1. Strategic Management/ Business Policy
Power Point Set #2
Performance Measurement

2. Fundamentals of Competitive Strategy
Superior Long-Run Performance
The central goal
Attractive Industry Structure
Competitive Advantage
High returns for the average participant
Outperform the average industry participant
Superior Competitive Position
Operational Effectiveness
Do different things than rivals
Do the same things as rivals but better

3. 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 appropriate some of that value in terms of higher prices; and
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

4. The First Rule of Strategy:
A Good Strategy Is “Coherent.”
Functional pieces of strategy support the whole (Michael Porter: HBR, 1996)
Oper.
Strategy
Finance
Acctg.
H.R.
Mktg.

5. Strategic Coherence The Logic of How The Business Fits Together:
Southwest Airlines
Low Price
Short Routes
No Frills
Point-to-Point
One Aircraft Boeing 737
High number of Aircraft per Route
No Meals
Flexible/ Lower Staffing
American Airlines
Premium Price
Short, Long, & Int’l
Variety
Hub & Spoke System
Multiple Aircraft
Low number of Aircraft per Route
Meals & Service
Higher Staffing

8. Opportunities & Threats Values Of Stakeholders
SWOT Analysis
Strengths, Weaknesses, Opportunities, and Threats
Strengths & Weaknesses
Opportunities & Threats
Values Of
Management
Values Of Stakeholders
Strategy
Internal Factors
External Factors
Drivers
Objectives

9. 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

12. 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

13. 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.

14. 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)

15. 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.

16. 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).

18. 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

19. 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

22. Problems With Shareholder Wealth Maximization
Under what conditions does “maximizing shareholder wealth” not make sense? When do we need to pay attention to other “stakeholders?”
What are the social responsibilities of business to:
Employees?
Communities?
Customers?
The Issue: What are the “externalities,” and who bears the costs?