CHAPTER

Competitive Advantage and Firm Performance

LDR 660 - Team 2 Presentation Deborah Elliott Ben Gilsdorf Nathan Sarkissian April 14, 2014

McGraw-Hill/Irwin

Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Part 1 Strategy Analysis

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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.

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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 firms accounting profitability?

3. How much shareholder value does the firm create?

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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 SOLD! Consumer Surplus

$12 - $10 = $2

Producer Surplus
$10 - $7 = $3

Economic Value
$12 - $7 = $5
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EXHIBIT 5.2 Competitive Advantage & Economic Value

COMPETITIVE ADVANTAGE =

_
Firms Cost (C)

Consumer Surplus is also referred to as good will

(Hawawini & Viallet, 2011)

Hawawini, G., & Viallet, C. (2011). Finance for executives: managing for value creation. (4th ed.). Mason, OH: South-Western Cengage Learning.
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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

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Economic Value Creation (contd) Some Drawbacks to Consider.

Determining value is often NOT easy Value may be widely varied

Income, preferences, time, etc.

Firm level competitive advantage

We must have economic value for all goods and services Fairly easy for small or focused firms Quite difficult for conglomerates like GE or Tata

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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.

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Accounting Profitability
Uses standard, publicly available metrics Regulated by
Accounting principles (GAAP)
U.S. Securities & Exchange Commission (SEC) Sarbanes-Oxley Act (2002)

Permits direct firm performance comparisons

Using standard ratios See Table 1 of text for typical strategic financial

ratios

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

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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.
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Profits vs. Return on Revenue (ROR)

Ranking changes markedly with the use of different metrics

2010 Profits in $M

2010 ROR %
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EXHIBIT 5.5 Firm Performance - Pharmaceutical Industry by ROR

Pfizer performance declines as Merck improves and takes the competitive advantage over this period
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Drawbacks for Accounting Measures

Historical data
Backward-looking Driving a car by looking in the review mirror

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

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EXHIBIT 5.6 Declining Importance of Book Value in Stock Valuation

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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.

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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
Nucor (steel) slow growth
Dell (computer) faster growth

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EXHIBIT 5.7 Normalized Stock Returns 20052010

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Drawbacks to Shareholder Value as CA

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

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Google vs. Microsoft, Continued 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%.

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EXHIBIT 5.8 Comparing Google and Microsoft Using ROE & ROA

Microsoft outperforms Google in 2010 based on this accounting data

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EXHIBIT 5.9 Normalized Stock Returns 20052010

Google is enjoying a sustained competitive advantage over Microsoft based on shareholder value.

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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.

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THE BALANCED SCORECARD

Multiple internal & external metrics
Considers both financial & strategic

Customer perspective Linked to revenues & profits Future processes to create value 3M 30% revenues from products less than 4 years old Internal core competencies Honda engine design and manufacture Shareholder perspective A variety of financial measures
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THE BALANCED SCORECARD

Advantages
Communicate vision

Disadvantages
Tool for strategy

thru the organization

Translate vision into

implementation NOT formulation.

Limited guidance on

measureable goals
Design business

selecting metrics
processes
Implement Limited insight on how

to get back on track to meet goals

organizational learning

Can be viewed as just a tracking tool for metrics

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A Balanced-Scorecard Approach to Competitive Advantage

EXHIBIT 5.10

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.

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THE TRIPLE BOTTOM LINE

Economic, Social, & Ecological Considerations
Also known as "People,

EXHIBIT 5.11

Planet, & Profits" BP oil spill had many major effects BMW changed car designs to enhance recycling Integrative approach for sustainable strategy

The Triple Bottom Line

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STRATEGY HIGHLIGHT

People
Largest tire and rubber company

Employs over 50,000 people

Planet
Preventing product waste Cutting CO2 emissions by 25% by 2020

Profits
Merger in 1988 for 2.6 billion dollars

Information found at: http://www.bridgestonetire.com/about/who-we-are

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Approaches to Reflect Upon

All Encompassing View
Qualitative AND Quantitative (QUANTqual).

Overall Company Performance

Not specific parts

Metrics aggregate upward, useful to gauge firm's

strategy

No BEST Strategy
Only better options exist Must be measurable with the competition

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EXHIBIT 5.12

How Do We Measure Competitive Advantage?

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Jack Welch vs. Jeffrey Immelt

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http://finance.yahoo.com/q/bc?t=my&s=GE&l=on&z=l&q=l&c=&ql=1&c=^DJI

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The current consensus among 16 polled investment analysts is to Hold stock in General Electric Co. This rating has held steady since April, when it was unchanged from a Hold rating.

http://money.cnn.com/quote/forecast/forecast.html?symb=GE

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Welch Promoted internal communication.

Focused on performance and strictly quantifiable results. (i.e.production)

Immelt Promotes external communication communicate with investors and third parties.

Allows employees to come up with innovative ideas and generate customer satisfaction.
Removed emphasis from the bottom line- employees to take risks and develop more innovative ideas.

Environmentally conscious investing large amounts of money into technologies that would lead to cleaner and environmentally responsible products and processes.

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GE's stock is trending lower because of the weak demand for products. Increasing loan defaults and loss of revenue. Loss of revenue due to the sale of NBC Universal. Investing in green technology. 60% of profits come from international retail. Accounting scandal (tax avoidance) hurt reputation. Lower credit rating.
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Answer: No (Welch 1981-2001 / Immelt 2001 present)

GEs diversity of the strategic business units during Welchs tenure continues with Immelt.
The units may have had some changes but those changes were made in order to maintain a competitive advantage. (i.e. emerging markets)
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Answer: No

Shareholders own the company. Investors are looking for companies that are making money, declaring record earnings, and offering dividends on their stocks. But, shareholders cannot control the economy.
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Other ways to assess performance:

Economic Value Creation -Economic value is represented by the maximum amount a consumer is willing to pay for a product minus the cost of the product. This spread represents profit. Accounting Profitability Provides information that can be compared to prior years as well as the industry competitors.

Assessment:

In 2008, greed and recklessness brought down the financial world. At this point, survival was connected to Government intervention. The two time periods were like apples and oranges in regard to external factors.

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There is no black and white answer to this question. Though the management style and business strategy are significantly different, there were and are many external factors that contributed to performance.
Some of these factors: 9/11/2001 2001 - The emergence of corporate fraud (Enron and Arthur Andersen), and corporate governance 2002- Stock market crash Years 2001 and 2003 - present: War on Terror and Iraq War 2007- Subprime mortgage loan crisis began 2007 Beginning of recession Current economy slowly recovering

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Conclusion: Take-Away Concepts

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.

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