Mgmtg494BI Chapter Five

Standard performance dimensions
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Standard performance dimensions
- (Traditional frameworks of competitive advantage) - (assess the competitive advantages, assess whether reach the goal or not)

Three Standard Performance Dimensions
•What is the firm's accounting profitability? (internal→ profit/ assets)
•How much shareholder value does the firm create?
•How much economic value does the firm generate?
These performance dimensions generally correlate over time:
•Accounting profitability and economic value creation tend to be reflected in the firm's stock price.
•Determines the stock's market valuation.
Accounting Profitability
- Accurately assesses firm performance. (internal metrics)
- Compares firm performance (internal metrics) to competitors / industry average.
- Available through:
•Standardized accounting metrics (GAAP, FASB).
•Form 10-K statements.
•Profitability ratios.
•Return on invested capital (ROIC), return on equity (ROE), return on assets (ROA), and return on revenue (ROR).

One of the most commonly used metrics in assessing firm financial performance is return on invested capital (ROIC), where ROIC = Net profits / Invested capital. - ROIC is a popular metric because it is a good proxy for firm profitability.
- In particular, the ratio measures how effectively a company uses its total invested capital, which consists of two components:
(1) shareholders' equity through the selling of shares to the public, and
(2) interest-bearing debt through borrowing from financial institutions and bondholders.

- Apple's ROIC is 17.3 percent, which is 8.5 percentage points higher than Microsoft's (8.8 percent). This means that for every $1.00 invested in Apple, the company returned $1.17, while for every $1.00 invested in Microsoft, the company returned $1.09. Since Apple was almost twice as efficient as Microsoft at generating a ROIC, Apple had a clear competitive advantage over Microsoft.
- Although this is an important piece of information, managers need to know the underlying factors driving differences in firm profitability.
Elements of ROIC Explained
•Return on revenue:How much of the firm's sales is converted into profits. (profitability/how efficiency making profits)

•Working capital turnover:How effectively capital is being used to generate revenue.(how efficient/ effective to use the profits they made)(future plans)

ROIC = Net profits / Invested capital.
Limitations of Accounting Data
•Historical and backward-looking.
•Does not consider off-balance (operating) sheet items
•Focuses mainly on tangible assets (innovation, quality, brand image, customer satisfaction)

- This limitation of accounting data is nicely captured in the adage: Not everything that can be counted counts. Not everything that counts can be counted. - Although accounting data capture some intangible assets, such as the value of intellectual property (patents, trademarks, and so on) and customer goodwill, many key intangible assets are not captured. - Today, the most competitively important assets tend to be intangibles such as innovation, quality, and customer experience, which are not included in a firm's balance sheets.
Shareholders value creation
- Risk Capital:
•Money provided for an equity share.
•Cannot be recovered if a firm goes bankrupt.
- Total Return to Shareholders:
•Stock price appreciation + dividends.

- Market Capitalization:
•Dollar value of total shares outstanding.(value of the firm, if sold, how much expected to have)
•Number of outstanding shares x share price.

- Limitations of Shareholder Value Creation
•Stock prices can be volatile. (hard to predict the changes, competitors)
•Macroeconomic factors affect stock prices. (covid-19, great influence with no control by business)
•Stock prices can reflect the mood of investors.

All public companies in the United States are required to report total return to shareholders annually in the statements they file with the Securities and Exchange Commission (SEC).
-In addition, companies must also provide benchmarks, usually one comparison to the industry average and another to a broader market index that is relevant for more diversified firms.
- Investors also adjust their expectations over time. Since the business in the slow-growth industry surprised them by delivering higher than expected growth, they adjust their expectations upward. The next year, they expect this firm to again deliver 4 percent growth. On the other hand, if the industry average is 10 percent a year in the high-tech business, the firm that delivered 8 percent growth will again be expected to deliver at least the industry average growth rate; otherwise, its stock will be further discounted
Economic value creation
The difference between:
•A buyer's willingness to pay for a product / service and the firm's total cost to produce it.
•The difference between value (V) and cost (C).
•Opportunity costs: The value of the best forgone alternative.

Example of Opportunity Costs of an Entrepreneur:
(1) forgone wages if employed elsewhere;
(2) the cost of capital invested in the business vs. the stock market vs. U.S. Treasury bonds.
Limitations of Economic Value Creation?
Balance score card?
Valuing a consumer good isn't easy.
- The value of a good changes in the eyes of a consumer's income, preferences, time, etc.

The balanced scorecard
- Helps managers achieve their strategic objectives.
- Uses internal and external performance metrics.
- Balances both financial and strategic goals.

Just as airplane pilots rely on a number of instruments to provide constant information about key variables—such as altitude, airspeed, fuel, position of other aircraft in the vicinity, and destination—to ensure a safe flight, so should managers rely on multiple yardsticks to more accurately assess company performance in an integrative way.
Advantages of Balanced Scorecard
- Links strategic vision to responsible parties.
- Translates vision into measurable goals.
- Designs and plans business processes.
- Implements feedback and organizational learning.
- Alerts to needed strategic goal adaptation

Implementing a balanced scorecard allowed FMC's managers to align their different perspectives to create a more focused corporation overall. General managers now review progress along the chosen metrics every month, and corporate executives do so on a quarterly basis. Implementing a balanced-scorecard approach is not a onetime effort. It requires continuous tracking of metrics and updating of strategic objectives, if needed. It is a continuous process, feeding performance back into the strategy process to assess its effectiveness.
Disadvantages of the Balanced Scorecard
- Focused on implementation (how is the strategy?)
- How to get back on track if deviations occur.
Triple Bottom Line
Focus: economic, social and ecological performance.
- Three dimensions:
•Profits: Economic Dimension.
•People: Social Dimension.
•Planet: Ecological Dimension.

- main goal: achieving competitive advantages through sustainable strategy(social, ecological, economics)

- Rather than emphasizing sustaining a competitive advantage over time, sustainable strategy means a strategy that can be pursued over time without detrimental effects on people or the planet. Using renewable energy sources such as wind or solar power, for example, is sustainable over time. It can also be good for profits, or, simply put, "green is green," as Jeffrey Immelt was fond of saying while CEO at GE. GE's renewable energy business brought in more than $9 billion in revenues in 2016 (up from $3 billion in 2006). Immelt retired in 2017.
What is a business model?- Details a firm's competitive tactics and initiatives. - Explains how the firm: •Intend to make money. •Conducts its business with buyers, suppliers, and partners. (include how firm manage relationship with in/external stakeholders) How companies do business can sometimes be as important, if not more so, to gaining and sustaining competitive advantage as what they do. Indeed, a slight majority (54 percent) of senior executives responded to a recent survey stating that they consider business model innovation to be more important than process or product innovation. This is because product and process innovation is often more costly, is higher risk, and takes longer to come up with in the first place and to then implement. Moreover, business model innovation is often an area that is overlooked in a firm's quest for competitive advantage, and thus much value can be unlocked by focusing on business model innovation.Different types of business models- Razor-razor blades: pay for replacements. Razor-razorblade: was invented by Gillette, which gave away its razors and sold the replacement cartridges for relatively high prices. The razor-razor-blade model is found in many business applications today. For example, HP charges little for its laser printers but imposes high prices for its replacement toner cartridges - Subscription: pay for access. Subscription: Microsoft uses a subscription-based model for its new Office 365 suite of application software. Other industries that use this model presently are cable television, cellular service providers, satellite radio, internet service providers, and health clubs. Netflix also uses a subscription model. - Pay as you go: pay for what you consume. Pay as you go: most widely used by utilities providing power and water and cell phone service plans, but it is gaining momentum in other areas such as rental cars and cloud computing such Microsoft's Azure. - Freemium: pay for extra features / add-ons. Freemium: examples include Spirit Airlines (in the United States), Ryanair (in Europe), or AirAsia, which provide minimal flight services but allow customers to pay for additional services and upgrades à la carte, often at a premium. - Wholesale: products sold at a discount. Wholesale: book publishers sell books to retailers at a fixed price (usually 50 percent below the recommended retail price). Retailers, however, were free to set their own price on any book and profit from the difference between their selling price and the cost to buy the book from the publisher (or wholesaler)., - Agency: products sold on commission. Agency: long used in the entertainment industry where agents place artists or artistic properties and then take their commission. More recently we see this approach at work in a number of online sales venues, as in Apple's pricing of book products or its app sales. Bundling: In the Microsoft Office Suite, a user might value Word more than Excel and vice versa. Instead of selling both products for $120 each, Microsoft bundles them in a suite and sells them combined at a discount, say $150. - Bundling: more than one product sold at a discount. .Dynamic nature of business modelsBusiness Models: •Can be combined. •Can evolve. •Can be disrupted. •Businesses must respond to disruption and adapt. •Legal conflicts can arise. Business models can be combined: AT&T uses both razor-razorblade & subscription models Business models can evolve: Freemium is an evolution of razor-razorblade Business models can be disrupted: Amazon disrupted wholesale models of publishers Businesses must respond to disruption & adapt: Many book publishers worked with Apple on an agency approach, in which the publishers would set the price for Apple and receive 70 percent of the revenue, while Apple received 30 percent. Publishers inked their deals with Apple, but how could they get Amazon to play ball? For leverage, publishers withheld new releases from Amazon. This forced Amazon to raise prices on newly released e-books in line with the agency model to around $14.95 Legal conflicts can arise: In 2012 the Department of Justice determined that Apple and major publishers had conspired to raise prices of e-books. A year later, Apple was found guilty of colluding with several major book publishers to fix prices on e-books and had to change its agency model.