Overview
An important concept, due to Porter (1985), is called the value chain which is defined from the firm’s business model. This tells you the sequence of activities the company performs so you can see what the firm does; this lets you see where it is weak and where it is strong. For example, think of a bookseller. Given their assets (e.g., the store), the activities will consist of buying books from publishers (procurement), internal operations (receiving the books, putting them on the shelves, paying bills), marketing and sales (advertising, store displays, helping people find books), and customer service (special orders, returns). The activities help you decide what to look for when identifying their business strategy and evaluating their performance.
Financial
statement analysis is a set of techniques to analyze the financial performance
of a company, to assess its strengths and weaknesses, and to compare it to
other firms in the same industry. It
provides information about the past and current performance of a company. It is also used to project the future
performance of a company. It is used by
the company’s managers to improve performance, by analysts who provide recommendations
on the company’s stock, by the company’s creditors who decide whether to lend
money to the company, and by the shareholders of the company who are interested
in the current performance of the company and in whether the company will
continue to be profitable.
A
necessary condition for successful analysis of a company is to first understand
the business. This is summarized by the
company’s business model, which describes how the company creates shareholder
value. For example, a company could
decide to produce cars, computer chips, or operate retail stores. The business model is described in Item 1,
The Business, in a standard 10-K. For example, IBM’s 2011 10-K filing states:
“BUSINESS
MODEL
The company's business model is built
to support two principal goals: helping clients to become more innovative,
efficient and competitive through the application of business insight and IT
solutions; and providing long-term value to shareholders. The business model
has been developed over time through strategic investments in capabilities and
technologies that have superior long-term growth and profitability prospects
based on the value they deliver to clients.
The company's global capabilities
include services, software, systems, fundamental research and related
financing. The broad mix of businesses and capabilities are combined to provide
integrated solutions to the company's clients.
The business model is resilient,
adapting to the continuously changing market and economic environment. The
company continues to divest certain businesses and strengthen its position
through strategic organic investments and acquisitions in higher-value segments
like business analytics, smarter planet and cloud computing. In addition, the
company has transformed itself into a globally integrated enterprise which has
improved overall productivity and is driving investment and expanding
participation in the world's fastest growing markets.
This business model, supported by the
company's financial model, has enabled the company to deliver strong earnings,
cash flows and returns to shareholders over the long term. “
Describing
the Business Model with Porter’s Value Chain
An important concept, due to Porter (1985), is called the value chain which is defined from the firm’s business model. This tells you the sequence of activities the company performs so you can see what the firm does; this lets you see where it is weak and where it is strong. For example, think of a bookseller. Given their assets (e.g., the store), the activities will consist of buying books from publishers (procurement), internal operations (receiving the books, putting them on the shelves, paying bills), marketing and sales (advertising, store displays, helping people find books), and customer service (special orders, returns). The activities help you decide what to look for when identifying their business strategy and evaluating their performance.
In Porter’s original formulation, the value chain was
separated into two types of activities: primary and support activities. Primary Activities were identified by Porter as:
Inbound Logistics, Operations, Outbound Logistics, Sales and
Marketing, and Customer Service
Support
Activities were identified by Porter as:
Procurement, Human
Resource Management, Infrastructure, and Technology Management.
In Valuation Tutor, this “default” value chain is shown as
follows:
You can
see the primary activities in the chart and the support activities below.
The Value Chain and the 10-K
Constructing
a chain for an individual firm requires us to identify the key primary and
secondary activities. Let us do this for
IBM.
Step
1: Locating the Business Model
In
Valuation Tutor, bring up IBM’s 10-K. In
this example, we will use the 2010 10-K, filed in February 2011. Choose IBM as the stock, set the filing date,
click the “Complete Filing” tab, and find “Part 1” of the 10-K from the Quick
Links, and scroll down to Item 1:
The last
part of the first paragraph states: “IBM
solutions typically create value by reducing a client's operational costs or by
enabling new capabilities that generate revenue. These solutions draw from an
industry leading portfolio of consulting, delivery and implementation services,
enterprise software, systems and financing.”
If you
scroll down the report a little bit, you will see:
“Consistent with this strategy IBM is
leveraging its capabilities to build and expand strong positions in targeted
growth areas. IBM's growth initiatives include Smarter Planet, Growth Markets,
Business Analytics and Optimization and Cloud Computing. Each initiative
represents a significant growth opportunity with attractive profit margins for
IBM.”
Step 2: Identifying the Activities
In part
1of the 10-K, the Business Model and Strategy is defined in general terms. A firm’s organization chart on the other hand
provides information about the structure of an organization and the
relationships among its important parts in terms of positions or jobs. As a result, combined an organization chart
and Part 1 of the 10-K provides more comprehensive information about how the
firm is implementing its business model.
In a standard 10K firms typically don’t disclose a detailed organization
chart but they do disclose the job title descriptions of their executive
officers that in turn provide important information about their organization
chart. That is, how the firm has organized
human resources around their business model in order to efficiently implement this
model. We can use this information to
help identify what the firm views as their value adding activities.
A good
starting point therefore, is to first identify how IBM has organized its
activities. After all, if an activity is
an important part of what they do, it is likely that there is someone in charge
of that activity! You can search for terms like “executive officers” by
clicking the “Find on Page” button. This
leads to:
So some
specific titles that help identify the primary activities are:
·
Systems
and Technology
·
Global
Technology Services (GTS)
·
Sales,
Marketing and Strategy
·
Research
and Intellectual Property
·
Global
Business Services
·
GTS
Services Delivery
Now,
let’s put these together with the business model in Part 1. A section is reproduced here, and we have
highlighted terms that match the titles above:
The company’s business model is built to support two
principal goals: helping clients succeed in delivering business value by
becoming more innovative, efficient and competitive through the use of business
insight and IT solutions; and providing long-term value to shareholders. The
business model has been developed over time through strategic investments in
capabilities and technologies that have the best long-term growth and
profitability prospects based on the value they deliver to clients.
The company’s
global capabilities include services,
software, systems, fundamental research and related financing. The
broad mix of businesses and capabilities are combined to provide business
insight and solutions for the company’s clients.
The business
model is resilient, adapting to the continuously changing market and economic
environment. The company continues to divest commoditizing businesses and
strengthen its position through strategic organic investments and acquisitions
in higher-value segments like business
analytics, smarter planet and cloud computing. In addition, the
company has transformed itself into a globally
integrated enterprise which has improved overall productivity and is driving
investment and expanding participation in the world’s fastest growing markets.
Drawing from
the above related information we can identify the following primary activities for
IBM:
1.
Research
and Intellectual Property
2.
Sales,
Marketing and Strategy
3.
Global
Service Project Formation (Technology and Business)
4.
Global
Services Project Operations
5.
Global
Service Projects Delivery
6.
Customer
Relationship Management
This is
depicted in Valuation Tutor below:
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