Corporate Financial Strategy - Bender and Ward - Essay Example

Running Header: Bender and Ward Student’s Name: Instructor’s Name: Course Code: Date of Submission: Introduction Bender and Ward’s basic model mainly comprises of four main areas that include launch, growth, maturity and decline. Some of the major aspects or strategy parameters notable in all those stages include business risk, financial risk, source of funding, dividend policy, future growth prospects, price/earnings multiple, current profitability, and share price (Bender and Ward, 2003). In this review, it has been found out that Warder’s Model has placed much on discussing the concept of risk, valuing the shareholder and the company and product life cycles. The major weakness of this model is that Ward is that he has failed to recognize the work of other scholars such as Porter which provide good grounds in analyzing the industries that the companies for developing good strategies (Baranek 1998). Warder’s model is a theory that in general that tries to explain the concept of corporate finance and the relationship that exists between the corporate strategy and corporate finance. It is a theory because it does not provide any supporting evidence that can be used determine whether the risk levels vary with the company’s life cycle (Baranek 1998). The approach that has been employed here is that the model has reviewed various existing literatures on value chain, shareholder management and payment of dividends as well as market growth. The objective of this essay was to critically evaluate Ward’s Model in relation to corporate finance strategy. Analysis of Bader and Ward’s Model According to Bader and Ward’s Model, the highest levels in terms of risk are found at the start up stage of a business life cycle. They are various compounding risks related with a new product; this is mainly concerned with whether the product will work effectively. It also concerns whether the product will be accepted in the market by potential customers (Bender and Ward, 2003). Moreover, in case it is accepted, then there is worry of whether its market will grow significantly mainly due to development and launch costs implicated and whether adequate market share will be attained by the product or company. Therefore, risks of high levels in business should ensure that related financial risk must be kept very low hence; it is suitable to have equity funding. However, despite equity funding this may not be attractive to all prospective investors. It is important to note that only those investors ready to accept high risk will be attracted by the high overall risk of the company; however, they will need a corresponding high return (Bari, 2000). This high return will come to investors in terms of capital gains as business negative cash flow makes it impossible to pay dividends in this preliminary phase. There is a creation of key concerns due to this dominance of capital gains on the part of venture capital investors within such business related with high risk. Investors do not wish being locked in till the business becomes cash-positive and can begin paying dividends (Bari, 2000). Therefore, the buyers require to be found for this equity in its increased value immediately the firm proves that product works and that the potential of the market results to a financially attractive investment. Venture capitalists usually need rates of return that are very high in the investment portfolio (Bari, 2000). In the launch stage of the bender & Ward Model, they are several parameters or issues involved as summarized or analyzed by the table below. Business Risk Very High Financial Risk Very Low Source Of Funding Venture Capital Dividend policy Nil payout Ration Future Growth prospects Very High Price/earnings multiple Very High Current profitability Nominal or negative Share Price Rapidly growing but high volatile Figure 1 Launch stage financial strategy parameters (Bender and Ward, 2003) Figure 2 Bender & Ward Model In Bender and Ward model, growth stage usually takes place after launch stage. After the product has been launched successfully into the marketplace, its sales volume should grow rapidly (Frank & Scholefield, 2000). This represent the need for modifying the company’s strategic thrust as well as reduced overall risk of the business related to the product. It is crucial to place competitive strategy on marketing activities so as to make sure firm increases its market share of the increasing volume of sales and that product sales total growth is satisfactory (Baranek, 1998). These critical concerns indicate that the business risk though reduced during launch stage is still high within the quick sales growth duration. Therefore, there is need to design suitable source of funding in order to keep a low financial risk profile which point out continued utilization of equity funding. Nevertheless, a crucial aspect of transition management to growth from start-up is that initial venture capitalist investors will be eager to take in their capital gains so as to allow them reinvest within other start-up business (Bender and Ward, 2003). Therefore, there is need to identify new equity investors who can replace initial venture capital hence provide for any continued needed funding in this high growth period. One of the key sources of funding at this stage within Bender and Ward model is through public floatation of the company. The higher volumes of sales attained at a reasonable margins of profit will produce stronger flows of cash as compared to launch stage. Nonetheless, there is need for the firm to invest heavily within both market share development and market development activities in order to keep at par with operational activity increasing levels (Baranek, 1998). Subsequently, generated cash by the business need to be reinvested within the business with the result that the dividend payout ratio will stay incredibly little. The new equity investors should not see this as a problem in the company as they will have been attracted mostly by the high future development projections. These predictions in growth need to be replicated in a share price indicating high price/earnings multiple applied to the little existing per share (eps) of the firm. Because the yield of dividend is little, the bulk of investors expected return need to be generated as gains in capital with increases in price shares (Baranek, 1998). This means that the firm need to generate considerable growth in eps within this development stage through winning a prevailing market share in the quickly emergent market. It is crucial to note that within the launch and growth stages of this Bender and Ward model, the firm has its key opportunities to develop and even improve its sustainable competitive advantage to be utilized later cash positive maturity level (Baranek, 1998). The table below summarizes the parameters or issues of Bender and Ward’s growth stage. Business Risk High Financial Risk Low Source of Funding Growth equity investors Dividend policy Nominal payout ratio Future growth prospects High Price/earnings multiple High Current profitability, i.e. eps Low Share price Growing but volatile Figure 3 Growth stage financial strategy parameters (Bender and Ward, 2003) At the end of growth stage in the model, they are usually extremely violent price competition among rivals. These are the ones left with surplus capacity as predictable continuous sales growth within the industry fail to show up. After the stabilization of the industry, then there is a start of maturity stage of high though comparatively stable sales within a rational profit margin (David and Sonia, 2005). Definitely, the levels of business risk have come down with another phase of development being completed. The firm needs to enter the stage of maturity with a recommendable comparative market share due to its investment in the marketing during growth stage. The remaining significant business risks relate to this time span of stable maturity stage and whether the firm, has capacity to sustain its strong market share on a financially attractive basis, within this period (Agarwal, 2001). There is a shift of strategic emphasizes in this stage towards maintaining share as well as efficiency improvement. This brings some difficulties to manage the transition between growth and maturity. Nevertheless, business risk reduction allows the increase of financial risk through the introduction of debt financing. As the net cash flow could have turned positive, this makes it practical. This allows the debt to be serviced and even repaid. The capability to use debt funding and positive cash flow for reinvestments requirements are crucial to shareholders because they enable company to pay higher dividends (David and Sonia, 2005). Therefore, there is an increase of dividend payout ratio as a proportion of the new high current eps, increasing considerably the absolute dividend payments. The dividend yield increase is needed, as the business’s future growth forecasts are much lower as compared to life cycle’s earlier stages. The lower growth forecasts are replicated in a lower P/E ratio (Obert, 2002). Therefore, financial markets give shares a lower rating although this does not essentially result to share prices decrease. Earnings per share must be high and to some extent rising as a result of gains in efficiency within this stage in order to ensure these high eps counterbalance the falling P/E multiples (Agarwal, 2001). The net outcome must be a more stable share price. This is because more of the expected returns of the investors are at moment provided by yields from dividends, other than the gains in capital that dominated the earlier stages. The table below summarizes the financial strategy parameters or issues of Bender and Ward’s mature stage. Business risk Medium Financial risk Medium Source of Funding Retained earnings plus debt Dividend policy High payout ratio Future growth prospects Medium to Low Price/earnings multiple Medium Current profitability, i.e. eps High Share price Stable in real terms with low volatility Figure 4 Mature Stage financial strategy parameters (Bender and Ward, 2003) As decline stage starts, it is important to note that the strong positive generation of cash at stage of maturity cannot go on for a long time. The inflows of cash fade away with decrease in demand of a product. At maturity stage, funds were not mainly invested to increase market share or even develop the market but mainly to maintain factors affecting future sales levels (David and Sonia, 2005). After there is a beginning irreversible decline of sales demand, it is not important to continue spending the same amount on maintaining these marketing activities. Modification of business strategy accordingly is the only way that can maintain net cash inflows within initial stages of decline. The decline and death of a product at this stage should be considering the decline of related business risk as from previous stage of maturity. One of the risks remaining is to know for how long it will make economic sense for business to continue at this stage (Bender and Ward, 2003). Financial risk source of funding should complement the low business risk mainly through the utilization of debt financing and high dividend payout policy. However, the strategy of reinvestment in a declining business is usually low because future growth forecast are currently negative at this point and this links very easily to the high dividend payout policy. At this stage, the dividend paid out exceeds post-tax profits because of likelihood of having insufficient financial justification to reinvest depreciation. As a result, dividends is likely to be equal the total of depreciation and profits whereby it should be clear that section of dividend payment signify a capital repayment. This shows the way debt financing can be introduced to a business that is declining (Agarwal, 2001). Despite the fact that some assets are irreplaceable, as they are fully exhausted, parts of the funds are unavoidably tied up within the business within this period. In case the equity investors provide the funds, then this will need a risk-adjusted return on this investment. Nevertheless, the cost of equity is higher than cost of debt hence a refinancing operation may allow some of these equity funds to be released by the firm preceding to its ultimate liquidation. Company lenders are not likely take on an equity risk for a debt-based return. However, they should be willing to lend against the ultimate realizable assets value that are locking shares-holders equity up. It is through share repurchase or through dividend that borrowings can be paid to shareholders hence clearly representing capital repayment (Bender and Ward, 2003). The growth forecasts, that are negative obviously result to low price/earnings multiples for the shares. When this is allied with a decreasing eps trends experienced during this stage, the outcome is a decreased share price. Nevertheless, as long as shareholders have information that section of their high dividend payments are efficiently capital repayments and this decline of value should not be a worry. The table below summarizes the financial strategy parameters or issues of Bender and Ward’s decline stage. Business risk Low Financial risk High Source of funding Debt Dividend policy Total payout ratio Future growth prospects Negative Price/earnings multiple Low Current profitability, that is, eps Low and Declining Share price Declining and increasing in volatility Figure 5. Declining stage financial strategy parameters (Bender and Ward, 2003) Company life cycle/product life cycle in relation to Bender and Ward model In some extent, the product life cycle can be extended to the company life cycle as illustrated within the Bender and Ward model. This is because the decline of products significantly leads to decline of a company (Agarwal, 2001). On the other hand, the company can decide to launch a new product hence its continuous existence. It is important to note that Ward keeps risk grounded in the company of which is big advantage. In finance perspectives, bonds and shares are the ones always viewed as risk of investments. Risk always comes from the supply chain or the company. One of the notable weaknesses in Wards basic model is that it does not recognize well known weaknesses within the underlying disciplines. However, it is through Ward model that future developments come from (Bender and Ward, 2003). Some of the advantages of Ward model include the fact that it is simple to understand. It is also useful to managers. It also enables the companies to grow and change through knowing their areas of weakness hence improving them. The model also shows the link between the growth and finances sources especially in relation to shares and dividends. The risk of borrowing is exposed by the model assisting them to compact credit crisis. This makes risk grounded in the firm. The model puts the spot light on venture capital. It assists people in understanding the difference between junior and senior stock markets. It also assists people understand bonds. It keeps finance linked to business as well as providing a platform that links rationalist and empiricist approaches to business (David and Sonia, 2005). In general terms, the model can be said to link the theory and practice. Extensions of the model-Ward’s Model and Porter’s Bulge Porter’s bulge represents the diversion of the Ward model whereby instead of expected continued growth, there is a tendency deviation slowing the expected growth to an extent of no growth at all or even declining sales/growth. However, it starts to increase again after some time mainly due to change of strategies or introduction of new products. The bulge or deviation may be as a result of rivalry of unacceptability of the products in the market. The porter’s bulge usually starts at the entry point of the market or introduction of the product (David and Sonia, 2005). Shakeout is the point where the porter’s bulge ends almost at maturity level. They are several sizes of Porter’s Bulge that ranges from small, medium, and large bulge. A small bulge is usually characterized by slow though positive growth rate as illustrated by the figure below (Firth, 2000). For medium bulge, there is no growth of sales; it is constant with no negative or positive change, however, it accelerates after some time to accelerated positive rate (Agarwal, 2001). A large bulge is usually characterized by a decline in sales for sometimes but then it accelerates positively after some time to maturity level as clearly depicted by the given diagram. However, it is important to note that introduction of new products assists in smoothing out porter’s bulge (Loizos, 2003). Figure 6 Porter’s Bulge (Bender and Ward, 2003) Figure 7 Sizes of Porter’s Bulge The Porter’s Five Force Model identifies five major five forces that a good corporate finance strategy must incorporate in its theory (Agarwal, 2001). The forces identified by Porter include: the threat posed by new companies entering the industry, the existence of substitutes, the bargaining powers of the suppliers and buyers and the level of rivalry among the existing companies as shown in the diagram below. These five forces have not been incorporated in this model (Bari 2000). Warder’s model only talks of risk existence without giving due consideration how it arises and its origin. In my own view, the model ought to have included the industry analysis to determine its trends and what the company can do in order to create value of its investment and achieve long-term sustainability in competitive advantage. In conclusion, the Bender and Ward model plays a great role in evaluating the company and product life in relation to finance and related risk (Suresh, 2001). It assists in enabling people with financial interests to identify various aspects related to financial investments. Any investor should ensure he clearly identifies the risks involved in each and every level in the Ward model. The model makes it easy for one to understand the business processes as well as risks (Agarwal, 2001). However, it has various limitation associated with it. The model may also experience some bulge in the process of its growth, however, the size of the bulge varies due to level of competition and rivalry. Corporate strategy and corporate finance are two related aspects of corporate manage. This is because corporate strategy highlights what the company intends to achieve, while the corporate finance strategy is responsible in designing ways in which these objectives can be achieved (Suresh 2001). References Agarwal, N 2001, Analysis of Financial Management, New Delhi, National Publishing House. Bari, R 2000, Cash Planning and Management, Delhi, Triveni Publication. Baranek, W 1998, Working Capital Management, Belmont California Workshop Publishing Company. Bari R 2000, Selected reading in cash management (2ed.), Delhi Triveni Publication. Bender, R and Ward, K 2003, Corporate Financial Strategy, 3rd edn., Oxford, Elsevier. David, D and Sonia, M 2005, Kellogg on Strategy: Concepts, Tools, and Frameworks for Practitioners, London, Wiley. Frank, J & Scholefield H 2000, Corporate Financial Management, London, Gover Press. Firth, M 2000, Management of Working Capital, New York, The McMillan Press. Loizos, H 2003, Strategy & Organization: Realizing Strategic Management, Cambridge U. Press. Obert, L 2002, Derivatives Markets, New York, Addison Wesley. Suresh, S 2001, Fixed Income Markets and their Derivatives. London, South-Western Press. Read More