Strategic Management Chapter 5

Fixed Asset Turnover equals what?

Revenue/Fixed Assets -Measures how well a company leverages its fixed assets, particularly property, plant, and equipment -Higher fixed assets often go along with lower firm valuations

The relationship between consumer and producer surplus is the reason trade happens: both transacting parties capture _______ of the overall value created

Some

Combination Business Model

Telecommunication companies such as AT&T or Verizon, to take one industry, combine the Razor-Razorblade Model with the Subscription Model. They provide a basic cell phone at no charge, or significantly subsidize a high-end smartphone, when you sign up for a two-year wireless service plan.

Profits of the Triple Bottom Line

The economic dimension captures the necessity of businesses to be profitable to survive

Investors also adjust their expectations over _____

Time -Since the business in the slow-growth industry surprised them by delivering higher than expected growth, they adjust their expectations upward

Subscription Business Model

Users pay for access to a product or service whether they use the product or service during the payment term or not. -Traditionally used for (print) magazines and newspapers. -Industries that use this model presently are cable television, cellular service providers, satellite radio, Internet service providers, and health clubs

Return on Invested Capital

(ROIC) = (net profits/invested capital) -Popular metric because it is a good proxy for firm profitability -In particular, the ratio measures how effectively a company uses its total invested capital, which consists of two components: (1) shareholders' equity through the selling of shares to the public, and (2) interest-bearing debt through borrowing from financial institutions and bondholders

Strategy

A set of goal-directed actions a firm takes to gain and sustain competitive advantegae

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 -Ex: Using renewable energy sources such as wind or solar power over time

The transition of strategy into action takes place in the firm's _____ _____, which details the firm's competitive tactics and initiatives

Business Model -Explains how the firm intends to make money -Stipulates how the firm conducts its business with its buyers, suppliers, and partners

Inventory Turnover equals what?

COGS/Inventory -COGS captures the firm's production cost of merchandise it has sold -Inventory is the cost of the firm's merchandise to be sold -This ratio indicates how much of a firm's capital is tied up in its inventory

Triple Bottom Line

Combination of economic, social, and ecological concerns- or profits, people, and planet- that can lead to sustainable strategy -Like the Balanced Scoreboard, it takes a more integrative and holistic view in assessing a company's performance. -Using it, managers audit their company's fulfillment of its social and ecological obligations to stakeholders such as employees, customers, suppliers, and communities as conscientiously as they track its financial performance.

Razor-Razorblade Business Model

The initial product is often sold at a loss or given away for free in order to drive demand for complementary goods- the company makes its money on the replacement part needed.

Competitive advantage can result from a relative ______ ______ over rivals, assuming both firms can create the same total perceived consumer benefits

Cost Advantage

Rather than merely relying on historical costs, as done when taking the perspective of accounting profitability, in the ______ _______ _______ perspective, all costs must be considered

Economic Value Creation -Even Opportunity Costs

Total costs include both _______ and ________ costs

Fixed; Variable -Fixed Costs- independent of consumer demand. Ex.: the cost of capital to build computer manufacturing plants or an online retail presence to take direct orders -Variable Costs- change with the level of consumer demand. Ex.: components such as different types of display screens, microprocessors, hard drives, and keyboards

Agency Business Model

In this model the producer relies on an agent or retailer to sell the product, at a predetermined percentage commission. -Sometimes the producer will also control the retail price -Long used in the entertainment industry, where agents place artists or artistic properties and then take their commission

COGS/Revenue equals what?

Indicates how efficiently a company can produce a good

R&D/Revenue equals what?

Indicates how much of each dollar that the firm earns in sales is invested to conduct research and development -A higher percentage is generally an indicator of a stronger focus on innovation to improve current products and services, and to come up with new ones

Accounting data does not consider _____-balance sheet items

Off -Ex: one retailer may own all its stores, which would properly be included in the firm's assets; a second retailer may lease all its stores, which would not be listed as assets. All else being equal, the second retailer's return on assets would be higher. Strategists address this shortcoming by adjusting accounting data to obtain an equivalent economic capital base, so that they can compare companies with different capital structures.

Working Capital Turnover

Revenue/Working Capital -Measure of how effectively capital is being used to generate revenue

Bundling Business Model

Sells products or services for which demand is negatively correlated at a discount -Demand for two products is negatively correlated if a user values one product more than another

The goal of strategic management is to integrate and align each business function and activity to obtain...

Superior performance at the business unit and corporate levels -Competitive advantage is best measured by criteria that reflects overall business unit performance rather than the performance of specific departments

Cost

The cost (C) to produce the good or service

Economic Value Created

The difference between a buyer's willingness to pay for a product or service and the firm's total cost to produce it -(V-C)

Value

The dollar amount (V) a consumer attaches to a good or service -Captures a consumer's willingness to pay and is determined by the perceived benefits a good or service provides to the buyer

Planet of the Triple Bottom Line

The ecological dimension emphasizes the relationship between business and the natural environment

Reservation Price

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

Competitive Advantage goes to the firm that achieves the largest economic value created, which is the difference between:

V, the consumer's willingness to pay, and C, the cost to produce the good or service. -The reason is that a large difference between V and C gives the firm two distinct pricing options: (1) it can charge higher prices to reflect the higher value and thus increase its profitability, or (2) it can charge the same price as competitors, and thus gain market share

If a firm's ROIC is greater than its cost of capital, it generates ______; and vice versa

value

Freemium Business Model

(Free + Premium) 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: companies may provide a minimally supported version of their software as a trial to give users the chance to try the product

Market Capitalization

(Market Cap) Captures the total dollar market value of a company's total outstanding shares at any given point in time -(Market cap=number of outstanding shares x share price)

Profit

Difference between price charged (P) and the cost to produce (C) -(P-C) -Also called Producer Surplus

Consumer Surplus

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

When assessing and evaluating competitive advantage, a comparison of rival firms' share price development or market capitalization provides a helpful yardstick when used over the _____ ______

Long Term

Total Return to Shareholders

Return on risk capital that includes stock price appreciation plus dividends received over a specific period -Investors are primarily interested in this -Unlike accounting data, its 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, with most of the weight on future growth expectations

Return on Revenue

(ROR)= Net Profits/Revenue -Indicates how much of the firm's sales is converted into profits

To come up with an effective business model:

-A firm's managers first transform their strategy of how to compete into a blueprint of actions and initiatives that support the over-arching activities -In a second step, managers implement this blueprint through structures, processes, culture, and procedures

The three traditional frameworks to measure and assess firm performance are:

-Accounting profitability -Shareholder value creation -Economic value creation ---These tend to be correlated, particularly over time. Accounting profitability and economic value creation tend to be reflected in the firm's stock price, which in turn determines in part the stock's market valuation

Since Competitive Advantage is defined as superior performance relative to other competitors in the same industry or the industry average, a firm's managers must be able to accomplish two critical tasks:

-Accurately assess the performance of their firm -Compare and benchmark their firm's performance to other competitors in the same industry or against the industry average ---Standardized financial metrics, derived from such publicly available accounting data as income statements and balance sheets, fulfill both these conditions

Apple and Microsoft

-Apple is paid much faster than Microsoft -Apple's customers are mainly individual consumers who tend to pay with cash or credit cards at the time of purchase, while Microsoft's more important customers are other businesses -Apple takes quite a bit longer to pay its creditors

Advantages of the Balanced Scorecard

-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 -Can accommodate both short- and long-term performance metrics -Provides a concise report that tracks chosen metrics and measures and compares them to target values -Allows managers to assess past performance, identify areas for improvement, and position the company for future growth

The economic value creation framework shows that strategy is about:

-Creating economic value -Capturing as much of it as possible

Limitations of the Economic Value Creation Framework:

-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 -To measure firm-level competitive advantage, we must estimate the economic value created for all products and services offered by the firm

Managers using the balanced scorecard develop appropriate metrics to assess strategic objectives by answering four key questions

-How do customers view us?- the customer's perspective concerning the company's products and services link directly to its revenues and profits -How do we create value?- answering this question challenges managers to develop strategic objectives that ensure future competitiveness, innovation, and organizational learning. -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 process that support, hone, and leverage those competencies -How do shareholders view us?- the final perspective is the shareholders' view of financial performance

Apply shareholder value creation to assess and evaluate competitive advantage

-Investors are primarily interested in total return to shareholders, which includes stock price appreciation plus dividends received over a specific period -Total return to shareholders is an external performance metric; it indicates how the market views all publicly available information about a firm's past, current state, and expected future performance -Applying a shareholder's perspective, key metrics to measure and assess competitive advantage are the return on (risk) capital and market capitalization -Stock prices can be highly volatile, which makes it difficult to assess firm performance. Overall macroeconomic factors have a direct bearing on stock prices. Also, stock prices frequently reflect the psychological mood of the investors, which can at times be irrational -Shareholder value creation is a better measure of competitive advantage over the long term due to the "noise" introduced by market volatility, external factors, and investor sentiment

Disadvantages of the Balances Scorecard

-It's a tool for strategy implementation, not for strategy formulation -Provides only limited guidance about which metrics to choose -The balanced scorecard is only as good as the skills of the managers who use it: They first must devise a strategy that enhances the odds of achieving competitive advantage. Second, they must accurately translate the strategy into objectives that they can measure and manage within the balanced-scorecard approach -Doesn't provide much insight into how metrics that deviate from the set goals can be put back on track

Apply a triple bottom line to assess and evaluate competitive advantage

-Noneconomic factors can have a significant impact on a firm's financial performance, not to mention its reputation and customer goodwill -Managers are frequently asked to maintain and improve not only the firm's economic performance but also its social and ecological performance -Three dimensions- economic, social, and ecological- make up the triple bottom line. Achieving positive results in all three areas can lead to a sustainable strategy- a strategy that can endure over time -A sustainable strategy produces not only positive financial results, but also positive results along the social and ecological dimensions -Using a triple-bottom-line approach, managers audit their company's fulfillment of its social and ecological obligations to stakeholders such as employees, customers, suppliers, and communities in as serious a way as they track its financial performance -The triple-bottom-line framework is related to stakeholder theory, an approach to understanding a firm as embedded in a network of internal and external constituencies that each make contributions and expect consideration in return

Measuring firm performance through total return to shareholders and firm market capitalization has shortcomings:

-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

Apply a balanced scorecard to assess and evaluate competitive advantage

-The balanced-scorecard approach attempts to provide a more integrative view of competitive advantage -Its goal is to harness multiple internal and external performance dimensions to balance financial and strategic goals -Managers develop strategic objectives for the balanced scorecard by answering 4 key questions: How do customers view us? How do we create value? What core competencies do we need? How do shareholders view us?

Explain economic value creation and different sources of competitive advantage

-The relationship between economic value creation and competitive advantage is fundamental in strategic management. It provides the foundation upon which to formulate a firm's competitive strategy of cost leadership or differentiation -Three components are critical to evaluating any good or service: value (V), price (P), and cost (C). In this perspective, cost includes opportunity costs -Economic value created is the difference between a buyer's willingness to pay for a good or service and the firm's cost to produce it (V-C) -A firm has a competitive advantage when it is able to create more economic value than its rivals. The source of competitive advantage can stem from higher perceived value creation (assuming equal cost) or lower cost (assuming equal value creation)

Pay As You Go Business Model

Users pay for only the services they consume -Most widely used by utilities providing power and water and cell phone service plans, but its gaining momentum in other areas such as rental cars and cloud computing

Outline how business models put strategy into action

-The translation of a firm's strategy (where and how to compete for competitive advantage) into action takes place in the firm's business model (how to make money) -A business model details how the firm conducts its business with its buyers, suppliers, and partners -How companies do business is as important to gaining and sustaining competitive advantage as what they do

Conduct a firm profitability analysis using accounting data to assess and evaluate competitive advantage

-To measure competitive advantage, we must be able to (1) accurately assess firm performance, and (2) compare and benchmark the focal firm's performance to other competitors in the same industry or the industry average -To measure accounting profitability, we use standard metrics derived from publicly available accounting data -Commonly used profitability metrics in strategic management are ROA, ROE, ROIC, and ROR -All accounting data are historical and thus backward-looking. They focus mainly on tangible assets and do not consider intangibles that are hard or impossible to measure and quantify, such as an innovation competency

All accounting data is ______

Historical, thus backward-looking -Accounting profitability ratios show us only the outcomes from past decisions, and the past is no guarantee of future performance -While financial strength certainly helps, past performance is no guarantee that a company is prepared for market disruption

Sales, General, & Administrative Expenses/Revenue equals what?

Indicates how much of each dollar that the firm earns in sales is invested in sales, general, and administrative expenses -this ratio is an indicator of the firm's focus on marketing and sales to promote its products and services

Shareholders

Individuals or organizations that own one or more shares of stock in a public company -From their perspective, the measure of competitive advantage that matters most is the return on their risk capital

Both _____ and _____ performance dimensions matter in judging the effectiveness of a firm's strategy

Quantitative; Qualitative -Those who focus on only one metric will risk being blindsided by poor performance on another -Managers need to rely on a more holistic perspective when assessing firm performance, measuring different dimensions over different time periods

Cost of Capital

Represents a firm's cost of financing operations from both equity through issuing stock and debt through issuing bonds

Payables Turnover

Revenue/Accounts Payable -Indicates how fast the firm is paying its creditors and how much it benefits from interest-free loans extended by its suppliers -A lower ratio indicates more efficient management in paying creditors and generating interest-free loans from suppliers

Receivables Turnover equals what?

Revenue/Accounts Receivable -Implies more efficient management in collecting accounts receivable and shorter durations of interest-free loans to customers

All public companies in the US are required to report total return to shareholders annually in the statements they file with the ______ and ______ ______

Security and Exchange Commissions (SEC) -In addition, companies must also provide benchmarks, usually one comparison to the industry average and another to a broader market index that is relevant for more diversified firms

Stock Market Valuations

Share Price x Number of Outstanding Shares -Provides a useful metric to assess competitive advantage

Triple-Bottom-Line Framework is related to ______ ______, which is an approach to understanding a firm as being embedded in a network of internal and external constituencies that each make contributions and expect consideration in return

Stakeholder Theory

A firm's _____ ______ generally increases only if the firm's rate of growth exceeds investors' expectations

Stock Price -This is because investors discount into the present value of the firm's stock price whatever growth rate they foresee in the future

Balanced Scorecard

Strategy implementation tool that harnesses multiple internal and external performance metrics in order to balance financial and strategic goals -By relying on both an internal and external view of the firm, the balanced scorecard combines the strengths provided by the individual approaches to assessing competitive advantage discussed earlier: accounting profitability, shareholder value creation, and economic value creation -In a sense, the balanced scorecard is a broad diagnostic tool. It complements the common financial metrics with operational measures on customer satisfaction, internal processes, and the company's innovation and improvement activities

Accounting data focuses mostly on _____ assets, which are no longer the most important

Tangible -"Not everything that can be counted counts. Not everything that counts can be counted"

Evolution Business Model

The Freemium Business Model can be seen as an evolutionary variation on the Razor-Razorblade Model. The base product is provided free, and the producer finds other ways to monetize the usage.

Efficient-Market Hypothesis

The idea that all available information about a firm's past, current state, and expected future performance is embedded in the market price of the firm's stock -In this perspective, a firm's share price provides an objective performance indicator

the amount of total perceived consumer benefits equals...

The maximum willingness to pay, or the reservation price

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

People of the Triple Bottom Line

The social dimension emphasizes the people aspect, such as PepsiCo's initiative of the whole person at work

Opportunity Costs

The value of the best forgone alternative use of the resources employed

Wholesale Business Model

Traditional model in retail -Ex: under this model, book publishers would sell books to retailers at a fixed price (usually 50% below the recommended retail price). Retailers, however, were free to set their own price on any book and profit from the difference between their selling price and the cost to buy the book from the publisher (or wholesaler)