MGMT 498 Chapter 5

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. Given this, the strategic objective is to maximize (V - C), or the economic value created.

two critical tasks for competitive advantage

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

Limitations of economic value creation

1. Determining the value of a good in the eyes of consumers is not a simple task. 2. The value of a good in the eyes of consumers changes based on income, preferences, time, and other factors. 3. To measure firm-level competitive advantage, we must estimate the economic value created for all products and services offered by the firm.

triple bottom line

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

The cost (C)

Cost to produce the good or service matters little to the consumer, but it matters a great deal to the producer (supplier) of the good or service since it has a direct bearing on the profit margin.

return on invested capital (ROIC)

One of the most commonly used metrics in assessing firm financial performance. where ROIC = (Net profits / Invested capital).5 ROIC is a 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.

Triple bottom line three Ps:

Profits. The economic dimension captures the necessity of businesses to be profitable to survive. ▪ People. The social dimension emphasizes the people aspect, such as PepsiCo's initiative of the whole person at work. ▪ Planet. The ecological dimension emphasizes the relationship between business and the natural environment.

balanced scorecard

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

profit (Producer Surplus)

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

Freemium

The freemium (free + premium) business model 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

Razor-razorblades

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.

total perceived consumer benefits and economic value created components

Value (V) Price (P) Cost (C)

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 overarching goals. In a second step, managers implement this blueprint through structures, processes, culture, and procedures. If the company fails to translate a strategy into a profitable business model, the firm will run into trouble.

reservation price

absolute maximum customers are willing to pay for it, based on total perceived consumer benefits.

stakeholder theory

approach to understanding a firm as embedded in a network of internal and external constituencies that each make contributions and expect consideration in return

Market capitalization

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 × Share price)

total perceived consumer benefits

equals the maximum willingness to pay, or the reservation price. This amount is then split into economic value creation and the firm's total unit cost.

ROIC rule of thumb

if a firm's ROIC is greater than its cost of capital, it generates value; if it is less than the cost of capital, the firm destroys value

Shareholders

individuals or organizations that own one or more shares of stock in a public company—are the legal owners of public companies.

Economic value created

is the difference between a buyer's willingness to pay for a product or service and the firm's total cost to produce it.

consumer surplus

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

total return to shareholders

the return on risk capital, including stock price appreciation plus dividends received over a specific period. It's the primary interest of investors.

Pay as you go

users pay for only the services they consume. The pay-as-you-go model is most widely used by utilities providing power and water and cell phone service plans, but it is gaining momentum in other areas such as rental cars

popular business models

▪ Razor-razorblades ▪ Subscription ▪ Pay as you go ▪ Freemium

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.

business model

A firm's plan that details how it intends to make money.

Subscription

The subscription model has been traditionally used for (print) magazines and newspapers. Users pay for access to a product or service whether they use the product or service during the payment term or not. Industries that use this model presently are cable television, cellular service providers, satellite radio, Internet service providers, and health clubs. Above we discussed Netflix, which uses a subscription model.

Opportunity costs

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

Limitations of Accounting data

1. All accounting data are historical and thus backward-looking. 2. Accounting data do not consider off-balance sheet items. 3. Accounting data focus mainly on tangible assets, which are no longer the most important.

Balanced scorecard four key questions are:

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 standard performance dimensions

1. What is the firm's accounting profitability? 2. How much shareholder value does the firm create? 3. How much economic value does the firm generate?

The economic value creation framework shows that strategy is about

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

Value (V)

denotes the dollar amount (V) a consumer attaches to a good or service. Value captures a consumer's willingness to pay and is determined by the perceived benefits a good or service provides to the buyer.

Risk Capitol

the money they provide in return for an equity share, money that they cannot recover if the firm goes bankrupt. From the shareholders' perspective, the measure of competitive advantage that matters most is the return on their risk capital