10/9/2016

Chapter 5
Competitive Advantage, Firm Performance,
and Business Models

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Lecture Session Chapter Case 5

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Assessing Competitive Advantage: Apple vs. BlackBerry

 2012 – A comparison of Apple vs. BlackBerry on
return on invested capital (ROIC), where ROIC = (Net
profits / Invested capital) reveals:
• Apple’s ROIC was 35.0%.
• BlackBerry’s ROIC was 14.1%.
 Apple was 2.5 times more efficient than BlackBerry at
generating a return on invested capital, so Apple had a
clear competitive advantage over BlackBerry.

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Exhibit 5.1 Comparing Apple and

BlackBerry: Drivers of Firm Profitability
THREE TRADITIONAL FRAMEWORKS TO ASSESS
FIRM PERFORMANCE
ACCOUNTING PROFITABILITY
• What is the firm’s accounting profitability?

SHAREHOLDER VALUE CREATION

• How much shareholder value does the firm create?

ECONOMIC VALUE CREATION

• How much economic value does the firm generate?

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5.1 Competitive Advantage and

Accounting Profitability
Firm Performance
To measure competitive advantage, we must:  Examining one of these – Return on invested capital
1. Assess firm performance and
(ROIC), constituent parts are return on revenue and
working capital turnover.
2. Benchmark to the industry average / other competitors
 2012 – Apple had a distinct competitive advantage over
Three performance dimensions: BlackBerry because Apple’s ROIC was much higher
• What is the firm’s accounting profitability? than BlackBerry’s.
• How much shareholder value does the firm create?  Why is the ROIC for these two companies so different?
• How much economic value does the firm generate?  Apple vs. BlackBerry financial ratios are in Figure 5.1.

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Accounting Profitability Shareholder Value Creation

LIMITATIONS Shareholders
• Individuals or organizations who own one or more shares
 All accounting data are historical data and thus of stock in a public company
backward-looking. • The legal owners of public companies
 Accounting data do not consider off–balance sheet • Effective strategies to grow the business can increase a
items. firm’s profitability and its stock price.
 Accounting data focus mainly on tangible assets,
which are no longer the most important. Risk capital
 They do measure relative profitability, which is useful • The money provided by shareholders in exchange for an
equity share in a company.
when comparing firms of different size over time.
• Cannot be recovered if the firm goes bankrupt

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Exhibit 5.4 Apple’s Market Cap

(December 2011- April 2013) Shareholder Value Creation
LIMITATIONS
 Stock prices can be highly volatile, making it difficult to
assess firm performance, particularly in the short term.

 Overall macroeconomic factors such as the unemployment

rate, economic growth or contraction, and interest and
exchange rates all have a direct bearing on stock prices.

 Stock prices frequently reflect the psychological mood of

investors, which can at times be irrational.

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Economic Value Creation

• Pizza!
 A firm has a competitive advantage when it creates  Value: A dollar amount a
consumer is willing to pay for • Value = $12
more economic value than rival firms.
a good or service • Price = $10
 Economic value creation is the difference between a
buyer’s willingness to pay for a product/service and • Cost = $7 SOLD!
 Price: The dollar amount a
the firm’s total cost to produce it: good or service is offered for
• (V – C), where (V) = Value and (C) = Cost, also called sale • Consumer Surplus
economic contribution  $12 - $10 = $2
 The amount of total perceived consumer benefits  Cost: The dollar amount to • Producer Surplus
equals the maximum willingness to pay. make the good or service  $10 - $7 = $3
• Economic Value
 $12 - $7 = $5
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Exhibit 5.7 Competitive Advantage and

Economic Value Created:
The Role of Value, Cost, and Price
OPPORTUNITY COST

 Opportunity costs – The value of the best forgone

alternative use of the resources employed

 Accounting profitability – Relies on historical costs

 Economic value creation – All costs are considered,

including opportunity costs

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Economic Value Creation

LIMITATIONS  If the economic value created is

 Determining the value of a good in the eyes of • greater than its rivals  competitive advantage
consumers is not a simple task.
• equal to its rivals  competitive parity
 The value of a good in the eyes of consumers changes
based on income, preferences, time, etc. • lower than its rivals competitive disadvantage

 To measure firm-level competitive advantage, the

economic value created for all products/services
offered by the firm must be assessed.

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The Balanced Scorecard

HOLISTIC PERSPECTIVE OF FIRM PERFORMANCE ADVANTAGES OF THE BALANCED SCORECARD
 Balanced scorecard – Strategy implementation tool  Communicate and link the strategic vision to
that harnesses multiple internal and external responsible parties within the organization
performance metrics in order to balance financial and  Translate the vision into measureable operational
strategic goals goals
 The four key questions are:  Design and plan business processes
1. How do customers view us?
 Implement feedback and organizational learning in
2. How do we create value?
order to modify and adapt strategic goals when
3. What core competencies do we need?
indicated
4. How do shareholders view us?

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 While we have said that the objective of strategy is to

DISADVANTAGES OF THE BALANCED SCORECARD ―create competitive advantage,‖ specifically we have
the goal to maximize economic return.
 It is a tool for strategy implementation, not for strategy
formulation.
 It provides only limited guidance about which metrics  Economic & Accounting
Discounting Cash Flows
to choose−different situations call for different metrics. Measures of Performance Horizon
 Failure to achieve competitive advantage is not • Economic Profits CF1 CF2 CF3 CFt Valuet+1
NPV = 1+r + (1+r)2 + (1+r)3 + … + (1+r)t + (1+r)t+1
indicative of a poor framework but of strategic failure− • ROA, ROE, ROC
NPV: Net Present Value
i.e., managers must have crafted a strategy that builds
CFt: Cash Flow at time t
competitive advantage. r: Discount rate
 Financial Measures of
 Managers must accurately translate their strategy into Performance
Horizon Value: Value of
ongoing enterprise after time t
objectives that can be measured within this model. • NPV Methods
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 Projections are only as good as the ability of managers

 EBT - t (EBT) to measure accurately the financial consequences of
 EBT (1-t) = NET INCOME actions.
 EBT (1-t) + depreciation - capital expenditures =
NET CASH FLOW  An implicit assumption of value-based strategy was
 (note we are assuming no change in accounts receivable, no change in that business units and all investment proposals were
net working capital, no change in inventory) self-contained. It was usually expected that divesting a
business or curtailing an investment project would
 Equivalent concepts: have no financial repercussions elsewhere in the
corporation (e.g., ignores knowledge transfers).
• Maximize NPV
• DCF Approach  Strict financial measurement of many long-term
• Maximize Economic Profits (EVA) investments, particularly in intangible assets,
• Sustainable Competitive Advantage (SCA) is virtually impossible.
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 Investments in R&D typically do not offer direct returns; their

economic value is a strategic option to invest in new products and  Market Value Added (MVA)
processes that may arise from R&D. Narrowly- defined DCF does • Market Value less Total Investment
not accurately value investments where there is significant
strategic options value.  Economic Value Added (EVA)
• Operating Profit (after tax) less annual capital costs; basically, this is
• (Merck has been at the forefront of applying economic profit
strategic options theory to analyze
investments in R&D).  Tobin’s q (Market Value/Book Value)
• A firm’s market value divided by its “replacement” cost

 The Market Value of the Firm -

• Current Value of all securities issued by the firm
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The Triple Bottom Line

 Operating profit
$1,756 million - taxes $617 million = STAKEHOLDER PERSPECTIVE

 Economic, social and ecological dimensions make up

 WACC : 67% equity at 14.3% the triple bottom line.
33% debt at 5.2%  Noneconomic factors can have a significant impact
on a firm’s financial performance, as well as
itsreputation and goodwill.
Capital of $8 billion  Extended producer responsibility – In anticipation of
government regulation – proactively addressing
11.3% * $8billion = $904 million
social or ecological issues
$1,139 - $904 =
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Strategy Highlight 5.1

Interface: The World’s First Sustainable Company CORPORATE SOCIAL RESPONSIBILITY
 Historically, economic performance has been the focus of
 1994 – Founder Ray Anderson set the visionary goal firm performance.
for the company to be entirely ―off oil‖ by 2020.  More recently, society and investors require companies to
 Interface’s business model has revolutionized the also address social and ecological concerns.
carpet industry.  Millennials – born between 1980 and 1991 – expect firms
to be socially responsible and have a strong interest in
 Their BHAG—big hairy audacious goal—has working for companies that match their values.
catapulted Interface into being the world’s first fully  Research studies – CSR and firm performance
sustainable company. relationship:
• Some find CSR improves financial performance.
• Others conclude superior financial performance makes CSR
possible.

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5.2 Business Models:

Strategy Highlight 5.2
Putting Strategy into Action
Threadless: Leveraging Crowdsourcing to Design
 Business model – Plan that details the firm’s
Cool T-Shirts
competitive tactics and initiatives
 2000 – Founded by Jake Nickell & Jacob DeHart, their
 A business model explains how the firm intends to business model leverages prosumers, a hybrid between
make money, and how the firm conducts its business producers and consumers.
with buyers, suppliers, and partners.  Through Internet-enabled technology, crowdsourcing–
using a group of people who voluntarily perform tasks
 Business model innovation may be more important traditionally completed by firm employees–translates
in achieving superior performance than product or real-time market research and design contests into
process innovation. actual sales.

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5.3 Implications for the Strategist

COMPETITIVE ADVANTAGE AND FIRM PERFORMANCE
Effective Business Model – Two Steps
1. Formulate No One Best Strategy
Managers transform their strategy of how to compete into a blueprint of • Only better strategies – Relative to competitors or industry average
actions and initiatives that support the overarching goals.
Goal of Strategic Management
2. Implement
• Integrate and align each business function and activity to obtain
Managers implement this blueprint through structures, processes, overall superior performance.
culture, and procedures.
 If translation into a profitable business model fails, the Quantitative and Qualitative
• Holistic perspective is required for performance assessment,
firm will most likely fail. measuring different dimensions over different times.

Business Model
• How a firm does business is more critical to its competitive advantage
than what it does.
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ChapterCase 5
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Consider This…
• Firm profitability for Apple and BlackBerry are presented in
ChapterCase 5.
• The focus of the analysis is fiscal year 2012, which means
that this is a snapshot, a static analysis.
• Although the two key questions are answered:
1. Assess firm performance.
2. Compare this to competitors.
• Managers need to engage in a dynamic analysis, repeating
this over a number of years.
• This will help identify when and where things went wrong
(for BlackBerry) and how to get back on track.

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