MAN4720 Chapter 5

Economic value created

the difference between a buyers willingness to pay for a product or service, and the firms cost to produce it -when a firm is able to create more economic value than its rivals--> has a competitive advantage -the sum of consumer and producer surplus (profit) V-C

Value (V)

the dollar amount a consumer would attach to a good or service-how much they are willing to pay. V>P: consumer will purchase

Risk capital

the money shareholders provide in return for an equity share, money that they cannot recover if the firm goes bankrupt

Shareholder value creation limitations

-stock prices can be highly volatile, making it difficult to asses firm performance (in the short term) -overall macroeconomic factors (unemployment rate, economic growth, interest/exchange rates) have a direct bearing on stock prices -stock prices frequently reflect the psychological mood of investors, which can be irrational (overshoot or undershoot expectations)

Managerial implications

1. both quantitative and qualitative performance dimensions matter in judging how effective a firms strategy is 2. competitive advantage is best measured by criteria that reflect overall company performance rather than performance of specific parts 3. true performance can only be judged in comparison to other contenders in the field, not on an absolute basis

Economic value creation limitations

1. determining the value of a good in the eyes of consumers is hard 2. V in the eyes of consumers changes based on income, preferences, exc 3. to measure firm-level competitive advantage, we must estimate the economic value created for all products and services offered by the firm 4. lacks "hard numbers"

The balances scorecard-four key questions

1. how do customers view us? 2. how do we create value? 3. what core competencies do we need? 4. how do shareholders view us?

Three questions to measure competitive advantage

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?

Advantages of the balanced scorecard

1. links the strategic vision to responsible parties 2. translates vision into measurable operational goals 3. design and plan business processes 4. implement feedback to adapt strategic goals when indicated

Disadvantages of the balanced scorecard

a tool for strategy implementation, not for strategy formulation (provides limited guidance about which metrics to choose) -failure is not a reflection of poor framework, but of a strategic failure (only as good as the managers who use it)

Accounting profitability limitations

accounting data is historical and thus backward-looking does not consider off-balance sheet items focus's mainly on tangible assets, which are no longer the most important

The balanced scorecard

conceptual framework, harnesses multiple internal and external performance metrics in order to balance both financial and strategic goals -combines the strengths of the three previous approaches

Producer surplus/profit

difference between the price (P) charged, and the cost to produce (C) P-C

Consumer surplus

difference between what you would have been willing to pay (V) and what you paid (P) V-P

Accounting profitability improvements

go beyond a single year, compare to companies in the same industry

Competitive advantage from an economic standpoint

goes to the firm that achieves the largest difference between V and C -once gained: the firm can 1. charge higher prices to reflect the higher product value, increasing profitability. or 2. charge the same price as competitors and gain market share OBJECTIVE- maximize (V-C)

Multidimensional perspective

measuring competitive advantage using both qualitative and quantitative (financial, economic, accounting) performance metrics

Economic value creation

needed: value (V), price (P), and cost (C) strategy is about: creating economic value, and capturing as much of it as possible

Total return to shareholders

the return on risk capital, including stock price appreciation plus dividends received over a specific period external performance metric: indicates how the stock market views all available info about a firms past, current and expected future performance (efficient market hypothesis)

The triple bottom line

three dimensions: economic, social, and ecological holistic view related to stakeholder theory-understanding a firm as embedded in a network of internal/external factors that each make contributions and expect consideration

Accounting profitability

uses standard metrics derived from publicly available accounting data such as income statements, and balance sheets Most common metrics: return on assets (ROA), return on equity (ROE), and return on revenue (ROR) measure relative profitability, which is useful when comparing firms of different size over time

Benchmarks

usually one comparison to the industry average and another to a broader market index (which is relevant for more diversified firms) allow us to asses whether a firm has a competitive advantage