Strategic Management – Chapter 5: Competitive Advantage, Firm Performance & Business Models

Learning Objectives

• Assess competitive advantage using diverse analytical lenses:

  • Accounting data to gauge profitability and benchmark against rivals.

  • Shareholder value creation to track market-based performance.

  • Economic value creation to disentangle value (V) from cost (C).

  • Balanced scorecard to combine financial and non-financial metrics.

  • Triple bottom line (profits, people, planet) to evaluate sustainability.

  • Business-model analysis (why, what, who, how) to translate strategy into action.

Frameworks for Assessing Firm Performance

• Three traditional, quantitative approaches:

  1. Accounting profitability.

  2. Shareholder value creation.

  3. Economic value creation.

• Two integrative, quantitative + qualitative approaches:

  1. Balanced scorecard.

  2. Triple bottom line.

Standard Performance Dimensions

• Key guiding questions:

  • "What is the firm’s accounting profitability?"

  • "How much shareholder value does the firm create?"

  • "How much economic value does the firm generate?"

• Long-run correlation:

  • Superior accounting profitability and larger economic value generally raise the stock price, driving higher market valuation.

Accounting Profitability

Key Metrics & Data Sources

• Data are publicly available via \text{GAAP} filings, \text{FASB} rules, and firms’ \text{Form 10-K}.

• Core profitability ratios:

  • ROIC (Return on Invested Capital)

  • ROE (Return on Equity)

  • ROA (Return on Assets)

  • ROR (Return on Revenue)

Drivers of Firm Performance (ROIC Decomposition)

• ROIC broken into two primary levers:

  1. \textbf{Return on Revenue (ROR)}

  2. \textbf{Working Capital Turnover}

Return on Revenue Elements

• \frac{COGS}{Revenue} → efficiency in production.

• \frac{R\&D}{Revenue} → innovation investment intensity.

• \frac{SG\&A}{Revenue} → spending on sales, general & admin support.

• \text{Tax Rate} → proportion of earnings remitted to government.

Working Capital Turnover Elements

• \frac{Working\;Capital}{Revenue} → capital tied up in operations.

• \frac{PPE}{Revenue} → revenue intensity of physical assets.

• \frac{Intangibles}{Revenue} → monetisation of patents, brands, goodwill, etc.

Limitations of Accounting Data

• Historical / backward-looking; poor at predicting future.

• Ignores off-balance-sheet items (e.g., pension obligations, operating leases).

• Tangible-asset focus under-represents innovation, brand, customer experience.

Declining Importance of Book Value (1980 – 2015)

• 1980: \approx 80\% of market cap came from book value.

• 2000: fell to \approx 15\% during the dot-com boom.

• 2015: intangibles drove \approx 75\% of market valuation, underscoring the shift to knowledge-based advantages.

Shareholder Value Creation

Core Definitions

• Shareholders: legal owners of publicly traded shares.

• Risk Capital: equity supplied that cannot be recovered in bankruptcy.

• Total Return to Shareholders (TRS): \text{Stock price appreciation} + \text{Dividends}.

• Market Capitalisation: \text{# Shares Outstanding} \times \text{Share Price}.

Illustrative Trend: Apple vs Microsoft (1990 – 2019)

• Microsoft peaked near \$600\text{ billion} market cap in 1999, then fell.

• Apple surpassed Microsoft 2010–15; both exceeded \$500\text{ billion} by 2017.

• Post-2014 (CEO Satya Nadella) Microsoft’s rebound briefly retook the global #1 spot.

Limitations

• Stock prices are volatile and sentiment-driven → short-term noise.

• Macro factors (GDP growth, unemployment, interest & FX rates) sway valuations.

• Behavioural biases: investor mood can be irrational.

Economic Value Creation

Fundamental Expression

• \text{Economic Value Created} = V - C

  • V = buyer’s maximum willingness to pay (total perceived consumer benefits).

  • C = total cost to produce.

  • Price charged P splits value between firm & consumer.

Surplus Breakdown

• Producer surplus / Profit: P - C

• Consumer surplus: V - P

• V - C = (V - P) + (P - C)

Illustrative Comparisons

1. Firm B vs Firm A (Same Cost)

   • Both have C = \$400.

   • Firm A: V=\$1{,}000 \Rightarrow V - C = \$600.

   • Firm B: V=\$1{,}200 \Rightarrow V - C = \$800 → \$200 economic advantage via differentiation.

2. Firm C vs Firm D (Same Value)

   • Both provide V = \$1{,}200.

   • Firm C: C = \$300 \Rightarrow V - C = \$900.

   • Firm D: C = \$600 \Rightarrow V - C = \$600 → \$300 advantage through lower cost.

Opportunity Cost & Other Limits

• Opportunity cost: value of the best foregone alternative.

• Challenges: measuring V is subjective, varies with income, taste, time.

• Firm-level analysis requires aggregating value created across the entire product portfolio.

Integrative Framework 1: Balanced Scorecard (BSC)

Purpose

• Translate strategic vision into actionable goals.

• Use internal + external indicators; balance financial & strategic KPIs.

Four Key Perspectives & Guiding Questions

1. Shareholders – "How do shareholders view us?"

2. Customers – "How do customers view us?"

3. Value Creation / Internal Business – "How do we create value?"

4. Core Competencies / Learning & Growth – "What capabilities do we need?"

Example Metrics

• Customers: revenue, profit, satisfaction scores.

• Value Creation: competitiveness indices, innovation rate, organisational learning.

• Core Competencies: process quality, cycle time, error rate.

• Shareholders: cash flow, operating income, ROIC, ROE, TRS.

Advantages

• Links strategy to accountable parties.

• Converts vision → measurable objectives.

• Facilitates process design, feedback, learning, adaptation.

Disadvantages

• Emphasises implementation, not strategy formulation.

• Ambiguity in metric selection; limited guidance on corrective action.

Integrative Framework 2: Triple Bottom Line (TBL)

Concept & Dimensions

• Pursuit of sustainable strategy across three pillars:

  1. \textbf{Profits} – economic dimension.

  2. \textbf{People} – social dimension.

  3. \textbf{Planet} – ecological dimension.

• Overlap of all three → sustainable competitive advantage.

Business Models

Definition & Purpose

• Blueprint of a firm’s competitive tactics & initiatives.

• Clarifies how the firm intends to make $$\$\$ and interact with buyers, suppliers, partners.

The "Why–What–Who–How" Framework

• Why? → value creation logic (revenue & cost models).

• What? → activities required to create & deliver offerings.

• Who? → key stakeholders performing activities.

• How? → mechanisms & resources enabling activity execution.

Popular Archetypes

• Razor–razor blades: low-margin base, high-margin consumables.

• Subscription: periodic fee for access (e.g., Netflix).

• Pay-as-you-go: usage-based (e.g., utilities).

• Freemium: free core, paid add-ons (e.g., Spotify Premium).

• Wholesale: sell in bulk to retailers at discount.

• Agency: earn commission for matchmaking / sales (e.g., App Store).

• Bundling: package multiple products at discount (e.g., MS Office).

Dynamic Nature & Legal Considerations

• Models can be combined (e.g., freemium + subscription).

• They evolve over time and may be disrupted (e.g., digital streaming vs DVDs).

• Novel models can trigger legal battles over profit redistribution.