Chapter 5: Competitive Advantage, Firm Performance, and Business Models

Question 1

What are the 3 standard performance dimensions in the multidimensional perspective?

Answer 1

• accounting profitability
• shareholder value
• economic value

Question 2

What does accounting profitability measure?

Answer 2

it assesses a firm’s performance by comparing it to competitors as well as the industry on average. To do so, it uses standardized accounting metrics like statement and balance sheets, Form 10k Statements,and profitability ratios.

Question 3

What is a Form 10K Statement?

Answer 3

Public companies are legally required to release some financial data. The 10K reports are the primary source publicly-available accounting data.

Question 4

What is an ROIC?

Answer 4

• Return on Invested Capital
• one of the most commonly-used metrics in assessing firm’s financial performance because it is a good proxy for firm profitability.

Question 5

What does an ROIC measure?

Answer 5

How effectively a company uses its total invested capital.

Question 6

What 2 components comprise total invested capital?

Answer 6

1. ) Shareholders’ equity- selling of shares to the public

2. ) interest-bearing debt- borrowing from financial institutions and bond-holders.

Question 7

What is the rule-of-thumb for a firm’s ROIC?

Answer 7

-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.

Question 8

What are the limitations of accounting data? (3)

Answer 8

• all data are historical and thus backward-looking
• do not consider off-balance sheet items such as pension or leasing obligations.
• focus on tangible assets which are no longer the most important (innovation, quality, customer experience etc)

Question 9

What are shareholders?

Answer 9

-own one or more shares of stock in a company; the legal owners of public companies.

Question 10

What is risk capital?

Answer 10

the money provided by shareholders in exchange for an equity share in a company; it cannot be recovered if the firm goes bankrupt.

Question 11

What is total return to share holders?

Answer 11

return on risk capital that includes stock price appreciation plus dividends received over a specific period.

Question 12

What is market capitalization?

Answer 12

a firm performance metric that captures the total dollar market value of a company’s total outstanding shares at a given point in time.

Question 13

For shareholders, what measure of competitive advantage matters most?

Answer 13

the return on their risk capital.

Question 14

What is an external and forward-looking performance metric?

Answer 14

indicates how the stock market views all available public information about a firm’s past, present, and expected future performance, with the most weight on future growth expectations.

Question 15

What is the efficient market hypothesis?

Answer 15

the idea that all information about a firm’s past, present, and expected future performance is embedded in the market price of the firm’s stock.

Question 16

What are the limitations of shareholder value creation? (3)

Answer 16

1. ) Stock prices are volatile making it difficult to assess firm performance (particularly in the short-term).
2. ) Macroeconomic factors like the unemployment rate, exchange rates, etc, impact stock prices.
3. ) Stock prices reflect the mood of the investors; irrational.

Question 17

What is economic value creation?

Answer 17

The difference between:
-a buyer’s willingness to pay for a product/ service
- and the firm’s overall cost to produce it
(V-C)

Question 18

What is a reservation price?

Answer 18

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

Question 19

What 3 components are needed to calculate competitive advantage?

Answer 19

• Value (V)
• Price (P)
• Cost (C)

Question 20

What is value?

Answer 20

the dollar amount (V) a consumer attaches to a good or service; the consumer’s maximum willingness to pay; also called “reservation price.”

Question 21

What is profit?

Answer 21

difference between price charged (P) and the cost to produce (C), or (P-C); also called producer surplus.

Question 22

What is producer surplus?

Answer 22

another term for profit.

Question 23

What is consumer surplus?

Answer 23

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

Question 24

The economic value creation framework shows that strategy is about… (2)

Answer 24

1. ) creating economic value

2. ) Capturing as much of it as possible.

Question 25

What are opportunity costs?

Answer 25

the value of the best forgone alternative use of the resources employed.e.g., for an entrepreneur, opportunity costs would be the money he/she could have made if employed elsewhere, as well as the cost of capital invested in the business.

Question 26

What is an accounting profit?

Answer 26

total revenue minus expenses.

Question 27

What are the limitations of economic value creation? (3)

Answer 27

• difficult to determine the value of a good through the eyes of a customer.
• customer’s value of a good changes based on income, preferences etc.
• to measure firm-level competitive advantage, we must estimate the economic value created for all products and services offered by the firm- can become complicated if many are offered.

Question 28

What is the balanced scorecard?

Answer 28

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

Question 29

What are the 4 key questions on the balanced scorecard?

Answer 29

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?

Question 30

Explain the balance scorecard metric: How do customers view us?

Answer 30

customers decide their reservation price for a good/service based on how they view it. If the customer views the firm’s offering favorably, she is willing to pay more for it.

Question 31

Explain the balance scorecard metric: How do we create value?

Answer 31

the business processes and structures that allow a firm to create economic value.

Question 32

Explain the balance scorecard metric: What core competencies do we need?

Answer 32

focuses on managers, internally. e.g., Honda- to design and manufacture small but powerful/reliable engines. Has nurtured this core competency for decades and modeled its practices after it.

Question 33

Explain the balance scorecard metric: How do shareholders view us?

Answer 33

total returns, ROIC, etc.

Question 34

What are the advantages of the balanced scorecard? (4)

Answer 34

Managers can:

1. ) Link the strategic vision to responsible parties.
2. ) translate the vision into measurable goals.
3. ) design and plan business processes
4. ) implement feedback and organizational learning (modify and adapt strategic goals)

Question 35

What are the disadvantages of the balanced scorecard? (5)

Answer 35

• focused on strategy implementation; not formulation.
• limited guidance about what metrics to use
• only as useful as the managers that apply it
• strategy must be translated into measurable objectives
• not much guidance about how to get back on track if set backs occur.

Question 36

What is the triple bottom line?

Answer 36

combination of economic, social, and ecological concerns (profits, people, and planet) that can lead to a sustainable strategy.

Question 37

Explain profits, people, and planet in the triple bottom line.

Answer 37

profits: economic dimension. Businesses need to be profitable to survive.
people: social dimension.
Planet: ecological dimension- the relationship between the business and the natural environment.

Question 38

What is a sustainable strategy?

Answer 38

a strategy along the economic, social, and ecological dimensions that can be pursued over time without detrimental effects on people or the planet.

Question 39

What is a business model?

Answer 39

a firm’s plan that details how it intends to make money.