1. Competitive Advantage and Firm Performance

2. Part 1 Strategy Analysis

3. LO 5-1. Describe and evaluate economic value creation when
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.

4. 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. Google vs. Microsoft Google and Microsoft in multipoint competition
Chapter Case 5
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).

6. Comparing Google & Microsoft on Different Dimensions
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)

10. 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

11. 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?

12. Economic Value Creation
Pizza!
Value = $12
Price = $10
Cost = $7
Consumer Surplus
$12 - $10 = $2
Producer Surplus
$10 - $7 = $3
Economic Value
$12 - $7 = $5
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
SOLD!
INSTRUCTOR: An Interactive activity is available online through McGraw-Hill Connect on this section of the text.

13. Competitive Advantage & Economic Value
EXHIBIT 5.2
Competitive Advantage & Economic Value
HIGHEST
VALUE –
COST
COMPETITIVE
ADVANTAGE =
INSTRUCTOR: An Interactive activity is available online through McGraw-Hill Connect on this section of the text.

14. 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

15. 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

17. 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.

18. 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.

20. 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

23. Firms with the Highest Ratios of Market Value to Book Value (December 2005)
Company
Valuation ratio
Country
Yahoo! Japan
72.0
Japan
Coca-Cola
7.8 US
Colgate-Palmolive
20.8
Diageo
7.4 UK
Glaxo Smith Kline
13.4 3M
7.3
Anheuser-Busch
12.6
Nokia
6.7
Finland
eBay
11.2
Sanofi-Aventis
6.3
France
SAP
10.8
Germany
AstraZeneca
5.9
Yahoo!
10.7
Johnson & Johnson
5.7
Dell Computer
10.0
Boeing
Sumitomo Mitsui Financial
8.8
Eli Lily
5.6
Procter & Gamble
8.4
Cisco Systems
5.5
Qualcomm
8.3
Roche Holding
Switz.
Schlumberger
8.2
L’Oreal
5.3
Unilever
8.1
Neth/UK
Altria
5.2
PepsiCo
8.0
Novartis
5.1

24. 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.

25. Accounting Profitability
Uses standard, publicly available metrics
Permits direct firm performance comparisons
Using standard ratios
Regulated by:
Accounting principles (GAAP)
U.S. Securities & Exchange Commission (SEC)
Sarbanes-Oxley Act (2002)
INSTRUCTOR: McGraw-Hill Connect has a financial remediation section for use by students to refresh on some common financial and accounting knowledge useful in understanding accounting ratios and performing case analysis.

26. Top 10 Fortune 500 Companies by Profits ($M)
EXHIBIT 5.3
Top 10 Fortune 500 Companies by Profits ($M)

27. Top 10 Fortune 500 Companies by Return on Revenue
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.

28. Profits vs. Return on Revenue (ROR)
Ranking changes markedly with the use of different metrics
2010 Profits in $M
2010 ROR %

29. 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
INSTRUCTOR: McGraw-Hill Connect has a financial remediation section for use by students to refresh themselves about some common financial and accounting knowledge useful in understanding accounting ratios and performing case analysis.

30. Firm Performance - Pharmaceutical Industry by ROR
EXHIBIT 5.5
Firm Performance - Pharmaceutical Industry by ROR
Pfizer performance declines as Merck improves and takes the competitive advantage over this period

31. 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”

32. Declining Importance of Book Value in Stock Valuation
EXHIBIT 5.6
Declining Importance of Book Value in Stock Valuation

33. 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.

34. 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

35. Normalized Stock Returns 2005–2010
EXHIBIT 5.7

36. 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
INSTRUCTOR: Embedded at the bottom of this slide is a link to a 20-minute video of Duke Professor Dan Ariely. In the video, he describes several experiments he has performed to frame his “predictably irrational” argument for our financial behaviors. The link is also pasted below:
Dan Ariely Video

37. 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%.

38. Comparing Google and Microsoft Using ROE and ROA
EXHIBIT 5.8
Comparing Google and Microsoft Using ROE and ROA
Microsoft outperforms Google in 2010 based on this accounting data

39. Normalized Stock Returns 2005–2010
EXHIBIT 5.9
Normalized Stock Returns 2005–2010
Google is enjoying a sustained competitive advantage over Microsoft based on shareholder value.

40. 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.

42. 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

43. A Balanced-Scorecard Approach to Competitive Advantage
EXHIBIT 5.10
A Balanced-Scorecard Approach to Competitive Advantage

44. Balanced Scorecard Example
STRATEGIC DIRECTION
PERFORMANCE MEASUREMENT
Strategies & Objectives
Current-Year Initiatives
Process
Assessments
Business Results
Financial
Annual revenue - $X
Profit before tax - $X
ROA - X%
Revenue per employee - $X
Leadership
Make improvement in work environment as measured by employee survey
Gain recognition for community relations
Overriding Purpose:
Customer/Consumer
Improve customer delivery
Increase sales to Europe
Meet customer loyalty goals
Reduce defects
Strategic Planning
Establish an effective strategy-based M&A process.
Strategies & Objectives
Customer & Mkt Focus
Complete market segment analysis
Tie sales plan & budgets to group regional goals
Partner/Supplier/Operations
Develop strategy and plan to have suppliers own material inventory
Supplier contribution to cost reduction
Achieve inventory turns goal
Information/Analysis
Provide IT support for decentralized operations
Human Resources
Balance the Human Resource availability with initiative requirements, establish plans, & execute
Implement diversity plan
Plan and execute strategic staffing plan
INSTRUCTOR: This is ADDITIONAL material that is a complement to the textbook.
Human Resources
Develop a comprehensive college recruiting strategy
Implement an employee feedback process
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
Process Mgmt
Complete ISO 9000 tasks as planned
Improve overall new product introduction process
Group
SBU 1

45. 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
INSTRUCTOR: An Interactive video activity with the CEO of one of the world’s largest mining firms (Rio Tinto) is available online through McGraw-Hill Connect on this section of the text.
The Triple Bottom Line

46. Interface is a global leader in modular carpet tiles
STRATEGY HIGHLIGHT 5.1
Interface: The World’s First
Fully 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

47. 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.

48. How Do We Measure Competitive Advantage?
EXHIBIT 5.12
How Do We Measure Competitive Advantage?

49. 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