Capstone Project

PERFORMANCE TEMPLATE

MGMT 790 Fall 2022

Improving long-term firm performance is the focus of strategic management. We can’t develop a plan to improve something if we first don’t understand that ‘something’!

As you should know from your prior courses in accounting and finance, HOW you go about assessing a firm’s performance depends on WHY you are doing it. That is, there is not just one way to assess performance…there are many. And you first must be very clear about why you are doing it and to what ends. For example, an accounting focus often seeks to compare performance against goals or budgets to report on specific achievements of what is desired or required. A finance perspective may emphasize ‘return’ measures to evaluate the efficiency of resource deployment. General management might even use a balanced scorecard approach to measure ‘operational’ performance. Your banker will assess your credit-worthiness.

For the purposes of Strategic Management, we are assessing the degree a firm is achieving sustained (and sustainable) competitive advantage. This is not an operational measure or an investment quality measure or an efficiency measure. It is all about assessing if the strategic choices and the deployment of actions and assets to implement those choices is well designed and executed. So let’s look at a simple way we can meet our objective here.

Performance ( effect) is largely a function of the quality of the firm’s strategic alignment and the degree to which they possess competitive advantages over their rivals (there is, we must accept, also a factor of chance and luck!). That is, the quality of a firm’s strategy, their ability to execute, and the degree those provide an advantage over rivals largely determines performance. As an outcome variable, we can’t directly improve performance…we need to address underlying causes of performance outcomes related to alignment or competitive advantage. Remember, we are NOT analyzing the firm with an investment or credit-worthiness perspective – we are using performance to assess the quality and competitive advantage of their strategy, business model, and overall strategic alignment (i.e. the quality of current strategic management).

You can look at many different metrics (i.e. measures or data points) to assess performance. Accounting measures are backward-looking, but they are based on standards so you can compare them to other firms and across time. Stock prices tell you about how financial markets assess the firm’s prospects for future earnings. Qualitative measures such as customer loyalty, employee satisfaction, and company reputation can also provide clues about the quality of a firm’s alignment and competitive advantages.

At the most fundamental level we need to examine accounting metrics because they are not subject to non-strategic influences (like stock prices) and because we can make clear comparisons to referents . Ideally, the firm has superior growth – continued growth over time and at a rate higher than their industry rivals (i.e. industry average) – and superior profitability – also improving (or at least not declining) over time and superior to the industry average. A rather simple and straight-forward method then assesses the firm on these two factors: the degree of their ability to CREATE value (which relates to revenue growth) and their ability to CAPTURE value (which relates to profitability).

Any firm with a dollar of sales has ‘created’ value and any firm with a profit is ‘capturing’ value. Thus, we want to examine a firm’s level of creating value and level of capturing value. Is it strong or weak? Improving or declining? Erratic? For each of these metrics we need to examine the trend and relative level of performance.

CREATING VALUE – To what degree are they producing goods/services their market wants? What tells us about this? REVENUE GROWTH! (Not absolute revenues.... size isn’t an indicator of quality). Is the firm growing revenue over time? Is their revenue growing at a rate higher than the industry average? This is the most basic way to assess a firm’s value creation ability. We can also look at other indicators such as net increase in stores, changes in number of customers/visitors, increasing same store sales, etc. Anything that says “the market is buying more from us than before…the market likes what we offer more than that offered by our competitors”. So, look at Revenue Growth and other related metrics and compare them over time (minimum of three years) and compared to industry average (not just the top competitor or a select group of firms; versus overall industry comparison). Your final conclusion answers this : Is the firm growing, declining, or stable versus prior years and are they doing better, worse, or the same as the industry average in creating value?

· Note: don’t ‘average’ trends over several years as you can smooth out a trend too much. Just look at the patterns of year-to-year percentage changes.

CAPTURING VALUE – To survive, firms must create value in excess of their costs of creating value…that is, they must produce profits. Capturing value means they are retaining a portion of the value they create to fund future growth and cover increasing costs over time. Here we are assessing PROFITABILITY (not absolute dollar profits – again size doesn’t matter). At a basic level of analysis, there are three ways we should look at profitability because they tell us different things:

GROSS MARGIN (Revenue-COGS/Revenue)

GM tells us about pricing power/position and the cost of direct inputs.

Pricing position/power adds to an argument about creating value…but a

resulting higher margin says the firm has priced in a way to capture greater value and that is key. Likewise, controlling direct costs to achieve a higher GM is a positive.

OPERATING MARGIN (Operating Profit/Revenue)

OM tells us about the efficiency of the operating system to produce the ‘value’.

This is partly a function of a good gross margin, but is also related to the

effectiveness of the costs in the system (the expenses of operating the business)

Each of these metrics, at a minimum, can be assessed over time (minimum of 3 years) to see if the firm is getting better, worse, or holding steady in their ability to capture value. The metrics should also be compared to industry averages to assess if the firm has superior ability to capture value. To conclude, give your conclusions about the trend and relative nature of the firm’s ability to capture value.

· Note: as before, simply look at the pattern of change of year-to-year metrics.

Your final performance assessment conclusion should integrate your assessment of the firm’s ability to CREATE and CAPTURE value.

· How would you describe overall performance? (poor, okay, good, excellent….)

· Is the firm doing better at either creating or capturing value?

Note #1 - you are not diagnosing the underlying problem. DO NOT jump from assessing performance to hypothesizing what is wrong or suggesting what they need to change to improve. THAT COMES LATER! You cannot diagnose underlying causes from numbers alone!

Note #2 - This is NOT to say that other metrics such as stock price, customer loyalty, employee satisfaction, gains from learning, etc. are not important. You can add these to your analysis effectively as long as you clearly understand what they mean and their implications for assessing strategic management. Certainly, stock prices to some degree will follow the ‘story’ of expected economic performance. But there may be nuances or signs of positive/negative trends that don’t show up clearly in the numbers. The better and deeper you understand the condition of the firm’s performance the better you can later identify the underlying causes you can attack to improve performance.

To summarize the basic process to apply the Value Creation/Value Capture framework:

1. Assess the firm’s ability to CREATE VALUE using growth metrics (change in revenues, same store sales, net stores open, # customers, etc.) – over time (at least three years) and against the current industry average

CONCLUSIONS based on all of your growth metric analyses:

· Is the firm’s ability to create value getting better, worse, or staying the same? Does the firm have a superior, inferior, or similar ability to create value compared to industry rivals?

2. Assess the firm’s ability to CAPTURE VALUE using profitability metrics (gross margin, operating margin) – over time and against the current industry average

CONCLUSIONS based on all of your profitability metric analyses:

· Is the firm’s ability to capture value getting better, worse, or staying the same? Does the firm have superior, inferior, or similar ability to capture value compared to industry rivals?

3. What do your conclusions mean? Describe your overall assessment of the firm’s performance status. What dimension of performance appears to be the least desirable – creating or capturing value? Is it the trend that is bad, the relative comparison to industry average, or both?