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1

3 traditional framework to assess firm performance

accounting profitability, shareholder value creation, economic value creation

2

What is the firm's accounting profitability

use financial data and ratios derived from publicly available accounting data such as income statements and balance sheets. examine ROIC, constituent parts are ror and working capital turnover

3

Accounting profitability example

apple had a distinct competitive advantage over BlackBerry because apple's ROIC was much higher than blackberrys

4

limitations of accounting profitability

all accounting data are historical and backward looking, data do not consider off balance sheet items, accounting data focus mainly on tangible assets which are no longer most important

5

positive of accounting profitability

measures relative profitability, which is useful when comparing firms of different size over time

6

to measure competitive advantage, we must

1. assess firm performance 2. benchmark to the industry average/other competitors

7

Shareholder value creation

how much shareholder value does the firm create?

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shareholders

individuals or organizations who own one or more shares of stock in a public company and are the legal owners or public companies, effective strategies to grow the business can increase a firm's profitability and its stock price

9

risk capital

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

10

Total return to shareholders

return on risk capital, including stock price appreciation plus dividends received over a specific period, this is what investors are interested in

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total return to shareholders is an ______, unlike accounting data

external performance measure

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efficient market hypothesis

all available information about a firm's past, current state, and expected future performance is embedded in the firm's stock price

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limitations of shareholder value creation

stock prices can be volatile, making it difficult to assess firm performance, especially in the short term; overall macroeconomic factors such as unemployment and economic growth/contraction and interest and exchange rates all have a direct bearing on stock prices; stock prices frequently reflect psychological mood of investors which can be irrational at times

14

economic value creation

how much economic value does the firm generate, the foundation upon which to formulate a firm's competitive strategy of cost leadership or differentiation

15

a firm has competitive advantage when it creates more _____ than rival firms

economic value

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economic value creation formula

difference between buyer's willingness to pay for a product/service and the firm's total cost to product it: V-C, also called economic contribution

17

amount of total perceived consumer benefits need to equal _____

maximum willingness to pay

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Value (V)

consumer's willingness to pay maximum price, sometimes called the reservation price

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Cost (C)

cost to produce the good/service directly impacts the profit margin

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Profit (P)

Difference between the price (P) charges and the cost (C) to produce or (P-C)

21

from an economic context, strategy is about:

1. creating economic value 2. capturing as much of it as possible

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a large difference between v and c gives the firm two distinct pricing options

1. charge higher prices to reflect the higher product value and increase profitability 2. charge the same price as rivals and gain market share

23

opportunity costs

the value of the best forgone alternative use of the resources employed

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what strategy considers opportunity costs

economic value creation

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limitations of economic value creation

determining the value of a good in the eyes of the consumer is not a simple task; the value of a good in the eyes of consumers changes based on income, preferences, time' to measure firm level competitive advantage the economic value created must be assessed for all products/services the firm offers

26

What provides the bases for a sustainable strategy

the triple bottom line, the simultaneous pursuit of performance along social, economic, and ecological dimensions

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the triple bottom line from the stakeholder perspective

economic, social, and ecological dimensions make up the triple bottom line, noneconomic factors can have a significant impact on a firm's financial performance, as well as its reputation a goodwill

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extended producer responsibility

in anticipation of government regulation- proactively addressing social or ecological issues

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business model

plan that details the firm's competitive tactics and initiatives, a business model explains how the firm intends to make money and how the firm conducts its business with buyers, suppliers, and partners

30

business model innovation

may be more important in achieving superior performance than product of process innovation

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competitive advantage and firm performance

no one best strategy, goal of strategic managment, quantitative and qualitative, business model

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no one best strategy

only better strategies, relative to competitors or industry average, must interpret any performance metric relative to those of competitors

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goal of strategic management

integrate and align each business function and activity to obtain overall superior performance

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quantitative and qualitative

holistic perspective is required for performance assessment measuring different dimensions over different times

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accounting profitability ratios

percent operating margin, percent profit margin

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percent operating margin

operating income/revenue

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percent profit margin

net profit/net sales

38

liquidity ratios

current ratio and quick ratio

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current ratio

total current assets/ total current liabilities

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quick ratio

(total current assets - inventory)/total current liabilities

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shareholder value ratios

percent return on assets and percent return on equity

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percent return on assets

net profits/total assets

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percent return on equity

net profits/owners equity

44

competitive advantage is always measured ____

in relation to other firms

45

example of a business model

zipcar allows its members to rent a vehicle online that is already in their vicinity for a few hours or a day. users are charged for duration of use and gas and insurance are included in rental fees. appeals to urban dwellers and millenials, downside is it take a lot of up front investment to build a rental fleet, unable to obatin the capital necessary to scale its operations to be profitable

46

razor-razor blade business model

initial product is often sold at a loss or given away for free to drive demand for complimentary goods, make money off of replacement parts needed. ex: gillette gives away razorr base but you must buy expensive replacement blades

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subscription based business models

users pay for aceess to a product or service whether they use the product or service during the payment term or not. ex: cable television cell phone serviceproviders

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pay as you go business model

user pays for only the services he or she consumes. ex: utilities such as power and water

49

freemium business model

basic features of a product or service are provided free of charge but the user must pay for premium services such as advanced features or add ons. ex; software trials

50

Business level strategy

the goal directed actions managers take in their quest for competitive advantage when competing in a single product market

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who, what, why, and how of busienss level strategy

who-which customer segements-will be serve
what customer needs, wishes, and desires will we satisfy
why do we want to satisfy them
how will we satisfy our customers' needs

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how to compete for advantage

differentiation, cost leadership, and integration

53

differentiation

create higher value by delivering products/services with unique features

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cost leadership

create similar value by delivering products/services at a lower cost and lower prices than competitors

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integration

combination of differentiation and cost leadership strategies

56

strategic position

the greater the economic value created, the greater the firm's competitive advantage, a firm's business level strategy determines its strategic position, a business strategy is more likely to lead to a competitive advantage if it allows firms to either perform similar activities differently or perform different activities than their rivals

57

generic business strategies

independent of industry, can be used by any organization, manufacturing or service, large or small, public or private, us or non us, in the quest for competitive advantage.

58

value creation and cost in generic business strategies

tend to be positively correlated. there exist important trade offs between value creation and low cost

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value drivers

product features, customer service, complements

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product features

most important and clearest drivers, unique features>>higher price. ex: BMW M3

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customer service

ID umet customer needs and satisfy them. ex: ritz-Carlton, Zappos online retailer

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complements

add value when consumed as a bundle ex: AT&T u verse with a DVR add on

63

Whole Foods

lost its competitive advantage due to failure to control costs effectively, a clearly formulated business strategy enables them to increase differentiation value gap (healthy choices while educating customers) and command premium prices while keeping cost structure in check (offer more products)

64

A cost leadership strategy with adequate value

managers can manipulate cost drivers to keep their costs low

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cost drivers

cost of input factors, economies of scale, learning curve effects, experience curve effects

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economies of scale

output up, cost per unit down. spread fixed costs over large output, specialized systems, physical properties

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spread fixed costs over large outputs

microsoft upront R&D for windows upgrade

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specialized systems

ERP software or robots

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physical properties

cube square rule for big box stores

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minimum efficient scale

lowest cost position constant returns to scale

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diseconomies of scale

complexity of management or physical limits (gore associates and aircraft aeronautics)

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learning curves

steeper curve=more learning ex: aircraft manufacturing, cardiac surgeons

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experience curves

combine economy of scale and learning curves, scale comes down a given learning curve, technology allows movement to steeper curve, combination can leapfrog in competitive advantage

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ex of experience curves

walmart high volumes and technology leadership

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benefit and risk of cost leadership

benefit: protected from competitors if price war
risk: new entrant arrives and new capabilities needed

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benefit and risk of differentiation

benefit: reduced rivalry and high cost of imitation
risk: might overshoot features needed and vulnerable to price sensitive customers

77

combining cost leadership and differentiation

firms skilled in both lowering costs and uniqueness, difficult because firm manages internal value chain activities that are fundamentally different from one another. can work if investments are complements, not subsitutes

78

value and cost drivers of integration strategy

quality, economies of scope, customization, innovation, structure, culture and routines

79

The dynamics of competitive positioning

strategic positions need to change over time, productivity frontier

80

strategic positions need to change over time

PC assemblers need to move tablets or smartphones

81

productivity frontier

value cost realtionship; relationship that captures the result of performing best practices at any given time, the function is concave (bulging outward) to capture the trade-off between value creation and production cost

82

well formulated and implemented strategies =

enhanced chances of superior performane

83

integration strategies only successful if

an innovation that reconciles the trade offs, such as toyota lean manufacturing in the 80s and 90s

84

gale of creative destruction-Joseph Schumpter

continuous waves of market leadership changes in the encyclopedia business. innovation is a competitive weapon that can create and destroy value

85

move from typewriters to computers

Wang Labs, cimputer comp, helped to kill the typewriter industry, IBM and compaq defeated wang labs for the computer market, lenovo bought remains of ibm personal computer market, hp bought compaq and is inder threat from mobile device

86

tv viewing options

big 3 networks struggle against cable and satellite providers, customized online content now rising

87

Innovation process: discovery and development of new knowledge captured by the 4 is

idea, invention, innovation, imitation

88

Idea

may be presented in terms of abstract concepts or as findings derived from basic research

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invention

transformation of an idea into a new product, process, or the modification and recombination of existing ones

90

innovation

concerns the commercialiation of an invention by entrepreneurs

91

imitation

copying a successful innovation

92

Innovation

a novel and usful idea that is successfully implemented

93

who are the change agents for creative destruction

entrepreneurs

94

Jeff Bezos

Amazon, saw growth of internet in 1994, now the world's largest online retailer, created new opportunity and exploited it

95

Oprah

Harpo Productions, rose from abuse and poverty to over $2 billion net worth, ended talk show to devote time to OWN TV channel, created new opportunity and exploited it

96

Elon Musk

Tesla Motors, Solar City, SpaceX, Paypal, an engineer and serial entrepreneur, deep passion to solve environmental, social, and economic challenges

97

example of combining entrepreneurial with strategic actions

samsungs innovation in mobile devices

98

five different stages of the industry life cycle

introduction, growth, shakeout, maturity, and decline

99

New industries created by innovation

express delivery, internet retailing and advertsiign, nantotechology growing in medical and aircraft industries

100

competitors and the industry life cycle

the number and size of competitors change with each stage

101

consumers and the industry life cycle

different types of consumers enter the market at each stage. both the supply and demand sides of the market change as the industry ages

102

early adopters

excited by the possibilities of the product rather than the cool technology of technology enthusiasts

103

many innovators fail to get from _____ when crossing the chasm

early adopters to majority (15-50% of market)

104

the critical early majority base purchasing decisions on _____

practicality, can generate a herding effect

105

Introduction life cycle stage

R&D, product innovation at maximum, process innovation at minimum, slow growth and small size, want to differentiate and achieve market acceptance. usually bought by tech enthusiasts

106

Growth life cycle stage

R&D, some manufacturing and marketing. decrease product innovation and increase process innovation, high growth and moderate size. want to stake out strong strategic position, usually bought by early adopters

107

shakeout life cycle stage

manufacture, engineer, more increase in process innovation and decrease in product innovation, moderate/slowing growth and large size, survive by drawing on deep pockets, bought by early majority

108

maturity life cycle stage

manufacture, engineer, market. low product innovation, high process innovation, none to mderate growth and largest size, maintain strong strategic position, bought by late majority

109

decline life cycle stage

manufacture, process engineer, market, aservice, product inn at min, process inn at max, negative market growth, want to exit, harvest, maintain, or consolidate, bought by laggards

110

incremental innovation

steady improvement of a product or service, often from incumbent firms (econ incentives, organizational inertia, innovation ecosystem)

111

examples of incremental innovation

gillette now 6 bladed razors, intel 386 to 486 processprs

112

radical innovation

novel methods or materials serving new markets, often from new firms

113

examples of radical innovation

mass production (Ford), genetic engineering, airplanes predictable pattern of innovation

114

architectural innovation

reconfigure known components to create new markets

115

examples of architectural innovation

canon user friendly copiers, GPS to handheld consumer devices

116

disruptive innovation

novel technologies serving existing markets from bottom up, stealth attack (

117

examples of disruptive innovation

japanese autos, digital photography, data storage media

118

The internet as disruptive force: the long tail

80% of sales in a given category of boos or movies are hot hits (Pareto principle), technology allows easier acces to the tail, less of more, online firms can gain a large share from selling a small number og nearly unlimitied choices

119

what is the short head

the blockbuster that are available at brick and mortar stores, significant inventory costs

120

innovation in the 20th century

mostly closed, internal shift from closed to open in 21st

121

open innovation

mobility of skilled workers, exponential growth of venture capital, wider marketplace of ideas options, better capabilities in external sppliers

122

open innovation leverage

leverages both internal ideas and inventions and external ones; 2 way sharing

123

closed innovation principles

smart people in field work for us, must discover, develop, and ship ourselves to profit from R&D, if we discover ourselves we will get it to the market first, creating the most/best ideas in industry=win, should control IP so competitors dont profit from it

124

open innovation principles

not all smart people work for us, external r and d can create value, internal r and d needed to claim portion of value, dont have to originate research to profit, better business model is more important that getting to market first, should profit from others use of our IP, and buy others IP when it advances our business model

125

most innovative companies in 2013

nike, amazon, square ,uber, pinterest, target, all use continuous innovation

126

corporate strategy determines the firm's boundaries along three dimensions

1. industry value chain, 2. range of products and services 3. where to compete: geography

127

key strategic management concepts in corporate level strategy

core competencies, economies of scale, economies of scope, transaction costs

128

core competencies

unique strenghts

129

economies of scale

average cost per unit decreases

130

economies of scope

savings producing two or more outputs

131

transaction costs

all internal and external costs associated with an economic exchange

132

transaction cost economies

explains and predicts the scope of the firm (Market vs firm have differential costs),

133

external transaction costs

costs associated with economic exchanges (negotiating and enforcing contracts)

134

internal transaction costs

costs pertaining to organizing an exchange within a firm (recruiting and training employees)

135

if cost of in house < than cost of market

vertically integrate (make), google hires programmers to write code in house instead of contracting out

136

disadvantage or make in house

principal agent problem (owner = principal, manager = agent)

137

disadvantage of bur from markets

search cost, opportunism, information asymmetries

138

deciding whether to make in house or buy from markets determines the firms ___

boundaries

139

Alternatives to the make or buy continuum

short term contracts, strategic alliances, parent subsidiary relationship

140

short term contracts

competitive bidding process, less than one year term, lower prices - cost advantages

141

strategic alliances

facilitate investment without admin costs

142

examples of strategic alliances

long term contracts, equity alliances, joint ventures

143

parent subsidiary relationship

most integrated alternative, parent companies have command and control

144

example of parent subsidiary realtionship

GM owns Opel and Vauxhall in Europe

145

Make or buy continuum from less integrated to more integrated

buy > strategic alliances > make

146

vertical integration

ownership of its inputs, production, and outputs in the value chain, vertical value chain, industry level integration from upstream to downstream

147

ex of industry level integration from upstream to downstream

cell phone industry value chain has many different industries and firms

148

ex of full vertical integration

wyerhauser owns forests, mills, and distribution to retailers

149

ex of backwards vertical integration

HTC's backward integration into design of phones

150

ex of forward vertical integration

HTCs forward integration into sales and branding

151

not all industry value chain stages are equally profitable

apple designs in house software and hardware but partners for manufacturing

152

benefits of vertical integration

securing critical supplies, lowering costs and improving quality, lowering costs and improving quality, facilitating investments in specialized assets

153

risks of vertical integration

increasing costs and reducing quality, reducing flexibility, increasing the potential for legal repercussions

154

alternatives to vertical integration

taper integration and strategic outsourcing

155

taper integration

backward integrated but also relies on outside market firms for supplies OR forward integration but also relies on outside market firms for some of its distribution

156

strategic outsourcing

moving value chain activities outside the firm's boundaries

157

ex of strategic outsourcing

peoplesoft, eds, and perot systems provide hr services to many firms that chose to outsource it

158

degrees of diversification

range of products and services a firm should offer. pepsi owns lays and quaker oat but sold KFC

159

diversification strategies

product diversification, geographic diversification, product market diversification

160

product diversification

active in several different product categories

161

geographic diversification

active in several different countries

162

product market diversification

active in a range of both products and countries

163

single business form

derives > 95% from one business- google revenue from online research

164

dominant business firm

derives 70-95% from one business- harley yields 10% from clothing

165

related diversification strategy

< 70% from one business

166

related constrained diversification strategy

leverage current competencies, exxon strategic move into natural gas

167

related linked diversification strategy

share only limited links to current business, amazon moves to cloud computing, kindle tables, video streaming

168

unrelated diversification

< 70% and few if any links amon businesses, GE, LG, Tata

169

core competence

unique skills and strengths, allows firms to increase the value of product/service, lowers the cost

170

ex of core competencies

walmart-globally distributed supply chain at low cost

171

the core competence market matrix

provides guidance to executives on how to diversify in order to achieve continued growth

172

does corporate diversification lead to superior performance

are the individual businesses worth more under the company's management than if each were managed in seperate firms

173

ex of corporate strategy being dynamic over time

adidas founded in 1924 with focus on shoes, globalization led to less integration and wider sports apparel, nike started in 1978 as a vertically disinegrated firm