MAN4720 Ch4, Competitive Advantage

Competitive Advantage

Generating above average returns relative to your competitors.

3 dimensions of competitive advantage

• Economic value creation

• Accounting profitability

• Shareholder wealth/value

Economic Value Creation

The difference between what consumers are willing to pay for your product/service and what it costs to product

Economic value creation provides…

The foundation upon which to formulate a firm's competitive strategy of cost leadership or differentiation.

Economic Value Formula

Value minus cost

Limitations of measuring competitive advantage using economic value creation:

• Value is subjective and in the eyes of a 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. Challenging for companies with lots of SKU's

Accounting Profitability

Done via financial ratios, must be able to:

1. Accurately assess firm performance

2. Compare and benchmark with competitors

   1. Use metrics standardized by GAAP

Accounting Profitability Metrics

1. Standardized accounting metrics

2. Form 10-k statements

3. Profitability ratios

Accounting Profitability Ratios:

• Return on invested capital (ROIC)

• Return on assets (ROA)

• Return on equity (ROE)

  • Return on revenue (ROR)

Return on invested capital (ROIC)

The most commonly used profitability ratio, is calculated by dividing net profit by invested capital.

• If a firms ROIC is greater than its cost of capital then it generates value

Shareholder Wealth/Value

Return on (risk) capital and market capitalization.

Risk Capital

The money provided for an equity share in a company

Total Return to Shareholders

The stocks price appreciation plus dividends

Market Capitalization

The dollar value of total shares outstanding

Limitations of measuring competitive advantage using shareholder wealth/value

• Stock prices can be highly volatile, making it difficult to assess firm performance

• Reflects psychological mood of investors which can be irrational

• Better to be use over the long term

• Affected by macroeconomic factors like growth or contraction, unemployment, interest, and exchange rates.

Balanced Scorecard

A more integrated view of competitive advantage helping managers achieve their strategic objectives more effectively.

Balanced scorecards…

• Use internal and external performance metrics to translate an organization's mission and vision statements and overall business strategy into specific, quantifiable goals and objectives and to monitor the organization's performance in terms of achieving these goals.

  • Balance both financial and strategic goals

Balanced scorecards ask 4 key questions:

1. How do customers view us? And how does it affect our revenue, profit, and satisfaction?

2. How do we create value?

3. What core competencies do we need?

   1. How do shareholders view us?

How do companies gauge customer feedback?

Utilization of surveys

Why do companies want to know how they create value?

It helps develop future competitiveness, innovation, and organizational leadership

How can we analyze how shareholders view a company?

Analyzing the cash flow, operating income, ROIC, ROE, and total returns to shareholders

Advantages of using a balanced scorecard

• Attempts to link the strategic vision to responsible parties

• Translates the vision into measurable goals (if you cant measure it, you cant manage it)

• Designs and plans business processes

  • Implement feedback and organizational learning

Disadvantages of using a balanced scorecard

• Focused on strategy implementation, not formulation

• Limited guidance about which metric to use

• Only as useful as the managers who apply it

• Strategy must be translated into measurable objectives

  • Not much guidance on how to get back on track if setbacks occur

Triple Bottom Line:

• Profit: the economic dimension

• People: the social dimension

  • Planet: ecological dimension

Business Model

How the firms conduct business with its buyers, suppliers, and partners

• Shows how a firm plans to make money

• Not the same as your strategy

Freemium Business Model

Offer basic services for free, charge for premium services (LinkedIn)

Razor/Blades Business Model

Offer the high-margin razor below cost to increase volume sales of the low-margin razor blades. (Printers and ink)

Subscription Business Model

Charge a subscription fee to gain access to a service. (Netflix)

Business models…

• Can be combined, evolved, disrupted

• Must respond to disruptions and adapt

• Can have legal conflicts can arise.