CHAPTER

Competitive
Advantage and
Firm Performance

McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
 Fundamentals of Competitive Strategy

Superior Long-Run
Performance The central goal

Attractive Industry Competitive

Structure Advantage
High returns for the average Outperform the average
participant industry participant

Superior Competitive Operational

Position Effectiveness
Do different things than Do the same things as
rivals rivals but better
Part 1 Strategy Analysis
LO 5-1 Describe and evaluate economic value creation when
measuring competitive advantage.
LO 5-2 Describe and evaluate accounting profitability when
measuring competitive advantage.
LO 5-3 Describe and evaluate shareholder value creation when
measuring competitive advantage.
LO 5-4 Describe and evaluate the balanced-scorecard approach
for assessing competitive advantage.
LO 5-5 Describe and evaluate the triple-bottom-line approach
when assessing competitive advantage.
LO 5-6 Compare and contrast different approaches to measuring
competitive advantage, and derive managerial implications.
 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
Chapter Case 5 Google vs. Microsoft

• Google and Microsoft in multipoint competition

 How to measure success of this competition?

 Revenues and net income?

 Performance per employee?

• There are several ways to measure firm performance.

• The key idea is to “triangulate” (i.e., to use multiple
measures of performance to evaluate the health of
the organization).
EXHIBIT 5.1 Comparing Google & Microsoft on Different Dimensions

Performance viewpoint changes significantly when the

measurement changes from absolute to per-employee
figures (on the bottom)
 Measuring Competitive Advantage

• Always measured relative to other firms

• Three standards are typical by asking:

 1. How much economic value does the firm

generate?

 2. What is the firm’s accounting profitability?

 3. How much shareholder value does the firm create?

 Economic Value Creation

• Pizza!
• Value: A dollar amount a
consumer is willing to pay • Value = $12
for a good or service • Price = $10
• Cost = $7 SOLD!
• Price: The dollar amount a
good or service is offered
for sale • Consumer Surplus
 $12 - $10 = $2
• Cost: The dollar amount to • Producer Surplus
make the good or service  $10 - $7 = $3
• Economic Value
 $12 - $7 = $5
EXHIBIT 5.2 Competitive Advantage & Economic Value

COMPETITIVE
HIGHEST
HIGHEST
ADVANTAGE =
VALUE
VALUE
––
COST
COST
 Economic Value Creation

• Opportunity Costs

 The next best alternative use for resources

 Pizza entrepreneur
 Wages $40,000 employment salary
 Capital invested $25,000 interest on capital

 If the restaurant made $60,000 in (accounting) profits…

 The owner actually had an economic LOSS of $5,000
 Economic Value as Competitive Advantage

• If the economic value created is

 greater than its rivals  competitive advantage

 equal to its rivals  competitive parity

 lower than its rivals competitive disadvantage

LO 5-1 Describe and evaluate economic value creation when measuring
competitive advantage.
LO 5-2 Describe and evaluate accounting profitability when
measuring competitive advantage.
LO 5-3 Describe and evaluate shareholder value creation when measuring
competitive advantage.
LO 5-4 Describe and evaluate the balanced-scorecard approach for
assessing competitive advantage.
LO 5-5 Describe and evaluate the triple-bottom-line approach when
assessing competitive advantage.
LO 5-6 Compare and contrast different approaches to measuring
competitive advantage, and derive managerial implications.
 Accounting Profitability
• Uses standard, publicly available metrics

• Permits direct firm performance comparisons

Using standard ratios

• Regulated by:
Accounting principles (GAAP)
U.S. Securities & Exchange Commission (SEC)
Sarbanes-Oxley Act (2002)
EXHIBIT 5.3 Top 10 Fortune 500 Companies by Profits ($M)
EXHIBIT 5.4 Top 10 Fortune 500 Companies by Return on Revenue

ROR measures the profit earned per dollar of revenue as a percentage.

A size-adjusted measure of profits.
Profits vs. Return on Revenue (ROR)

Ranking changes markedly with

the use of different metrics

2010 Profits in $M

2010 ROR %
 Accounting Profitability

• Need to move beyond a “snapshot” metric

 Look at more than one year of data

• Permits direct firm performance comparisons

 Using standard ratios

• Competitive advantage is relative to competitors

 Study firms in the same industry
 “Apples to apples” comparisons
EXHIBIT 5.5 Firm Performance - Pharmaceutical Industry by ROR

Pfizer performance declines as Merck improves and

takes the competitive advantage over this period
 Drawbacks for Accounting Measures
• Does not consider “off balance sheet” items
 Health care, pension obligations

• Focuses on tangible assets, which may no longer

be strategically relevant
 Key is intangible assets
 “Knowledge-based economy”
 Manufacturing vs. Services

• Historical data
 Backward-looking
 “Driving a car by looking in the review mirror”
EXHIBIT 5.6 Declining Importance of Book Value in Stock Valuation
LO 5-1 Describe and evaluate economic value creation when measuring
competitive advantage.
LO 5-2 Describe and evaluate accounting profitability when measuring
competitive advantage.
LO 5-3 Describe and evaluate shareholder value creation when
measuring competitive advantage.
LO 5-4 Describe and evaluate the balanced-scorecard approach for
assessing competitive advantage.
LO 5-5 Describe and evaluate the triple-bottom-line approach when
assessing competitive advantage.
LO 5-6 Compare and contrast different approaches to measuring
competitive advantage, and derive managerial implications.
 Shareholder Value Creation
• Shareholders – legal owners of public firms
 Total return to shareholders
 Return on risk capital + dividends
 External performance metric
 Efficient-market hypothesis
 All available information is embedded in the stock price

• SEC requires all public firms to submit

shareholder returns

• Stock price based on expectations of performance

EXHIBIT 5.7 Normalized Stock Returns 2005–2010
Drawbacks to Shareholder Value as Competitive Advantage

• Stock prices can be highly volatile, which makes it

difficult to assess firm performance (at least in the
short term)

• Macro economic factors (e.g., unemployment rate,

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

• Stock prices frequently reflect the psychological mood

of the investors, which can be at times irrational
 “Irrational exuberance” Alan Greenspan, former Federal Reserve Chair

Dan Ariely Video

 Google vs. Microsoft, Continued

• Accounting perspective shows Microsoft with an

advantage over Google.
 But both firms have large intangible assets.

• BUT shareholder value favors Google over

Microsoft!
 Microsoft stock is flat while Google is up 200%.
EXHIBIT 5.8 Comparing Google and Microsoft Using ROE and ROA

Microsoft outperforms Google in 2010 based on this accounting data

EXHIBIT 5.9 Normalized Stock Returns 2005–2010

Google is enjoying a
sustained
competitive
advantage over
Microsoft based on
shareholder value.
Thank you .

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