Ch. 5 Flashcards
What is the goal of strategic management?
Gaining and sustaining a competitive advantage
What are the three traditional frameworks to measure and assess firm performance?
- Accounting Profitability
- Shareholder Value Creation
- Economic Value Creation
What are two frameworks to assess firm performance that integrate quantitative and qualitative data?
- The Balanced Scorecard
2. The Triple Bottom Line
Def: Strategy
A set of goal directed actions a firm takes in order to gain and sustain a competitive advantage
Def: Competitive Advantage
Superior performance relative to other competitors in the same industry or the industry average
Standardized metrics help you to accomplish what two tasks?
- accurately assess the performance of a firm
2. Compare and benchmark a firm’s performance against competitors or the industry average
Profitability ratios used in strategic management: (4)
ROIC - Return on Invested Capital
ROR - Return on Revenue
ROE - Return on Equity
ROA - Return on Assets
ROIC: What is it? What are the important parts?
ROI = Net Profit / Invested Capital
- Notes a firm’s profitability
- How a firm uses its total invested capital (Shareholder’s equity through selling shares and interest bearing debt it borrows)
If a firm’s ROIC is greater than it’s cost of capital, it __________ ________.
If a firm’s ROIC is greater than it’s cost of capital, it generates value.
What are the two aspects that drive a company’s ROIC?
- Return on revenue
2. Working capital turnover
ROR: What is it?
Return on Revenue = Net Profits / Revenue
- how much a firm’s sales are is converted into profits
Three additional financial ratios that are derived from ROR
Cost of Goods Sold / Revenue
R&D Expense / Revenue
Selling General & Admin. Expense / Revenue
COGS / Revenue shows
how efficiently a company can produce a good
R&D Expense / revenue shows
how much each dollar that the firm earns in sales is invested to conduct R&D
Selling General & Admin. Expense / Revenue shows
how much of each dollar a firm earns in sales is invested into sales, general, and administrative expenses
- how much a company focuses on marketing and sales to promote it’s products and services
What are the 4 parts of working capital turnover (rev/WC)?
Fixed Asset Turnover
Inventory Turnover
Receivables Turnover
Payables Turnover
Fixed Asset Turnover =
Revenue / Fixed assets
- measures how well a company leverages it’s fixed assets
Inventory Turnover =
COGS / Inventory
-how much of a firm’s capital is tied up in it’s inventory
Receivables Turnover =
revenue / accounts rec.
- managing accounts receivables
Payables Turnover =
revenue / accts. pay.
- how fast a firm is paying its creditors and how much it benefits from from interest free loans extended by it’s suppliers
The three limitations to accounting data:
- Acctg. data is historic so its back-ward looking
- Acctg. data doesn’t consider off-balance-sheet items
- Acctg. data only focuses on tangible assets, and intangible are more important
Book value vs. Not captured
Book value - firms cost of assets minus depreciation
Not captured - future expectations for a firm’s growth potential and performance
Using accounting data is a ________ ______ to assess competitive advantage
Using accounting data is a starting point to assess competitive advantage.
- market value is different than book value, changed over time so there’s a lot of valuation not shown by acctg. data alone.
Def: Shareholder
individuals or organizations that own one or more shares of stock in a public company
Def: Risk Capital
the money provided by shareholders in exchange for an equity share in a company; it cannot be recovered if a firm goes bankrupt
Def: Total Return to Shareholders
return on risk capital that includes stock price appreciation plus dividends received over a specific period
Def: 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
Market Capitalization =
same as stock market valuation
of outstanding shares * share price
Why is a competitive advantage transitory?
Difficult to gain and sustain a competitive advantage
What are the three limitations of shareholder value creation?
- stock prices can be volatile, making it difficult to assess firm performance in the short term
- Macroeconomic factors all have a direct impact on stock price
- Stock prices reflect the mood of investors which can be irrational
The three parts to calculate a competitive advantage:
Value Price Cost (VPC) -perceived consumer benefit and economic value
Def: Value
The dollar amt (V) a consumer attaches to a good or service; the maximum willingness to pay; also called reservation price
Value is the same as _________ ______.
Value is the same as reservation price
Def: Profit (Pi)
Difference between the price (P) charged and the cost (C) to produce
P - C = Profit
Profit is also called ______ _______.
Profit is also called Producer surplus
Def: Consumer Surplus
Difference between the value a consumer attaches to a good or service (V) and what they paid for it (P)
V - P = Consumer Surplus
The economic value creation framework shows a strategic that has two components:
- creating economic value
2. capturing as much economic value as possible
Competitive advantage goes to the company that created the largest ______ ______.
Competitive advantage goes to the company that created the largest economic value.
Profit = _______ - ______
Profit = total rev. - total costs
- where total rev. = price * quantity sold
Economic value creation also accounts for __________ costs.
Economic value creation also accounts for opportunity costs.
Def: opportunity costs
the value of the best forgone alternative use of the resources employed
The three limits of economic value creation:
- determining the value of a good in the eyes of the consumer is not an easy task
- the value of a good in the eyes of the consumer 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
Def: Balanced Scorecard
Strategy implementation tool that harnesses multiple internal and external performance metrics in order to balance financial and strategic goals
The 4 key questions to the balanced scorecard framework:
- How do customers view us?
- How do we create value?
- What core competencies do we need?
- How do shareholders view us?
- all work together but focus on the middle, competitive advantage!
The balanced scorecard allows managers to: (4 things)
- 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
The balanced scorecard can be used for what kind of goals?
Both - ST and LT
The 4 disadvantages of the balanced scorecard:
- Tool for strategy implementation NOT formulation
- Only limited guidance on which metrics to use
- Failure may be due to a strategic failure aka don’t blame the framework
- Doesn’t give guidance on how to set metrics back on track once they’ve deviated
A good manager must do these two things when using the balanced scorecard:
- devise a strategy that enhances the odds at gaining a competitive advantage
- accurately translate that strategy into objectives that they can measure and manage within the BSC approach
Def: Triple Bottom Line
Combination of economic, social, and ecological concerns that can lead to a sustainable strategy
Profits
People
Planet
Def (TBL): Profits
the economic dimension captures the necessity of a business to be profitable to survive
Def (TBL): People
the social dimension emphasizes the people aspect of a firm’s success
Def (TBL): Planet
the ecological dimension emphasizes the relationship between the firm and the natural environment
Def: 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
Def: Business Model
a firm’s plan that details how it intends to make money
Popular Business Models: razor-razorblades
Initial product sold for less or given away for free in order to drive demand for a complimentary good
(replacement parts)
Popular Business Models: Subscription
Users pay access to a product or service whether or not they actually use that product/service during the payment term
Popular Business Models: Pay as you go
consumers only pay for the services they consume ex. water bill
Popular Business Models: Freemium
(free+premium) provides basic features of a product or service for free but then charges for add-ons or advanced features ex. brainscape
Popular Business Models: Wholesale
Sell to retailers who mark up the product and retailers get to keep whatever the difference in buying and their selling price is
Popular Business Models: Agency
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
Popular Business Models: Bundling
Selling products or services together for which demand is negatively correlated at a discount ex. word > excel, buy each for $120 or both for $180
Business models can change and evolve due to disruptions in the market. What are 5 ways they can change?
- combination - combine 2 models
- evolution - tweak an existing model
- disruption - create a new way to do the same thing ex. books v. ebooks
- response to disruption - confine to new way of doing things ex. app store offerings
- Legal conflicts - conforming to new rules and regulations
No best strategy exists, only _____ ones.
No best strategy exists, only better ones
Competitive advantage is best measured by criteria that reflect ______ business unit performance rather than _______ business unit performance.
Competitive advantage is best measured by criteria that reflect OVERALL business unit performance rather than INDIVIDUAL business unit performance.
_______ and _______ performance dimensions matter in judging the effectiveness of a firm’s strategy.
Qualitative and quantitative performance dimensions matter in judging the effectiveness of a firm’s strategy.
A firm’s ______ ______ is critical to achieving a competitive advantage
A firm’s business model is critical to achieving a competitive advantage
Chapter 5: what part of AFI did we discuss?
Strategy analysis! :D
