????????? Competitive Strategies and Financial Performance -- An Application to Medical Service Industry

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????????? Competitive Strategies and Financial
Performance-- An Application to Medical Service
Industry

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The Du Pont System
ROE NI / Equity (managers goal)
ROA NI /TA (operating strategies)
Leverage ratio TA / E (1 D/E) (Financial
strategy)

Asset turnover Sales / TA (Low cost leadership)
Profit margin NI / Sales (product
differentiation)

NI Net Income, TA total Assets, D Debt, E
Equity
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The Du Pont System

• Firm pursues highest shareholders wealth (ROE).
• Firm needs to do good in both operating strategy
  (good ROA) and financial strategy. (leverage)
• Usually Profitability and Asset Turnover have a
  negative relation.
• High profitability shows a firms ability in
  product differentiation. (product differentiation
  advantage)
• High asset turnover reflect a firms ability in
  asset efficiency. A high TO firm tends to be
  able to lower its cost and increase demand. (low
  cost leadership)

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product differentiation
Profitability
Low cost leadership
Asset Turnover
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A Model of Competitive Advantage
Resources
Resources
Distinctive competences
Cost advantage Or Differentiation
Value Creation
Capabilities
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Competitive Advantage

• A competitive advantage exists when an
  organization is able to deliver the same benefit
  as competitors, but at a lower cost (cost
  advantage) or deliver benefits that exceed those
  of competing products. (differentiation
  advantage)

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• Resources are the firm specific assets useful for
  creating a cost or differentiation advantage.
• Patent and trademark, propriety know-how
• Installed customer base
• Reputation and brand equity

• Capabilities refers to the firms ability to
  utilize its resources effectively.

• The firms resources and capabilities together
  form its distinctive competences. These
  competences enable innovation, efficiency,
  quality, and customers responsiveness.

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How to improve operating performance?Improve
profit margin (product differentiation)

• Differentiation A firm enjoys superior return
  only if the price premium leading to its
  differentiation exceeds the extra cost of being
  unique.
• Good brand name, utilize the core competence of
  the organization. (specialized medical areas)
• First-mover advantage. The leader of the
  industry usually owns highest margin. Foresee the
  trend of customers needs. (old age care, nursing
  home)
• Value added. Identify which specialty will lead
  to most value added to the organization. (skin
  care, health management)
• Customers loyalty, usually good service leads to
  Good customers satisfaction. (customer referrals
  are important in medical service industry)

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Product Differentiation
Commonly required skills and resources Common organizational requirements
Strong marketing abilities Strong RD functions coordination
Long tradition in unique combination of skills drawn from other business. Subjective measurement and incentives instead of quantitative measures
Corporate reputation for quality leadership Amenities to attract highly skilled labor, scientists, or creative people.
Strong capability in basic research
Creative flair
Product engineering
Strong channels cooperation
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Structural Analysis of Industry Competition
Potential Entrants
Industry Competitors Rivalry Among
Existing Competitors
Customer Bargaining Power
Supplier Bargaining Power
Potential Substitutes
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Profit margin NI / Sales (product
differentiation)
Asset turnover Sales / TA (Low cost leadership)

• Usually, the profit margin will decrease over
  time due to increase in competition.
• The firm then can seek to increase asset
  turnover, to compensate the loss in margin, in
  order to maintain a good ROA.
• This increase in asset turnover need to be done
  while firm still has advantage in margin.

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How to improve operating performance?Improve
asset turnover Sales / TA

• Low cost leadership if a firm maintains cost
  advantage, and command the prices around
  industry, can achieve a high profit margin, and
  hence higher rate of return.
• Usually firms will lower price and pursue market
  share growth in order to maximize profit.
  (increase turnover)
• Provide cost efficient new products, and increase
  customer use per unit of time.
• Decrease assets invested.
• Reduce inventory (via efficient supply chain)
• Reduce idle assets
• Increase efficient use of current assets.
• Better use of human resource and facilities
• Increase service channels.

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Low Cost Leadership
Commonly required skills and resources Common organizational requirements
Substantial capital investment and access of capital Tight cost control
Process engineering skills Frequent detailed control report
Intense supervision of labor Structured organization and responsibility
Product designed for ease in manufacture Incentive based on meeting quantity targets
Low-cost distribution system
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Financial strategy-- Why use debt?

• What is good in using debt -- If the asset return
  is greater than the cost of debt, then the higher
  debt ratio, the higher ROE
• ROE ROA (ROA Cost of Debt) x Financial
  Leverage
• What is bad in using debt -- Use of debt
  increases the volatility in ROE (and EPS), and
  also bankruptcy risk.
• Usually when economy is good, a levered firms
  equity would have better return (than it is
  un-levered) otherwise when economy is poor, a
  levered firms equity would have poorer return
  (than it is un-levered).

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Assets Debt and Equity
Assets (100) (ROA 20) Debt (50) Cost of Debt 10
Assets (100) (ROA 20) Equity (50) Return on Equity 30
Assets Debt and Equity
Assets (100) (ROA 20) Debt (75) Cost of Debt 10
Assets (100) (ROA 20) Equity (25) Return on Equity 50
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Un-levered (Equity 175,000) 50 debt (debt 87,5000, Kd10, Equity 87,500) 50 debt (debt 87,5000, Kd10, Equity 87,500)
If Expected EBIT is 35,000 (before tax ROA 20) If Expected EBIT is 35,000 (before tax ROA 20) If Expected EBIT is 35,000 (before tax ROA 20) If Expected EBIT is 35,000 (before tax ROA 20) If Expected EBIT is 35,000 (before tax ROA 20)
Expected EBIT 35,000 35,000 35,000 35,000
Interest Exp. 0 0 0 8,750
Profit before Taxes 35,000 35,000 35,000 26,250
Income Taxes (40) 14,000 14,000 14,000 10,500
Profit after Taxes 21,000 21,000 21,000 15,750
Expected ROE 21,000/175,00012 21,000/175,00012 21,000/175,00012 15,750/87,50018
If the actual EBIT is ONLY 5,000 (before tax ROA 2.86) If the actual EBIT is ONLY 5,000 (before tax ROA 2.86) If the actual EBIT is ONLY 5,000 (before tax ROA 2.86) If the actual EBIT is ONLY 5,000 (before tax ROA 2.86) If the actual EBIT is ONLY 5,000 (before tax ROA 2.86)
Actual EBIT Actual EBIT 5,000 5,000 5,000
Interest Exp. Interest Exp. 0 0 8,750
Profit before Taxes Profit before Taxes 5,000 5,000 (3,750)
Income Taxes (40) Income Taxes (40) 2,000 2,000 1,500
Profit after Taxes Profit after Taxes 3,000 3,000 (2,250)
Actual ROE Actual ROE 3,000/175,0001.7 3,000/175,0001.7 (2,250)/87,500-2.6
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Financial Leverage and EPS
12.00
Debt
10.00
8.00
No Debt
Advantage to debt
6.00
Break-even point
EPS
4.00
Disadvantage to debt
2.00
0.00
1,000
2,000
3,000
EBIT in dollars, no taxes
(2.00)
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A good financial strategy should be integrated
with operating environment (risk)

• Firms with high operating risk, tend to adopt
  less financial risk financing (equity financing
  dominant) alternatives, to avoid high interest
  payment.
• Firms with low operating risk, tend to adopt more
  financial risk financing (debt financing
  dominant) alternatives, to increase ROE.

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SWOT analysis

• Strength factors that give the firm a
  comparative advantage in the market place. Such
  as customer loyalty, innovative RD, market
  leadership, or strong financial resources.
• Weakness when competitors have potentially
  exploitable advantage over the firm.
• Opportunities environmental factors that favor
  the firm, include a growing market for the forms
  products the exit of a competitor
  identification of a new market or product
  segment.
• Threats are environmental factors that can
  hinder the firm in achieving its goals. Such as
  a slowing domestic economy an increase in
  industry competition threats of entry buyers
  and suppliers seek to increase their bargaining
  power or new technology that can hurts this
  industry.

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SWOT analysis
Strategies Strategies External Environment External Environment
Strategies Strategies Opportunities Threats
Internal Abilities Strength Aggressive Expansion Diversify or Respond
Internal Abilities Weakness Turnaround Plan Rebuild or Exit
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Future Trends for Health Care Management

• Differentiations are usually resulted from unique
  combination with other industries
• Engineering nano-materials
• Information technology
• Business develop health care products
• Service industry Old age care, counseling
• Focus every hospital should develop its own core
  competence (specialized areas)
• Value creation identify, manage, and execute
• Spot the trend every societal change would lead
  to new demand in medical service.
• Find where your clients are, dont just wait for
  them!