Session 4: Competitive Advantage

Comp Adv Graph

• firms ability to generate ABOVE avg return

Strategy

The goal directed actions a firm takes to gain and sustain a competitive advantage

How to measure Competitive Advantage?

• measured relative to our competitors

• there is no absolute measure we use in strategy consulting

• There are three business dimensions that we can use to determine if a firm is generating above avg results: Use a multidimensional perspective that includes three arenas: Economic value creation, accounting profitability, shareholder wealth/value

Economic Value Creation

• sets you apart

• the difference btwn what customers are willing to pay for your product or service (value) and what it costs you to produce it (costO

• the relationship btwn econ value creation and comp adv is fundamental in start mngt

• provides the foundation upon which to formulate a firm’s comp strat of cost leadership or differentiation

• Three Components: Value (V), Price (P), Cost (C); costs include opportunity costs

• Economic value created is the diff btwn a buyer’s willingness to pay for a g/s and the firm’s cost to produce (V-C)

• a firm has a competitive adv when its able to create more economic value that its rivals

• the source of comp adv can stem from higher perceived value creation (assuming equal cost) or lower cost (assuming equal value creation)

• superior product differentiation or a relative cost adv over rivals

• figure out the true cost and then find the value (the right price)

• limitations: determining value for customers is not simple; the value is in the eyes of the consumer: changes based on income, preferences, time

• to measure firm level competitive adv using ebc, we must estimate the econ value created for all products and services offered by the firm

Account Profitability

• another common way to measure comp adv is thru examining accounting profitability via financial ratios

• to measure comp adv we must: accurately assess firm performance and compare and benchmark the focal firm’s performance to other competitors in the same industry or the industry avg

• to measure profitability, we use standard metrics derived from public available accounting data, a firm’s 10k is a great source to find this info

• Commonly used profitability metrics in strategic mangt are: Return on Invested Capital (ROIC) 9most commonly used: net profits/invested capital) (if its greater than cost of capital then it generates value), Return on Assets (ROA), Return on Equity (ROE), Return on Revenue (ROR)…

• Why dont we use financial ratios to determine competitive adv? All accounting data are historical and backward looking. They focus mainly on tangible assets and do not consider intangibles that are hard or impossible to measure and quantify, such as innovation competency

Shareholder Wealth/Value

• examine shareholder wealth thats created as a result

• investors are primarily interested in total return to shareholders, which includes stock price appreciation plus dividends received over a specific period

• total return to shareholders is an external performance metric; it indicates how the market views all publicly available info abt a firm’s past, current state, and expected future performance: Stock price appreciation plus dividends

• applying a shareholders’ perspective, key metrics to measure and assess comp adv are the return on (risk) capital and market capitalization

• _ Risk Capital: money provided for an equity share in a company; cannot be recovered if the firm goes bankrupt

• Market capitalization: dollar value of total shares outstanding; number of outstanding shares * share price

• Limitations:

• stock prices can be highly volatile, which makes it different to assess firm performance. Overall macroecon factors have direct bearing on stock prices. Also, stock prices freq reflect the psychological mood of the investors, which can be irrational sometimes

• Shareholder value creation is a better measure of comp adv over the long term due to the noise introduced by market volatility, external factors, and investor sentiment

• people are irrational. stock prices reflect the mood of investors

The Balanced Scorecard

• created by Robert Kaplan and David Norton in 1992

• at least 40% of all fortune 1000 comps use it, but it can be complex to implement, format varies

• attempts to provide a more integrative view of competitive adv

• goal is to harness multiple internal and external performance dimensions to balance financial and strategic goals

• managers develop strategic objectives for the balanced scorecard by answering 4 key questions:

  • How do customers view us? Revenue, profit, customer satisfaction; surveys

  • How do we create value? Competitiveness, innovation, organizational learning

  • What core competencies do we need? core competencies, supporting business processes

  • How do shareholders view us? cash flow, operating income, ROIC, ROE, total returns to shareholders

• the balanced scorecard is a framework designed to translate an orgs mission and vision statements and overall business strat into specific, quantifiable goals and objectives and to monitor the orgs performance in terms of achieving these goals

• Adv: link the strategic vision to responsible parties, translate the vision into measurable goals, design and plan business process, implement feedback and organizational learning (modify and adapt strategic goals)

• Disadv: **Focused on strat implementation not formulation, limited guidance abt which metrics 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 (People, Planets, and Profit)

• neo economic factors have a significant impact on a firm’s financial performance, not to mention its reputation and customer goodwill

• managers are freq asked to maintain and improve not only the firm’s economic performance but also its social and ecological performance

• Three dimensions: economic, social, and ecological (Profit, people, planet) (triple bottom line)

• Profits: economic dimension; the busines smust be profitable to survive

• People: social dimension, emphasized the people aspect

• Planet: eco dim; emphasized relationship btwn business and natural environment

• achieving positive results in all three areas can lead to a sustainable strategy that can endure over time

• a sustainable strat produces not only positive financial results along the social an ecological obligations to stakeholders such as employees, customers, suppliers, and communities in a serious way as they track its financial performance

Business Models

• details how the firm conducts its business with its buyers, suppliers, and partners

• a firm’s business model is not the same thing as a firms business strategy

• they explain how a firm plans to make money, whereas a bus strat explains what competitive position they’ve chose

• it details the competitive tactics and initiatives, explains how the firm intends to make money, stipulates how the firm conducts its business (buyers, suppliers, partners)

• Razor-Razorblades

  • when the initial product is sold at a loss or practically given away to drive demand for complementary good (razors or printer ink)

• Subscriptions

  • netflix, newspapers

• Pay as you go

• Freemium

  • give you basic features of a product or service for free but charge you for premium services; great way to increase switching cost

• Wholesale

• Agency

• Bundling

Busines smodels can be combined, can evolve, can be disrupted, must respond to disruption and adapt, legal conflicts can arise

Summary