Chapter 5

market capitalization

A firm performance metric that captures the total dollar market value of a company's total outstanding shares at any given point in time

Economic Value Creation

A way to measure performance -- focused on economic value created (V-C) The firm with the biggest gap between V and C has a competitive advantage Is also forward-looking since it tries to anticipate what the future value of something might be to consumers

Producer Surplus

Another term for profit, the difference between price charged (P) and the cost to produce (C), or (P - C); also called profit

Consumer Surplus

Difference between the value a consumer attaches to a good or service (V) and what he or she paid for it (P), or (V - P)

Economic Value Created

Difference between value (V) and cost (C), or (V - C)

There are 3 standard ways of measuring performance and competitive advantage

1. Accounting profitability 2. Shareholder value 3. Economic value

In order for accounting profitability to lead to an accurate picture of performance -- mangers must ...

1. Assess the performance of their firm accurately. 2. Compare and benchmark their firm's performance to other competitors in the same industry or against the industry average

The economic value creation framework is all about

1. Creating economic value. 2. Capturing as much of it as possible for the firm

Importance of Business Models

A slight majority (54 percent) of senior executives responded in a survey stating that they consider business model innovation to be more important than process or product innovation A firm's competitive advantage based on product innovation is less likely to be made obsolete if embedded within a dynamic business model innovation

Sustainable Strategy

A strategy along the economic, social, and ecological dimensions that can be pursued over time without detrimental effects on people or the planet

Downsides: Accounting Profitability

Accounting data are historical and thus backward-looking (past performance is no guarantee that a company is prepared for market disruption) Accounting data focus mainly on tangible assets, which are no longer the most important (intangible assets are typically more valuable -- like reputation, image, customer experience

Ultra-low cost

An ultra low-cost business model is quite similar to freemium: a model in which basic service is provided at a low cost and extra items are sold at a premium EX: Spirit Airlines

Main Takeaways from the Chapter:

Both quantitative and qualitative performance dimensions matter in judging the effective-ness of a firm's strategy A firm's business model is critical to achieving a competitive advantage No best strategy exists—only better ones (need to keep improving/innovating to remain on top)

Dynamism of Business Model

Business Models evolve dynamically Companies will combine business models, evolve old models into new models (razor-razor-blade into freemium), and even greatly disrupt the viability of previously popular models (EX: how severely Amazon disrupted the traditional wholesale model for publishers) There can also be legal conflicts with new business models (made as a result of disruption)

Triple Bottom Line (Profits, People, Planet)

Combination of economic, social, and ecological concerns—or profits, people, and planet—that can lead to a sustainable strategy

The balanced scorecard allows strategic leaders to:

Communicate and link the strategic vision to responsible parties within the organization. Translate the vision into measurable operational goals. Design and plan business processes. Implement feedback and organizational learning to modify and adapt strategic goals when indicated

Stock Valuations

Considering stock market valuations (Share price × Number of outstanding shares) over the long term provides a useful metric to assess competitive advantage NOTE: this also indicates that shareholder value creation takes the future into account, valuations are calculated through past performance and future expectations

Downsides: Economic Value Creation

Determining the value of a good in the eyes of consumers is not a simple task. The value of a good in the eyes of consumers changes based on income, preferences, time, and other factors (can't be standardized) To measure firm-level competitive advantage, we must estimate the economic value created for all products and services offered by the firm (gets complicated) It's theoretical, there are no concrete/official numbers behind it

Agency

In this model the producer relies on an agent or retailer to sell the product, at a predetermined percentage commission EX: entertainment industry

There are 2 ways to gain a competitive advantage in Economic Value Creation

Having a greater V than the comp while keeping C's relatively low (being a greater differentiator) Having the lowest C while maintaining a competitive level of V (being a cost-leader)

4 key questions when considering the balanced scorecard

How do customers view us? The customer's perspective concerning the company's products and services links directly to its revenues and profits (if they are willing to pay more for a firm's products, this increase comp ad) How do we create value? Challenges managers to develop strategic objectives that ensure future competitiveness, innovation, and organizational learning (takes into account business processes and structures) What core competencies do we need? This question focuses managers internally to identify the core competencies needed to achieve their objectives and the accompanying business processes that support, hone, and leverage those competencies How do shareholders view us? Shareholders' view of financial performance leads to managers having an idea of how to position the company in the future (to please shareholders)

Shareholders

Individuals or organizations that own one or more shares of stock in a public company.

total return to shareholder

Return on risk capital that includes stock price appreciation plus dividends received over a specific period IMPORTANT: total return to shareholders is an external and forward-looking performance metric. It essentially indicates how the stock market views all available public information about a firm's past, current state, and expected future performance

business model

Stipulates how the firm conducts its business with its buyers, suppliers, and partners in order to make money

Downsides: shareholder Value Creation

Stock prices can be highly volatile, making it difficult to assess firm performance, particularly in the short term Overall macroeconomic factors such as economic growth or contraction, the unemployment rate, and interest and exchange rates all have a direct bearing on stock prices Stock prices frequently reflect the psychological mood of investors, which can at times be irrational

Balanced Scorecard

Strategy implementation tool that harnesses multiple internal and external performance metrics in order to balance financial and strategic goals

Downsides: Balanced Scorecard

The balanced scorecard is a tool for strategy implementation, not for strategy formulation. It is up to a firm's leaders to formulate a strategy that will enhance the chances of gaining and sustaining a competitive advantage Not clear what metrics to use for balanced scorecard (up to manager)

value

The dollar amount (V) a consumer attaches to a good or service

Razor-razor-blades

The initial product is often sold at a loss or given away to drive demand for complementary goods. The company makes its money on the replacement part needed EX: razor and razor blades

reservation price

The maximum price a consumer is willing to pay for a product or service based on the total perceived consumer benefit

risk capital

The money provided by shareholders in exchange for an equity share in a company; it cannot be recovered if the firm goes bankrupt

Relationship between consumer and producer surplus

The relationship between consumer and producer surplus is the reason trade happens: Both transacting parties capture some of the overall value created Although the value captured doesn't have to be equal -- in some instances the producer captures greater value

Subscription

The subscription model has been traditionally used for print magazines and newspapers. EX: Netflix

Wholesale

The traditional model in retail is called a wholesale model Wholesale means that a business buys goods in large quantities directly from manufacturers or distributors, warehouses them, and resells them to other businesses EX: Walmart

Note on the 3 standard measurement methods...

These three performance dimensions generally correlate, particularly over time Accounting profitability and economic value creation tend to be reflected in the firm's stock price, which in part determines the stock's market valuation

Advantages: Balanced Scorecard

This approach allows strategic leaders to assess past performance, identify areas for improvement, and position the company for future growth. Including a broader perspective than financials allows managers and executives a more balanced view of organizational performance combines the strengths provided by the standard ways of measuring performance (accounting prof, etc.)

Shareholder Value Creation

This measurement method of performance takes into account the value a firm provides to shareholders by looking at a variety of metrics (market cap, share price, total return to shareholder)

Benchmarking

To measure performance (in Shareholder Value Creation method) companies must provide benchmarks, usually one comparison to the industry average and another to a broader market index that is relevant for more diversified firms

Growth-Rate Predictions

To measure performance (in Shareholder Value Creation method) managers should look at the firm's growth rate Investors expect continuous returns but they are also banking on higher growth rates, leading to a higher stock price (not of caution, each time a firm's growth rate rises so do shareholder expectations)

Triple bottom line and stakeholder theory

Triple bottom line goes hand-in-hand with stakeholder theory Accounts for the entire network of internal and external stakeholders of the firm

Accounting Profitability Measurement Method

When assessing competitive advantage by measuring accounting profitability, we use financial data and ratios derived from publicly available accounting data such as income statements and balance sheets Accounting data enable us to conduct direct performance comparisons between different companies -- managers use ratios (ROA, ROE, ROIC) to asses performance

Questions to keep in mind when evaluating/deciding upon a business model:

Why does the business model create value? What activities need to be performed to create and deliver the offerings to customers? Who are the main stakeholders performing the activities? (who will be buying your product/service?) How are the offerings to the customers created?

To come up with an effective business model...

a firm's leaders need to transform their strategy of how to compete into a blueprint of actions and initiatives that support the overarch-ing goals

Bundling

a marketing strategy that consists of companies selling several products or services together as a single combined unit, often for a lower price than they would charge customers to buy each item separately. EX: Instead of selling Word and Excel for $120 each, Microsoft bundles them in a suite and sells them combined at a discount, say $150

If a firm can maximize economic value created, they can...

charge higher prices to reflect the higher value and thus increase its profitability charge the same price as competitors and thus gain market share (since they offer more value)

Freemium

provides the basic features of a product or service free of charge, but charges the user for premium services such as advanced features or add-ons. EX: Spotify

Pay-as-you-go

users pay for only the services they consume EX: cell service plans, utilities