T11

Task 11

Corporate failure

Predicting business failure

Assessment of prediction model

Performance improvement strategy

Exam focus point

Section A or B

Article: Business failure

1. Predicting business failure

Corporate decline arises from the decline in the industry and

from poor management.

Causes of business failure:

1.Human causes

2.Internal and external causes

3.Structural causes

4.Financial causes

1. Predicting business failure

Symptoms of business decline:

Quantitative models

Z-scores

Z-scores

The lower a firms score, the greater likelihood there is of it

going bankrupt.

Z-score>3.0: financially sound and relatively safe; Z-score

Qualitative model: Argentis A score

Argentis A score

Argentis A score

The higher a firms score the greater the likelihood of it failing

and going bankrupt.

A score>25: at risk (35-70); 0

Dec 2012: 4

Other information

Other information

Information in chairmans report, directors report and audit report.

Information in press Credit ratings Published information about environment or external

matters: new legislation, international events, new and

better product, rise in interest rate, change in foreign

exchange rates.

2. Assessment of prediction models

Weaknesses of using financial information to predict:

(a) Significant events can take place between the end of the

financial year and the publication of the accounts.

(b) The information is essentially backward looking and takes

no account of current and future situations.

(c) The underlying financial information may not be reliable.

The use of creative, or even fraudulent, accounting can be

significant in situations of corporate failure. Similarly, the

pressure to deliver earnings growth (and therefore short-term

results) may result in companies making poor decisions that

eventually lead to their downfall.

Value of Z-scores

Advantages of qualitative models

Disadvantages of qualitative models

Other corporate models

3. Performance improvement strategy

Gap analysis

Forecasts based on current performance may reveal a gap

between the firm's objectives and the likely outcomes.

New strategies (eg market penetration, market development,

product development, diversification, withdrawal) are

developed to fill the gap.

Gap analysis

Gap analysis involves comparing an organisation's ultimate

objective (most commonly expressed in terms of demand, but

may be reported in terms of profit, ROCE and so on) and the

expected performance of planned and current projects.

(a) Determine the organisation's targets for achievement over the planning period

(b) Establish what the organisation would be expected to achieve if it 'did nothing' (did not develop any new

strategies, but simply carried on in the current way with the

same products and selling to the same markets)

This difference is the gap. New strategies will then have to

be developed which will close this gap.

Gap analysis

7: PERFORMANCE HIERARCHY

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Considerations in setting objectives

3.6 Objectives must take into account the attitudes of stakeholders and of the conflicts that

may arise between stakeholder groups.

3.7 Setting financial objectives in multinationals is complex, especially if subsidiaries are to be

compared. Problems include different:

(a) Capital structures

(b) Cost structures

(c) Accounting policies

(d) Government policy

(e) Transfer prices.

4 Gap analysis

Definition

4.1 The comparison between an entitys ultimate objective and the expected performance from projects both planned and under way, identifying means by which any identified difference,

or gap, might be filled.

4.2 Fixed period gap analysis

Objective

eg sales

Objective (F1)

Forecast gap

Forecast (F0)

Time

Gap analysis

Product-market mix: Ansoffs growth vector matrix

Product-market mix is a short-hand term for the

products/services a firm sells (or a service which a public

sector organisation provides) and the markets it sells them

to.

Business strategy and performance

Gap analysis

The Ansoff matrix identifies various options

Market penetration: current products, current markets

Market development: current products, new markets

Product development: new products, current markets

Diversification: new products, new markets

All of these can secure growth (growth strategy).

Gap analysis

Gap analysis

Market penetration

In pursuing a strategy based on market penetration,

management is attempting to sell greater volumes of existing

products into existing markets. This is a low-risk strategy

which is most unlikely to lead to high rates of growth. This

may involve increasing revenue by, for example, promoting

the product or repositioning the brand. However, the product

is not altered in any way and no attempt is made to find any

new customers. The emphasis is solely upon selling more of

the same products to the same customers.

Gap analysis

Market development

In pursuing a strategy based on market development,

management is attempting to sell the existing product range in

a new market. This means that the product remains the same

but it is marketed to a new audience. Exporting the product, or

marketing it in a new region, is an example of a market

development strategy.

Gap analysis

Product development

In pursuing a strategy based on product development,

management is attempting to sell a new product to existing

customers. Efforts are focused on the development and

innovation of new product offerings with which to replace

existing ones. New products are then marketed to existing

customers. This often occurs within the automobile market

where existing models are updated or replaced and then

marketed to existing customers.

Gap analysis

Diversification

Management is attempting to sell completely new products to

new customers. There are two types of diversification

related and unrelated diversification.

Related diversification means that management remains in a market or industry with which it is familiar.

Unrelated diversification occurs where the investing company has neither previous industry nor market

experience.

Gap analysis

The model has little predictive capability. However, in using a

model which focuses on alternative strategic options,

management will be able to assess the level of risk attached to

each potential strategic option. For example, the adoption of a

strategy of market penetration entails the lowest risk, whereas

a strategy based upon diversification has the highest risk

especially when the entry strategy is not based upon the core

competences of the organisation.

Gap analysis

Growth is often an important measure of corporate success. So Ansoffs model can be useful for suggesting how

businesses can achieve growth.

The strategies in the Ansoff matrix are not mutually exclusive. A firm can quite legitimately pursue a

penetration strategy in some of its markets, while aiming to

enter new markets.

Gap analysis

BCG portfolio matrix

The Boston Consulting Group matrix helps the management

of an organisation assess its products, services and strategic

business units in terms of their market potential. This is

measured in terms of market share and market growth and

can therefore suggest the attractiveness of entering or

remaining in an industry or sector.

The matrix allows a company to assess the balance and development of its portfolio of products or business units.


Analysis can take place at two levels

(a) Product/service level: the brands or products/services

offered by the firm are examined to determine their current

position and prospects.

(b) Corporate level: the strategic business units of the

diversified firm are examined for their interrelationships and

balance.


Horizontal axis: Relative market share

An organisation should compare its sales from a product or service in a

specified market to the sales earned by the entity with the largest

market share, not the total sales in the market as a whole.


If an organisation is the market leader, it compares its market share to

the entity with the next largest market share.

A relative market share of >1 indicates that a product or strategic

business unit is the market leader, and this is used as the dividing line

between high and low relative market share.


Vertical axis: Market growth.

Measures market growth, not an individual firms growth.

The rate of market growth can often depend on the stage an industry is at

in its life cycle; with new markets often growing rapidly while mature ones

grow hardly at all.

As a guide 10% is often used as a dividing line between high and low

growth.


(a) Stars

Stars are products or business units which have a high relative market

share in a high growth market.

In the short term, stars may require significant investment in excess of the

cash they generate (eg marketing expenditure) in order to maintain their

market position. However, stars promise high returns in the future.


(b) Cash Cows

Over time, as markets become more mature and market growth slows,

stars will become cash cows. (In effect, cash cows are fallen stars).

Cash cows are products or business units with a high market share in a

low growth (mature) market.

They generate more cash than they incur, and finance growth of rising

stars and problem children.(cost control and cash generation )


(c) Question Marks

Question marks are products or business units with a low share

of a high growth market.

In order to convert into star management need to invest large

amount to develop and advertise product.

Risky .

Cash negative.


(d) Dogs

Dogs are products or business units with a low share of a low growth

market.

They too may be a drain on cash, and may use up a disproportionate

amount of a companys time and resources.

Discontinue.


Four strategies:

(a) Build

This involves increasing the market share, even at the expense of short-

term profits. A 'build' strategy might be to turn a question mark into a

star. A penetration pricing policy or investment in stabilising quality

and brand loyalty may be required to turn .


Four strategies:

(b) Hold

This involves preserving market share and ensuring that cash cows

remain cash cows. Additional investment in customer retention through

competitive pricing and marketing may be required.


Four strategies:

(c) Harvest

This involves using funds to promote products which have the

potential to become future stars or to support existing stars.


Four strategies:

(d) Divest

This involves eliminating dogs and question marks which are under

performing.


The suggested strategies for each type of product or business unit are:

(a) Star: Build

(b) Cash cow: Hold, or Harvest if weak.

(c) Question marks: Build (if it seems likely they can increase their market share) or Harvest (if it seems likely they will be squeezed out of the expanding market by rivals)

(d) Dog: Divest, or Hold.


A firm should have a balanced portfolio of products or business units.

It needs enough cash generating products (cash cows) to support the

cash requirements of question marks or stars (which are cash negative

due to the levels of investment they require), and it should have a

minimum of dogs.


Advantages:

Look at their portfolio of products or SBUs as a whole.

Long-term strategic management.

Assessing performance.


Weakness:

Too simplistic in the four classifications used.

A high market share is assumed to indicate competitive strength and lower costs ?

High market growth is deemed to indicate an attractive industry.

Cash is the critical resource for organisations

Market definition

Relationship between divisions and behavioural implication.

Life cycle and survive

The product life cycle model suggests that a product goes through stages launch, growth, maturity and decline

each of which has different financial and operating

characteristics.

In todays competitive environment, the combination of high levels of technological innovation plus increasingly

sophisticated customer demands is leading to the

shortening of product life cycles.

Life cycle and survive

Jun 2011:4

Ten commandments

Turnaround strategy

Crisis stabilisation: reducing cost and increasing revenues.

Management changes

Communication with stakeholders

Attention to target markets

Concentration of effort

Financial restructuring

Prioritisation

Turnaround strategy

The first two stages of the turnaround process clearly identify the need to increase revenues and reduce costs. However, by doing so, they also suggest the need for suitable performance measures and a suitable performance management system to be in place to assess how well these goals are being achieved.

Linking strategy and targets

Accountability

Employees rewards

T11

Documents

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