Business Models & Risks Flashcards
What should a business model do?
A business model should:
- Identify a firm’s potential customers
- Describe its products or services and explain how it will sell them
- Describe its key assets and suppliers
- Explain its pricing strategy.
What is a value proposition?
Value proposition refers to how a firm’s customers will value the characteristics of the product or service.
What is a value chain?
Value chain refers to how a firm executes its value proposition.
What is Macro Risk and what does it arise from?
Macro risk refers to the risk (to operating profit) arising from economic, political, and legal risk factors, as well as other risks that affect all businesses within a country or region, such as demographic changes over time. The primary macro risk for many companies is the risk of an economic slowdown or recession.
What is business risk comprised of?
Industry and firm specific risk
Name some industry risk factors
Revenue and earnings cyclicality.
Industry structure: Low concentration (many smaller firms) is associated with high competitive intensity.
Competitive intensity: Higher competitive intensity in the industry typically reduces profitability.
Competitive dynamics within the value chain: Profits are affected by actions of buyers, suppliers, and actual and potential competitors.
Long-term growth and demand expectations: An industry with increasing demand and high long-term growth prospects is more attractive to investors, but may also attract more competition.
Other industry risks are regulatory risks and other relevant external risks.
Name some firm specific risk factors
Competitive risks include the erosion of an existing competitive advantage over time or the introduction of innovative business models that disrupt the industry. Competitive advantage results from cost advantages (including scale of operations), product differentiation, and positive network effects from greater product usage. High costs incurred by a customer to change to a different supplier (switching costs) increase the competitive advantage of existing firms. Firms always have execution risk, as some managements can find a way to fail with even the best of business plans.
Product market risk: For firms early in their life cycles, expectations of growth in demand may decrease over time, consumer preferences may change, products may become obsolescent, and patents may expire. Firms with many products typically face less product risk.
Capital investment risk refers to investing firm assets in opportunities that do not produce returns above the firm’s cost of capital. Many acquisitions (e.g., Time Warner) turn out to be quite ill-advised, while some (e.g., YouTube) turn out to be brilliant.
ESG risk measures often focus on corporate governance risk, but the risk of running afoul of current expectations for environmentally and socially progressive company policies can damage a company’s reputation and bottom line (or not, e.g., Volkswagen).
Business risk is increased by higher operating leverage that results from higher percentages of fixed costs, relative to variable costs, in a firm’s cost structure. The effect of sales variability on operating income is magnified by higher operating leverage.
Financial risk increases with higher levels of debt in a firm’s capital structure, which increases, the risk of financial distress, default, or even insolvency.
