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Chapter 5
Competitive Advantage,
Firm Performance, and
Business Models

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 Learning Objectives
1. Conduct a firm profitability analysis using accounting data
to assess and evaluate competitive advantage.
2. Apply shareholder value creation to assess and evaluate
competitive advantage.
3. Explain economic value creation and different sources of
competitive advantage.
4. Apply a balanced scorecard to assess and evaluate
competitive advantage.
5. Apply a triple bottom line to assess and evaluate
competitive advantage.
6. Use the why, what, who, and how of business models
framework to put strategy into action.
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 An Overview of Frameworks Discussed
Three traditional
frameworks to measure
and assess firm
performance:
• Accounting profitability.
• Shareholder value
creation.
• Economic value creation.
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Two integrative
frameworks, combining
quantitative data with
qualitative assessments:
• Balanced scorecard.
• Triple bottom line.
 Three Standard Performance Dimensions

What is the firm’s accounting profitability?

How much shareholder value does the firm create?
How much economic value does the firm generate?

These performance dimensions generally

correlate over time:
• Accounting profitability and economic value creation
tend to be reflected in the firm’s stock price.
• Determines the stock’s market valuation.

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 Accounting Profitability

Accurately assesses Available through:

firm performance. • Standardized accounting
Compares firm metrics (GAAP, FASB).
performance to • Form 10-K statements.
competitors / industry • Profitability ratios.
average. • Return on invested capital
(ROIC), return on equity
(ROE), return on assets
(ROA), and return on
revenue (ROR).

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 Drivers of Firm Performance

Exhibit 5.1
Source: Analysis of publicly available data.

Access the text alternative for slide image.

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 Elements of ROIC Explained

Return on revenue:
• How much of the firm’s sales is converted into profits.

Working capital turnover:

• How effectively capital is being used to generate revenue.

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 Return on Revenue Elements

Cost of goods sold (COGS) / Revenue:

• How efficiently a company can produce a good.

Research and development expense / Revenue:

• How much of each dollar earned is invested in R&D.

Selling, general, and administrative expense /

Revenue:
• How much of each dollar earned is invested in SG&A.

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 Working Capital Turnover Elements

Working capital / Revenue:

• How much working capital the firm has tied up in its
operations.
PPE / Revenue:
• How much of a firm’s revenues are dedicated to cover
plant, property, and equipment.
• Critical assets and difficult to get rid of.
Intangibles / Revenue:
• Intangibles include patents, copyrights, and trademarks,
goodwill, and brand value.

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 Limitations of Accounting Data

Historical and backward-looking.

Does not consider off–balance sheet items:

• For example: pension obligations, operating
leases.

Focuses mainly on tangible assets:

• May not be the most important.
• Consider: innovation, quality, customer
experience.

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 The Declining Importance of Book Value in a Firm’s Stock
Market Valuation, 1980–2015

Exhibit 5.2
Source: Analysis and
depiction of data from
Compustat, 1980–2015

Access the text alternative for slide image.

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 Shareholder Value Creation: Definitions

Shareholders
• Own shares of stock, are legal owners of public
companies.
Risk Capital:
• Money provided for an equity share.
• Cannot be recovered if a firm goes bankrupt.
Total Return to Shareholders:
• Stock price appreciation + dividends.
Market Capitalization:
• Dollar value of total shares outstanding.
• Number of outstanding shares x share price.
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 Stock Market Valuations of Apple and Microsoft (in $ billion),
1990–2019

Exhibit 5.3
Source: Depiction of publicly available data Access the text alternate for slide image.

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 Limitations of Shareholder Value Creation

Stock prices can be volatile.

• Difficult to assess short-term firm performance.
• This is due to market volatility, external factors and investor
sentiment.
Macroeconomic factors affect stock prices.
• Economic growth or contraction.
• Unemployment, interest and exchange rates.
Stock prices can reflect the mood of investors.
• Investors can be irrational.

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 Economic Value Creation

The difference between:

• A buyer’s willingness to pay for a product / service and the
firm’s total cost to produce it.
• The difference between value (V) and cost (C).

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 Firm B’s Competitive Advantage: Same Cost as Firm A but Firm
B Creates More Economic Value

Exhibit 5.4

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 Firm C’s Competitive Advantage: Same Total Perceived Consumer
Benefits as Firm D but Firm C Creates More Economic Value

Exhibit 5.5

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 The Role of Consumer Surplus and Producer Surplus (Profit)

Exhibit 5.6

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 Competitive Advantage and Economic Value Created: The Role
of Value, Cost, and Price

Exhibit 5.7
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 Opportunity Costs and Limitations of Economic Value
Creation

Opportunity costs:
• The value of the best forgone alternative.
Limitations of Economic Value Creation:
• Valuing a consumer good isn’t easy.
• The value of a good changes in the eyes of consumer’s
income, preferences, time, etc.
• To measure firm-level competitive advantage, we must
estimate economic value created for all products and
services offered by the firm.

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 The Balanced Scorecard

Helps managers achieve their strategic objectives.

Uses internal and external performance metrics.

Balances both financial and strategic goals.

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 Balanced-Scorecard Approach to Creating and Sustaining
Competitive Advantage

Exhibit 5.8
Access the text alternate for slide image.

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 Examples of Metrics for the Balanced
Scorecard
Customers:
• Revenue, profit, customer satisfaction.
Value Creation:
• Competitiveness, innovation, organizational learning.
Core Competencies:
• Key business processes.
Shareholders:
• Cash flow, operating income, ROIC, ROE, total returns to
shareholders.

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 Advantages of the Balanced Scorecard

Links strategic vision to responsible parties.

Translates vision into measurable goals.

Designs and plans business processes.

Implements feedback and organizational learning.

Alerts to needed strategic goal adaptation.

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 Disadvantages of the Balanced Scorecard

Focused on implementation,
• Not formulation
How to get back on track if deviations occur.
Lacks guidance:
• Which metrics to use?
• How to address setbacks?

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 The Triple Bottom Line

Focus: economic, social and ecological

performance.

Three dimensions:
• Profits: Economic Dimension.
• People: Social Dimension.
• Planet: Ecological Dimension.

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 Sustainable Strategy: A Focus on the
Triple Bottom Line
Exhibit 5.9
The simultaneous pursuit
of performance along
social, economic, and
ecological dimensions
provides a basis for a
triple-bottom-line
strategy.

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 What Is a Business Model?

Details a firm’s competitive tactics and initiatives.

Explains how the firm:

• Intends to make money.
• Conducts its business with buyers, suppliers, and partners.

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 The Why, What, Who, and How of Business Models
Framework

Exhibit
5.10
Source: Adapted from
R. Amit and C. Zott
(2012, Spring),
“Creating value
through business
model innovation,”
MIT Sloan
Management Review:
41–49.

Acess the text alternate for slide image.

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 Popular Business Models

Razor-razorblades: pay for replacements.

Subscription: pay for access.
Pay as you go: pay for what you consume.
Freemium: pay for extra features / add-ons.
Wholesale: products sold at a discount.
Agency: products sold on commission.
Bundling: more than one product sold at a discount.

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 Dynamic Nature of Business Models

Business Models:
• Can be combined.
• Can evolve.
• Can be disrupted.

Businesses must respond to disruption and adapt.

Legal conflicts can arise.

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© 2019 McGraw Hill. All rights reserved. Authorized only for instructor use in the classroom.
No reproduction or further distribution permitted without the prior written consent of McGraw Hill.