Chapter 5: Competitive Advantage, Firm Performance, and Business Models
Traditional Frameworks to Measure and Assess Firm Performance (3)
• Accounting profitability
• Shareholder value creation
• Economic value creation
Integrative Frameworks, Combining Quantitative Data with Qualitative Assessments (2)
• Balanced scorecard
• Triple bottom line
Standard Performance Dimensions (3)
• What is the firm’s accounting profitability?
• How much shareholder value does the firm create?
• How much economic value does the firm generate?
Critical Tasks for Managers to Accomplish (2)
• Accurately assess the performance of their firm
• Compare and benchmark their firm’s performance to other competitors in the same
industry or against the industry average
Profitability Ratios Used in Strategic Management (4)
• Return on invested capital (ROIC)
o Measures how effectively a company uses its total invested capital
o Components (2)
▪
Shareholders’ equity through the selling of shares to the public
▪
Interest-bearing debt through borrowing from financial institutions and
bondholders
o Constituents (2)
▪
Return on revenue
▪
Working capital turnover
• Return on equity (ROE)
• Return on assets (ROA)
• Return on revenue (ROR)
o Additional financial ratios (3)
▪
Cost of goods sold (COGS)/Revenue
•
Captures the firm’s production cost of merchandise it has sold
▪
Research & development (R&D) expense/Revenue
▪
Selling, general, & administrative (SG&A) expense/Revenue
Cost of Capital
• Represents a firm’s cost of financing operations from both equity through issuing stock
and debt through issuing bonds
Fixed Asset Turnover
• Revenue/Fixed assets
• Measures how well a company leverages its fixed assets, particularly property, plant, and
equipment (PPE)
Shareholders
• Individuals or organizations that own one or more shares of stock in a public company
• Are the legal owners of public companies
Risk Capital
• The money provided by shareholders in exchange for an equity share in a company; it
cannot be recovered if the firm goes bankrupt
Total Return to Shareholders
• Return on risk capital that includes stock price appreciation plus dividends received over
a specific period
• External and forward-looking performance metric
Efficient Market Hypothesis
• Idea that all available information about a firm’s past, current state, and expected future
performance is embedded in the market price of the firm’s stock
Market Capitalization
• A firm performance metric that captures the total dollar market value of a company’s total
outstanding shares at any given point in time
• Number of outstanding shares x share price
• Shortcomings (3)
o Stock prices can be highly volatile, making it difficult to assess firm performance,
particularly in the short term
o Overall macroeconomic factors such as economic growth or contraction, the
unemployment rate, and interest and exchange rates all have a direct bearing on
stock prices
o Stock prices frequently reflect the psychological mood of investors, which can at
times be irrational
Economic Value Created
• Difference between value (V) and cost (C), or (V—C)
Reservation Price
• The maximum price a consumer is willing to pay for a product or service based on the
total perceived consumer benefits
Value
• The dollar amount (V) a consumer attaches to a good or service; the consumer's
maximum willingness to pay; also called reservation price
Profit
• Difference between price charged (P) and the cost to produce (C), or (P—C)
• Also called producer surplus
Producer Surplus
• Another term for profit, the difference between price charged (<em>P</em>) and the cost
to produce (C) or (P-C) also called profit
Consumer Surplus
• Difference between the value a consumer attaches to a good or service (V) and what he
or she paid for it (P), or (V-P).
Economic Value Creation Framework Strategy (2)
• Creating economic value
• Capturing as much of it as possible
• Limitations (3)
o Determining the value of a good in the eyes of consumers is not a simple task
o The value of a good in the eyes of consumers changes based on income,
preferences, time, and other factors
o To measure firm-level competitive advantage, we must estimate the economic
value created for all products and services offered by the firm
Opportunity Costs
• The value of the best forgone alternative use of the resources employed
• Types (2)
o Forgone wages she could be earning if she was employed elsewhere
o The cost of capital she invested in her business
Balanced Scorecard
• Strategy implementation tool that harnesses multiple internal and external performance
metrics in order to balance financial and strategic goals
• Can accommodate both short- and long-term performance metrics
• Key questions (4)
o How do customers view us
o How do we create value
o What core competencies do we need
o How do shareholders view us
• Advantages (4)
o Communicate and link the strategic vision to responsible parties within the
organization
o Translate the vision into measurable operational goals
o Design and plan business processes
o Implement feedback and organizational learning to modify and adapt strategic
goals when indicated
• Disadvantages (2)
o A tool for strategy implementation, not for strategy formulation
o Does not provide much insight into how metrics that deviate from the set goals
can be put back on track
Triple Bottom Line
• Combination of economic, social, and ecological concerns—or profits, people, and planet
—that can lead to a sustainable strategy
• Profits
o The economic dimension captures the necessity of businesses to be profitable to
survive
• People
o The social dimension emphasizes the people aspect
• Planet
o The ecological dimension emphasizes the relationship between business and the
natural environment
Sustainable Strategy
• A strategy along the economic, social, and ecological dimensions that can be pursued
over time without detrimental effects on people or the planet
Business Model
• A firm's plan that details how it intends to make money
• Types
o Razor-razorblades
▪
Initial product is often sold at a loss or given away for free in order to
drive demand for complementary goods
o Subscription
▪
Users pay for access to a product or service whether they use the product
or service during the payment term or not
o Pay as you go
▪
Users pay for only the services they consume
o Freemium
▪
Provides the basic features of a product or service free of charge, but
charges the user for premium services such as advanced features or add-
ons
o Wholesale
▪
Traditional model in retail
o Agency
▪
Producer relies on an agent or retailer to sell the product, at a
predetermined percentage commission
o Bundling
▪
Sells products or services for which demand is negatively correlated at a
discount
