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Strategic Management/ Business Policy. Power Point Set #2 Performance Measurement. Fundamentals of Competitive Strategy. Superior Long-Run Performance. The central goal. Attractive Industry Structure. Competitive Advantage. Outperform the average industry participant.

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strategic management business policy

Strategic Management/ Business Policy

Power Point Set #2

Performance Measurement

fundamentals of competitive strategy
Fundamentals of Competitive Strategy

Superior Long-Run Performance

The central goal

Attractive Industry Structure

Competitive Advantage

Outperform the average industry participant

High returns for the average participant

Operational Effectiveness

Superior Competitive Position

Do different things than rivals

Do the same things as rivals but better

economic profits and competitive advantage
Economic Profits and Competitive Advantage
  • Driving a wedge between revenues and costs is how competitive advantage is created.
  • In strategy, we need to think simultaneously about:
    • The value we create for our customer;
    • How we appropriate some of that value in terms of higher prices;
    • The costs we incur in creating that value.
  • Conceptual traps that managers fall into:
    • Accounting Costs versus Opportunity Costs
    • Market Share is not competitive advantage
the first rule of strategy

Finance

Oper.

Mktg.

Strategy

Acctg.

H.R.

The First Rule of Strategy
  • A Good Strategy Is “Coherent.”
    • Functional pieces of strategy support the whole (Michael Porter: HBR, 1996)
strategic coherence the logic of how the business fits together
Southwest Airlines

Low Price

Short Routes

No Frills

Point-to-Point

One Aircraft -- Boeing 737

High number of Aircraft per Route

No Meals

Flexible/ Lower Staffing

American Airlines

Premium Price

Short, Long, & Int’l

Variety

Hub & Spoke System

Multiple Aircraft

Low number of Aircraft per Route

Meals & Service

Higher Staffing

Strategic Coherence The Logic of How The Business Fits Together:
swot analysis

Opportunities& Threats

Strengths &Weaknesses

InternalFactors

Strategy

ExternalFactors

Values OfStakeholders

Values Of

Management

SWOT Analysis
  • Strengths, Weaknesses, Opportunities, and Threats

Drivers

Objectives

how do we measure performance
How Do We Measure Performance?
  • “The strategic aim of a business is to earn a return on capital, and if in any particular case the return in the long run is not satisfactory, then the deficiency should be corrected or the activity abandoned for a more favorable one.”
      • Alfred P. Sloan My Years with General Motors
sustainable competitive advantage and the measurement of performance
Sustainable Competitive Advantage and the Measurement of Performance
  • While we have said that the objective of strategy is to “create competitive advantage,” specifically we have the goal to maximize economic return.
  • Economic & Accounting Measures of Performance
    • Economic Profits
    • ROA, ROE, ROC
  • Financial Measures of Performance
    • NPV Methods
financial measures of performance npv or dcf analysis
Financial Measures of Performance: NPV or DCF Analysis
  • The principle of discounted cash flow (DCF) analysis that firms apply to their individual projects can also be applied to the firm as a whole. Maximizing the net present value of the firm’s cash flow (“sustainable competitive advantage”) corresponds to maximization of its stock market valuation and hence maximizes the wealth of its shareholders.
net cash flow
Net Cash Flow
  • EBT - t (EBT)
  • EBT (1-t) = NET INCOME
  • EBT (1-t) + depreciation - capital expenditures = NET CASH FLOW
      • (note we are assuming no change in accounts receivable, no change in net working capital, no change in inventory)
  • Equivalent concepts:
    • Maximize NPV
    • DCF Approach
    • Maximize Economic Profits (EVA)
    • Sustainable Competitive Advantage (SCA)
limitations of present value measures
Limitations of Present Value Measures
  • Projections are only as good as the ability of managers to measure accurately the financial consequences of actions.
  • An implicit assumption of value-based strategy was that business units and all investment proposals were self-contained. It was usually expected that divesting a business or curtailing an investment project would have no financial repercussions elsewhere in the corporation (e.g., ignores knowledge transfers).
  • Strict financial measurement of many long-term investments, particularly in intangible assets, is virtually impossible.
limitations of present value measures15
Limitations of Present Value Measures
  • Investments in R&D typically do not offer direct returns; their economic value is a strategic option to invest in new products and processes that may arise from R&D. Narrowly- defined DCF does not accurately value investments where there is significant strategic options value.
    • (Merck has been at the forefront of applying strategic options theory to analyze investments in R&D).
capital market approaches to measuring performance
Capital Market Approaches To Measuring Performance
  • Market Value Added (MVA)
    • Market Value less Total Investment
  • Economic Value Added (EVA)
    • Operating Profit (after tax) less annual capital costs; basically, this is economic profit
  • 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
economic value added eva
Economic Value Added (EVA)
  • Anheuser-Busch: Operating profit $1,756 million - taxes $617 million = $1,139 million
  • WACC : 67% equity at 14.3%

33% debt at 5.2%

11.3% WACC

Capital of $8 billion

11.3% * $8billion = $904 million

$1,139 - $904 = $235 million EVA

problems with shareholder wealth maximization
Problems With Shareholder Wealth Maximization
  • Under what conditions does “maximizing shareholder wealth” not make sense? When do we need to pay attention to other “stakeholders?”
  • What are the social responsibilities of business to:
    • Employees?
    • Communities?
    • Customers?
  • The Issue: What are the “externalities,” and who bears the costs?
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