5 chapter mcgraw-hill/irwin copyright © 2013 by the mcgraw-hill companies, inc. all rights...
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5CHAPTER
McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Competitive Advantage and
Firm Performance
LO 5-1 Describe and evaluate economic value creation when measuring competitive advantage.
LO 5-2 Describe and evaluate accounting profitability when measuring competitive advantage.
LO 5-3 Describe and evaluate shareholder value creation when measuring competitive advantage.
LO 5-4 Describe and evaluate the balanced-scorecard approach for assessing competitive advantage.
LO 5-5 Describe and evaluate the triple-bottom-line approach when assessing competitive advantage.
LO 5-6 Compare and contrast different approaches to measuring competitive advantage, and derive managerial
implications.
5–3
How Do We Measure Performance?
•“The strategic aim of a business is to earn a return on capital, and if in any particular case the return in the long run is not satisfactory, then the deficiency should be corrected or the activity abandoned for a more favorable one.”
Alfred P. Sloan My Years with General Motors
5–4
Chapter Case 5 Chapter Case 5 Google vs. Microsoft
• Google and Microsoft in multipoint competition
How to measure success of this competition?
Revenues and net income?
Performance per employee?
• There are several ways to measure firm performance.
• The key idea is to “triangulate” (i.e., to use multiple measures of performance to evaluate the health of the organization).
5–5
EXHIBIT 5.1 Comparing Google & Microsoft on Different Dimensions
Performance viewpoint changes significantly when the measurement changes from absolute to per-employee figures (on the bottom)
5–6
7
Net Inc. ROS ROE EVA Market Return to Value Added Shareholders
($m) (%) (%) ($m) ($m) (%)General Motors 2,956 1.8 19.7 -5,525 -17,943 21.4General Electric 6,573 9.4 22.2 4,370 285,320 45.3Exxon 6,370 6.3 14.6 -2,262 114,774 22.4Philip Morris 5,450 10.3 39.0 5,180 98,657 64.8IBM 6,328 7.7 32.6 2,541 -5,878 77.5Coca-Cola 3,533 18.8 42.0 2,194 157,356 1.3Wal-Mart 4,430 3.2 21.0 1,159 159,444 107.7 Procter & Gamble 3,780 10.2 12.2 61,661 102,379 15.9Microsoft 4,490 31.0 27.0 3,776 328,257 37.5Hewlett-Packard 2,945 6.3 17.4 -593 45,464 10.7
How U.S. Companies Perform Under Different Profitability Measures, 1998
How U.S. Companies Perform Under Different Profitability Measures, 1998
8
Shareholdervalue
creation
Shareholdervalue
creation ROCEROCE
Economic Profit
Economic Profit
MarginMargin
CapitalTurnover
CapitalTurnover
Sales Targets
Sales Targets
cogs/sales
cogs/sales
DevelopmentCost/Sales
DevelopmentCost/Sales
InventoryTurnover
InventoryTurnover
CapacityUtilization
CapacityUtilization
CashTurnover
CashTurnover
Order SizeCustomer MixSales/Account
Customer ChurnRate
Deficit Rates
Cost per DeliveryMaintenance cost
New productdevelopment time
Indirect/DirectLabor
Customer Complaints
Downtime
Accounts PayableTime
Accounts Receivable Time
CEO Corporate/Divisional Functional Departments & Teams
Linking Value Drivers to Performance TargetsLinking Value Drivers to Performance Targets
Copyright 1998 by Houghton Mifflin Company. All rights reserved.
2-20
Tradeoff Between Profitability Tradeoff Between Profitability and Growth Rate and Growth Rate
G0
P1
P2
PMAX
G1 G2
Growth Rate
Profitability
Economic Profits and Competitive Advantage
• Driving a wedge between revenues and costs is how competitive advantage is created.
• In strategy, we need to think simultaneously about:
The value we create for our customer; How we capture some of the value in terms of higher prices; The costs we incur in creating that value.
• Conceptual traps that managers fall into:
Accounting costs versus Opportunity Costs Market Share is not competitive advantage
Measuring Competitive Advantage
• Always measured relative to other firms
• Three standards are typical by asking:
1. How much economic value does the firm
generate?
2. What is the firm’s accounting profitability?
3. How much shareholder value does the firm create?
5–11
Economic Value Creation
• Value: A dollar amount a consumer is willing to pay for a good or service
• Price: The dollar amount a good or service is offered for sale
• Cost: The dollar amount to make the good or service
• Pizza!• Value = $12• Price = $10• Cost = $7
• Consumer Surplus $12 - $10 = $2
• Producer Surplus $10 - $7 = $3
• Economic Value $12 - $7 = $5
SOLD!
5–12
EXHIBIT 5.2 Competitive Advantage & Economic Value
COMPETITIVE COMPETITIVE
ADVANTAGE = ADVANTAGE = HIGHEST
VALUE –
COST
HIGHEST
VALUE –
COST
5–13
Economic Value Creation
• Opportunity Costs
The next best alternative use for resources Pizza entrepreneur
Wages $40,000 employment salary Capital invested $25,000 interest on capital
If the restaurant made $60,000 in (accounting) profits… The owner actually had an economic LOSS of $5,000
Economic Value as Competitive Advantage
• If the economic value created is
greater than its rivals competitive advantage
equal to its rivals competitive parity
lower than its rivals competitive disadvantage
16
Sustainable Competitive Advantage and the Measurement of Performance
• While we have said that the objective of strategy is to “create competitive advantage,” specifically we have the goal to maximize economic return.
• Economic & Accounting Measures of Performance Economic Profits ROA, ROE, ROC
• Financial Measures of Performance NPV Methods
Discounting Cash Flows
NPV =CF1
1+r +CF2
(1+r)2 +CF3
+ …CFt
+ +
Horizon Valuet+1
NPV: Net Present Value
CFt: Cash Flow at time t
r: Discount rate
Horizon Value: Value of ongoing enterprise after time t
(1+r)3 (1+r)t (1+r)t+1
Financial Measures of Performance: NPV or DCF Analysis
• The principle of discounted cash flow (DCF) analysis that firms apply to their individual projects can also be applied to the firm as a whole. Maximizing the net present value of the firm’s cash flow (“sustainable competitive advantage”) corresponds to maximization of its stock market valuation and hence maximizes the wealth of its shareholders.
-
+
0
Cash Flow
Time
5–17
Net Cash Flow
• EBT - t (EBT) • EBT (1-t) = NET INCOME• EBT (1-t) + depreciation - capital expenditures =
NET CASH FLOW
(note we are assuming no change in accounts receivable, no change in net working capital, no change in inventory)
• Equivalent concepts: Maximize NPV DCF Approach Maximize Economic Profits (EVA) Sustainable Competitive Advantage (SCA)
19
Limitations of Present Value Measures
•Projections are only as good as the ability of managers to measure accurately the financial consequences of actions.
•An implicit assumption of value-based strategy was that business units and all investment proposals were self-contained. It was usually expected that divesting a business or curtailing an investment project would have no financial repercussions elsewhere in the corporation (e.g., ignores knowledge transfers).
•Strict financial measurement of many long-term investments, particularly in intangible assets, is virtually impossible..
Limitations of Present Value Measures
• Investments in R&D typically do not offer direct returns; their economic value is a strategic option to invest in new products and processes that may arise from R&D. Narrowly- defined DCF does not accurately value investments where there is significant strategic options value.
(Merck has been at the forefront of applying strategic options theory to analyze investments in R&D).
21
Capital Market Approaches To Measuring Performance
• Market Value Added (MVA) Market Value less Total Investment
• Economic Value Added (EVA) Operating Profit (after tax) less annual capital costs; basically,
this is economic profit
• Tobin’s q (Market Value/Book Value) A firm’s market value divided by its “replacement” cost
• The Market Value of the Firm - Current Value of all securities issued by the firm
22
Economic Value Added (EVA)
•Anheuser-Busch: Operating profit $1,756 million - taxes $617 million = $1,139 million
•WACC : 67% equity at 14.3% 33% debt at 5.2%
11.3% WACC
Capital of $8 billion 11.3% * $8billion = $904 million $1,139 - $904 = $235 million EVA
Company Valuation ratio
Country Company Valuation ratio
Country
Yahoo! Japan 72.0 Japan Coca-Cola 7.8 US
Colgate-Palmolive 20.8 US Diageo 7.4 UK
Glaxo Smith Kline 13.4 UK 3M 7.3 US
Anheuser-Busch 12.6 US Nokia 6.7 Finland
eBay 11.2 US Sanofi-Aventis 6.3 France
SAP 10.8 Germany AstraZeneca 5.9 UK
Yahoo! 10.7 US Johnson & Johnson 5.7 US
Dell Computer 10.0 US Boeing 5.7 US
Sumitomo Mitsui Financial 8.8 Japan Eli Lily 5.6 US
Procter & Gamble 8.4 US Cisco Systems 5.5 US
Qualcomm 8.3 US Roche Holding 5.5 Switz.
Schlumberger 8.2 US L’Oreal 5.3 France
Unilever 8.1 Neth/UK Altria 5.2 US
PepsiCo 8.0 US Novartis 5.1 Switz.
Firms with the Highest Ratios of Market Value to Book Value (December 2005)
Firms with the Highest Ratios of Market Value to Book Value (December 2005)
LO 5-1 Describe and evaluate economic value creation when measuring competitive advantage.
LO 5-2 Describe and evaluate accounting profitability when measuring competitive advantage.
LO 5-3 Describe and evaluate shareholder value creation when measuring competitive advantage.
LO 5-4 Describe and evaluate the balanced-scorecard approach for assessing competitive advantage.
LO 5-5 Describe and evaluate the triple-bottom-line approach when assessing competitive advantage.
LO 5-6 Compare and contrast different approaches to measuring competitive advantage, and derive managerial implications.
5–24
Accounting Profitability
• Uses standard, publicly available metrics
• Permits direct firm performance comparisonsUsing standard ratios
• Regulated by:
Accounting principles (GAAP)U.S. Securities & Exchange Commission (SEC)Sarbanes-Oxley Act (2002)
1–25
EXHIBIT 5.4 Top 10 Fortune 500 Companies by Return on Revenue
ROR measures the profit earned per dollar of revenue as a percentage. A size-adjusted measure of profits.
5–27
Profits vs. Return on Revenue (ROR)
2010 Profits in $M
2010 ROR %
Ranking changes markedly with the use of different metrics
5–28
Accounting Profitability
• Need to move beyond a “snapshot” metric Look at more than one year of data
• Permits direct firm performance comparisons Using standard ratios
• Competitive advantage is relative to competitors Study firms in the same industry “Apples to apples” comparisons
5–29
EXHIBIT 5.5 Firm Performance - Pharmaceutical Industry by ROR
Pfizer performance declines as Merck improves and takes the competitive advantage over this period
5–30
Drawbacks for Accounting Measures
• Does not consider “off balance sheet” items Health care, pension obligations
• Focuses on tangible assets, which may no longer be strategically relevant Key is intangible assets “Knowledge-based economy” Manufacturing vs. Services
• Historical data Backward-looking “Driving a car by looking in the review mirror”
5–31
LO 5-1 Describe and evaluate economic value creation when measuring competitive advantage.
LO 5-2 Describe and evaluate accounting profitability when measuring competitive advantage.
LO 5-3 Describe and evaluate shareholder value creation when measuring competitive advantage.
LO 5-4 Describe and evaluate the balanced-scorecard approach for assessing competitive advantage.
LO 5-5 Describe and evaluate the triple-bottom-line approach when assessing competitive advantage.
LO 5-6 Compare and contrast different approaches to measuring competitive advantage, and derive managerial implications.
5–33
Shareholder Value Creation
• Shareholders – legal owners of public firms
Total return to shareholders Return on risk capital + dividends
External performance metric Efficient-market hypothesis
All available information is embedded in the stock price
• SEC requires all public firms to submit shareholder returns
• Stock price based on expectations of performance
5–34
Drawbacks to Shareholder Value as Competitive Advantage
• Stock prices can be highly volatile, which makes it difficult to assess firm performance (at least in the short term)
• Macro economic factors (e.g., unemployment rate, economic growth or contraction, interest rate and exchange rates…) all have a direct bearing on stock prices
• Stock prices frequently reflect the psychological mood of the investors, which can be at times irrational “Irrational exuberance” Alan Greenspan, former Federal Reserve Chair
Dan Ariely Video
Google vs. Microsoft
• Accounting perspective shows Microsoft with an advantage over Google. But both firms have large intangible assets.
• BUT shareholder value favors Google over Microsoft! Microsoft stock is flat while Google is up 200%.
5–37
EXHIBIT 5.8 Comparing Google and Microsoft Using ROE and ROA
Microsoft outperforms Google in 2010 based on this accounting data
5–38
EXHIBIT 5.9 Normalized Stock Returns 2005–2010
Google is enjoying a sustained competitive advantage over Microsoft based on shareholder value.
5–39
LO 5-1 Describe and evaluate economic value creation when measuring competitive advantage.
LO 5-2 Describe and evaluate accounting profitability when measuring competitive advantage.
LO 5-3 Describe and evaluate shareholder value creation when measuring competitive advantage.
LO 5-4 Describe and evaluate the balanced-scorecard approach for assessing competitive advantage.
LO 5-5 Describe and evaluate the triple-bottom-line approach when assessing competitive advantage.
LO 5-6 Compare and contrast different approaches to measuring competitive advantage, and derive managerial implications.
5–40
41
The Four Perspectives of the Balanced ScorecardThe Four Perspectives of the Balanced Scorecard
© The McGraw-Hill Companies, Inc., 1998Irwin/McGraw-Hill
Slide 4-5Exh. 4.8
Financial
Customer
Operations
Organizational
EVAProfitabilityGrowth
DifferentiationCostQuick Response
Product DevelopmentDemand ManagementOrder Fulfillment
LeadershipOrganizational LearningAbility to Change
Perspective Assessed through analysis of:
THE BALANCED SCORECARD
• Advantages Communicate vision
thru the organization
Translate vision into measureable goals
Design business processes
Implement organizational learning
• Disadvantages Tool for strategy
implementation not formulation.
Limited guidance on selecting metrics
Limited insight on how to get back on track to meet goals Can be viewed as just
a tracking tool for metrics
5-42
Information/Analysis • Provide IT support for decentralized operations
Customer & Mkt Focus • Complete market segment analysis
• Tie sales plan & budgets to group regional goals
Strategic Planning • Establish an effective strategy-based M&A process.
Financial•Annual revenue - $X •Profit before tax - $X•ROA - X%•Revenue per employee - $X
Strategies &Objectives
Current-YearInitiatives
STRATEGIC DIRECTION PERFORMANCE MEASUREMENT
Strategies & Objectives
Overriding Purpose:
Process Mgmt•Complete ISO 9000 tasks as planned
• Improve overall new product introduction process
ProcessAssessments
Leadership•Make improvement in work environment as measured by employee survey
•Gain recognition for community relations
Human Resources•Develop a comprehensive college recruiting strategy
• Implement an employee feedback process
Business Results
SBU-Specific•Develop rapid prototyping processes and match prototype capacity to business needs
•Software process improvement to goal •Acquire new services customers to meet plans
•Meet on-time product launch goal
Customer/Consumer• Improve customer delivery • Increase sales to Europe•Meet customer loyalty goals •Reduce defects
Human Resources • Balance the Human Resource availability with initiative requirements, establish plans, & execute
• Implement diversity plan• Plan and execute strategic staffing plan
Partner/Supplier/Operations• Develop strategy and plan to have suppliers own material inventory
• Supplier contribution to cost reduction• Achieve inventory turns goal
Group
Balanced Scorecard Example
SBU5-44
The Triple Bottom Line
• Financial, Social, and Ecological Considerations
Also known as "People, Planet, & Profits"
BP oil spill had many major effects
BMW changed car designs to enhance recycling
Integrative approach for sustainable strategy
EXHIBIT 5.11
The Triple Bottom Line
1–46
STRATEGY HIGHLIGHT 5.1STRATEGY HIGHLIGHT 5.1 Interface: The World’s FirstFully Sustainable Company• Interface is a global leader in modular carpet tiles
Business to business so not a consumer name
In 1994, founder & CEO set a BHAG
Highly industrial, petroleum-intensive business to go “off oil”!
By 2008, estimates savings at $400 million
Energy efficiency
Recycled raw materials instead of virgin material
Sustainability as a market differentiator
Employee motivation
LO 5-1 Describe and evaluate economic value creation when measuring competitive advantage.
LO 5-2 Describe and evaluate accounting profitability when measuring competitive advantage.
LO 5-3 Describe and evaluate shareholder value creation when measuring competitive advantage.
LO 5-4 Describe and evaluate the balanced-scorecard approach for assessing competitive advantage.
LO 5-5 Describe and evaluate the triple-bottom-line approach when assessing competitive advantage.
LO 5-6 Compare and contrast different approaches to measuring competitive advantage, and derive managerial implications.
5-47
Implications for the Strategist
• Both quantitative AND qualitative performance dimensions matter. Managers need to have a holistic view
• Competitive advantage is best by criteria, reflecting overall company performance Metrics aggregate upward, useful to gauge firm's
strategy
• Only better strategy is our goal. No best strategy exists Strategic performance metrics must be relative
5–49