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The Organizational and Operational Plans assignment references the possible benefits and risks of forming a strategic...

The Organizational and Operational Plans assignment references the possible benefits and risks of forming a strategic alliance. What would be the risks of forming a strategic alliance in terms of the firm's profitability ratios? Which of those five ratios is most likely to reveal immediate information for analysis of the alliance's effectiveness?
Considering today's financial climate, how likely is it that the organization could acquire the capital necessary to support an aggressive value-enhancement strategy? From where would that capital originate? Compared to current interest rates, what do you believe is a realistic interest rate the firm might incur? Which of the liquidity ratios will be impacted by the influx of capital, if borrowed?

Determine which of the ratios provide the most key insights into the firm's current level of performance. How can you assess whether the results of your calculations are positive or negative? Explain which of the ratios give you reason to be concerned with the organization's current strategy and why.
The Organizational and Operational Plans assignment references the possible benefits and risks of forming a strategic alliance. What would be the risks of forming a strategic alliance in terms of the firm's profitability ratios? Which of those five ratios is most likely to reveal immediate information for analysis of the alliance's effectiveness?
Considering today's financial climate, how likely is it that the organization could acquire the capital necessary to support an aggressive value-enhancement strategy? From where would that capital originate? Compared to current interest rates, what do you believe is a realistic interest rate the firm might incur? Which of the liquidity ratios will be impacted by the influx of capital, if borrowed?

Solutions

Expert Solution

Note:- There are three separate questions but as per answering guidelines, only the first question can be answered.

Solution:-

While organic growth and business combinations (M&A) are the two commonly followed methods adopted to grow a business, another alternative which is used by businesses is strategic alliance. This sort of arrangement allows two companies to enter into a strategic partnership wherein the two partners continue to operate independently yet benefitting from each other in certain ways. This happens when two firms want to leverage certain assets of each other, yet don't want to combine their businesses.

Example of strategic alliance:

A US automobile manufacturers enters into a alliance with an Indian automobile company to use its manufacturing capabilities and dealer network to produce and sell their cars in the Indian market.

Profitability Ratios:

Sometimes, the strategic alliances are a win-win result for both parties, however at other times it may be beneficial for one partner and no so much for the other. One way to analyse the risks of strategic alliances is through profitability ratios which includes the following five major financial metric:-

  1. Gross margin
  2. Profit margin
  3. Return on assets
  4. Return on capital employed
  5. Return on equity

The potential risks in a strategic alliance with respect to profitability metrics are as follows:-

  • The gross margins or profit margins post strategic alliances could take a hit and reduce as a result of the arrangement. For e.g.: A consumer brand presently generating 80% gross margins enters into a new strategic partnership with Walmart for exclusive branding and sale of their products. While this is expected to result in higher number of units sold but the gross margins would fall to 50%.
  • The strategic alliance related to use of manufacturing facilities or other assets could result in reduction in return on assets if the terms of the arrangement aren't favourable enough. For e.g.: A car company enters into an alliance with an overseas car manufacturer to produce cars on its behalf in the local market. The return on assets is expected to be 5% which is lower than the 7% return on assets it enjoys at present
  • The company's overall return on capital employed (ROCE) could be adversely impacted if the terms of the alliance don't generate same return on the capital invested as compared to the existing ROCE levels. For E.g.- A strategic alliance requires an investment of $ 1billion and expected to generate a net operating profit after tax (NOPAT) of $100 million, giving a ROCE of 10% which is lower than the existing ROCE of 12%
  • Reduction in company's return on equity from the existing levels if the terms of the arrangement don't add enough value to equity shareholders as compared to the current business

Best indicator for the effectiveness of strategic alliance:

While all the profitability ratios are good indicators of how good the strategic alliance is, the best among the lot is return on capital employed (ROCE). This is because the purpose of any business, investment, strategic decision is to generate high returns on capital invested and it gives a great picture of the overall effectiveness. Since, this is the broader goal behind all business decisions, looking at ROCE would best give the overall picture of how effective the strategic alliance is. If the ROCE goes up after strategic alliance, it means that the alliance is beneficial for the company and vice-versa.


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