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MEMO TO: FROM: SUBJECT: DATE: BILL WATSON, CEO TOBY ODENHEIM, PRINCIPAL CONSULTANT SCIENCE TECHNOLOGY COMPANY

STRATEGIC SUMMARY MARCH 20, 1985

Although industry growth for automated test equipment (ATE) and very-large-scale integration (VLSI) increased dramatically from 1978 to 1984, this growth is being outpaced by new entrants and competitors. Global competition, which in many countries is propped up by governmental policy and price supports, is resulting in excess supply and rapidly falling prices. Thus obsolescence is a risk for many industry players, Scientific Technology Company (STC) notwithstanding. Equally concerning, when compared to key competitors, STC is lagging behind on a number of financial metrics including earnings growth, return on equity, and return on assets. To remain viable STC should adopt a two-fold strategy, focused on cost-savings and innovation, in order to maintain leadership in ATE and testing software, and strengthen their patents and intellectual property portfolio. Cost Savings STC must implement immediate cost-cutting measures to improve financial position and remain competitive in the face of increasing competition in both the U.S. and abroad. Specific costsaving measures include: Narrow core focus and concentrate on automated test equipment and software. Having a broad array of diverse product lines distracts the business from being best-of-breed in the most profitable sectors. o Sell off VLSI division and other secondary product lines that can command a good price. o Capture revenue from profitable but non-essential lines without further investment, harvesting as much profit prior to obsolescence. Close Colorado plant and sell associated fixed assets. While it makes sense to maintain both an east coast and west coast presence for manufacturing, sales and support, two separate facilities in adjacent states results in added expense and excess manufacturing capacity. Outsource manufacturing if additional capacity is required. Close unprofitable sales and service offices. Rather than maintaining offices in over a dozen international locations, close unprofitable offices and work through resellers and strategic partnerships to support dispersed geographic locations in secondary markets.

The sell off is expected to bring the company between $30 and $50 million and reduce inventory as a percent of cost of goods sold to 50%, in line with many competitors. Total assets as a percent of sales will decrease to 80% along with a reduction of COGs from 46% to 30% of sales, which results in $36 million dollars of saving in 1985, alone assuming flat sales growth due to PPE sales. These changes will producte an estimated 20% return on total assets and increase EPS from $1.45 to $2.80 in 1985. Innovation Semiconductor products are rapidly becoming commoditized with customers expecting high quality at low prices. Japan, in particular, has made such great strides in manufacturing efficiency and quality processes that it will be difficult for STC to compete head on. STC should differentiate by focusing on R&D and producing cutting-edge next-generation ATE, and licensing out patents and software. To achieve this aim R&D spending will need to be increased to 20% of sales and focused selectively on strategic projects with an NPV of 20% at a 12% cost of capital. Licensing and royalties from patents should become a significant source of revenue for STC, providing good diversification from manufacturing. A portion of the cost saving recognized through the steps outlined above can be invested into R&D with the remainder used to pay down dept. Also by focusing R&D on a smaller number of projects the company will be better positioned to improve time-to-market.

Economics Analysis In the 1960s and 1970s the semiconductor industry in the U.S. was growing rapidly. The U.S. was asserting strong technological leadership, but global competition rapidly increased. The semiconductor industry was strengthening in Europe, Japan and South Korea, led in part by technology-focused industrial policies. However, Europe in contrast to Asia had less success supporting high-technology projects that could later emerge as commercial successes. For example, Britain had to provide equity support for semiconductors companies and Frances two nationalized computer companies failed to be profitable despite direct subsidies in excess of one billion dollars. In contrast to Europe, Japanese and to a less extent South Korean companies were proving formidable competitors. Japans strong growth can in part be attributed to strong governmental industry policy including research subsidies, tax credits, import barriers, and financing. Japanese government subsidies for the computer and semiconductor industries are estimated to contribute 6.7% of firms R&D budget; not a huge amount, but enough to put STC at a competitive disadvantage, especially when taken in tandem with the strong valuation of the U.S. dollar and trade barriers on U.S. exports.

By 1982 the world was still in recession and many governments were responding by enacting strong protectionist policies and boosting their industrial research spending. In 1983, the world began to emerge out of recession, led largely by strong growth in the U.S., but trade deficits remained a major U.S. concern, led in part by the strong valuation of the U.S. dollar relative to other foreign currencies. Both protectionist policies and the strong dollar are expected to hurt demand for STC exports, making it difficult for STC to compete directly with the high-quality, cost-competitive products coming out of Japanese and South Korean. World SemiConductor Market in Billions of Dollars

Source: http://www.shmj.or.jp/english/trends/trd80s.html

Technologic Landscape The Japanese semiconductor industry was rapidly gaining a reputation for quality manufacturing, stable supply chain, and competitive pricing. Core technologies included: CMOS LSIs for electronic calculators and watches Analog ICs for consumer electronics Silicon transistors DRAM Single-chip microcontrollers As a result many U.S. companies began adopting Japanese semiconductor products, especially 64-Kbit and 256-Kbit DRAMs. Japanese global market share for DRAM eclipsed the U.S. begin in 1981. Indeed, Japan was rising so rapidly that strong nationalistic overtones began to emerged in the U.S.

SWOT Analysis The table below summarizes STCs Strength, Weaknesses, Opportunities and Threats.
Strength 31% Market Share Extensive Software Excellent credit rating Number one designer & manufacture of industry testing equipment and software Overly broad product line Poor forecasting track record Inconsistent financial results year to year Failing to keep pace with competition Multiple failed or delayed projects impacting profitability Market expected to grow over the next 5-10 years Many new consumer products being developed, ranging from computer to calculators to electronic toys. Good opportunities to collaborate with Asian and European companies to expand geographic footprint Constant need for improvement, and innovation (smaller chips, more memory, lower power utilization etc) High valuation of the dollar makes foreign purchase cheaper Fierce competition Falling prices Efficient, high-quality manufacturing from pacific rim competitors High valuation of dollar makes exporting more difficult Trade barriers and other protectionist practices discourage exports

Weaknesses

Opportunities

Threats

Conclusion By engaging in cost-costing measures and streamlining operations STC will boost shareholder value and provide an influx of capital to strengthen R&D. STC is best served by focusing on high-value products, software and intellectual capital rather than trying to compete head on with commodity manufacturers.

References
http://inflationdata.com/Inflation/Inflation_Rate/HistoricalInflation.aspx http://www.presidency.ucsb.edu/economic_reports/1984.pdf http://www.presidency.ucsb.edu/economic_reports/1985.pdf http://www.irle.berkeley.edu/worktech/SloanGlobal.pdf http://www.shmj.or.jp/english/trends/trd80s.html

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