Smith & Wesson Strategic Analysis: Porter's Five Forces

Company Overview and Financial Performance

Smith & Wesson (S&W) is the nation's leading manufacturer of handguns, hunting accessories, and safety equipment, and has one of the strongest brand names in the firearms industry, with a 153-year-old legacy to build on. The company is publicly traded on the NASDAQ exchange under the symbol SWHC, and at the time of this analysis had a market capitalization of $518M with a P/E ratio of 59.64. The turnaround strategy defined in this profile had been very successful, as quarterly results attested, with total revenue of $48M, gross profit of $16.6M, operating income of $5.8M, and net income of $3.37M.

With 854 employees producing pistols, firearms, accessories, and safety products across two manufacturing plants, Smith & Wesson is well positioned to move into entirely new segments of the firearms and weapons market. One manufacturing center is located in Springfield, Massachusetts, where revolvers and pistols are produced; a second center in Houlton, Maine manufactures handcuffs and pistols. The company's accomplishments include being the largest U.S. manufacturer of handguns, the largest U.S. exporter of handguns, and the largest U.S. manufacturer of handcuffs. In addition, S&W revolvers hold the number-one market share position in the U.S., and the company also holds the number-three U.S. pistol market share. Most significantly, Smith & Wesson has 87% brand awareness with the general public. Senior management's biggest challenge is turning this significant brand identity into greater growth in high-growth security markets.

A new leadership team was brought in during calendar year 2004, and their immediate results were impressive. There was more than 20% growth in sales, primarily driven by an aggressive new marketing campaign, a greater focus on core markets, and more aggressive selling and distribution strategies in the fragmented U.S. handgun industry.

The strategy of bringing in a turnaround team of senior executives, as directed by the Smith & Wesson Board of Directors, is working. The impressive turnaround is quantified in both total revenues and a gain of $3.4M in net income between 2005 and 2006. The most recent 10-Q filed by Smith & Wesson on July 31, 2006 with the Securities and Exchange Commission showed continued strength in sales, with quarterly net product and services sales of $48M, a gross margin of 35%, and net income of $3.37M.

The financial ratio analysis also shows the strength of the turnaround then in progress at the company. Return on Equity (ROE) continued to post very solid gains as the company moved into higher-margin, more in-demand pistols and security products at the regional, national, and global level. Return on Assets (ROA) had also turned around, mainly as the result of more efficient processes being put in place within the key manufacturing centers in Massachusetts and Maine. The most significant result of the turnaround team's efforts was the dramatic improvement in EBITDA. This came from rejuvenating the value of the brand, introducing better cost controls and distribution channel processes, and better management of the product mix as it related to high-growth customer segments — including state and local police departments, which had been a high-growth area for Smith & Wesson.

Markets Served

Smith & Wesson's revenue growth is attributable to more than 20% sales growth in sports, law enforcement, military and federal, and international markets, including new sales to the California Highway Patrol and the Afghan Army. Below is a brief description of each core market in which Smith & Wesson competes.

Sporting Goods: The turnaround management team abandoned an indirect sales force and moved to a direct sales force — sixteen salespersons at last count — to work with dealers and increase sales in high-margin segments. These segments include engraving, commemorative guns, and performance centers. The launch of the S&W 460 and 500 revolvers assisted the growth of this segment.

Law Enforcement: S&W had nearly lost this market during the 1970s to Glock, which had created a polymer revolver that was very popular with law enforcement agencies throughout the U.S. In response to declining sales within this segment, S&W hired two sales representatives away from Glock and expanded its sales staff by adding eight additional reps. With the introduction of the M&P pistol, S&W also gained more demonstration opportunities with police departments. At last count S&W had demonstrated the pistol at 150 departments and 33 law enforcement agencies.

Military/Federal: Through intensive lobbying and sustained outreach to Washington-based agencies — stressing the fact that the majority of U.S. government agencies were using foreign-manufactured pistols and firearms — S&W executives successfully secured four U.S. government contracts worth $20M to manufacture firearms for the Afghan Army. Executives were also working with senior U.S. government contacts to pursue the opportunity of selling weapons to the Iraqi Army and police forces.

International: After hiring a former Colt executive who subsequently revamped the sales channels for Europe, Latin America, Asia, and the Middle East, this segment declined during FY2003 and FY2004 but saw significant growth in FY2006, attributed mostly to sales in Latin America.

Licensing: Previously unstaffed at the senior management level, the licensing market and business development function is now managed by a senior executive with over 20 years of experience in the area. The result has been a $1.8M increase from licenses for hearing and eye protection, knives, safes, soft air guns, and branded merchandise.

Existing and New Products

At the time of this analysis, S&W was the market share leader in revolvers and pistols, yet did not participate in hunting rifles, tactical rifles, ammunition, or security systems. On November 16th, S&W announced its move into the shotgun market, valued at approximately $350M per year in sales and an integral part of the $1B per year long gun market. S&W planned to unveil two models at the January SHOT Show, with production taking place at a manufacturing center in Turkey. Particularly notable about their entrance into the shotgun market was the lifetime Heirloom Warranty offered on both shotgun models.

Existing products include the S&W line of revolvers and pistols. Revolvers in the lineup include the Scandium, Model 500, and Model 460XR. Pistols include the S&W 1911 Family and the M&P Pistol, launched in 2005. The company was also relying on the S&W 460 and S&W 500 to further penetrate the sporting goods channel and segment.

Several key differentiators emerged during the turnaround:

• Regaining market share in the Law Enforcement segment through new product introductions better aligned with the needs of that segment relative to competitors.
• A rejuvenated Sporting Goods segment through a more focused product strategy combined with a more aggressive sales approach.
• Entrance into the long gun marketplace with the launch of two new shotgun models to be formally introduced at the SHOT trade show in January.
• Strengthening brand equity and very strong name awareness throughout the general public, which translated into growth in licensing revenues — an increase of $1.8M overall for the latest fiscal year.
• Emerging strength in the Military and Federal markets and strengthening relationships in Washington, D.C., yielding $20M in incremental revenue from four new contracts.