Deals & Acquisitions
Feb 20, 2023
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This guide explains what strategic analysis is, the factors that need to be considered, and the role of strategic analysis in the M&A process. Here are some key takeaways about strategic analysis:
Here, we'll look at why strategy matters to financial analysis.
The objective of analyzing business performance qualitatively is ultimately to look at how the company-specific strategy, industry trends, and economic climate will support or discredit the assumptions we're making with financial models.
When we value a business, we're ultimately trying to decide what it would be worth paying (in today's dollars) for the expected cash flows the business will produce in the future.
Most valuation models are based on market outlook and/or on forecasted growth. Meaning that we're looking at the target business' financials and we're inferring value relative to the market's position and/or our forecast for future cash flows based off our assumed growth rate.
In other words, there are a lot of assumptions made.
Strategic analysis helps us to make sense of our assumptions by taking into account the economic, industry, and company-specific growth drivers and risks that impact our assumptions.
If we're assuming this company will be able to grow at 10 percent year-over-year, why? Is the industry growing at 10 percent? Is the economic climate shifting favorably or unfavorably? What company-specific risks, such as increased competition, will impact the business going forward?
Qualitative strategic analysis is needed to understand the underlying assumptions we're using to value the business or to assess it quantitatively in some other way.
So in conclusion, while financial analysis (quantitative) is certainly important, we need to understand the strategic (qualitative) side of the puzzle to be able to make any type of informed decision.
We typically look at business strategy from a top-down perspective because it helps us to ask questions in a more logical order. The infographic below illustrates our approach:
The main purpose of this strategic analysis is to ask questions about the external business environment, industry, and underlying business that will help us to make decisions about how reasonable our assumptions are.
For example, if our model is assuming the business can continue to grow at 10 percent year-over-year for the next five years, we can use this strategic analysis to help us determine if that is reasonable. We would form a different opinion about that assumption if the industry growth rate was 20 percent versus if it was declining at 5 percent every year.
In this example if the industry is growing at 20 percent and our company grows at 10 percent, we would actually be losing market share. This would indicate that our assumption of a 10 percent growth rate is probably reasonable (if not conservative).
If we saw that the industry was shrinking at 5 percent, we would need to have a good reason why we assume this business can grow at 10 percent.
Now that we've explained how a top-down approach works, we'll look at the three main components to strategic analysis.
When we look at the external environment, we usually use a framework called a PESTEL analysis. PESTEL is an acronym for political, economic, social, technological, environmental, and legal.
These factors are considered to give an outlook of the external business environment the business operates in. We can use this analysis to help us question and debate whether or not our assumptions about the business are realistic.
So, buyers often use PESTEL analysis to help assess risks and opportunities in order to inform investment decisions.
To learn more about PESTEL Analysis, we recommend this guide.
When we analyze an industry, we're ultimately looking to understand the reality of the competitive environment and the lifecycle stage of the industry as a whole.
Just like we used PESTEL analysis to help us understand the external business environment, we can use Porter's Five Forces as a tool to help model and understand the competitive forces that shape the industry.
This framework ultimately uses five lenses to look at the industry as a whole: barriers to entry, buyer's bargaining power, the threat of substitutes, supplier's bargaining power, and industry competition.
From there, it's important to understand the lifecycle stage of the industry. Generally, industries can be emerging, growing, maturing, or declining.
Artificial intelligence is an example of an industry in a rapid, early growth stage, typewriters, fax machines, and newspapers are examples of industries in decline.
To learn more about industry analysis, we recommend this guide.
When we're analyzing a business, we're ultimately looking at how companies create relationships with their customers through different types of value propositions.
Here, we want to understand the competitive position the business has in the market place.
Some examples of competitive positions could include: best product, lowest price, best payment terms, offer differentiation, complete versus specific solutions, etc.
Just as we've used PESTEL analysis and Porter's Five Forces as tools for learning about external business environments and industries, we can use tools to help us analyze a business.
We can use an Ansoff Matric and SWOT analysis to help us learn more about a specific company.
An Ansoff Matrix helps us look at the role that products and services play in expansion. We look at the reality of selling existing or new products to existing or new markets.
To learn more about the Ansoff Matrix, we recommend this guide.
SWOT analysis is basically a summary of all of the findings we get from our other analyses. It helps us look at and assess a business' strengths, weaknesses, opportunities, and threats.
To learn more about SWOT analysis, we recommend this guide.
Ultimately, the tools we use for strategic analysis give us insights into the external business environment, the industry, and the company's competitive position.
If nothing else, this provides us with an incredible opportunity to learn about a business.
Strategic analysis is important in M&A, private equity, and corporate finance. It helps FP&A analysts to compare their performance to that of their industry. This strategic analysis will also help inform the investment decisions that drive the M&A process for financial and strategic buyers.
If you own a business that you are considering selling, it's important to note that the buyer will conduct this sort of analysis before they make an offer for your business.
This strategic analysis finds its way to financial models through the assumptions and drivers that ultimately govern the model. Ultimately we use these findings to create the model assumptions.
Most financial models have scenario and sensitivity analysis built into them. It's these model assumptions that govern the scenarios we build and assess.
It's through this strategic analysis that we can ground our model assumptions with data that captures unique economic, industry, and company-specific characteristics that will ultimately play into our investment decisions.
