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Institute of Certified Management Accountants of Sri Lanka
Professional I Stage
March 2011 Examination
Examination Date : 3rd April 2011
Number of Pages : 03
Examination Time : 9.30 a:m.- 12.30 p:m.
Number of Questions : 04
Instructions to candidates:
Time allowed is three (3) Hours
Answer all questions
Answers should be entirely in the English Language
Strategic Business Management
(SBM / 702)
Question No.1 (25 Marks)

Read the following case and answer the questions given at the end.

Porter’s Five Forces Model in the Medicines Industry 

Historically, the medicines producing industry has been a profitable one. For every dollar of capital invested in the industry, the average medicines producing company generated 16.45%. This is high compared to an average return on invested capital (ROIC) of 12.76% for companies in the computer hardware industry, 8.54% for grocers, and 3.88% for firms in the electronics industry. However, the average level of profitability in the medicines producing industry has been declining of late. In 2002, the average ROIC in the industry was 21.6%; by 2006, it had fallen to 14.5%. The profitability of the medicines producing industry can be best understood by looking at several aspects of its underlying economic structure. First, demand for medicines has been strong and has grown between 1990 and 2003. There was a 12.5% annual increase in spending on prescription medicine in the United States. This growth was driven by favorable demographics. As people grow older, they tend to need and consume more prescription medicines and the population in most western nations has been growing older as the post-World War II baby boom generation ages. Projections suggest that spending on prescription medicine will increase between 10 and 11% annually through Second, successful new prescription medicine can be extraordinarily profitable. Lipitor, the cholesterol lowering medicine sold by Pfizer, was introduced in 1997 and by 2006 this medicine had generated a staggering $12.5 billion in annual sales for Pfizer. The costs of manufacturing, packing, and distributing Lipitor amounted to only 10% of revenues. Pfizer spent close to $500 million on promoting Lipitor and on maintaining a sales force to sell the product. That still left Pfizer with a gross Institute of Certified Management Accountants of Sri Lanka Professional I Stage – Strategic Business Management (SBM / 702) – March 2011 CMA Examination Since the medicine is protected from direct competition by a twenty-year patent, Pfizer has a temporary monopoly and can charge a high price. Once the patent expires, which is scheduled to occur in late 2011, other companies will be able to produce similar but not identical versions of Lipitor and the price will fall typically by 80% within a year. Competing companies can patent similar medicines that have a similar medical effect. Thus, Lipitor does have competitors in the market for cholesterol lowering medicine, such as Zocor, sold by Merck, and Crestor, sold by Astra, which are also protected On an average, estimates suggest that it costs some $800 million and takes anywhere from ten to fifteen years to bring a new medicine to market. Once on the market, only three out of ten medicines ever recoup their R&D and marketing costs and turn a profit. Thus, the high profitability of the medicines producing industry rests on a handful of medicines. At Pfizer, the world’s largest medicines producing company, 55% of revenues were generated from just eight medicines. To produce a medicine, a company must spend large amounts of money on research, most of which fails to produce a marketable product. The high costs and risks associated with developing a new medicine and bringing it to market limit new competition. Out of 5,000 compounds tested in the laboratory by a company, only one of these ultimately make it to the market. Only very large companies can shoulder the costs and risks of doing this, making it difficult for new companies to enter the industry. Pfizer, for example, spent some $7.44 billion on R&D in 2005 alone, equivalent to 14.5% of its total revenues. Only two companies, Amgen and Genentech, were ranked among the top twenty in the industry in terms of sales in 2005. Most have failed to bring a product to market. In addition to spending on R&D, companies in the medicines producing industry spend large amounts of money on advertising and sales promotion. Expenditure by Pfizer of $500 million a year, promoting Lipitor is small relative to the revenues and is a large for a new competitor to match, making market entry difficult unless the competitor has a significantly better product. There are also considerable opportunities on the horizon for companies in the industry. New scientific breakthroughs are holding out the promise that within the next decade medicines producing companies might be able to bring to market new medicines that treat some of the most difficult medical conditions such as cancer, heart disease, AIDS etc. There are threats to the long term dominance and profitability of industry giants like Pfizer. As spending on health care rises, politicians are looking for ways to limit health care costs and one possibility is some form of price control on prescribed medicines. Further, twelve of the thirty-five top-selling medicines in the industry will lose their patent protection between 2006 and 2009. By one estimate, some 28% of the global drug industry’s sales of $307 billion would be exposed to ‘new medicines’ challenge, due to medicines going off patent. Moreover, competitor medicine producing companies have been aggressive in challenging the patents of well established medicines producing companies such as Pfizer and in pricing their new offerings. As a result, their share of industry sales has been growing. In 2005, they accounted for more than half by volume of all medicines prescribed in the United States, up from one-third in 1995. Institute of Certified Management Accountants of Sri Lanka Professional I Stage – Strategic Business Management (SBM / 702) – March 2011 CMA Examination Case Discussion Questions:
(a)
Discuss Porter’s five forces model with reference to medicines producing industry and explain why the medicines producing industry has historically been a very profitable industry. (15 Marks)
What must medicines producing firms do to exploit the opportunities and counter threats? (10 Marks)
(Total 25 Marks)

Question No. 2 (25 Marks)

(a)
What do you mean by competitive advantage, sustained competitive advantage and distinctive competencies? What role can top management play in helping a company achieve these? Support your answer with appropriate examples from the local scenario. (15 Marks)
Briefly explain the generic building blocks of competitive advantage and how are they related to each other by referring to particular industry of your choice in Sri Lanka. (10
(Total 25 Marks)

Question No. 3 (25 Marks)

What do we mean by strategy and explain the main issues involved in strategy formulation? (10 Marks)
Johnson and scholes introduced key components of strategy as characteristics of strategic decisions. Briefly explain five of those components by referring to particular industry in Sri
Lanka. (15
(Total 25 Marks)

Question No. 4 (25 Marks)

(a)
Explain the Ansoff’s product-market scope matrix? (10 Marks)
“Developing a firm beyond its present product/market space exposes it to a combination of four sorts of risks. These risks are particularly acute where diversification is concerned because of the simultaneous novelty of both product and market”. Explain this statement in detail. (15 Marks)
(Total 25 Marks)
Institute of Certified Management Accountants of Sri Lanka Professional I Stage – Strategic Business Management (SBM / 702) – March 2011 CMA Examination

Source: http://www.cma-srilanka.org/pub/march11SBM.pdf

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