where there are many threats from competition and changing technology. The new model is a good and timely response to such new market environment and it helped SAP generate revenues and growth.
2. Resources
· Brand name and brand recognition
· State-of-the-art ERP system
· High skilled software programmers, talented and professional staff
· Control and reward system that motivate and retain employees
· Cross-functional teams focusing on customizing products
· Loose matrix structure that allows maximum capacity and competencies
3. Capabilities
· Management team with long term vision
· Culture of value and norms that emphasizes technical innovation
· Capability to innovate and develop technology
· In-house training and consulting capabilities
· Decentralized control that allows flexibility in work
SAP’s distinctive competency is product innovation.
Value chain (Appendix 3)
Before 1999, SAP had many weaknesses in its value chain because it ignored marketing & sales, outsourced customer service, human resource management and related consulting service. Its flat structure caused the loss of control over marketing, sale, installation and relationships with external consultants and its product-oriented culture made it less responsive to customers. The weak value chain did not allow SAP to transfer its competencies into value to customers and caused implementation problems.
Together with the change of strategy, SAP has strengthened its value chain through series of activities such as building its own HRM, centralizing marketing & sales, developing consulting capabilities, changing organizational structure from divisional to matrix structure, building a new corporate culture based on customer-oriented concept. The new value chain allows SAP to implement the new strategy. Please refer to Appendix 4 for further information about how corporate infrastructure affects SAP’s implementation plan.
Competitive advantages (Appendix 5)
· Quality: High. ERP system is highly reliable and added more attributes
· Superior innovation: High. SAP continuously add new solutions to its ERP system
· Customer responsiveness: low before 1999 but high from the introduction of mySAP
· Durability of competitive advantage: SAP’s high quality, superior innovation and high customer responsiveness competitive advantages are vulnerable because: 1) the barrier to imitation is high due to fast changing technology; 2) competitors such as Oracle and potential competitor such as Microsoft have capabilities to develop ERP system which has nearly the same features ad SAP’s ERP system. 3) companies in software industry are dynamic to changing technology and business environment.
Value discipline (Appendix 6)
· SAP focused on product leadership before 1999 because it believed that technical advances were competitive advantages and allowed it to charge premium prices. However, SAP changed the strategy to pursue both product leadership and customer intimacy and gradually achieve cost reduction.
Global strategy (Appendix 7)
Before 1999, SAP pursued international strategy because it was not under the pressure of cost reduction and was not well locally responsive. However, in response to intense competition and threats of changing technology and customer needs, SAP changed this strategy in 1999 to a transnational strategy to have more local responsiveness and cost reduction.
I think that the new global strategy is a timely and effective response to the fast change of business environment and will be successful in the future: 1) SAP will have deep understanding customers’ needs and therefore it can use its competencies to develop and current products and create new solutions to them; 2) SAP will enter new potential markets in terms of locations, industries and business processes before its competitors; 3) SAP can gradually reduce costs to offer cheaper products because premium prices will be eliminated by competition; 4) Through customization, SAP can build brand loyalty, increase brand awareness in every market and all industries; 5) SAP can surpass its competitors in technology, solutions, customer base. However, SAP needs to be able to change its strategy in response to changing environment.
8. Corporate level strategy
- Outsource strategy: SAP’s outsource strategy before 1999 allowed it to penetrate overseas market quickly while eliminating huge capital investment but brought it serious problems: 1) losses of high revenues from consulting service; 2) losses of contacts with customers so SAP did not have knowledge of its customers and understanding of changing needs of its customers; 3) less customer responsiveness because SAP did not contact directly its customers; 4) increasing complaints from customers regarding consulting service; 5) external consultants became more expert in installation, implementation and software service; 6) SAP became much more dependent on those consultants. However, SAP limited outsourced activities to implementation and service after 1999 to solve the above problems.
- Horizontal integration: SAP considers small acquisitions as important parts of its strategy to reduce costs, enhance functionality of its products and build its customer base. SAP also builds strategic partnerships with its niche and potential competitors to exploit competencies that it does not have and synergies across partner companies.
- Vertical integration: SAP builds strategic partnerships with external consultants to promote its products. This strategy is necessary since SAP still needs to expand market quickly with little capital investment, especially in overseas markets.
- Strategic partnerships: SAP not only builds partnerships with its competitors and suppliers but also builds partnerships with companies who provide complimentors such as Netscape and Sun to develop its products. The partnership strategy helps SAP reduce competition, increase market shares and develop its products. But there is a risk that SAP will lose its technology to its partners if it does not have effective control methods.
9. Business level strategy
Before 1999
Focused differentiation strategy
This strategy is suitable for the market situation at that time because technology was not changing fast and competition was not yet intense.
After 1999
Differentiation strategy but attempting to reduce cost
This strategy move was to respond to threats of changing technology, intense and new competition and is consistent with its global strategy.
10. Functional level strategy
11. Strengths and weaknesses
Strengths:
· Superior product innovation and development capabilities
· State-of-the-art ERP system
· Skilled, talented and professional employees
· Cross-functional product development teams
· Brand name and reputation
· In-house training & consulting service
· Loose matrix structure that allows SAP to be very responsive to customers’ needs
Weaknesses:
· Cooperation between subunits
· Control over external consultants
C. Problems Identification
· Coordination between and among subunits
· Control partner consultants
· Vulnerability of business model in intense competition and changing technology
II. Alternatives, Cost/Benefit Analysis
III. Recommendations and Implementation
A. Recommendations
I recommend SAP to choose all the above alternatives.
B. Implementation Plan
1. Build corporate culture to enhance cooperation between subunits and implement strategies in the entire company
- Hiring & Training: hire qualified people who fits SAP’s culture; create and maintain: learning corporation; environment of trust and nurture unconventional thinking and creativity; share values and behavior norms in the entire corporation; customer and service-oriented, performance-enhancing, unified, open and diverse culture. To do so, SAP needs to have in-house professional training centers to design and conduct training programs, good managers at all levels who can tell stories, become models, transfer the corporate mission, inspire passion, promote team-work spirit and experience sharing.
- Reward system: offer equal career opportunities to all employees; set up performance-related pay system; reward individual efforts; offer bonus plans, annual profit-sharing programs, stock options, equity saving package, capital saving programs, retirement and pension program; welcome package to welcome foreign nationals to work at SAP Germany and foreign subsidiaries.
- Organizational structure: flat and flexible structure.
2. Selective acquisitions (Appendix 8)
3. Develop consulting and maintenance as a main business
- Hiring: increase number of qualified consultants and software engineers
- Training: develop training packages for newly recruited consultants and software engineers; create training programs to upgrade consulting skills and maintenance capabilities
- Reward: reward systems to motivate, retain and develop staff in these two areas
4. Strategic alliances, network and partnership with external consultants and other software firms
- Choose strategic partners carefully. Partners may include niche competitors, potential competitors, external consultants and complement providers who have competencies and technology that SAP does not have or wants to improve.
- Create a learning environment to learn competencies from the partners while working with them
- Create an implementation plan so that SAP can acquire synergies of the network to reduce costs and develop its technology and service capabilities.
5. Non-competitive strategy to prevent new entrants, manage rivalry and seize opportunities
- Product development strategy: create new solutions to add in mySAP such as corporate governance, risk management, IT management, customer profitability analysis; develop mySAP solutions for new usage such as internet, mobile business, ebiz, on-line, broadband; increase consulting services to all business processes such as finance, strategy, risk management, corporate governance.
- Market development strategy: customize mySAP to new market segments such as insurance, public sector, food, textiles; customize mySAP for all size foreign customers; enter more foreign markets.
IV. Balanced Scorecard (Appendix 9)
SAP should use Balanced Scorecard as a measure of business performance. The Balanced Scorecard starts from SAP’s vision, mission statement and goes to four specific perspectives. Here I recommend only measures of the above recommendations and implementation plan.
Learning and growth: build a unique and open corporate culture that fosters a willingness to take responsibilities, help others and seize opportunities.
Internal process: reduce cost, develop products, service and technology, innovate new products.
Customer: help all customers win in every business environment.
Financial: satisfy investors’ expectations in terms of returns and sustained growth.
Thursday, July 13, 2006
VIACOM EMPIRE
1. Introduction
Viacom, established by CBS Broadcasting as an independent company in 1970 has now become world’s second largest media conglomerate. Bought by visionary Sumner M. Redstone in 1986, Viacom gradually emerged as an “entertainment colossus” and expanded its empire through a number of mergers and acquisitions, timely strategic alliances and product diversification. Most notable among them were the merger with Blockbuster in January, 1994 and the acquisition of Paramount in July, 1994. However, this transformation into a media giant did not come without its toll. The company incurred huge debt, structure and management challenges loomed and the fast-changing entertainment and media industry posed new threats to the company. In a very risky movie industry where past successes are no indication of future success, Paramount’s share of the box office dropped from 14 percent in 1994 to 10 percent in 1995. To compound the problem, the Blockbuster division was also not doing well.
By applying Five-force model, SWOT, PEST and value chain analysis we explored internal and external environment; then we used M&A evaluation method to get an insight of the company’s relative value. We also analyzed synergy applying discounted cash flow NPV analysis. Finally, we analyzed the costs and benefits of the alternative solutions and came up with some recommendations and their implementation plans. We suggest the use of Balanced Scorecard to measure our solution with described criteria.
2. Internal Analysis
2.1 Corporate-level strategy: global expansion strategy
2.2 Business-level strategy company pursuing: product leadership strategy. (Appendix 1)
2.3 Distinctive competencies
Resource: syndication right for some popular TV programs like Cosby show; product line proliferation; brand name; strategic alliance; knowledge and experience in product development; state-of-art production capacity in Orlando, Florida; good network and connection with other companies like telephone companies, wireless companies; opening of new channels.
Capabilities: keeping cost under control; good functional structure that enables company to manage cost and create profit center.
2.4 Value chain analysis: (Appendix 2)
Viacom has outstanding value chain to transform inputs to outputs that continuously create value to its customers. It has capability to lever resources to design, create and deliver new products to its customers. It also has efficient supporting activities that enable primary activities to be taken easily and timely.
3. External Analysis Through Five-Force Model
Although the industry demand is growing steadily, the intensity of rivalry is high owing to high exit barriers and consolidated industry structure. Because of huge capital investment and high risk of failure (difficult to predict whether a program/movie/song will be popular or not), the entry barrier is high. The bargaining power is low to moderate because the company can make it content in house. Owing to low switching cost and low brand loyalty, the bargaining power is high. The large number of existing and emerging entertainment channels cause high substitute threat. Complementors may become substitutes and the threat of complements is moderate. The environment is in the favor of the company as explained in the Appendix 3.
4. SWOT Analysis
Internal analysis
Strength
Clear mission and vision of future; brand name; management skills; scale and scope of business; copyrights; high market share in the US.
Weakness
Huge debt; often changes of top management; lack of international experience of management team; weak cooperation among business units;
External analysis
Opportunity
Globalization and growing markets (Asia, Western Europe etc.); Prices liberalization in cable TV industry; Market consolidation (increasing bargaining power, and non-price competition); Technology advancement
Threats
Deregulation that lowers the entry barrier; fast changes in technologies that might lead to potential entry with lower costs or create new substitutes; piracy; low brand loyalty of customers
5. Key Issues To Address
- Poor performance of Paramount and Blockbuster;
- Heavy debt
- Global expansion
- Difficulties in realizing expected synergy
6. Cost/Benefit Analysis of Alternatives:
7. Recommendations :
Based on above analysis, we recommend that Viacom should follow : first, restructuring organization; second, finding out possible acquisition & merger ; and third, following a global strategy.
8. Implementation plan (Appendix 4)
8.1. Restructuring: to lever the company’s resources to create value for its customers
- selling unprofitable business units such as Paramount Picture
- integrating properties to reduce cost by sharing resources of cross-business units
- combine value chain activities to achieve lower cost or collaborating to create new resource, strength and capabilities
- Cross functional team to lower cost and enhance productivity and efficiency
8.2. Acquisitions & Merger: Consider possible M&A that would benefit company with steps :
- Analyze the needs and right time
- Search for target companies
- Evaluate M&A by using the methods in Appendix 5
- Negotiation, deal execution
- Post-M&A restructuring
After restructuring and taking possible acquisition, Viacom will have better access to maintain a mixed strategy (combination of cost and differentiation strategy in the future (Appendix 6).
8.3. Global strategy: Move from multi-domestic strategy to transnational strategy (Appendix 7)
The choice of entry mode depends on different countries where it wants to enter because of some political reasons and responses from local communities. For example, in China, it should set up global strategy alliance with Chinese broadcasting partners since Chinese broadcast industry is under the control of the government.
9. Balanced Scorecard to Measure Performance
Viacom, established by CBS Broadcasting as an independent company in 1970 has now become world’s second largest media conglomerate. Bought by visionary Sumner M. Redstone in 1986, Viacom gradually emerged as an “entertainment colossus” and expanded its empire through a number of mergers and acquisitions, timely strategic alliances and product diversification. Most notable among them were the merger with Blockbuster in January, 1994 and the acquisition of Paramount in July, 1994. However, this transformation into a media giant did not come without its toll. The company incurred huge debt, structure and management challenges loomed and the fast-changing entertainment and media industry posed new threats to the company. In a very risky movie industry where past successes are no indication of future success, Paramount’s share of the box office dropped from 14 percent in 1994 to 10 percent in 1995. To compound the problem, the Blockbuster division was also not doing well.
By applying Five-force model, SWOT, PEST and value chain analysis we explored internal and external environment; then we used M&A evaluation method to get an insight of the company’s relative value. We also analyzed synergy applying discounted cash flow NPV analysis. Finally, we analyzed the costs and benefits of the alternative solutions and came up with some recommendations and their implementation plans. We suggest the use of Balanced Scorecard to measure our solution with described criteria.
2. Internal Analysis
2.1 Corporate-level strategy: global expansion strategy
2.2 Business-level strategy company pursuing: product leadership strategy. (Appendix 1)
2.3 Distinctive competencies
Resource: syndication right for some popular TV programs like Cosby show; product line proliferation; brand name; strategic alliance; knowledge and experience in product development; state-of-art production capacity in Orlando, Florida; good network and connection with other companies like telephone companies, wireless companies; opening of new channels.
Capabilities: keeping cost under control; good functional structure that enables company to manage cost and create profit center.
2.4 Value chain analysis: (Appendix 2)
Viacom has outstanding value chain to transform inputs to outputs that continuously create value to its customers. It has capability to lever resources to design, create and deliver new products to its customers. It also has efficient supporting activities that enable primary activities to be taken easily and timely.
3. External Analysis Through Five-Force Model
Although the industry demand is growing steadily, the intensity of rivalry is high owing to high exit barriers and consolidated industry structure. Because of huge capital investment and high risk of failure (difficult to predict whether a program/movie/song will be popular or not), the entry barrier is high. The bargaining power is low to moderate because the company can make it content in house. Owing to low switching cost and low brand loyalty, the bargaining power is high. The large number of existing and emerging entertainment channels cause high substitute threat. Complementors may become substitutes and the threat of complements is moderate. The environment is in the favor of the company as explained in the Appendix 3.
4. SWOT Analysis
Internal analysis
Strength
Clear mission and vision of future; brand name; management skills; scale and scope of business; copyrights; high market share in the US.
Weakness
Huge debt; often changes of top management; lack of international experience of management team; weak cooperation among business units;
External analysis
Opportunity
Globalization and growing markets (Asia, Western Europe etc.); Prices liberalization in cable TV industry; Market consolidation (increasing bargaining power, and non-price competition); Technology advancement
Threats
Deregulation that lowers the entry barrier; fast changes in technologies that might lead to potential entry with lower costs or create new substitutes; piracy; low brand loyalty of customers
5. Key Issues To Address
- Poor performance of Paramount and Blockbuster;
- Heavy debt
- Global expansion
- Difficulties in realizing expected synergy
6. Cost/Benefit Analysis of Alternatives:
7. Recommendations :
Based on above analysis, we recommend that Viacom should follow : first, restructuring organization; second, finding out possible acquisition & merger ; and third, following a global strategy.
8. Implementation plan (Appendix 4)
8.1. Restructuring: to lever the company’s resources to create value for its customers
- selling unprofitable business units such as Paramount Picture
- integrating properties to reduce cost by sharing resources of cross-business units
- combine value chain activities to achieve lower cost or collaborating to create new resource, strength and capabilities
- Cross functional team to lower cost and enhance productivity and efficiency
8.2. Acquisitions & Merger: Consider possible M&A that would benefit company with steps :
- Analyze the needs and right time
- Search for target companies
- Evaluate M&A by using the methods in Appendix 5
- Negotiation, deal execution
- Post-M&A restructuring
After restructuring and taking possible acquisition, Viacom will have better access to maintain a mixed strategy (combination of cost and differentiation strategy in the future (Appendix 6).
8.3. Global strategy: Move from multi-domestic strategy to transnational strategy (Appendix 7)
The choice of entry mode depends on different countries where it wants to enter because of some political reasons and responses from local communities. For example, in China, it should set up global strategy alliance with Chinese broadcasting partners since Chinese broadcast industry is under the control of the government.
9. Balanced Scorecard to Measure Performance
Kikkoman Corporation in the Mid-1990s
1. Introduction:
Slow sales growth and underperforming stock price present new Kikkoman president Yuzaburo Mogi challenges as Kikkoman faces the end of the 1990s and the twenty-first century. The company, headed by 17 generations of the Mogi family and held 50% of US soy sauce market and 30% of the world market , faces a mature market and slipping market share in Japan for its soy sauce, as well as challenges for its diversified product line in the 94 other countries in which the company distributes. By using Five-force model, SWOT, PEST, value chain analysis we understand internal and external envronment; then we use ratio and ROIC analysis to realize strength and weaknesses in financial situation of company. After all, through evaluating cost/benefit of 2 alternatives and choosing a long-term global strategy for Kikkoman, we come to r recommendation with a plan and steps of implementation aiming to solve facing problems. At last, we suggest using Balance Score card to measure our solution with described criteria.
2. Key Issues to address:
Slow sales growth starting from the early 1996 ; Underperforming stock in Nikkei Exchange in relation to the market; Ongoing changes in taste preferences and dietary needs presented threats; How the company focus on and try to enhance US market while keeping hold of the Japanese market
3. Internal analysis
3.1 Corporate-level strategy: Kikkoman Focused on globalization keeping hold of the Japanese market with high assimilation and long term commitment
3.2 Business-level strategy company pursuing: Company follow a cost leadership strategy in Japan Continuous development of new recipes; Variations of its older products as well as development of new products (APPENDIX 2)
3.2 Distinctive competencies
Resources : Kikkoman has Expertise and more than 300 years of experience in production of soy sauce ; Know-how of esoteric technology developed by family; State-of-the-art laboratories ; A number of patents in Japan and US’ Non unionized dedicated labor force; Localized operation ; Economy of scale; Convenient location of the plant and closeness to main markets
Capabilities : Business network with wholesalers and distributors ; Harmony with society and local community; Good corporate citizen; Decisions made by consensus from the bottom up; Hard working mixed culture; Practice of rotating managers
3.3 Value chain analysis: Kikkoman has a long history of R&D (development of new recipes, number of patents), a family know-how and a marketing and distribution center for its product in the US (APPENDIX 4)
3.4 ROIC analysis / Profitability (APPENDIX 5, 6 )
Return on sales: Return on sales is the main factor that influences ROIC and has the same trend. The ratios of COGS to sales and SG&A to sales keep almost constant. We can infer that there is no big change on average prices of products compared to the cost of products. It is the change on amount of sales or market share that leads to the fluctuation of sales and ROIC. Market share and business strategy based on market share are vitally important to the development of the company.
Capital turnover: This rate has been decreasing in the last few years. Both the ratio of working capital to sales and the ratio of PPE to sales are increasing. We can infer the internal efficiency is decreasing.
4. External analysis through Five-Force Model:
· In Japan: Rivalry is intensive because mature market, Entry barrier is very low (commodity market; technology use is minimal, low capital needed, easy to establish production), Bargaining power of buyers is high (many brands with diversification and price variance, switching cost is low), Bargaining power of suppliers is low (materials are commodity and easy to supply), Complements power is high (cuisine culture).
· In US/Europe: Rivalry is moderate, because of consolidated market, Entry barriers are low (commodity market; technology use is minimal, low capital needed, easy to establish production), Bargaining power of buyers is high (switching cost is low, despite of the Asians consumers are early adopters), Bargaining power of suppliers is low (materials are commodity and easy to supply) . For details of External environment analysis, please see APPENDIX 1.
5. Evaluation of SWOT analysis:
Internal analysis
Strength
Brand name, management skills, long history, know-how, large market share, hardworking culture, good relation with community, R & D, advertising, Highest productivity in the industry
Weakness
Longer production process compared to technology based competitors, Production process more expensive, more cerebration needed; decreased efficiency
External analysis
Opportunity
Growing markets in USA and EU
Economic growth in USA
Increasing popularity of Orient cuisine
New emerging markets in Asia
Threats
Ongoing changes in taste preferences and dietary needs; highly sensitive to price
Competitors pressure at the retail level in Japan
Aggressive introduction of private brands
Country risk in foreign markets
Low entry barriers
Slowdown in Japanese economy
New automated chemical technology
· Evaluate SWOT analysis : Ongoing chages in taste create an opportunity to diffrentiate (product lines) and high sensitivity of demand to price will create a chance to differentiate product price. Keeping low cost at least in some products is an effective way to guard against external threats. And slowdown in Japanese economy makes an opportunity for Kikkoman to look for overseas markets to grow rapidly.
6. Alternative solutions:
6.1General strategy: Organizational structure: reform its corporate governance structure from a Japanese style to a more internationalized one.
Market strategy: apply blue ocean strategy, by expanding market boundaries to overseas markets. (APPENDIX 3)
6.2 Cost/benefit analysis of each alternative‘s actions
5. Recommendation: Based on above analysis, We suggest that Kikkoman choose Alternative solution #1 (total scores of alternative 1 > that of alternative 2).
6. Implementation plan:
7. Balance Scorecard to measure performance (APPENDIX 7)
Financial: to succeed financially and increase value of Kikkoman’s shareholders
Customers: to achieve Kikkoman vision, mission and strategies
Internal business process: to satisfy Kikkoman’s shareholders and customers
Learning and growth: to know how Kikkoman can sustain its ability to change and adapt to international environments
Slow sales growth and underperforming stock price present new Kikkoman president Yuzaburo Mogi challenges as Kikkoman faces the end of the 1990s and the twenty-first century. The company, headed by 17 generations of the Mogi family and held 50% of US soy sauce market and 30% of the world market , faces a mature market and slipping market share in Japan for its soy sauce, as well as challenges for its diversified product line in the 94 other countries in which the company distributes. By using Five-force model, SWOT, PEST, value chain analysis we understand internal and external envronment; then we use ratio and ROIC analysis to realize strength and weaknesses in financial situation of company. After all, through evaluating cost/benefit of 2 alternatives and choosing a long-term global strategy for Kikkoman, we come to r recommendation with a plan and steps of implementation aiming to solve facing problems. At last, we suggest using Balance Score card to measure our solution with described criteria.
2. Key Issues to address:
Slow sales growth starting from the early 1996 ; Underperforming stock in Nikkei Exchange in relation to the market; Ongoing changes in taste preferences and dietary needs presented threats; How the company focus on and try to enhance US market while keeping hold of the Japanese market
3. Internal analysis
3.1 Corporate-level strategy: Kikkoman Focused on globalization keeping hold of the Japanese market with high assimilation and long term commitment
3.2 Business-level strategy company pursuing: Company follow a cost leadership strategy in Japan Continuous development of new recipes; Variations of its older products as well as development of new products (APPENDIX 2)
3.2 Distinctive competencies
Resources : Kikkoman has Expertise and more than 300 years of experience in production of soy sauce ; Know-how of esoteric technology developed by family; State-of-the-art laboratories ; A number of patents in Japan and US’ Non unionized dedicated labor force; Localized operation ; Economy of scale; Convenient location of the plant and closeness to main markets
Capabilities : Business network with wholesalers and distributors ; Harmony with society and local community; Good corporate citizen; Decisions made by consensus from the bottom up; Hard working mixed culture; Practice of rotating managers
3.3 Value chain analysis: Kikkoman has a long history of R&D (development of new recipes, number of patents), a family know-how and a marketing and distribution center for its product in the US (APPENDIX 4)
3.4 ROIC analysis / Profitability (APPENDIX 5, 6 )
Return on sales: Return on sales is the main factor that influences ROIC and has the same trend. The ratios of COGS to sales and SG&A to sales keep almost constant. We can infer that there is no big change on average prices of products compared to the cost of products. It is the change on amount of sales or market share that leads to the fluctuation of sales and ROIC. Market share and business strategy based on market share are vitally important to the development of the company.
Capital turnover: This rate has been decreasing in the last few years. Both the ratio of working capital to sales and the ratio of PPE to sales are increasing. We can infer the internal efficiency is decreasing.
4. External analysis through Five-Force Model:
· In Japan: Rivalry is intensive because mature market, Entry barrier is very low (commodity market; technology use is minimal, low capital needed, easy to establish production), Bargaining power of buyers is high (many brands with diversification and price variance, switching cost is low), Bargaining power of suppliers is low (materials are commodity and easy to supply), Complements power is high (cuisine culture).
· In US/Europe: Rivalry is moderate, because of consolidated market, Entry barriers are low (commodity market; technology use is minimal, low capital needed, easy to establish production), Bargaining power of buyers is high (switching cost is low, despite of the Asians consumers are early adopters), Bargaining power of suppliers is low (materials are commodity and easy to supply) . For details of External environment analysis, please see APPENDIX 1.
5. Evaluation of SWOT analysis:
Internal analysis
Strength
Brand name, management skills, long history, know-how, large market share, hardworking culture, good relation with community, R & D, advertising, Highest productivity in the industry
Weakness
Longer production process compared to technology based competitors, Production process more expensive, more cerebration needed; decreased efficiency
External analysis
Opportunity
Growing markets in USA and EU
Economic growth in USA
Increasing popularity of Orient cuisine
New emerging markets in Asia
Threats
Ongoing changes in taste preferences and dietary needs; highly sensitive to price
Competitors pressure at the retail level in Japan
Aggressive introduction of private brands
Country risk in foreign markets
Low entry barriers
Slowdown in Japanese economy
New automated chemical technology
· Evaluate SWOT analysis : Ongoing chages in taste create an opportunity to diffrentiate (product lines) and high sensitivity of demand to price will create a chance to differentiate product price. Keeping low cost at least in some products is an effective way to guard against external threats. And slowdown in Japanese economy makes an opportunity for Kikkoman to look for overseas markets to grow rapidly.
6. Alternative solutions:
6.1General strategy: Organizational structure: reform its corporate governance structure from a Japanese style to a more internationalized one.
Market strategy: apply blue ocean strategy, by expanding market boundaries to overseas markets. (APPENDIX 3)
6.2 Cost/benefit analysis of each alternative‘s actions
5. Recommendation: Based on above analysis, We suggest that Kikkoman choose Alternative solution #1 (total scores of alternative 1 > that of alternative 2).
6. Implementation plan:
7. Balance Scorecard to measure performance (APPENDIX 7)
Financial: to succeed financially and increase value of Kikkoman’s shareholders
Customers: to achieve Kikkoman vision, mission and strategies
Internal business process: to satisfy Kikkoman’s shareholders and customers
Learning and growth: to know how Kikkoman can sustain its ability to change and adapt to international environments
AMERICAN CHEMICAL CORPORATION
1. Executive Summary
Dixon, an American specialty chemical producer, wants to buy Collinsville plant from American Chemical Corporation, another typical chemical company in 1979. Dixon wants to diversify its product line buy acquiring the aforesaid plant, which produces sodium-chlorate to supply to paper producers in Southeastern part of the US. This plant initially cost 12 mln. USD and additional 2,25 mln. USD needed to buy laminate technology to increase efficiency and profitability of the plant in order.
Dixon has conducted thorough marketing research for the industry providing cash flow analysis on purchase of the plant. The cash flow analysis based with and without laminate technology cases, where the company should decide whether it should go on further to buy that plant and technology.
2. Calculating of WACC
2.1 Assumptions for calculations in the case:
l Plant life is 10 years (p.4)
l Salvage value of plant is 0 (p.4)
l Book value of plant at end of 1979 is 10.6 million (=12 million purchase price - 1.4 million working capital)
l Tax rate is 48% (calculated from Exhibit 7)
l For the period from 1980 to 1984: all data of sales, depreciation and manufacturing and other costs are given in the case (Exhibit 8)
l For the period from 1984 to 1989 we use the below assumption:
- Price growth rate is 8% (p.4)
- Power cost growth rate is 12% (p.4)
- Net working capital is always 9% of sales (Exhibit 8, current asset and liability items remain historical to sales)
- PPE and depreciation are based on historical data in 1980-1984 period (Exhibit 8)
- Capital investment are based on historical data in 1980-1984 period (Exhibit 8)
- Variable and fixed costs: we use 4-year average growth rates calculated based on Exhibit 8. So non-power variable cost growth rate is 11%, fixed cost growth rate is 6%, selling expenses growth rate is 7% and R&D expenses growth rate is at 5%
- To use this 4-year average growth rates, we assume that the scale of operations of this plant is constant so we need to adjust such cost growths to account for inflation. If the scale increases we should consider growths in costs on percentage of sale basis
2.2 Cost of capital:
a. Calculate beta β of sodium chlorate:
The β of Dixon is 1.06 (Exhibit 7). This beta may be irrelevant to the project to buy Collinsville plant because Dixon produces specialty chemical products but never produce sodium chlorate. The systematic risk of the project could be the risk of the production of sodium chlorate in the industry. Therefore, we calculate beta of the project based on the beta of the sodium chlorate industry.
We do not simply use the beta of Brunswick and Southern, 2 firms purely produce sodium chlorate, because they are small in the industry and their stocks might not be traded largely on the market. Hence, we decide to calculate the beta of all firms that produce sodium chlorate to see the trend of beta of all firms in the market since we believe that such trend can be a benchmark for calculating the beta of sodium chlorate for Dixon’s project.
The average beta is calculated from the formula: βasset = βequity / [1+ (1-t)*D/E], where D is debt, E is equity and t is tax rate. To simplify the calculation, we assume that all these firms have tax rate at 48% and βdebt is zero. The detailed calculation is provided in the Appendix 1. From the table, we notice that the betas of 3 diversified chemical producers American Chemical, Kerr-McGee and Int. Minerals and Chemicals (Ga is a paper company and Pennwalt is a large diversified chemical producer) is less than the market beta (1.00). We also observe that the two pure play firms (last 2 rows) have higher beta than the market beta. Thus, sodium chlorate may have higher beta than other chemical products. Because sodium chlorate is totally new to Dixon, we assume that Dixon plays the role of a pure sodium chlorate producer and consider the average of the beta of Brunswick and Southern as the beta for Dixon in this project. This beta is β=1.09. The beta 1.09 seems more reasonable as Dixon may have more risk to take the project than other companies who already produce this product for a long time.
Now, Dixon needs to re-lever this beta by using its own target capital structure (35%, p.4). The formula for re-levered beta is: βlevered equity = βasset * [1+ (1-t)*D/E] = 1.09*[1+(1-0.48) *0.35/0.65] = 1.40.
b. Weighted average cost of capital (WACC):
Cost of equity: in the case, the yield on Tbonds is 9.5% (p.4). We assume that it is the risk free rate. We use the historical equity risk premium 8.4% stated on the Table 9.2, page 247 of the textbook. According to the CAPM method, the cost of equity for this project is 9.5%+1.38*8.4% = 21.26%.
Cost of debt: because there is little information about Dixon’s debt provided on the case, we assume that all debt Dixon intends to borrow is used in the acquisition of Collinsville plant at 11.25%. We also assume that debt is issued at par. The after-tax cost of debt is (1-0.48)*11.25% = 5.85%.
WACC: we use Dixon’s 35% target level of debt-to-asset ratio in acquiring the plant to calculate cost of capital. WACC = D/V*After-tax cost of debt + E/V*Cost of equity = 0.35*5.85%+0.65*21.26% = 15.87% @ 16%. Therefore, the WACC for Collinsville’s plant cash flow is nearly 16%. We use this cost of capital to calculate NPV of the project.
3. Calculating NPV
To calculate the NPV for the project we have observed two cases during the investment: purchasing the plant without laminate technology and with laminate technology.
3.1 Without laminate technology
We have calculated NPV on the basis of the current cash flow provided in appendixes of the case and information provided in case material. So we have used the data in Exhibit 8 and projected cash flow from 1980 to 1984, and we have calculated cash flow to 1989 based on our assumptions aforesaid. For further details please refer to Appendix 2.
It had resulted on NPV being negative – 3,703 thousand USD.
3.2 With laminate technology
Case defines us some cost reductions and benefits such as graphite cost elimination, tax benefits and power cost savings, since 2,25 mln. USD worth of laminate technology is bought and installed. So we had calculated additional NPV, which has derived from cost savings and tax benefits we have out of buying the additional laminate technology. Our assumption is NPV with laminate technology = NPV without laminate + NPV additional savings.
From this approach we have calculated Additional NPV of 6,634 thousand USD in Appendix 3.
So NPV with laminate technology is -3,703+6,634=2,931 thousand USD.
4. Sensitive analysis
In order to see whether the project is viable in case of negative changes in variables, we have conducted sensitive analysis having one of major variables such as sales growth rate, which can be reflected by different reasons such as decrease in demand, production slowdown, economic recession and etc. We have tried other possible valuables, but they occasionally did not have much effect on the project outcomes.
We wanted to know what is the rate of growth rate should be in both cases (without and with laminate technology) so that the company will have Zero NPV. Using Solver function in Excel, we found that in case of Zero NPV without laminate technology sales growth rate should kept up around 14% and with laminated technology growth rate should not go down of around 2% level (Please see Appendix 4).
5. Strategic and economic benefits
Besides increasing shareholders wealth, company gets some strategic and economic benefits, such as:
- Increase in product range
- Larger market share in paper industry
- Opportunities to enter new market
- New market development and competition reduction
- Enhancement of relationships with current customers
- Development of new technology
By acquiring Collinsville plant, Dixon could complement its strategy of supplying chemicals products to the paper and pulp industry. It can use the existing sales force to market products to save selling costs. Dixon will add a new product in its existing product mix.
Laminate technology would allow company to considerably cut power cost and completely eliminate graphite costs. By gaining technological savvy, the company can use the same practices in other plants and reduce production costs.
Company has developed the relationships with Collinsville existing customers. It is 6 more times cheaper to retain existing customer than acquire a new one. Buying plant, company will not incur potential marketing costs in initial selling of new products.
The company is better off buying the plant than building from the scratch a new one. Usually, plants are costly to build. Also, the company can reduce competition in the market. Buying a plant would be the best entry strategy for company. Building a plant would take a year, and market is changing rapidly, so Dixon could lose market potential if it takes a long time to build a new plant.
Laminate technology makes the Collinsville plant acquisition attractive on economic grounds. In acquisition negotiation, Dixon should make a clause in the acquisition agreement, which protects the Dixon in the case that the laminate technology fails to produce the desired results. This clause should include that in the case the laminate technology fails, American Chemical Corporation should compensate Dixon for installation charges.
6. Recommendations
Based on our analysis, we would like to make recommendations as follows:
Most fundamentally, a firm that is operating in the interests of its shareholders should try to accept all projects that increase the wealth of the shareholders. In case of Collinsville, we use NPV to approach to our recommendations.
Based on our calculation, without the laminate addition, the NPV of Collinsville turns out to be negative (-3,703 thousand USD). Under this circumstance, we recommend not to invest in this project since it is against shareholders interests.
But at the same time new Laminate Technology would allow company to considerably cut power cost and completely eliminate graphite costs. Additional $2.25 mln. USD is needed to install this new technology. We consider this technology as a subproject attached to Collinsville and calculate its NPV. The NPV of this new technology is 6,634 thousand USD. That means, by using laminate technology, NPV of Collinsville will change to 2,931 thousand USD. Under this new circumstances, our recommendation is to invest in Collinsville because it will not only increase the wealth of the shareholders, but also complement its strategy of supplying chemicals products to the paper and pulp industry.
Dixon, an American specialty chemical producer, wants to buy Collinsville plant from American Chemical Corporation, another typical chemical company in 1979. Dixon wants to diversify its product line buy acquiring the aforesaid plant, which produces sodium-chlorate to supply to paper producers in Southeastern part of the US. This plant initially cost 12 mln. USD and additional 2,25 mln. USD needed to buy laminate technology to increase efficiency and profitability of the plant in order.
Dixon has conducted thorough marketing research for the industry providing cash flow analysis on purchase of the plant. The cash flow analysis based with and without laminate technology cases, where the company should decide whether it should go on further to buy that plant and technology.
2. Calculating of WACC
2.1 Assumptions for calculations in the case:
l Plant life is 10 years (p.4)
l Salvage value of plant is 0 (p.4)
l Book value of plant at end of 1979 is 10.6 million (=12 million purchase price - 1.4 million working capital)
l Tax rate is 48% (calculated from Exhibit 7)
l For the period from 1980 to 1984: all data of sales, depreciation and manufacturing and other costs are given in the case (Exhibit 8)
l For the period from 1984 to 1989 we use the below assumption:
- Price growth rate is 8% (p.4)
- Power cost growth rate is 12% (p.4)
- Net working capital is always 9% of sales (Exhibit 8, current asset and liability items remain historical to sales)
- PPE and depreciation are based on historical data in 1980-1984 period (Exhibit 8)
- Capital investment are based on historical data in 1980-1984 period (Exhibit 8)
- Variable and fixed costs: we use 4-year average growth rates calculated based on Exhibit 8. So non-power variable cost growth rate is 11%, fixed cost growth rate is 6%, selling expenses growth rate is 7% and R&D expenses growth rate is at 5%
- To use this 4-year average growth rates, we assume that the scale of operations of this plant is constant so we need to adjust such cost growths to account for inflation. If the scale increases we should consider growths in costs on percentage of sale basis
2.2 Cost of capital:
a. Calculate beta β of sodium chlorate:
The β of Dixon is 1.06 (Exhibit 7). This beta may be irrelevant to the project to buy Collinsville plant because Dixon produces specialty chemical products but never produce sodium chlorate. The systematic risk of the project could be the risk of the production of sodium chlorate in the industry. Therefore, we calculate beta of the project based on the beta of the sodium chlorate industry.
We do not simply use the beta of Brunswick and Southern, 2 firms purely produce sodium chlorate, because they are small in the industry and their stocks might not be traded largely on the market. Hence, we decide to calculate the beta of all firms that produce sodium chlorate to see the trend of beta of all firms in the market since we believe that such trend can be a benchmark for calculating the beta of sodium chlorate for Dixon’s project.
The average beta is calculated from the formula: βasset = βequity / [1+ (1-t)*D/E], where D is debt, E is equity and t is tax rate. To simplify the calculation, we assume that all these firms have tax rate at 48% and βdebt is zero. The detailed calculation is provided in the Appendix 1. From the table, we notice that the betas of 3 diversified chemical producers American Chemical, Kerr-McGee and Int. Minerals and Chemicals (Ga is a paper company and Pennwalt is a large diversified chemical producer) is less than the market beta (1.00). We also observe that the two pure play firms (last 2 rows) have higher beta than the market beta. Thus, sodium chlorate may have higher beta than other chemical products. Because sodium chlorate is totally new to Dixon, we assume that Dixon plays the role of a pure sodium chlorate producer and consider the average of the beta of Brunswick and Southern as the beta for Dixon in this project. This beta is β=1.09. The beta 1.09 seems more reasonable as Dixon may have more risk to take the project than other companies who already produce this product for a long time.
Now, Dixon needs to re-lever this beta by using its own target capital structure (35%, p.4). The formula for re-levered beta is: βlevered equity = βasset * [1+ (1-t)*D/E] = 1.09*[1+(1-0.48) *0.35/0.65] = 1.40.
b. Weighted average cost of capital (WACC):
Cost of equity: in the case, the yield on Tbonds is 9.5% (p.4). We assume that it is the risk free rate. We use the historical equity risk premium 8.4% stated on the Table 9.2, page 247 of the textbook. According to the CAPM method, the cost of equity for this project is 9.5%+1.38*8.4% = 21.26%.
Cost of debt: because there is little information about Dixon’s debt provided on the case, we assume that all debt Dixon intends to borrow is used in the acquisition of Collinsville plant at 11.25%. We also assume that debt is issued at par. The after-tax cost of debt is (1-0.48)*11.25% = 5.85%.
WACC: we use Dixon’s 35% target level of debt-to-asset ratio in acquiring the plant to calculate cost of capital. WACC = D/V*After-tax cost of debt + E/V*Cost of equity = 0.35*5.85%+0.65*21.26% = 15.87% @ 16%. Therefore, the WACC for Collinsville’s plant cash flow is nearly 16%. We use this cost of capital to calculate NPV of the project.
3. Calculating NPV
To calculate the NPV for the project we have observed two cases during the investment: purchasing the plant without laminate technology and with laminate technology.
3.1 Without laminate technology
We have calculated NPV on the basis of the current cash flow provided in appendixes of the case and information provided in case material. So we have used the data in Exhibit 8 and projected cash flow from 1980 to 1984, and we have calculated cash flow to 1989 based on our assumptions aforesaid. For further details please refer to Appendix 2.
It had resulted on NPV being negative – 3,703 thousand USD.
3.2 With laminate technology
Case defines us some cost reductions and benefits such as graphite cost elimination, tax benefits and power cost savings, since 2,25 mln. USD worth of laminate technology is bought and installed. So we had calculated additional NPV, which has derived from cost savings and tax benefits we have out of buying the additional laminate technology. Our assumption is NPV with laminate technology = NPV without laminate + NPV additional savings.
From this approach we have calculated Additional NPV of 6,634 thousand USD in Appendix 3.
So NPV with laminate technology is -3,703+6,634=2,931 thousand USD.
4. Sensitive analysis
In order to see whether the project is viable in case of negative changes in variables, we have conducted sensitive analysis having one of major variables such as sales growth rate, which can be reflected by different reasons such as decrease in demand, production slowdown, economic recession and etc. We have tried other possible valuables, but they occasionally did not have much effect on the project outcomes.
We wanted to know what is the rate of growth rate should be in both cases (without and with laminate technology) so that the company will have Zero NPV. Using Solver function in Excel, we found that in case of Zero NPV without laminate technology sales growth rate should kept up around 14% and with laminated technology growth rate should not go down of around 2% level (Please see Appendix 4).
5. Strategic and economic benefits
Besides increasing shareholders wealth, company gets some strategic and economic benefits, such as:
- Increase in product range
- Larger market share in paper industry
- Opportunities to enter new market
- New market development and competition reduction
- Enhancement of relationships with current customers
- Development of new technology
By acquiring Collinsville plant, Dixon could complement its strategy of supplying chemicals products to the paper and pulp industry. It can use the existing sales force to market products to save selling costs. Dixon will add a new product in its existing product mix.
Laminate technology would allow company to considerably cut power cost and completely eliminate graphite costs. By gaining technological savvy, the company can use the same practices in other plants and reduce production costs.
Company has developed the relationships with Collinsville existing customers. It is 6 more times cheaper to retain existing customer than acquire a new one. Buying plant, company will not incur potential marketing costs in initial selling of new products.
The company is better off buying the plant than building from the scratch a new one. Usually, plants are costly to build. Also, the company can reduce competition in the market. Buying a plant would be the best entry strategy for company. Building a plant would take a year, and market is changing rapidly, so Dixon could lose market potential if it takes a long time to build a new plant.
Laminate technology makes the Collinsville plant acquisition attractive on economic grounds. In acquisition negotiation, Dixon should make a clause in the acquisition agreement, which protects the Dixon in the case that the laminate technology fails to produce the desired results. This clause should include that in the case the laminate technology fails, American Chemical Corporation should compensate Dixon for installation charges.
6. Recommendations
Based on our analysis, we would like to make recommendations as follows:
Most fundamentally, a firm that is operating in the interests of its shareholders should try to accept all projects that increase the wealth of the shareholders. In case of Collinsville, we use NPV to approach to our recommendations.
Based on our calculation, without the laminate addition, the NPV of Collinsville turns out to be negative (-3,703 thousand USD). Under this circumstance, we recommend not to invest in this project since it is against shareholders interests.
But at the same time new Laminate Technology would allow company to considerably cut power cost and completely eliminate graphite costs. Additional $2.25 mln. USD is needed to install this new technology. We consider this technology as a subproject attached to Collinsville and calculate its NPV. The NPV of this new technology is 6,634 thousand USD. That means, by using laminate technology, NPV of Collinsville will change to 2,931 thousand USD. Under this new circumstances, our recommendation is to invest in Collinsville because it will not only increase the wealth of the shareholders, but also complement its strategy of supplying chemicals products to the paper and pulp industry.
Thursday, June 22, 2006
Distributorship Agreement and Copyrights
International Business Law Final Exam
Date: June 15, 2006 Pham Thi Thuy Ha
1. Distributorship Negotiation with Grande Trade (GT)
Unlike agency agreement with Zeller, by appointing GT as a distributor in Germany, IUJ ill have more benefits and fewer liabilities. For example, GT will take all risks in distributing products; IUJ needs to enter only in sales transactions to GT; IUJ can not held liability to its distributor; GT has an incentive to sell IUJ’s product and increase IUJ’s market share; IUJ does not face any fluctuation in terms of prices and market conditions. However, IUJ may have disadvantages such as loss control over prices and distribution situation in Germany, price reduction to GT, limited understanding of market demand and customers’ preferences. Therefore, IUJ should consider carefully conditions of the Distributorship Agreement with GT.
In response to the 5 requirements of GT, IUJ should analyze these requirements carefully and consider counter-solutions. From the point of view of IUJ’s overseas sales department head, he or she should consider the analysis below before entering the distributorship agreement with GT:
Type of distributorship: GT wants to become IUJ’s exclusive distributor in Germany. This requirement is reasonable and IUJ should accept because:
1) GT will take all risks and responsibilities to distribute GIZMO within German territory.
2) This arrangement assure that there will be no competition in this territory for distributing GIZMO and thus GT has strong motivation to effectively promote this product and bring IUJ secure financial return.
3) The excusive distributorship will motivate GT to expand fast the market for GIZMO by using its nationwide distribution networks and marketing experience. Therefore, IUJ can capture huge market in Germany without any investment in building distribution channel there.
4) IUJ should appoint only one distributor in one territory and should not distribute GIZMO to other firms for use or resale. This point is to avoid conflicts of distribution of GIZMO, secure the rights to make profits for GT and motivate it to use its best efforts to develop business in, to promote the sale of, and to sell the product.
However, IUJ should impose some restrictions on GT such as: not to enter into any distribution agreements involving competing products; not to sell GIZMO outside the German territory; not to remove or repack the product in this territory; follow recommended retailed prices provided by IUJ; be able to provide sale & customer support and maintain sales staff to expand the market. These restrictions help IUJ prevent GT from selling competitive products, marking up prices so high that GIZMO is much more expensive than competitive products or reducing too much prices to enter unfair competition, selling outside assigned territory and being unable to develop markets.
Buyer-seller relationship: GT requests that the seller-buyer relationship should be the relation between IUJ and GTHK. This relationship might not have any effect on the distributorship agreement with GT. However, IUJ might face a high financial risk in selling GIZMO to GTHK since it owns no property and other assets with substantial value. The other risk is that GTHK can resell GIZMO to other GT’s group members even though it has no sales to other outside parties. Therefore, IUJ could accept this requirement when imposing other conditions: 1) GTHK, under any circumstance, will not be allowed to resell GIZMO to any other parties; 2) the payment shall be made in L/C in advance to IUJ’s bank account (to make sure that IUJ receives payment before producing ordered quantity by GTHK); 3) sales contracts shall be made under the Japanese commercial law; prices and all other sales conditions are agreed by IUJ and GT; 4) GTHK shall not be GT’s representative in working with IUJ. It means that GTHK shall automatically follow the agreement reached by IUJ and GT and shall not intervene in any discussion and negotiation between the two parties. This condition allows IUJ to control over GT in terms of prices and selling conditions.
Delivery: GT requests that the delivery should be made directly from IUJ to its warehouses or retail shops or business customers in accordance with its designation to be made from time to time. This requirement seems to be unreasonable and unrealistic because IUJ could not know the specific locations in Germany designated by GT. If IUJ can know these places, the delivery costs will be very high as IUJ needs to hire a freight company to do such specific deliveries and IUJ could not have necessary control over those deliveries. Under general international trade practices, international delivery terms are commonly FOB and CIF. Therefore, IUJ should reject this requirement. Instead, IUJ should propose FOB Tokyo, and the date of the bill of lading shall be taken to be the date of delivery of the product. IUJ shall not be liable for delays in delivery or failure to manufacture due to strikes, lock-outs, riots, civil commotions, insurrections, wars, acts of God, operation of law or any other causes beyond its control.
Duration and termination: GT’s request on duration and termination is reasonable and IUJ should accept this proposal because a 5-year agreement and possible renewals will build a long term business relationship with GT, generate its loyalty and devotion to work with IUJ in the long term and motivate it to become IUJ’s reliable business partner who is willing to distribute IUJ’s products in Germany. However, IUJ should impose conditions on the sales performance such as the minimum monthly sales GT needs to achieve. Otherwise, IUJ shall have right to terminate the agreement at any time if GT fails to achieve this target.
Non-competition after termination of an agency contract: Because the case does not provide detailed information about the agency contract between IUJ and Zeller, I suggest two options:
- First option: if the agency contract between IUJ and Zeller has already imposed obligations on non-competition for a certain time after the termination of the agency contract, GT’s request on prohibition against Zeller from selling GIZMO is not necessary. In this case, I guess that the non-competition should includes prohibitions to manufacture products of the same type as GIZMO; to sell under trade marks and refrain from altering the products or packaging; to maintain adequate stocks to meet anticipated demand after termination; to continue to provide after sale service after the termination; to inform his clients about the termination and to settle consequences of the termination such as to clear remained stocks and stop to sell GIZMO right after the termination. Hence, the request to prohibit Zeller from selling other similar handled computer games and software in Germany is not reasonable because Zeller has the rights to re-organize his business and to become an agent or distributor of other manufacturers after the termination of agency contract with IUJ. Therefore, IUJ should reject this requirement.
- Second option: If the agency contract between IUJ and Zeller has not imposed obligations on non-competition for a certain time after the termination, a non-competition agreement with Zeller upon the termination is necessary to avoid potential conflicts of distribution of GIZMO between GT and Zeller in future. However, it is quite difficult to persuade Zeller to enter into such agreement as Zeller needs to re-organize his business after the termination and he has no obligation to sign such agreement. Thus, IUJ needs to negotiate with Zeller and if necessary sacrifice by giving him certain compensation or letting him sell GIZMO in markets outside Germany if possible. In this case, IUJ only can accept GT’s requirement after successfully signing a non-competition agreement with Zeller. However, this option is quite rare because in general every company should have non-competition clauses in their agency agreements.
Besides, IUJ should impose obligations on non-competition after the termination of the distributorship agreement as discussed above. IUJ also should request other conditions on intellectual property, confidentiality, consequences of termination, arbitration, notification, legal jurisdiction, currency & currency fluctuation, competition law and force majeure.
2. Analysis of the relationship between IUJ and Zeller
The relationship between IUJ and Zeller is the legal relationship between a principal and an agent engaged in an agency contract. IUJ and Zeller, through consent, signed a 5-year agency contract in June 2001 in which Zeller is IUJ’s agent to sell GIZMO product in Germany. Under the agent agreement, both IUJ and Zeller have legal duties toward each other. For example, Zeller has the duties to obey instruction from IUJ, to hold personal liability to IUJ, to act with skill to promote GIZMO in the German market, to avoid conflicts of interests with IUJ, to protect confidential information, to notify IUJ all information that may be useful for IUJ to evaluate the matter at hand, and to account financial report to IUJ. On the other hand, IUJ has duties toward Zeller such as to compensate Zeller for his service and effort to sell GIZMO and to support Zeller in selling GIZMO. However, IUJ is liable for contracts made by Zeller to the third party as he acts in a fiduciary to IUJ. It has both direct and indirect liability for the torts caused by Zeller to the third party and Zeller also has personal liability for any torts he committed. In case of disclosed principal, Zeller has no personal liability for contracts made on behalf of IUJ. In partially disclosed principal situation, Zeller is liable for the contract and IUJ may be liable on the contract also. But in case of undisclosed principal, IUJ is liable on the contract.
The agency contract will expire in July 2006. Due to Zeller’s limited capability to expand the market in Germany, IUJ want to terminate this contract when it expires. This termination is by the act of IUJ and legally right. Both IUJ and Zeller have responsibilities to settle all consequences of termination.
3. Copyrights and the Production and Distribution of Pocket Monster in Germany
According to the information in the case, Pocket Monster is new software invented by a copyright holder in which he features the characteristics of a famous Japanese cartoon. Under the copy right law, he has the rights to reproduce the original, make derivative versions and distribute copies. IUJ has had his permission to produce and sell it in Japanese language and in Japan. The legal relationship between him and IUJ is that he grants IUJ the right to reproduce and distribute those copies of Pocket Monster in Japanese language and in Japan under a copyright contract or a copyright agreement. But he does not grant IUJ the right to make derivative versions such as translated Pocket Monster in German language and to distribute copies of the original outside Japan.
The copyright prohibits IUJ from distributing copies of Pocket Monster in markets outside Japan and making translated versions of this software. Therefore, to produce Pocket Monster in German version and sell it in Germany, IUJ needs to enter a new copyright agreement or a new copyright contract with him in order to have the legal right to do 3 things:
1) produce a derivative software in German version
2) reproduce this derivative software
3) sell it in Germany
Only after having such agreement, can IUJ start to make a German version, produce it and sell it in Germany.
Date: June 15, 2006 Pham Thi Thuy Ha
1. Distributorship Negotiation with Grande Trade (GT)
Unlike agency agreement with Zeller, by appointing GT as a distributor in Germany, IUJ ill have more benefits and fewer liabilities. For example, GT will take all risks in distributing products; IUJ needs to enter only in sales transactions to GT; IUJ can not held liability to its distributor; GT has an incentive to sell IUJ’s product and increase IUJ’s market share; IUJ does not face any fluctuation in terms of prices and market conditions. However, IUJ may have disadvantages such as loss control over prices and distribution situation in Germany, price reduction to GT, limited understanding of market demand and customers’ preferences. Therefore, IUJ should consider carefully conditions of the Distributorship Agreement with GT.
In response to the 5 requirements of GT, IUJ should analyze these requirements carefully and consider counter-solutions. From the point of view of IUJ’s overseas sales department head, he or she should consider the analysis below before entering the distributorship agreement with GT:
Type of distributorship: GT wants to become IUJ’s exclusive distributor in Germany. This requirement is reasonable and IUJ should accept because:
1) GT will take all risks and responsibilities to distribute GIZMO within German territory.
2) This arrangement assure that there will be no competition in this territory for distributing GIZMO and thus GT has strong motivation to effectively promote this product and bring IUJ secure financial return.
3) The excusive distributorship will motivate GT to expand fast the market for GIZMO by using its nationwide distribution networks and marketing experience. Therefore, IUJ can capture huge market in Germany without any investment in building distribution channel there.
4) IUJ should appoint only one distributor in one territory and should not distribute GIZMO to other firms for use or resale. This point is to avoid conflicts of distribution of GIZMO, secure the rights to make profits for GT and motivate it to use its best efforts to develop business in, to promote the sale of, and to sell the product.
However, IUJ should impose some restrictions on GT such as: not to enter into any distribution agreements involving competing products; not to sell GIZMO outside the German territory; not to remove or repack the product in this territory; follow recommended retailed prices provided by IUJ; be able to provide sale & customer support and maintain sales staff to expand the market. These restrictions help IUJ prevent GT from selling competitive products, marking up prices so high that GIZMO is much more expensive than competitive products or reducing too much prices to enter unfair competition, selling outside assigned territory and being unable to develop markets.
Buyer-seller relationship: GT requests that the seller-buyer relationship should be the relation between IUJ and GTHK. This relationship might not have any effect on the distributorship agreement with GT. However, IUJ might face a high financial risk in selling GIZMO to GTHK since it owns no property and other assets with substantial value. The other risk is that GTHK can resell GIZMO to other GT’s group members even though it has no sales to other outside parties. Therefore, IUJ could accept this requirement when imposing other conditions: 1) GTHK, under any circumstance, will not be allowed to resell GIZMO to any other parties; 2) the payment shall be made in L/C in advance to IUJ’s bank account (to make sure that IUJ receives payment before producing ordered quantity by GTHK); 3) sales contracts shall be made under the Japanese commercial law; prices and all other sales conditions are agreed by IUJ and GT; 4) GTHK shall not be GT’s representative in working with IUJ. It means that GTHK shall automatically follow the agreement reached by IUJ and GT and shall not intervene in any discussion and negotiation between the two parties. This condition allows IUJ to control over GT in terms of prices and selling conditions.
Delivery: GT requests that the delivery should be made directly from IUJ to its warehouses or retail shops or business customers in accordance with its designation to be made from time to time. This requirement seems to be unreasonable and unrealistic because IUJ could not know the specific locations in Germany designated by GT. If IUJ can know these places, the delivery costs will be very high as IUJ needs to hire a freight company to do such specific deliveries and IUJ could not have necessary control over those deliveries. Under general international trade practices, international delivery terms are commonly FOB and CIF. Therefore, IUJ should reject this requirement. Instead, IUJ should propose FOB Tokyo, and the date of the bill of lading shall be taken to be the date of delivery of the product. IUJ shall not be liable for delays in delivery or failure to manufacture due to strikes, lock-outs, riots, civil commotions, insurrections, wars, acts of God, operation of law or any other causes beyond its control.
Duration and termination: GT’s request on duration and termination is reasonable and IUJ should accept this proposal because a 5-year agreement and possible renewals will build a long term business relationship with GT, generate its loyalty and devotion to work with IUJ in the long term and motivate it to become IUJ’s reliable business partner who is willing to distribute IUJ’s products in Germany. However, IUJ should impose conditions on the sales performance such as the minimum monthly sales GT needs to achieve. Otherwise, IUJ shall have right to terminate the agreement at any time if GT fails to achieve this target.
Non-competition after termination of an agency contract: Because the case does not provide detailed information about the agency contract between IUJ and Zeller, I suggest two options:
- First option: if the agency contract between IUJ and Zeller has already imposed obligations on non-competition for a certain time after the termination of the agency contract, GT’s request on prohibition against Zeller from selling GIZMO is not necessary. In this case, I guess that the non-competition should includes prohibitions to manufacture products of the same type as GIZMO; to sell under trade marks and refrain from altering the products or packaging; to maintain adequate stocks to meet anticipated demand after termination; to continue to provide after sale service after the termination; to inform his clients about the termination and to settle consequences of the termination such as to clear remained stocks and stop to sell GIZMO right after the termination. Hence, the request to prohibit Zeller from selling other similar handled computer games and software in Germany is not reasonable because Zeller has the rights to re-organize his business and to become an agent or distributor of other manufacturers after the termination of agency contract with IUJ. Therefore, IUJ should reject this requirement.
- Second option: If the agency contract between IUJ and Zeller has not imposed obligations on non-competition for a certain time after the termination, a non-competition agreement with Zeller upon the termination is necessary to avoid potential conflicts of distribution of GIZMO between GT and Zeller in future. However, it is quite difficult to persuade Zeller to enter into such agreement as Zeller needs to re-organize his business after the termination and he has no obligation to sign such agreement. Thus, IUJ needs to negotiate with Zeller and if necessary sacrifice by giving him certain compensation or letting him sell GIZMO in markets outside Germany if possible. In this case, IUJ only can accept GT’s requirement after successfully signing a non-competition agreement with Zeller. However, this option is quite rare because in general every company should have non-competition clauses in their agency agreements.
Besides, IUJ should impose obligations on non-competition after the termination of the distributorship agreement as discussed above. IUJ also should request other conditions on intellectual property, confidentiality, consequences of termination, arbitration, notification, legal jurisdiction, currency & currency fluctuation, competition law and force majeure.
2. Analysis of the relationship between IUJ and Zeller
The relationship between IUJ and Zeller is the legal relationship between a principal and an agent engaged in an agency contract. IUJ and Zeller, through consent, signed a 5-year agency contract in June 2001 in which Zeller is IUJ’s agent to sell GIZMO product in Germany. Under the agent agreement, both IUJ and Zeller have legal duties toward each other. For example, Zeller has the duties to obey instruction from IUJ, to hold personal liability to IUJ, to act with skill to promote GIZMO in the German market, to avoid conflicts of interests with IUJ, to protect confidential information, to notify IUJ all information that may be useful for IUJ to evaluate the matter at hand, and to account financial report to IUJ. On the other hand, IUJ has duties toward Zeller such as to compensate Zeller for his service and effort to sell GIZMO and to support Zeller in selling GIZMO. However, IUJ is liable for contracts made by Zeller to the third party as he acts in a fiduciary to IUJ. It has both direct and indirect liability for the torts caused by Zeller to the third party and Zeller also has personal liability for any torts he committed. In case of disclosed principal, Zeller has no personal liability for contracts made on behalf of IUJ. In partially disclosed principal situation, Zeller is liable for the contract and IUJ may be liable on the contract also. But in case of undisclosed principal, IUJ is liable on the contract.
The agency contract will expire in July 2006. Due to Zeller’s limited capability to expand the market in Germany, IUJ want to terminate this contract when it expires. This termination is by the act of IUJ and legally right. Both IUJ and Zeller have responsibilities to settle all consequences of termination.
3. Copyrights and the Production and Distribution of Pocket Monster in Germany
According to the information in the case, Pocket Monster is new software invented by a copyright holder in which he features the characteristics of a famous Japanese cartoon. Under the copy right law, he has the rights to reproduce the original, make derivative versions and distribute copies. IUJ has had his permission to produce and sell it in Japanese language and in Japan. The legal relationship between him and IUJ is that he grants IUJ the right to reproduce and distribute those copies of Pocket Monster in Japanese language and in Japan under a copyright contract or a copyright agreement. But he does not grant IUJ the right to make derivative versions such as translated Pocket Monster in German language and to distribute copies of the original outside Japan.
The copyright prohibits IUJ from distributing copies of Pocket Monster in markets outside Japan and making translated versions of this software. Therefore, to produce Pocket Monster in German version and sell it in Germany, IUJ needs to enter a new copyright agreement or a new copyright contract with him in order to have the legal right to do 3 things:
1) produce a derivative software in German version
2) reproduce this derivative software
3) sell it in Germany
Only after having such agreement, can IUJ start to make a German version, produce it and sell it in Germany.
Japan: Deficit, Demography and Deflation
Date: June 12, 2006 Pham Thi Thuy Ha
The bursting Bubble and Globalization:
The performance of the Japanese economy in 1990s was poor with slow growth. Banks needed to merger to reduce nonperforming debts. Firms needed to restructure their business activities such as seek viable strategy, reduce loans, improve corporate governance and begin to compete. Deflation began due to excess capacity, falling asset prices and stagnant consumer demand. In 1996, Hashimoto announced a grand plan to restructure administration, deregulation, education system, social security and fiscal policy. Japanese financial markets were deregulated to become free, fair and global. The government started to cut budgets, long-term spending and reduce public works. Bank supervision of the Ministry of Finance was taken away. The primer minister was granted more power and his cabinet could have final control over fiscal policy.
Demographic Crisis:
Aging population is one of serious problems Japan needs to address. Due to decrease in birth rate and increase in life expectancy, Japan’s population is getting older, shrinking labor force and leaving a heavy burden in social security, pension and medical care funds.
Pension system: The first pension system was created in 1940s with a single layer, remuneration-based, proportional pension. It was revised in 1954 to two layer system. The 3rd version was created in 1961 to add national pension for self-employed workers, agriculture, forestry and fishery workers. The basis pension system was financed by fixed amount of insurance premiums. The problem with the pension system is that there are more people enjoy pension benefits while there are fewer workers.
Health care: health care funds need to be risen due to rapid aging and longevity. In Japan, almost all people are insured by health care and elder people go to hospitals more often than elder people in other developed countries. As a result, Japan will face a problem in raising health care funds in the future.
The Koizumi Reform:
Koizumi took office in 2001 with a four-part economic reform: 1) privatize the post office; 2) force banks to write off bad debts; 3) accelerate the implementation of structural reforms; 4) cap the insurance of Japanese government bonds. To implement this plan, Koizumi used the Council on Economic and Fiscal Policy, which is the cross-ministry organization. This council changed the decision-making process for preparing the government budget by coordinating the policies proposed by different ministries to control the overall spending in line with long-term goal of reaching the budget balance in 2012.
1) Privatization of post office: to break the postal service into 4 parts: mail delivery and post office management parts would be under the government control; a bank and an insurance company would be spun off through IPO.
2) Force banks to write off bad debts: the government used three-pronged approaches: accelerate the disposal of nonperforming loans; strengthen loan-classification and provisioning practices; reduce exposure to the price risks of equity by issuing regulations that banks should lower their equity shareholding to 100% or less of their tier-one capital.
3) Pension reform: The pension reform was approved by the Diet in 2004. This reform package includes 3 issues: premium levels, benefits and government subsidies. Premiums rates would rise from 2004 to 2007 and the contribution rate of 13.85% would rise to 18.3% by 2007. Benefits levels would decrease gradually through an adjustment level tied to the CPI. Government subsidies would increase from one-third to 50%
4) Fiscal reform: The government would cut public investment, limit or cut education and defense, eliminate subsidies to local governments, cut social security expenses. By raising taxes to hold government spending constant, the government hoped to reduce deficits toward the balance in 2012. At the same time, the government would apply monetary contraction by issuing more bonds thus public debts increase. To achieve deficit reduction, one-third of primary deficits could be reduced by expenditure cut, the two-third by VAT tax raise.
The prerequisites for Japan to get back its high economic growth are completing structural reforms, refinancing social security, controlling fiscal deficits and ending deflation.
Compare with reforms in Vietnam from late 1980s to 2000s:
The former Soviet Union started to cut aids to Vietnam in early 1980s and the country needed to find a way to grow itself. The Vietnamese communist party decided to change from the close to open economy and the government implemented a compete reform package. Same as Japan in fiscal reforms, Vietnam reduced the number of ministries, reformed pension benefits, cut long-term spending and issued government bonds. However, Vietnam has done different economic reforms. For example, the Vietnamese government changed currency in 1986, from 100 Dong to 1 Dong, privatized SOEs and agricultural collectives, deregulated all economic sectors, broadcast, publishing, telecommunications, established new laws and promote private sector. Reforms were also done educational privatization, electricity production, medical service, transportation, banking system.
In my opinion, the recent massive reforms in Vietnam have helped the country achieve dramatic economic growth in the right direction that fits the situation of the country. Vietnam is continuing reforms to boost the economy. Reforms are always necessary for economic growth because the local and international environments are changing fast.
The bursting Bubble and Globalization:
The performance of the Japanese economy in 1990s was poor with slow growth. Banks needed to merger to reduce nonperforming debts. Firms needed to restructure their business activities such as seek viable strategy, reduce loans, improve corporate governance and begin to compete. Deflation began due to excess capacity, falling asset prices and stagnant consumer demand. In 1996, Hashimoto announced a grand plan to restructure administration, deregulation, education system, social security and fiscal policy. Japanese financial markets were deregulated to become free, fair and global. The government started to cut budgets, long-term spending and reduce public works. Bank supervision of the Ministry of Finance was taken away. The primer minister was granted more power and his cabinet could have final control over fiscal policy.
Demographic Crisis:
Aging population is one of serious problems Japan needs to address. Due to decrease in birth rate and increase in life expectancy, Japan’s population is getting older, shrinking labor force and leaving a heavy burden in social security, pension and medical care funds.
Pension system: The first pension system was created in 1940s with a single layer, remuneration-based, proportional pension. It was revised in 1954 to two layer system. The 3rd version was created in 1961 to add national pension for self-employed workers, agriculture, forestry and fishery workers. The basis pension system was financed by fixed amount of insurance premiums. The problem with the pension system is that there are more people enjoy pension benefits while there are fewer workers.
Health care: health care funds need to be risen due to rapid aging and longevity. In Japan, almost all people are insured by health care and elder people go to hospitals more often than elder people in other developed countries. As a result, Japan will face a problem in raising health care funds in the future.
The Koizumi Reform:
Koizumi took office in 2001 with a four-part economic reform: 1) privatize the post office; 2) force banks to write off bad debts; 3) accelerate the implementation of structural reforms; 4) cap the insurance of Japanese government bonds. To implement this plan, Koizumi used the Council on Economic and Fiscal Policy, which is the cross-ministry organization. This council changed the decision-making process for preparing the government budget by coordinating the policies proposed by different ministries to control the overall spending in line with long-term goal of reaching the budget balance in 2012.
1) Privatization of post office: to break the postal service into 4 parts: mail delivery and post office management parts would be under the government control; a bank and an insurance company would be spun off through IPO.
2) Force banks to write off bad debts: the government used three-pronged approaches: accelerate the disposal of nonperforming loans; strengthen loan-classification and provisioning practices; reduce exposure to the price risks of equity by issuing regulations that banks should lower their equity shareholding to 100% or less of their tier-one capital.
3) Pension reform: The pension reform was approved by the Diet in 2004. This reform package includes 3 issues: premium levels, benefits and government subsidies. Premiums rates would rise from 2004 to 2007 and the contribution rate of 13.85% would rise to 18.3% by 2007. Benefits levels would decrease gradually through an adjustment level tied to the CPI. Government subsidies would increase from one-third to 50%
4) Fiscal reform: The government would cut public investment, limit or cut education and defense, eliminate subsidies to local governments, cut social security expenses. By raising taxes to hold government spending constant, the government hoped to reduce deficits toward the balance in 2012. At the same time, the government would apply monetary contraction by issuing more bonds thus public debts increase. To achieve deficit reduction, one-third of primary deficits could be reduced by expenditure cut, the two-third by VAT tax raise.
The prerequisites for Japan to get back its high economic growth are completing structural reforms, refinancing social security, controlling fiscal deficits and ending deflation.
Compare with reforms in Vietnam from late 1980s to 2000s:
The former Soviet Union started to cut aids to Vietnam in early 1980s and the country needed to find a way to grow itself. The Vietnamese communist party decided to change from the close to open economy and the government implemented a compete reform package. Same as Japan in fiscal reforms, Vietnam reduced the number of ministries, reformed pension benefits, cut long-term spending and issued government bonds. However, Vietnam has done different economic reforms. For example, the Vietnamese government changed currency in 1986, from 100 Dong to 1 Dong, privatized SOEs and agricultural collectives, deregulated all economic sectors, broadcast, publishing, telecommunications, established new laws and promote private sector. Reforms were also done educational privatization, electricity production, medical service, transportation, banking system.
In my opinion, the recent massive reforms in Vietnam have helped the country achieve dramatic economic growth in the right direction that fits the situation of the country. Vietnam is continuing reforms to boost the economy. Reforms are always necessary for economic growth because the local and international environments are changing fast.
Japan: Beyond the Buble
Date: June 5, 2006 Pham Thi Thuy Ha
Fruits of the Miracle:
Although Japan was affected by the ending of the Breton Woods system of fixed exchange rates and the first oil shock, the 2nd the oil shock helped depreciate Yen so Japan gained export competitiveness at the end of 1980s. Due to the rise of U.S real interest rate in 1981, Yen was weakened again and Japan enjoyed export competitiveness and much cheaper imported materials to boost economic growth. However, under a threat of inflation and pressure of estate speculation, the Bank of Japan had to raise interest rate and cool off the economy in 1989. After a series of attempts to balance budget, the government implemented fiscal stimulus in 1992. As a result, deficit spending rose quickly but the economic growth was still stagnated. Then, the government lowered interest rate to 0.5% by 1995 and the Bank of Japan introduced a zero-interest rate policy in 1999 in order to have enough cash to raise price and reduce price deflation. The bank increased interest rate in august 2000 but implemented again this policy in 2001 to deal with deflation problem. However, the bank will gradually increase interest rate to turn monetary policy to normal.
Institutional Concerns:
The ministry of Finance (MOF) managed government fiscal policy and influenced over monetary and securities policy and therefore the Bank of Japan has not acted independently in monetary policy making. In the labor market, job security and seniority system were changed in the late 1990s due to recession. Labor costs were increasing. The bankruptcy of some companies forced employees to find alternative solutions. In the financial market, banks changed from book-value systems to marked-to-market accounting systems to increase their transparency. The government also changed its long-term policy not to allow banks fail to allow banks collapse in 1997. Still, individuals had limited opportunities in the capital markets and were limited in reporting foreign exchange transactions so their personal savings were held in personal saving accounts with very flat interest rates. As a result, unlike American firms, Japanese firms have had limited capital equity. Keiretsu, business groups, has been a dominant business practice in Japan. Keiretsu has 3 types: horizontal keiretsu, vertical keiretsu and satellite groups centered on banks for funds. Cross-holding of share is still common practice and thus, firms were not really under the pressure from shareholders. Japan also faced social issues such as aging problem, medical care, pensions, role of women, standard of living and education.
The Hashimoto Era and Structural Reform:
Hashimoto introduced a grand plan to restructure administration, education, the financial system, fiscal policy and social security among which the financial market reform was the most important reform. According to the plan, the administrative reform is to re-organize the governing structure to be more efficient and more responsive to the needs of the people by strengthening the power of the primer minister and cabinet, reducing number of ministries and limiting numbers of bureaucrats. The economic reform encompassed removal of restrictions on large-scale retailers, telephone deregulation, series of deregulations in 5 main areas: logistics, energy, petroleum and gas, telecommunications and trade/commerce. The educational reform was to reorganize educational system, cultivate a rich humanity, elicit prompt responses to changing social needs and increase schools’ cooperation with students’ families and communities. The financial restructure aimed at the financial market reform and disposal of the massive bad debts by lifting the ban on derivative and amending the Anti-Monopoly Law. The fiscal reform included five major principles: 1) reduce budget deficit; 2) devote to fiscal reform; 3) implement year-to-year reductions in general expenditures; 4) reduce all current long-term spending programs; 5) maintain the national burden below 50%. The social security reform received 5 different proposals and a pension reform bill was completed in 2000. This massive reform resulted in less power of MOF and the primer minister was granted the rights to submits policy proposals to the cabinet.
Structural Reform under Koizumi:
In early May 2001, Koizumi proposed structural reforms. The new reform agenda was: 1) force banks to write off all nonperforming loans in 2 or 3 years; 2) privatize the postal saving system; 3) a cap of government borrowing of $245 billion to halt Japan’ $5.6 trillion debts; 4) Reduce deficits by cutting government spending; 5) a government-subsidized unemployment plan to grant jobless benefits so that firms can lay off worker easily.
Lessons drawn from the case:
The government should change timely the policy in response to the changes of domestic and international macroeconomic conditions. In my country, a massive reform was done in late 1980s and 1990s in accordance with the change of the government’s policy from a close to an open economy after the collapse of the former Soviet Union. So far this reform has boosted economic growth at high rates and maintained political stability. The government continues reforms in all areas such as deregulation, legislation, education, health care, pensions, social security… and promotes privatization.
Fruits of the Miracle:
Although Japan was affected by the ending of the Breton Woods system of fixed exchange rates and the first oil shock, the 2nd the oil shock helped depreciate Yen so Japan gained export competitiveness at the end of 1980s. Due to the rise of U.S real interest rate in 1981, Yen was weakened again and Japan enjoyed export competitiveness and much cheaper imported materials to boost economic growth. However, under a threat of inflation and pressure of estate speculation, the Bank of Japan had to raise interest rate and cool off the economy in 1989. After a series of attempts to balance budget, the government implemented fiscal stimulus in 1992. As a result, deficit spending rose quickly but the economic growth was still stagnated. Then, the government lowered interest rate to 0.5% by 1995 and the Bank of Japan introduced a zero-interest rate policy in 1999 in order to have enough cash to raise price and reduce price deflation. The bank increased interest rate in august 2000 but implemented again this policy in 2001 to deal with deflation problem. However, the bank will gradually increase interest rate to turn monetary policy to normal.
Institutional Concerns:
The ministry of Finance (MOF) managed government fiscal policy and influenced over monetary and securities policy and therefore the Bank of Japan has not acted independently in monetary policy making. In the labor market, job security and seniority system were changed in the late 1990s due to recession. Labor costs were increasing. The bankruptcy of some companies forced employees to find alternative solutions. In the financial market, banks changed from book-value systems to marked-to-market accounting systems to increase their transparency. The government also changed its long-term policy not to allow banks fail to allow banks collapse in 1997. Still, individuals had limited opportunities in the capital markets and were limited in reporting foreign exchange transactions so their personal savings were held in personal saving accounts with very flat interest rates. As a result, unlike American firms, Japanese firms have had limited capital equity. Keiretsu, business groups, has been a dominant business practice in Japan. Keiretsu has 3 types: horizontal keiretsu, vertical keiretsu and satellite groups centered on banks for funds. Cross-holding of share is still common practice and thus, firms were not really under the pressure from shareholders. Japan also faced social issues such as aging problem, medical care, pensions, role of women, standard of living and education.
The Hashimoto Era and Structural Reform:
Hashimoto introduced a grand plan to restructure administration, education, the financial system, fiscal policy and social security among which the financial market reform was the most important reform. According to the plan, the administrative reform is to re-organize the governing structure to be more efficient and more responsive to the needs of the people by strengthening the power of the primer minister and cabinet, reducing number of ministries and limiting numbers of bureaucrats. The economic reform encompassed removal of restrictions on large-scale retailers, telephone deregulation, series of deregulations in 5 main areas: logistics, energy, petroleum and gas, telecommunications and trade/commerce. The educational reform was to reorganize educational system, cultivate a rich humanity, elicit prompt responses to changing social needs and increase schools’ cooperation with students’ families and communities. The financial restructure aimed at the financial market reform and disposal of the massive bad debts by lifting the ban on derivative and amending the Anti-Monopoly Law. The fiscal reform included five major principles: 1) reduce budget deficit; 2) devote to fiscal reform; 3) implement year-to-year reductions in general expenditures; 4) reduce all current long-term spending programs; 5) maintain the national burden below 50%. The social security reform received 5 different proposals and a pension reform bill was completed in 2000. This massive reform resulted in less power of MOF and the primer minister was granted the rights to submits policy proposals to the cabinet.
Structural Reform under Koizumi:
In early May 2001, Koizumi proposed structural reforms. The new reform agenda was: 1) force banks to write off all nonperforming loans in 2 or 3 years; 2) privatize the postal saving system; 3) a cap of government borrowing of $245 billion to halt Japan’ $5.6 trillion debts; 4) Reduce deficits by cutting government spending; 5) a government-subsidized unemployment plan to grant jobless benefits so that firms can lay off worker easily.
Lessons drawn from the case:
The government should change timely the policy in response to the changes of domestic and international macroeconomic conditions. In my country, a massive reform was done in late 1980s and 1990s in accordance with the change of the government’s policy from a close to an open economy after the collapse of the former Soviet Union. So far this reform has boosted economic growth at high rates and maintained political stability. The government continues reforms in all areas such as deregulation, legislation, education, health care, pensions, social security… and promotes privatization.
Foreign Exchange Markets and Transactions
Date: May 31, 2006 Pham Thi Thuy Ha
Foreign Exchange Market:
Started in 1970s, the foreign exchange market first enables the conversion of other currencies to US dollars at fixed exchange rate. This market has grown over time due to the expansion of international trade and became the largest market in the world with 1.2 trillion average daily turnover in 2001. The largest trading center is in UK with 16% of US dollars, 9% of Japanese Yen. OTC is the most popular trading method and transactions include spot transactions, outright forwards and swaps. Euro and world-wide consolidation of in the financial sector have reduced traded volume of the market. There was a trend toward fewer banks with larger market share in the exchange market. Electronic brokering systems account for increasing share of turnover in spot market.
What is an exchange rate?
An exchange rate is the rate at which one currency can be exchanged for another. On other words, it is the price of a currency in the exchange market. Direct quotes are exchange rates listed in the form of US $ Equivalent and give the price of a unit of foreign currency in US dollars. Indirect quotes are rates listed in the form of Currency per U.S. $ and give the number of units of foreign currency required to buy 1 U.S.$. Cross exchange rate are exchange rates in terms of two non-U.S. dollar currencies. For instance, the cross rate between RMB and Euro. Bid/ask spread is the service fees that banks or brokers charge for each currency transaction. A quote is a bank’s buy price and an ask quote is a bank’s sell price. The spread is the difference between these two prices. Therefore, bank currency quotes are usually given in pairs with the first rate being the bid quote and the second being the ask quote.
Exchange rate movements:
Prices of currencies fluctuate quite often in the exchange market like the prices of goods fluctuate in the good market.
Currency appreciation is the increase in the value of a currency relative to other currencies. When the value is decrease, currency is depreciated. When a currency is appreciated, its purchasing power increases.
Exchange rate fluctuations are measured in percentage relative to some reference currency, for example Euro could appreciate 10% relative to US dollars. Three steps to calculate percentage of fluctuation: 1) convert exchange rates into a standard form; 2) determine whether the studied currency is depreciated or appreciated; 3) calculate the percentage of changes of the original exchange rate.
There are 2 reasons why exchange rates fluctuate: 1) according to purchasing power parity theory, exchange rate fluctuate because of the changes of purchasing power of a currency to another currency; 2) according to interest parity theory, exchange rates fluctuate because of the fluctuation of interest rates. In other words, potential holders of foreign currency deposits should not be different between two currencies.
5 types of foreign exchange transactions:
- Spot transactions are foreign exchange transactions based on spot rates, daily exchange rates quoted in the Wall Street Journal and other news sources.
- Forwards are transactions made sometime in the future at forward rates and forward contracts, an agreement between buyer and seller to trade a particular currency on a date in the future for a fixed price regardless of the changes in spot rates. If the currency is expected to appreciate in the future, forward rates will contain a premium. If the currency is expected to depreciate in the future, forward rates will contain a discount. Forwards end with the purchase of currencies.
- Swaps are a series of forwards under a contract that hedges long-term, sustained foreign exchange exposure. It differs from forwards in the sense that swaps cover multiple future transactions until the mature date while forwards deal with one transaction. Swaps are arranged by brokers and banks in favor of two parties who have complementary foreign exchange to pair up and trade their currencies.
- Futures are contracts that specify a standard volume of a currency to be exchanged on a settlement date some time in the future. Futures are similar to forwards except the fact that futures are standardized for trading on markets like Chicago Mercantile Exchange. They are often used as a tool for currency speculation rather than a hedging tool. Future contracts are traded on the market and the holder can have gains or losses depending on the movement of spot rate over time and changing expectation about the spot rate’s value on the settlement date.
- Options are contracts that allow their owners to buy or sell a currency at a designated price within specific period of time. A currency call option is a contract that allows its owner the right to buy a specific currency. A currency put option is a contract that allows its owner the right to sell a specific currency. Exercising an option is to take the right to buy or sell the currency. Options are sold in standard volumes.
Lessons drawn from the case
1. Companies using foreign currency should have different strategies of foreign currency against unfavorable movements of exchange rates before making decisions on any transaction relating to foreign currency.
2. Corporations conducting international business should consider currency options to cover the risks of unfavorable exchange movements.
3. Call options are suitable for companies that need future foreign currency and want to hedge against currency appreciation
4. Put options are suitable for companies who hold a large amount of foreign currency and want to hedge against currency depreciation
Foreign Exchange Market:
Started in 1970s, the foreign exchange market first enables the conversion of other currencies to US dollars at fixed exchange rate. This market has grown over time due to the expansion of international trade and became the largest market in the world with 1.2 trillion average daily turnover in 2001. The largest trading center is in UK with 16% of US dollars, 9% of Japanese Yen. OTC is the most popular trading method and transactions include spot transactions, outright forwards and swaps. Euro and world-wide consolidation of in the financial sector have reduced traded volume of the market. There was a trend toward fewer banks with larger market share in the exchange market. Electronic brokering systems account for increasing share of turnover in spot market.
What is an exchange rate?
An exchange rate is the rate at which one currency can be exchanged for another. On other words, it is the price of a currency in the exchange market. Direct quotes are exchange rates listed in the form of US $ Equivalent and give the price of a unit of foreign currency in US dollars. Indirect quotes are rates listed in the form of Currency per U.S. $ and give the number of units of foreign currency required to buy 1 U.S.$. Cross exchange rate are exchange rates in terms of two non-U.S. dollar currencies. For instance, the cross rate between RMB and Euro. Bid/ask spread is the service fees that banks or brokers charge for each currency transaction. A quote is a bank’s buy price and an ask quote is a bank’s sell price. The spread is the difference between these two prices. Therefore, bank currency quotes are usually given in pairs with the first rate being the bid quote and the second being the ask quote.
Exchange rate movements:
Prices of currencies fluctuate quite often in the exchange market like the prices of goods fluctuate in the good market.
Currency appreciation is the increase in the value of a currency relative to other currencies. When the value is decrease, currency is depreciated. When a currency is appreciated, its purchasing power increases.
Exchange rate fluctuations are measured in percentage relative to some reference currency, for example Euro could appreciate 10% relative to US dollars. Three steps to calculate percentage of fluctuation: 1) convert exchange rates into a standard form; 2) determine whether the studied currency is depreciated or appreciated; 3) calculate the percentage of changes of the original exchange rate.
There are 2 reasons why exchange rates fluctuate: 1) according to purchasing power parity theory, exchange rate fluctuate because of the changes of purchasing power of a currency to another currency; 2) according to interest parity theory, exchange rates fluctuate because of the fluctuation of interest rates. In other words, potential holders of foreign currency deposits should not be different between two currencies.
5 types of foreign exchange transactions:
- Spot transactions are foreign exchange transactions based on spot rates, daily exchange rates quoted in the Wall Street Journal and other news sources.
- Forwards are transactions made sometime in the future at forward rates and forward contracts, an agreement between buyer and seller to trade a particular currency on a date in the future for a fixed price regardless of the changes in spot rates. If the currency is expected to appreciate in the future, forward rates will contain a premium. If the currency is expected to depreciate in the future, forward rates will contain a discount. Forwards end with the purchase of currencies.
- Swaps are a series of forwards under a contract that hedges long-term, sustained foreign exchange exposure. It differs from forwards in the sense that swaps cover multiple future transactions until the mature date while forwards deal with one transaction. Swaps are arranged by brokers and banks in favor of two parties who have complementary foreign exchange to pair up and trade their currencies.
- Futures are contracts that specify a standard volume of a currency to be exchanged on a settlement date some time in the future. Futures are similar to forwards except the fact that futures are standardized for trading on markets like Chicago Mercantile Exchange. They are often used as a tool for currency speculation rather than a hedging tool. Future contracts are traded on the market and the holder can have gains or losses depending on the movement of spot rate over time and changing expectation about the spot rate’s value on the settlement date.
- Options are contracts that allow their owners to buy or sell a currency at a designated price within specific period of time. A currency call option is a contract that allows its owner the right to buy a specific currency. A currency put option is a contract that allows its owner the right to sell a specific currency. Exercising an option is to take the right to buy or sell the currency. Options are sold in standard volumes.
Lessons drawn from the case
1. Companies using foreign currency should have different strategies of foreign currency against unfavorable movements of exchange rates before making decisions on any transaction relating to foreign currency.
2. Corporations conducting international business should consider currency options to cover the risks of unfavorable exchange movements.
3. Call options are suitable for companies that need future foreign currency and want to hedge against currency appreciation
4. Put options are suitable for companies who hold a large amount of foreign currency and want to hedge against currency depreciation
Singapore: Committee on Singapore’s Competitiveness
Date: May 27, 2006 Pham Thi Thuy Ha
Economy overview from 1959 to 1998:
From 1959 to 1956, Singapore adopted import-substitution policy while it was a member of the Federation of Malaysia. But right after becoming an independent country in 1965, the country moved from labor-intensive exports to high value adding industries while shifting manufacturing facilities to lower-cost neighboring countries. In 1990s, it changed the policy to become an international business hub international financial center to turn the country in a knowledge economy and enjoyed fruitful economic growth (about 8%/year) until 1997-Asia-economic crisis. Since the country’s economy was largely regional focus, it was drastically hurt by this crisis and economic growth was less than 1% by the end of 1999.
The Committee on Singapore’s competitiveness (CSC):
In May 1996, CSC was formed with most members from private sectors to:1) evaluate the country’s competitiveness in the next 10 years in the context of rapid globalization and emerging competition; 2) to detect problems and propose strategies and policies to maintain the competitiveness of Singapore in the future. However, due to 1997-crisis, CSC added one objective which is to examine short-tern issues and recommend solutions to help Singapore overcome the economic downturn. CSC’s 1998-report presented short-term and medium-term solutions to help Singapore stay competitive. Those solutions are:
- Short-term recommendations: 1) reduce business costs and help businesses survive; 2) remain strong financial system; 3) Maintain investors’ confidence; 4) Push economic restructuring; 5) make Singapore’ economy stay resilient; 6) seek business opportunities in the region through partnerships; 7) implement cost-cutting and tax-cutting measures
- Long-term recommendations: 8 key strategies:
1. Promoting manufacturing and service as twin engines: develop manufacturing in the regional hub; attract multinational companies; develop services sector in a premier hub in Asia through fast-growth services.
2. Strengthening the external wing: Diversify market dependency beyond the region; invade into the abundant resources overseas.
3. Building world-class companies: Nurture stable world-class companies by broadening the corporate profile and economic base of Singapore for sustained and resilient growth.
4. Strengthening the base of small and medium local enterprises: Help them remain resilient and reach maximum potential; underpin their role as strategic partners of multinational companies and government-linked companies.
5. Developing human & intellectual capital as key competitive edge: develop a world-class work force by providing world-class education for youth, promoting life-long learning for life-long employability and encouraging management, innovation & technology.
6. Leveraging science, technology & innovation: lever science, technology and innovation; construct the existing IT2000 program to turn Singapore into an IT hub in Asia.
7. Optimizing resources management: optimize the allocation of scare resources to increase supply and encourage efficient usage of those resources.
8. Reinforcing Government role as a business facilitator: Support private sector by providing consistent policies & regulatory environment.
Besides the 8 keys strategies, CSC also recommended strategies for 5 sectors to enhance each sector. In manufacturing: develop world-class work force move to R&D, and nurture enterprises. In financial and banking: develop fund management industry, expand domestic capital market. In service: develop international trading, transport and logistics, business & professional services, media, communications and tourism. In domestic business: help local enterprises to optimize scare resources and develop business.
Responses from Government and Public: the report was warmly welcomed by the government and public and the recommendations were quickly adopted with immediate or nearly immediate effect.
Lessons drawn from the case
1. Build a competitive society is the core of the sustained growth in globalization context
2. Education is the core strategy that each government should take to build a world-class work force, lever science, technology and innovation
3. Private sector and small and medium enterprises play an important role in economic growth so it is deserved to receive full support and assistance from government
4. Effective integration in international markets is a strong wing of the national economy
In Vietnam, the government has formed policies and strategies that cover all above areas to build a knowledge－based and competitive society.
Economy overview from 1959 to 1998:
From 1959 to 1956, Singapore adopted import-substitution policy while it was a member of the Federation of Malaysia. But right after becoming an independent country in 1965, the country moved from labor-intensive exports to high value adding industries while shifting manufacturing facilities to lower-cost neighboring countries. In 1990s, it changed the policy to become an international business hub international financial center to turn the country in a knowledge economy and enjoyed fruitful economic growth (about 8%/year) until 1997-Asia-economic crisis. Since the country’s economy was largely regional focus, it was drastically hurt by this crisis and economic growth was less than 1% by the end of 1999.
The Committee on Singapore’s competitiveness (CSC):
In May 1996, CSC was formed with most members from private sectors to:1) evaluate the country’s competitiveness in the next 10 years in the context of rapid globalization and emerging competition; 2) to detect problems and propose strategies and policies to maintain the competitiveness of Singapore in the future. However, due to 1997-crisis, CSC added one objective which is to examine short-tern issues and recommend solutions to help Singapore overcome the economic downturn. CSC’s 1998-report presented short-term and medium-term solutions to help Singapore stay competitive. Those solutions are:
- Short-term recommendations: 1) reduce business costs and help businesses survive; 2) remain strong financial system; 3) Maintain investors’ confidence; 4) Push economic restructuring; 5) make Singapore’ economy stay resilient; 6) seek business opportunities in the region through partnerships; 7) implement cost-cutting and tax-cutting measures
- Long-term recommendations: 8 key strategies:
1. Promoting manufacturing and service as twin engines: develop manufacturing in the regional hub; attract multinational companies; develop services sector in a premier hub in Asia through fast-growth services.
2. Strengthening the external wing: Diversify market dependency beyond the region; invade into the abundant resources overseas.
3. Building world-class companies: Nurture stable world-class companies by broadening the corporate profile and economic base of Singapore for sustained and resilient growth.
4. Strengthening the base of small and medium local enterprises: Help them remain resilient and reach maximum potential; underpin their role as strategic partners of multinational companies and government-linked companies.
5. Developing human & intellectual capital as key competitive edge: develop a world-class work force by providing world-class education for youth, promoting life-long learning for life-long employability and encouraging management, innovation & technology.
6. Leveraging science, technology & innovation: lever science, technology and innovation; construct the existing IT2000 program to turn Singapore into an IT hub in Asia.
7. Optimizing resources management: optimize the allocation of scare resources to increase supply and encourage efficient usage of those resources.
8. Reinforcing Government role as a business facilitator: Support private sector by providing consistent policies & regulatory environment.
Besides the 8 keys strategies, CSC also recommended strategies for 5 sectors to enhance each sector. In manufacturing: develop world-class work force move to R&D, and nurture enterprises. In financial and banking: develop fund management industry, expand domestic capital market. In service: develop international trading, transport and logistics, business & professional services, media, communications and tourism. In domestic business: help local enterprises to optimize scare resources and develop business.
Responses from Government and Public: the report was warmly welcomed by the government and public and the recommendations were quickly adopted with immediate or nearly immediate effect.
Lessons drawn from the case
1. Build a competitive society is the core of the sustained growth in globalization context
2. Education is the core strategy that each government should take to build a world-class work force, lever science, technology and innovation
3. Private sector and small and medium enterprises play an important role in economic growth so it is deserved to receive full support and assistance from government
4. Effective integration in international markets is a strong wing of the national economy
In Vietnam, the government has formed policies and strategies that cover all above areas to build a knowledge－based and competitive society.
GDP Calculation
Macroeconomics – National Economic Accounting: Past, Present and Future
Date: April 22, 2006
Student Name: Pham Thi Thuy Ha Student ID: 2A5026
Question 1: Three approaches to measure GDP:
- Value-added approach: GDP is the sum of the value-added at each stage of production, where value added is revenues minus material costs.
- Income approach: GPD is total income which is the sum of rent, wages and profits.
- Expenditure approach: GDP is total spending on final goods and services of a nation. In other words, GDP = C + G + I + X – M where C is consumption, G is government expenditure, I is investment, X is export and M is import.
Among three methods, expenditure approach is the most widely used because it provides policy makers with the most usefulness in formulating economic policies.
Question 2: In general the final results of these three approaches should be the same because GDP measures the value of output of a nation in a specific period of time (1 year). However, the results are not the same in reality. The reason is that the information on which the data is collected may come from different sources and inevitably contains inaccuracies and round-up data.
Question 3: Depreciation is a decrease in the value of a property as a result of wear and tear, obsolescence, accidental damage and aging. In macroeconomics, depreciation covers reductions of the capital stock by disasters. If the capital depreciation is very large, the investment might not be sufficient to support rapid growth in the long run. Therefore, the term Net Domestic Product (NDP), which is GDP minus depreciation, is used instead of GDP.
Question 4: According to Kuznet, the value of net output is the sum of Income Paid Out and Business Saving, where Income Paid Out is the sum of wages, salaries, rent and distributed post-tax corporate profits, and Business Saving is positive business saving (investment, reserves, additions to capital stock) and negative business saving such as depreciation, depletion of natural resources and withdrawals from reserves.
According to Keynes, the value of the net output is the sum of consumption, investment and government spending. This approach incorporates the relationship between employment, the quantity of money, the interest rate and aggregate expenditures.
Question 5: The reason why Kuznet was unhappy with the inclusion of government expenditures in the value of output is the double-counting problem in calculating the output value. Kuznet argued that most government spending was on intermediate goods crucial to the production process rather than on the final products. Therefore, if the government spending is counted, there would be double-counted products in the value of net output and the true value of output would be over-calculated.
Question 6: Challenges in accounting for aggregate output:
Inputting Output:
- How to count for new goods and services that were unsold in the formal economy or that were unpriced in the market. The challenge to count the value of unsold goods such as home-made clothes, unpaid household work and unpriced services like free bank services remains the most difficult challenge that each country faces in calculating their GDP.
- How to count the value of the informal economy. If a country has a big informal economy like Colombia, GDP would be under-calculated if this country ignores the informal economic sector.
- How to count the value of barter if the country still has barter systems.
- How to measure the quality of goods produced. The quality of goods is not fully reflected on the price.
Natural Resources:
- How and what to count the value and depletion of natural resources. Even though UN has provided guidance on how to estimate the annual value of natural resources used, this calculation remains inaccurate since natural resources are what we might not be able to measure accurately.
Question 7: Factors that should be considered:
- The value of non-tradable, un-owned aspects of the environment such as clean air, clean water and climate
- The value of non-market economy of household and community
- The value of informal economy
- Unpriced social cost associated with production such as pollution and environmental degradation
Question 8: Reasons for the importance of the traditional GDP: The traditional GDP suggested by Keynes reflects the relationship between employment, quantity of money, interest rate and aggregate expenditures. Therefore it is:
- An essential tool for analyzing and assessing the state of a nation’s economy.
- A valuable metric for short-term macroeconomic planning because the government can use fiscal and monetary policies to push or cool down the economy.
- An essential tool for formulating macroeconomic stabilization policies.
- An important indicator of the economic growth and potential for investors.
Question 9: Arguments for the environmental accounting:
- Economic growth must be sustainable, growth together with environmental protection.
- Sustainable growth is needed to ensure that our younger generations could have living standards at least as high as those of current generations.
- GDP will provide a more complete overview of economic performance and living standards than GDP without concerning about environmental matters.
- The value of output in environmental accounting (NNG) would be a better indicator of sustainable social well-being than traditional GDP.
- NNG would help policy makers make better decisions in planning the economic growth strategies for a nation.
Question 10: Reasons for “A higher GDP is not necessary mean a higher measure of welfare”:
- GDP might be over or under calculated, depending on the methods of collecting and interpreting data.
- GDP ignores the value of non-market economy of household and community such as recreation, intellectual capital, education…
- GDP treats depletion of natural resources, pollution, environment degradation, disasters as income because it measures expenses on those areas as economic gains.
- GDP takes no account for income distribution.
- GDP ignores the drawbacks of borrowing money from other countries.
Date: April 22, 2006
Student Name: Pham Thi Thuy Ha Student ID: 2A5026
Question 1: Three approaches to measure GDP:
- Value-added approach: GDP is the sum of the value-added at each stage of production, where value added is revenues minus material costs.
- Income approach: GPD is total income which is the sum of rent, wages and profits.
- Expenditure approach: GDP is total spending on final goods and services of a nation. In other words, GDP = C + G + I + X – M where C is consumption, G is government expenditure, I is investment, X is export and M is import.
Among three methods, expenditure approach is the most widely used because it provides policy makers with the most usefulness in formulating economic policies.
Question 2: In general the final results of these three approaches should be the same because GDP measures the value of output of a nation in a specific period of time (1 year). However, the results are not the same in reality. The reason is that the information on which the data is collected may come from different sources and inevitably contains inaccuracies and round-up data.
Question 3: Depreciation is a decrease in the value of a property as a result of wear and tear, obsolescence, accidental damage and aging. In macroeconomics, depreciation covers reductions of the capital stock by disasters. If the capital depreciation is very large, the investment might not be sufficient to support rapid growth in the long run. Therefore, the term Net Domestic Product (NDP), which is GDP minus depreciation, is used instead of GDP.
Question 4: According to Kuznet, the value of net output is the sum of Income Paid Out and Business Saving, where Income Paid Out is the sum of wages, salaries, rent and distributed post-tax corporate profits, and Business Saving is positive business saving (investment, reserves, additions to capital stock) and negative business saving such as depreciation, depletion of natural resources and withdrawals from reserves.
According to Keynes, the value of the net output is the sum of consumption, investment and government spending. This approach incorporates the relationship between employment, the quantity of money, the interest rate and aggregate expenditures.
Question 5: The reason why Kuznet was unhappy with the inclusion of government expenditures in the value of output is the double-counting problem in calculating the output value. Kuznet argued that most government spending was on intermediate goods crucial to the production process rather than on the final products. Therefore, if the government spending is counted, there would be double-counted products in the value of net output and the true value of output would be over-calculated.
Question 6: Challenges in accounting for aggregate output:
Inputting Output:
- How to count for new goods and services that were unsold in the formal economy or that were unpriced in the market. The challenge to count the value of unsold goods such as home-made clothes, unpaid household work and unpriced services like free bank services remains the most difficult challenge that each country faces in calculating their GDP.
- How to count the value of the informal economy. If a country has a big informal economy like Colombia, GDP would be under-calculated if this country ignores the informal economic sector.
- How to count the value of barter if the country still has barter systems.
- How to measure the quality of goods produced. The quality of goods is not fully reflected on the price.
Natural Resources:
- How and what to count the value and depletion of natural resources. Even though UN has provided guidance on how to estimate the annual value of natural resources used, this calculation remains inaccurate since natural resources are what we might not be able to measure accurately.
Question 7: Factors that should be considered:
- The value of non-tradable, un-owned aspects of the environment such as clean air, clean water and climate
- The value of non-market economy of household and community
- The value of informal economy
- Unpriced social cost associated with production such as pollution and environmental degradation
Question 8: Reasons for the importance of the traditional GDP: The traditional GDP suggested by Keynes reflects the relationship between employment, quantity of money, interest rate and aggregate expenditures. Therefore it is:
- An essential tool for analyzing and assessing the state of a nation’s economy.
- A valuable metric for short-term macroeconomic planning because the government can use fiscal and monetary policies to push or cool down the economy.
- An essential tool for formulating macroeconomic stabilization policies.
- An important indicator of the economic growth and potential for investors.
Question 9: Arguments for the environmental accounting:
- Economic growth must be sustainable, growth together with environmental protection.
- Sustainable growth is needed to ensure that our younger generations could have living standards at least as high as those of current generations.
- GDP will provide a more complete overview of economic performance and living standards than GDP without concerning about environmental matters.
- The value of output in environmental accounting (NNG) would be a better indicator of sustainable social well-being than traditional GDP.
- NNG would help policy makers make better decisions in planning the economic growth strategies for a nation.
Question 10: Reasons for “A higher GDP is not necessary mean a higher measure of welfare”:
- GDP might be over or under calculated, depending on the methods of collecting and interpreting data.
- GDP ignores the value of non-market economy of household and community such as recreation, intellectual capital, education…
- GDP treats depletion of natural resources, pollution, environment degradation, disasters as income because it measures expenses on those areas as economic gains.
- GDP takes no account for income distribution.
- GDP ignores the drawbacks of borrowing money from other countries.
Thursday, April 13, 2006
Business Policy
ANALYZING A CASE STUDY TO FORM CORPORATE STRATEGY INTENT
As just mentioned, the purpose of the case study is to let you apply the concepts you've learned when you analyze the issues facing a specific company. To analyze a case study, therefore, you must examine closely the issues with which the company is confronted. Most often you will need to read the case several times - once to grasp the overall picture of what is happening to the company and then several times more to discover and grasp the specific problems.
Generally, detailed analysis of a case study should include eight areas:
As just mentioned, the purpose of the case study is to let you apply the concepts you've learned when you analyze the issues facing a specific company. To analyze a case study, therefore, you must examine closely the issues with which the company is confronted. Most often you will need to read the case several times - once to grasp the overall picture of what is happening to the company and then several times more to discover and grasp the specific problems.
Generally, detailed analysis of a case study should include eight areas:
The history, development, and growth of the company over time
The identification of the company's internal strengths and weaknesses
The nature of the external environment surrounding the company
A SWOT analysis
The kind of corporate-level strategy pursued by the company
The nature of the company's business-level strategy
The company's structure and control systems and how they match its strategy
Recommendations
To analyze a case, you need to apply what you've learned to each of these areas. We offer a summary of the steps you can take to analyze the case material for each of the eight points we just noted.
1. Analyze the company's history, development, and growth. A convenient way to investigate how a company's past strategy and structure affect it in the present is to chart the critical incidents in its history - that is, the events that were the most unusual or the most essential for its development into the company it is today. Some of the events have to do with its founding, its initial products, how it makes new-product market decisions, and how it developed and chose functional competencies to pursue. Its entry into new businesses and shifts in its main lines of business are also important milestones to consider.
2. Identify the company's internal strengths and weaknesses. Once the historical profile is completed, you can begin the SWOT analysis. Use all the incidents you have charted to develop an account of the company's strengths and weaknesses as they have emerged historically. Examine each of the value creation functions of the company, and identify the functions in which the company is currently strong and currently weak. Some companies might be weak in marketing; some might be strong in research and development. Make lists of these strengths and weaknesses. The SWOT checklist gives examples of what might go in these lists.
3. Analyze the external environment. The next step is to identify environmental opportunities and threats. Here you should apply all information you have learned on industry and macroenvironments, to analyze the environment the company is confronting. Of particular importance at the industry level is Porter's five forces model and the stage of the life cycle model. Which factors in the macroenvironment will appear salient depends on the specific company being analyzed. However, use each factor in turn (for instance, demographic factors) to see whether it is relevant for the company in question.
Having done this analysis, you will have generated both an analysis of the company's environment and a list of opportunities and threats. The SWOT checklist lists some common environmental opportunities and threats that you may look for, but the list you generate will be specific to your company.
4. Evaluate the SWOT analysis. Having identified the company's external opportunities and threats as well as its internal strengths and weaknesses, you need to consider what your findings mean. That is, you need to balance strengths and weaknesses against opportunities and threats. Is the company in an overall strong competitive position? Can it continue to pursue its current business- or corporate-level strategy profitably? What can the company do to turn weaknesses into strengths and threats into opportunities? Can it develop new functional, business, or corporate strategies to accomplish this change? Never merely generate the SWOT analysis and then put it aside. Because it provides a succinct summary of the company's condition, a good SWOT analysis is the key to all the analyses that follow.
5. Analyze corporate-level strategy. To analyze a company's corporate-level strategy, you first need to define the company's mission and goals. Sometimes the mission and goals are stated explicitly in the case; at other times you will have to infer them from available information. The information you need to collect to find out the company's corporate strategy includes such factors as its line(s) of business and the nature of its subsidiaries and acquisitions. It is important to analyze the relationship among the company's businesses. Do they trade or exchange resources? Are there gains to be achieved from synergy? Alternatively, is the company just running a portfolio of investments? This analysis should enable you to define the corporate strategy that the company is pursuing (for example, related or unrelated diversification, or a combination of both) and to conclude whether the company operates in just one core business. Then, using your SWOT analysis, debate the merits of this strategy. Is it appropriate, given the environment the company is in? Could a change in corporate strategy provide the company with new opportunities or transform a weakness into a strength? For example, should the company diversify from its core business into new businesses?
Other issues should be considered as well. How and why has the company's strategy changed over time? What is the claimed rationale for any changes? Often it is a good idea to analyze the company's businesses or products to assess its situation and identify which divisions contribute the most to or detract from its competitive advantage. It is also useful to explore how the company has built its portfolio over time. Did it acquire new businesses, or did it internally venture its own? All these factors provide clues about the company and indicate ways of improving its future performance.
6. Analyze business-level strategy. Once you know the company's corporate-level strategy and have done the SWOT analysis, the next step is to identify the company's business-level strategy. If the company is a single-business company, its business-level strategy is identical to its corporate-level strategy. If the company is in many businesses, each business will have its own business-level strategy. You will need to identify the company's generic competitive strategy - differentiation, low cost, or focus - and its investment strategy, given the company's relative competitive position and the stage of the life cycle. The company also may market different products using different business-level strategies. For example, it may offer a low-cost product range and a line of differentiated products. Be sure to give a full account of a company's business-level strategy to show how it competes.
Identifying the functional strategies that a company pursues to build competitive advantage through superior efficiency, quality, innovation, and customer responsiveness and to achieve its business-level strategy is very important. The SWOT analysis will have provided you with information on the company's functional competencies. You should further investigate its production, marketing, or research and development strategy to gain a picture of where the company is going. For example, pursuing a low-cost or a differentiation strategy successfully requires a very different set of competencies. Has the company developed the right ones? If it has, how can it exploit them further? Can it pursue both a low-cost and a differentiation strategy simultaneously?
The SWOT analysis is especially important at this point if the industry analysis, particularly Porter's model, has revealed the threats to the company from the environment. Can the company deal with these threats? How should it change its business-level strategy to counter them? To evaluate the potential of a company's business-level strategy, you must first perform a thorough SWOT analysis that captures the essence of its problems.
Once you complete this analysis, you will have a full picture of the way the company is operating and be in a position to evaluate the potential of its strategy. Thus, you will be able to make recommendations concerning the pattern of its future actions. However, first you need to consider strategy implementation, or the way the company tries to achieve its strategy.
7. Analyze structure and control systems. The aim of this analysis is to identify what structure and control systems the company is using to implement its strategy and to evaluate whether that structure is the appropriate one for the company. Different corporate and business strategies require different structures. For example, does the company have the right level of vertical differentiation (for instance, does it have the appropriate number of levels in the hierarchy or decentralized control?) or horizontal differentiation (does it use a functional structure when it should be using a product structure?)? Similarly, is the company using the right integration or control systems to manage its operations? Are managers being appropriately rewarded? Are the right rewards in place for encouraging cooperation among divisions? These are all issues that should be considered.
In some cases there will be little information on these issues, whereas in others there will be a lot. Obviously, in analyzing each case you should gear the analysis toward its most salient issues. For example, organizational conflict, power, and politics will be important issues for some companies. Try to analyze why problems in these areas are occurring. Do they occur because of bad strategy formulation or because of bad strategy implementation?
Organizational change is an issue in many cases because the companies are attempting to alter their strategies or structures to solve strategic problems. Thus, as a part of the analysis, you might suggest an action plan that the company in question could use to achieve its goals. For example, you might list in a logical sequence the steps the company would need to follow to alter its business-level strategy from differentiation to focus.
8. Make recommendations. The last part of the case analysis process involves making recommendations based on your analysis. Obviously, the quality of your recommendations is a direct result of the thoroughness with which you prepared the case analysis. The work you put into the case analysis will be obvious to the professor from the nature of your recommendations. Recommendations are directed at solving whatever strategic problem the company is facing and at increasing its future profitability. Your recommendations should be in line with your analysis; that is, they should follow logically from the previous discussion. For example, your recommendation generally will center on the specific ways of changing functional, business, and corporate strategy and organizational structure and control to improve business performance. The set of recommendations will be specific to each case, and so it is difficult to discuss these recommendations here. Such recommendations might include an increase in spending on specific research and development projects, the divesting of certain businesses, a change from a strategy of unrelated to related diversification, an increase in the level of integration among divisions by using task forces and teams, or a move to a different kind of structure to implement a new business-level strategy. Again, make sure your recommendations are mutually consistent and are written in the form of an action plan. The plan might contain a timetable that sequences the actions for changing the company's strategy and a description of how changes at the corporate level will necessitate changes at the business level and subsequently at the functional level.
After following all these stages, you will have performed a thorough analysis of the case and will be in a position to join in class discussion or present your ideas to the class, depending on the format used by your professor. Remember that you must tailor your analysis to suit the specific issue discussed in your case. In some cases, you might completely omit one of the steps in the analysis because it is not relevant to the situation you are considering. You must be sensitive to the needs of the case and not apply the framework we have discussed in this section blindly. The framework is meant only as a guide and not as an outline that you must use to do a successful analysis.
CONCLUSION
When evaluating a case, it is important to be systematic. Analyze the case in a logical fashion, beginning with the identification of operating and financial strengths and weaknesses and environmental opportunities and threats. Move on to assess the value of a company's current strategies only when you are fully conversant with the SWOT analysis of the company. Ask yourself whether the company's current strategies make sense, given its SWOT analysis. If they do not, what changes need to be made? What are your recommendations? Above all, link any strategic recommendations you may make to the SWOT analysis. State explicitly how the strategies you identify take advantage of the company's strengths to exploit environmental opportunities, how they rectify the company's weaknesses, and how they counter environmental threats. Also, do not forget to outline what needs to be done to implement your recommendations
THE ROLE OF FINANCIAL ANALYSIS
Profit Ratios
Profit ratios measure the efficiency with which the company uses its resources. The more efficient the company, the greater is its profitability. It is useful to compare a company's profitability against that of its major competitors in its industry. Such a comparison tells whether the company is operating more or less efficiently than its rivals. In addition, the change in a company's profit ratios over time tells whether its performance is improving or declining. A number of different profit ratios can be used, and each of them measures a different aspect of a company's performance. The most commonly used profit ratios are gross profit margin, net profit margin, return on total assets, and return on stockholders' equity.
Gross profit margin. The gross profit margin simply gives the percentage of sales available to cover general and administrative expenses and other operating costs. It is defined as follows:
Gross Profit Margin
=
(Sales Revenue - Cost of Goods Sold)/Sales Revenue
Net profit margin. Net profit margin is the percentage of profit earned on sales. This ratio is important because businesses need to make a profit to survive in the long run. It is defined as follows:
Net Profit Margin=Net Income/Sales Revenue
Return on total assets. This ratio measures the profit earned on the employment of assets. It is defined as follows:
Return on Total Assets=Net Income Available to Common Stockholders/Total Assets
Net income is the profit after preferred dividends (those set by contract) have been paid. Total assets include both current and noncurrent assets.
Return on stockholders' equity. This ratio measures the percentage of profit earned on common stockholders' investment in the company. In theory, a company attempting to maximize the wealth of it stockholders should be trying to maximize this ratio. It is defined as follows:
Return on Stockholders' Equity
=
Net Income Available to Common Stockholders/Stockholders' Equity
Liquidity Ratios
A company's liquidity is a measure of its ability to meet short-term obligations. An asset is deemed liquid if it can be readily converted into cash. Liquid assets are current assets such as cash, marketable securities, accounts receivable, and so on. Two commonly used liquidity ratios are current ratio and quick ratio.
Current ratio. The current ratio measures the extent to which the claims of short-term creditors are covered by assets that can be quickly converted into cash. Most companies should have a ratio of at least 1, because failure to meet these commitments can lead to bankruptcy. The ratio is defined as follows:
Current Ratio
=
Current Assets/Current Liabilities
Quick ratio. The quick ratio measures a company's ability to pay off the claims of short-term creditors without relying on the sale of its inventories. This is a valuable measure since in practice the sale of inventories is often difficult. It is defined as follows:
Quick Ratio
=
(Current Assets - Inventory)/Current Liabilities
Activity Ratios
Activity ratios indicate how effectively a company is managing its assets. Inventory turnover and days sales outstanding (DSO) are particularly useful:
Inventory turnover. This measures the number of times inventory is turned over. It is useful in determining whether a firm is carrying excess stock in inventory. It is defined as follows:
Inventory Turnover
=
Cost of Goods Sold/Inventory
Cost of goods sold is a better measure of turnover than sales, since it is the cost of the inventory items. Inventory is taken at the balance sheet date. Some companies choose to compute an average inventory, beginning inventory, plus ending inventory, but for simplicity use the inventory at the balance sheet date.
Days sales outstanding (DSO), or average collection period. This ratio is the average time a company has to wait to receive its cash after making a sale. It measures how effective the company's credit, billing, and collection procedures are. It is defined as follows:
DSO=Accounts Receivable/Total Sales/360
Accounts receivable is divided by average daily sales. The use of 360 is standard number of days for most financial analysis.
Leverage Ratios
A company is said to be highly leveraged if it uses more debt than equity, including stock and retained earnings. The balance between debt and equity is called the capital structure. The optimal capital structure is determined by the individual company. Debt has a lower cost because creditors take less risk; they know they will get their interest and principal. However, debt can be risky to the firm because if enough profit is not made to cover the interest and principal payments, bankruptcy can occur.
Three commonly used leverage ratios are debt-to-assets ratio, debt-to-equity ratio, and times-covered ratio.
Debt-to-assets ratio. The debt-to-asset ratio is the most direct measure of the extent to which borrowed funds have been used to finance a company's investments. It is defined as follows:
Debt-to-Assets Ratio=Total Debt/Total Assets
Total debt is the sum of a company's current liabilities and its long-term debt, and total assets are the sum of fixed assets and current assets.
Debt-to-equity ratio. The debt-to-equity ratio indicates the balance between debt and equity in a company's capital structure. This is perhaps the most widely used measure of a company's leverage. It is defined as follows:
Debt-to-Equity Ratio=Total Debt/Total Equity
Times-covered ratio. The times-covered ratio measures the extent to which a company's gross profit covers its annual interest payments. If the times-covered ratio declines to less than 1, then the company is unable to meet its interest costs and is technically insolvent. The ratio is defined as follows:
Times-Covered Ratio
=
Profit Before Interest and Tax/Total Interest Charges
Shareholder-Return
Ratios Shareholder-return ratios measure the return earned by shareholders from holding stock in the company. Given the goal of maximizing stockholders' wealth, providing shareholders with an adequate rate of return is a primary objective of most companies. As with profit ratios, it can be helpful to compare a company's shareholder returns against those of similar companies. This provides a yardstick for determining how well the company is satisfying the demands of this particularly important group of organizational constituents. Four commonly used ratios are total shareholder returns, price-earnings ratio, market to book value, and dividend yield.
Total shareholder returns. Total shareholder returns measure the returns earned by time t + 1 on an investment in a company's stock made at time t. (Time t is the time at which the initial investment is made.) Total shareholder returns include both dividend payments and appreciation in the value of the stock (adjusted for stock splits) and are defined as follows:
Total Shareholder Returns=(Stock Price (t + 1) - Stock Price (t) + Sum of Annual Dividends per Share)/Stock Price (t)
Thus, if a shareholder invests $2 at time t, and at time t + 1 the share is worth $3, while the sum of annual dividends for the period t to t + 1 has amounted to $0.2, total shareholder returns are equal to (3 - 2 + 0.2)/2 = 0.6, which is a 60 percent return on an initial investment of $2 made at time t.
Price-earnings ratio. The price-earnings ratio measures the amount investors are willing to pay per dollar of profit. It is defined as follows:
Price-Earnings Ratio=Market Price per Share/Earnings per Share
Market to book value. Another useful ratio is market to book value. This measures a company's expected future growth prospects. It is defined as follows:
Market to Book Value=Market Price per Share/Earnings per Share
Dividend yield. The dividend yield measures the return to shareholders received in the form of dividends. It is defined as follows:
Dividend Yield=Dividend per Share/Market Price per Share
Market price per share can be calculated for the first of the year, in which case the dividend yield refers to the return on an investment made at the beginning of the year. Alternatively, the average share price over the year may be used. A company must decide how much of its profits to pay to stockholders and how much to reinvest in the company. Companies with strong growth prospects should have a lower dividend payout ratio than mature companies. The rationale is that shareholders can invest the money elsewhere if the company is not growing. The optimal ratio depends on the individual firm, but the key decider is whether the company can produce better returns than the investor can earn elsewhere.
Cash Flow Cash flow position is simply cash received minus cash distributed. The net cash flow can be taken from a company's statement of cash flows. Cash flow is important for what it tells us about a company's financing needs. A strong positive cash flow enables a company to fund future investments without having to borrow money from bankers or investors. This is desirable because the company avoids the need to pay out interest or dividends. A weak or negative cash flow means that a company has to turn to external sources to fund future investments. Generally, companies in strong-growth industries often find themselves in a poor cash flow position (because their investment needs are substantial), whereas successful companies based in mature industries generally find themselves in a strong cash flow position.
A company's internally generated cash flow is calculated by adding back its depreciation provision to profits after interest, taxes, and dividend payments. If this figure is insufficient to cover proposed new-investment expenditures, the company has little choice but to borrow funds to make up the shortfall or to curtail investments. If this figure exceeds proposed new investments, the company can use the excess to build up its liquidity (that is, through investments in financial assets) or to repay existing loans ahead of schedule.
WHAT IS CASE STUDY ANALYSIS?
A case study presents an account of what happened to a business or industry over a number of years. It chronicles the events that managers had to deal with, such as changes in the competitive environment, and charts the managers' response, which usually involved changing the business- or corporate-level strategy.
Cases prove valuable in a course for several reasons. First, cases provide you, the student, with experience of organizational problems that you probably have not had the opportunity to experience firsthand. In a relatively short period of time, you will have the chance to appreciate and analyze the problems faced by many different companies and to understand how managers tried to deal with them.
Second, cases illustrate what you have learned. The meaning and implication of this information are made clearer when they are applied to case studies. The theory and concepts help reveal what is going on in the companies studied and allow you to evaluate the solutions that specify companies adopted to deal with their problems. Consequently, when you analyze cases, you will be like a detective who, with a set of conceptual tools, probes what happened and what or who was responsible and then marshals the evidence that provides the solution. Top managers enjoy the thrill of testing their problem-solving abilities in the real world. It is important to remember, after all, that no one knows what the right answer is. All that managers can do is to make the best guess. In fact, managers say repeatedly that they are happy if they are right only half the time in solving strategic problems. Management is an uncertain game, and using cases to see how theory can be put into practice is one way of improving your skills of diagnostic investigation.
Third, case studies provide you with the opportunity to participate in class and to gain experience in presenting your ideas to others. Instructors may sometimes call on students as a group to identify what is going on in a case, and through classroom discussion the issues in and solutions to the case problem will reveal themselves. In such a situation, you will have to organize your views and conclusions so that you can present them to the class. Your classmates may have analyzed the issues differently from you, and they will want you to argue your points before they will accept your conclusions; so be prepared for debate. This is how decisions are made in the actual business world.
Instructors also may assign an individual, but more commonly a group, to analyze the case before the whole class. The individual or group probably will be responsible for a thirty- to forty-minute presentation of the case to the class. That presentation must cover the issues involved, the problems facing the company, and a series of recommendations for resolving the problems. The discussion then will be thrown open to the class, and you will have to defend your ideas. Through such discussions and presentations, you will experience how to convey your ideas effectively to others. Remember that a great deal of managers' time is spent in these kinds of situations, presenting their ideas and engaging in discussion with other managers, who have their own views about what is going on. Thus, you will experience in the classroom the actual process of what goes on in a business setting, and this will serve you well in your future career.
If you work in groups to analyze case studies, you also will learn about the group process involved in working as a team. When people work in groups, it is often difficult to schedule time and allocate responsibility for the case analysis. There are always group members who shirk their responsibilities and group members who are so sure of their own ideas that they try to dominate the group's analysis. Most business negotiations take place in groups, however, and it is best if you learn about these problems now.
WRITING A CASE STUDY ANALYSIS
Often, as part of your course requirements, you will need to present your instructor with a written case analysis. This may be an individual or a group report. Whatever the situation, there are certain guidelines to follow in writing a case analysis that will improve the evaluation your work will receive from your instructor. Before we discuss these guidelines and before you use them, make sure that they do not conflict with any directions your instructor has given you.
The structure of your written report is critical. Generally, if you follow the steps for analysis discussed in the previous section, you already will have a good structure for your written discussion. All reports begin with an introduction to the case. In it you outline briefly what the company does, how it developed historically, what problems it is experiencing, and how you are going to approach the issues in the case write-up. Do this sequentially by writing, for example, "First, we discuss the environment of Company X...Third, we discuss Company X's business-level strategy... Last, we provide recommendations for turning around Company X's business."
In the second part of the case write-up, the strategic-analysis section, do the SWOT analysis, analyze and discuss the nature and problems of the company's business-level and corporate strategy, and then analyze its structure and control systems. Make sure you use plenty of headings and subheadings to structure your analysis. For example, have separate sections on any important conceptual tool you use. Thus, you might have a section on Porter's five forces model as part of your analysis of the environment. You might offer a separate section on portfolio techniques when analyzing a company's corporate strategy. Tailor the sections and subsections to the specific issues of importance in the case.
In the third part of the case write-up, present your solutions and recommendations. Be comprehensive, and make sure they are in line with the previous analysis so that the recommendations fit together and move logically from one to the next. The recommedations section is very revealing because, as mentioned earlier, your instructor will have a good idea of how much work you put into the case from the quality of your recommendations.
Following this framework will provide a good structure for most written reports, though obviously it must be shaped to fit the individual case being considered. Some cases are about excellent companies experiencing no problems. In such instances, it is hard to write recommendations. Instead, you can focus on analyzing why the company is doing so well, using that analysis to structure the discussion. Following are some minor suggestions that can help make a good analysis even better.
Do not repeat in summary form large pieces of factual information from the case. The instructor has read the case and knows what is going on. Rather, use the information in the case to illustrate your statements, to defend your arguments, or to make salient points. Beyond the brief introduction to the company, you must avoid being descriptive; instead, you must be analytical.
Make sure the sections and subsections of your discussion flow logically and smoothly from one to the next. That is, try to build on what has gone before so that the analysis of the case study moves toward a climax. This is particularly important for group analysis, because there is a tendency for people in a group to split up the work and say, "I'll do the beginning, you take the middle, and I'll do the end." The result is a choppy, stilted analysis because the parts do not flow from one to the next, and it is obvious to the instructor that no real group work has been done.
Avoid grammatical and spelling errors. They make the paper sloppy.
In some instances, cases dealing with well-known companies don't include up-to-date research because it was not available at the time the case was written. If possible, do a search for more information on what has happened to the company in subsequent years. Following are sources of information for performing this search:
The World Wide Web is the place to start your research. Very often you can download copies of a company's annual report from its Web site, and many companies also keep lists of press releases and articles that have been written about them. Thoroughly search the company's Web site for information such as the company's history and performance, and download all relevant information at the beginning of your project.
Compact disk sources such as Lotus One Source and InfoTrac provide an amazing amount of good information, including summaries of recent articles written on specific companies that you can then access in the library.
F&S Predicasts provide a listing on a yearly basis of all the articles written about a particular company. Simply reading the titles gives an indication of what has been happening in the company.
Annual reports on a Form 10-K often provide an organization chart.
Companies themselves provide information if you write and ask for it.
Fortune, BusinessWeek, and Forbes have many articles on companies featured in most cases.
Standard & Poor's industry reports provide detailed information about the competitive conditions facing the company's industry. Be sure to look at this journal.
Sometimes instructors hand out questions for each case to help you in your analysis. Use these as a guide for writing the case analysis. They often illuminate the important issues that have to be covered in the discussion.
If you follow the guidelines in this section, you should be able to write a thorough and effective evaluation.
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