Dupont Analysis Adapted by P. V. Viswanath with permission from http://marriottschool.net/teacher/swinyard/Retailing/ The Du Pont Identity ROA = NI/ TA ROA = (NI/ Sales)*(Sales / TA) ROA = (Net Profit Margin)*(Asset Turnover) ROE = (NI/Sales)*(Sales/TA)*(TA/TE) = Net Profit Margin*Asset Turnover*Equity Multiplier Net Profit margin is a measure of the firms operating efficiency how well it controls costs Total asset turnover is a measure of the firms asset use efficiency how well it manages its assets Equity multiplier is a measure of the firms financial leverage. Lets first look at the ROA identity a firm could have a high volume/ low margin strategy, which would be reflected in high asset turnover but low profit margins or the reverse. P.V. Viswanath ROE = NI / TE 2 ROA: Turnover vs Margin High Turnover Unattainable High Margin Low Margin Failure
Low Turnover Two of the four segments might be unattainable or undesirable. But how should a manager improve the firms positioning in the other two segments? Illustrations of the Dupont Identity The Dupont identity is fairly well known as an accounting identity. Accountants use it as a model for managerial control and as a basis for firm valuation. However, it can also be the basis for alternative marketing strategies. Let us see how this works, as reflected in the practices of some US corporations. We first look at Provo Bakery and Zales Jewelry, two firms in two different industries. Return on Assets Margin Provo Bakery Zales Jewelry Net Profit X Asset = Turnover Assets 10% 90% X X Return on 9 times = 1 time =
90% 90% Both firms have the same ROA, but different combinations of profit margin and asset turnover. Perhaps the different approaches simply reflects the difference in industries? Lets now look at two firms in the same industry: Tiffany, a jewelry retail firm and Walmart, which is another jewelry retail firm and, according to its website, the worlds largest but quite different. (http://walmartstores.com/sustainability/9137.aspx) Income Statements: Wal-Mart vs Tiffany (2000, in millions) Wal-Mart Tiffany Net sales $ 139,208 $ 1,173 Less: Cost of goods sold $ 515 Gross margin 30,483 $ Less: Interest expense $ 9 $ $ 658 Less: Operating expense
$ 493 Total expense 23,313 $ 108,725 502 $ 22,363 $ 950 $ Net profit, pretax $ * Effective tax rates often differ among corporations due to different tax breaks and advantages. 7,170 $ 156 Less: Taxes* Which has the higher net margin? 2,740 $ 66 Source: Levy & Weitz Tax rate 38.21% 42.31% $ Profit Margin Model: Wal-Mart vs Tiffany (2000, in millions) Net NetSales
margin margin $30,493 $30,493(21.9%) (21.9%) $658 (56.1%) $658 (56.1%) Total Total expenses expenses $23,313 $23,313 $502 $502 Top Number = Wal-Mart Bottom Number = Tiffany Net Netprofit profit before beforetax tax $7,170 $7,170 $156 $156 - Taxes Taxes $2,740 $2,740 $66
$66 Net Netprofit profit after aftertaxes taxes $4,430 $4,430 $90 $90 Net Netsales sales $139,208 $139,208 $1,173 $1,173 Net Netprofit profit margin margin 3.18% 3.18% 7.68% 7.68% Profit Margins Clearly, Tiffany has the larger profit margin (gross margins 56.1% vs 21.9%; net margins 7.68% vs 3.18%)%. The model in the previous slide also shows exactly where the profit margin comes from. The focus in this approach is on the numerator of the profit
margin ratio, viz. on Net Profit After Taxes (NPAT). It behooves the savvy manager to look at the components of NPAT as a fraction of sales. Is it possible to improve cost of goods sold and operating expenses as a fraction of sales but without affecting sales? How are these being used to improve sales? Asset Turnover Model: Wal-Mart vs Tiffany (2000, in millions) Accounts Accounts receivable receivable $1,118 $1,118 $108 $108 Top Number = Wal-Mart Bottom Number = Tiffany + Merchandise Merchandise inventory inventory $17,076 $17,076 $481 $481 + Cash Cash $1,878 $1,878 $189
$189 Total Totalcurrent current assets assets $21,123 $21,123 $816 $816 + + Other Othercurrent current assets assets $1,059 $1,059 $37 $37 Fixed Fixedassets assets $28,864 $28,864 $241 $241 Net Netsales sales $139,208 $139,208 $1,173
$1,173 Total Totalassets assets $49,996 $49,996 $1,057 $1,057 What does this represent? From income statement Asset Asset turnover turnover 2.78 2.78 1.11 1.11 From balance sheet The sales $ generated by each $ of assets Asset Turnover Clearly, Walmart has the larger asset turnover. The model in the previous slide also shows exactly what is the source of the higher asset turnover. The focus in this approach is on the denominator of the asset turnover ratio, viz. on Total Assets. It behooves the savvy manager to look at the components of total assets in terms of how they contribute to sales. Is it possible to reduce accounts receivable and merchandise
turnover and other assets but without affecting sales? How are these assets being used to improve sales? Dupont Analysis: Wal-Mart vs Tiffany (2000, in millions) 2000 data Walmart Tiffanys Net Profit Margin Net Income/Net Sales 3.18 7.68 Asset Turnover Net Sales/TA ROA 2.78 1.11 8.84 8.525 Although Walmart and Tiffany clearly have different marketing/merchandising strategies, they end up with approximately the same ROA! In principle, this approach could be extended to look at ROE and include leverage choices as part of the mix. The next slide shows how different firms have made different choices in terms of net profit margin, asset turnover and leverage. Financial Objectives: The Strategic Profit Model (SPM)
Return on Investment = Return on Assets Net Profit Net Worth Return on Assets Net Profit Total Assets x Net Profit Total Assets = Asset Turnover Net Sales Total Assets The $ sales generated by each $ of assets Leverage Ratio Total Assets Net Worth x
Net Profit Margin Net Profit Net Sales The net profit generated by each $ of sales and so ... Return on Equity Investment Big Lots: 24.6% 1998 data SPM Examples = Net Profit Margin % x Asset Turnover x Leverage Ratio 13.1 1.5
The Gap: 25.5% 6.6 2.4 1.6 ROI Model, Including The Strategic Profit Model Which is the income statement? Balance sheet? SPM? Net NetSales Sales Cost Costofof goods goodssold sold Gross Gross margin margin Variable Variable expenses expenses + Fixed Fixed expenses expenses
Accounts Accounts receivable receivable + Other Othercurrent current assets assets Net Netprofit profit Total Total expenses expenses Net NetSales Sales Net Netprofit profit margin margin x Inventory Inventory +
Income Statement Balance Sheet Strategic Profit Model Net Netsales sales Total Totalcurrent current assets assets + Fixed Fixed assets assets Total Total assets assets Return Returnon on assets assets x Asset Asset turnover turnover
Financial Financial Leverage Leverage = Return Returnon on Net Worth Net Worth Retail Stratgies Look at some of these firms and figure out their strategy http://marriottschool.net/teacher/swinyard/Retailing/retail_links.htm As the previous slide points out, the two arms of the Dupont ROA identity could be thought of as reflecting alternatives focusing on the income statement (profit margin) versus on the balance sheet (volume). However, both approaches really reflect different uses of a companys assets/capabilities. The next two slides show how Walmart has worked on one aspect of its balance sheet, while the remaining slides look at how Tiffanys marketing focus on profit margin is reflected in its asset choices. Walmarts focus on efficient asset use The use of information technology has been an essential part of Wal-Mart's growth. A decade ago Wal-Mart trailed K-Mart, which could negotiate lower wholesale prices due to its size. Part of WalMart's strategy for catching up was a point-of-sale system, a computerized system that identifies each item sold, finds its price in a computerized database, creates an accurate sales receipt for the customer, and stores this item-by-item sales information for use in analyzing sales and reordering inventory. Aside from handling information efficiently, effective use of this information helps WalMart avoid overstocking by learning what merchandise is selling slowly. Wal-Mart's inventory and distribution system is a world leader. Over one 5 year period, Wal-Mart invested over $600 million
in information systems. http://www.prenhall.com/divisions/bp/app/alter/student/useful/ch1walmart.html Walmarts focus on efficient asset use Wal-Mart uses telecommunications to link directly from its stores to its central computer system and from that system to its supplier's computers. This allows automatic reordering and better coordination. Knowing exactly what is selling well and coordinating closely with suppliers permits Wal-Mart to tie up less money in inventory than many of their competitors. At its computerized warehouses, many goods arrive and leave without ever sitting on a shelf. Only 10% of the floor space in Wal-Mart stores is used as an inventory area, compared to the 25% average for the industry. http://www.prenhall.com/divisions/bp/app/alter/student/useful/ch1walmart.html Financial Information Tiffany Net Sales/Cash from Sales Net Sales/Net A/R Net Sales/Inventory Asset Turnover Net Income/Sales ROA ROE 2004 0.993 15.153 2.296 0.836 9.90% 9.01% 11.84% 2003 0.995 15.095 2.331 0.887
99.84 2.14 1.454 2003 1.001 252.54 1.99 1.404 2002 0.999 285.04 1.95 1.343 2001 0.995 210.39 1.73 1.252 2000 1 135.48 1.67 1.201 Zales Net Sales/Cash from Sales Net Sales/Net A/R Net Sales/Inventory Asset Turnover 2004 1 N/A 2.91 1.338
2003 1 N/A 2.88 1.496 2002 1 N/A 2.8 1.472 2001 1 N/A 2.77 1.709 2000 1 N/A 1.57 1.007 Do you see a difference in the strategies of the three firms? Tiffany, in particular, has a low asset turnover compared to Whitehall and Zales, particularly in the later years. Lets see why.. The Tiffany Approach In the following videos, consider Tiffanys and asset use and think of our previous discussion. http://www.youtube.com/watch?v=tbG0btCu1S4&f eature=related http://www.trendhunter.com/trends/tiffany-co-to-l aunch-70-new-stores Lets now look at how Tiffanys management considers the issue in its 10K report.
Tiffany Brand Strategy Tiffany focuses on the profit margin. To do this, it needs to spend more on certain assets than Walmart. The TIFFANY & CO. brand is the single most important asset of Tiffany. The strength of the Brand goes beyond trademark rights and is derived from consumer perceptions of the Brand. Management monitors the strength of the Brand through focus groups and survey research. Management believes that consumers associate the Brand with high-quality gemstone jewelry, particularly diamond jewelry; excellent customer service; an elegant store and online environment; upscale store locations; classic product positioning; distinctive and high-quality packaging materials (most significantly, the TIFFANY & CO. blue box); and sophisticated style and romance. Intangible Assets consist primarily of Product Rights and Trademarks (about $10m. in 2010) Tiffany Brand Strategy Tiffanys business plan includes many expenses and strategies to maintain the strength of the Brand. Stores must be staffed with knowledgeable professionals to provide excellent service. Elegant store and online environments increase capital and maintenance costs. Display practices require sufficient store footprints and lease budgets to enable Tiffany to showcase fine jewelry in a retail setting consistent with the Brands positioning. Stores in the best high street and luxury mall locations are more expensive and difficult to secure, but reinforce the Brands luxury connotations through association with other luxury brands. Tiffany Brand Strategy The classic positioning of Tiffanys product line supports the Brand, but limits the display space that can be afforded to fashion jewelry. Tiffanys packaging practices support consumer expectations with respect to the Brand and are more expensive.
Some advertising is done primarily to reinforce the Brands association with luxury, sophistication, style and romance, while other advertising is primarily intended to increase demand for particular products. Maintaining its position within the high-end of the jewelry market requires Tiffany to invest significantly in diamond and gemstone inventory and accept reduced overall gross margins; it also causes some consumers to view Tiffany as beyond their price range. The Walmart Stores In the following videos, look at Walmarts asset use and think of our previous discussion. How does it differ from Tiffany? Walmart Stores http://www.youtube.com/watch?v=RJphoRD1w0I http://vimeo.com/11111204 http://projects.flowingdata.com/walmart/ Crafting strategy post Dupont Once we look at the firms Dupont and other ratios (such as Sales/GSA Expense ratio), we might want to suggest that the firm move in the direction of increasing profit margin or in the direction of increasing volume. This decision has to be taken, keeping in mind the capabilities and resources that the firm possesses. It is also necessary to look at the competitive environment. If there are many competing brands, then it might not be a valuable strategy to create a new brand, ab initio, in the same space. All the other Porter framework forces have to be considered. If the decision is to move in the direction of higher profit margin, then the firm has to think of a better brand. It might want to look at the ratio of Sales to advertising expenses. It might want to increase trade promotion efforts, as well. If it pursues the goal of higher volume, then a lower price and all that it entails is indicated. However, this may be achieved through different strategies, e.g. coupons or other off-price methods. Better credit terms may also be an option.
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