As competition intensifies profitability likely

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As competition intensifies, profitability likely declines, and the amount of assets companies need to carryon their balance sheet likely increases in an effort to generate more profit. Such changes are revealed in the income statement and the balance sheet.
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1-17 Module 1 I Framework for Analysis and Valuation Applying Competitive Analysis We apply the competitive analysis framework to help interpret the financial results of McLane Company. McLane is a subsidiary of Berkshire Hathaway and was acquired several years ago as explained in the following note to the Berkshire Hathaway annual report: On May 23,2003, Berkshire acquired McLane Company, Inc., ("McLane") a distributor of grocery and food products to retailers, convenience stores and restaurants. Results of McLane's business operations are included in Berkshire's consolidated results beginning on that date. McLane's reve- nues in 2005 totaled $24.1 billion compared to $23.4 billion in 2004 and approximately $22.0 billion for the full year of 2003. Sales of grocery products increased about 5% in 2005 and were partially offset by lower sales to foodservice customers. McLane's business is marked by high sales volume and very low profit margins. Pretax earnings in 2005 of $217 million declined $11 million versus 2004. The gross margin percentage was relatively unchanged between years. However, the result- ing increased gross profit was more than offset by higher payroll, fuel and insurance expenses. Approximately 33% of McLane's annual revenues currently derive from sales to Wal-Mart. Loss or curtailment of purchasing by Wal-Mart could have a material adverse impact on revenues and pre-tax earnings of McLane. McLane is a wholesaler of food products; it purchases food products in finished and semifinished form from agricultural and food-related businesses and resells them to grocery and convenience food stores. The extensive distribution network required in this business entails consider- able investment. Our business analysis of McLane's financial results includes the following observations: Industry competitors McLane has many competitors with food products that are difficult to differentiate. Bargaining power of buyers The note above reveals that 33% of McLane's sales are to Wal-Mart, which has considerable buying power that limits seller profits; also, the food industry is characterized by high turnover and low profit margins, which implies that cost control is key to success. Bargaining power of suppliers McLane is large ($24 billion in annual sales), which implies its suppliers are unlikely to exert forces to increase its cost of sales. Threat of substitution Grocery items are usually not well differentiated; this means the threat of substitution is high, which inhibits its ability to raise selling prices.
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