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 / TE

P.V. Viswanath
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
2
volume/low margin strategy, which would be reflected in high
asset turnover but low profit margins or the reverse.
 ROA: Turnover vs Margin

High Turnover

Unattainable

Low High
Margin 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
Net Profit X Asset = Return on
Margin Turnover Assets

Provo Bakery 10% X 9 times = 90%

Zales Jewelry 90% X 1 time = 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
(2013, in millions)

Wal-Mart Tiffany
Net sales $ 469,162 $ 3,794
Less: Cost of goods sold $ 352,488 $ 1,631
Gross margin $ 116,674 $ 2,163
Less: Operating expense $ 88,873 $ 1,466
Less: Interest expense $ 2064 $ 59
Total expense $ 90,937 $ 1525
Other Income, Net - $ 5
Net profit, pretax $ 25,737 $ 644
Less: Taxes* $ 7,981 $ 227
Tax rate 31.01% 35.34%
Net profit after tax $ 17,756 $ 416
* Effective tax rates often differ among corporations due to different tax breaks and advantages.

Which has the higher net margin?

Source: Wal-Mart Stores Inc(WMT) Annual Report (10K) 2013
Tiffany & Co. (TIF) Annual Report (10K) 2013
 Profit Margin Model: Wal-Mart vs Tiffany
(2013, in millions)

Net Sales
$469,162
$3,794 Gross
margin Top Number = Wal-Mart
-
Cost of
$116,674 (24.9%) Bottom Number = Tiffany
$2,163 (57%)
goods sold
$352,488 Net profit
$1,631 before tax

Operating
- $25,737
$638+5
Net profit
after taxes
expenses
$88,873 Total
- $17,756
$417
Net profit
$1,466 Taxes margin
expenses
+ $7,981 / 3.78%
$90,937
Interest $227 10.96%
$1,525 Net sales
expenses $469,162
$2,064 $3,794
$59
Profit Margins
Clearly, Tiffany has the larger profit margin (gross margins 57%
vs 24.9%; net margins 10.96% vs 3.78%)%.
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
(2013, in millions)

Accounts
receivable
$6,768
$174 Top Number = Wal-Mart What does this
+ Bottom Number = Tiffany represent?
Merchandise
inventory From income
Net sales statement
$43,803
Total current $466,114
$2,234
assets $3,794 Asset
+ $59,940 turnover
$3,152 / 2.29
Cash
$7,781 0.82
Total assets
$504 + $203,105
$4,631 From balance sheet
+
Other current Fixed assets The sales $ generated
assets $143,165 by each $ of assets
$1,588 $1,479
$238
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 Net Profit Asset Turnover ROA

Margin Net Sales/TA
Net Income/Net
Sales
Walmart 3.78 2.29 8.66
Tiffanys 10.96 0.82 8.98

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 Return on Leverage

= Assets
x
Investment Ratio

Net Profit Net Profit Total Assets

Net Worth Total Assets Net Worth

Return on Asset Net Profit

= Turnover
x
Assets Margin

Net Profit Net Sales Net Profit

Total Assets Total Assets Net Sales

The $ sales The net profit

generated generated
by each $ of assets by each $ of sales and so ...
 SPM Examples
Return on Equity Net Profit Asset Leverage
= x Turnover x
Investment Margin % Ratio

Big Lots:
24.6% 13.1 1.5 1.2

Albertsons:
18.9% 2.1 4.2 2.1

The Dress Barn:

32.4% 7.4 2.9 1.5

Lands End:
40.2% 6.8 3.1 1.9

The Limited:
32.3% 6.7 2.2 2.2

The Gap:
25.5% 6.6 2.4 1.6

1998 data
 ROI Model, Including
The Strategic Profit Model
Which is the income statement? Balance sheet? SPM?
Net Sales
Gross
- margin Income Statement
Cost of Balance Sheet
goods sold
Strategic Profit Model
- Net profit
Variable
expenses
Total
Net profit
margin
+ Net Sales
Fixed expenses
expenses
Return on
x assets
Inventory Return on
Net sales
x =
Net Worth
+ Asset Financial
Accounts
receivable
Total current
assets turnover Leverage
Total
+ + assets
Other current Fixed
assets assets
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 Wal-
Mart'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 Wal-
Mart 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 2012 2011 2010 2009 2008
Net Sales/Cash from Sales 0.993 0.995 1.003 1.006 0.991
Net Sales/Net A/R 18.600 15.602 15.791 16.401 11.915
Net Sales/Inventory 1.757 1.898 1.898 1.786 2.141
Asset Turnover 0.876 0.826 0.777 0.922 0.979
Net Income/Sales 12.06% 11.94% 9.80% 7.69% 11.01%
ROA 10.56% 9.86% 7.62% 7.09% 10.78%
ROE 18.70% 16.92% 14.11% 13.85% 18.85%

Signet Jewelers 2012 2011 2010 2009 2008

Net Sales/Cash from Sales 1.003 1.001 0.999 0.995 1
Net Sales/Net A/R 3.445 3.673 3.815 4.033 3.952
Net Sales/Inventory 2.875 2.903 2.791 2.439 2.536
Asset Turnover 1.038 1.112 1.075 1.086 1.212

Zales 2012 2011 2010 2009 2008

Net Sales/Cash from Sales 1 1 1 1 1
Net Sales/Net A/R N/A N/A N/A N/A N/A
Net Sales/Inventory 2.517 2.418 2.299 2.404 2.743
Asset Turnover 1.594 1.464 1.393 1.446 1.503
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-
launch-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.