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Competitive Advantage and Firm Performance

Q: Profitability Ratios: ROR

ROR indicates how much of the firm's sales is converted into profits. (ROR = first component of ROIC)

Q: ROR can be split up into 3 Financial ratio's

1) COGS/ Revenue 2) R&D expense / Revenue 3) SG&A / Revenue

Q: Financial Ratios (ROR): 1) COGS/Revenue

Indicates how efficiently a company can produce a good.

Q: Financial Ratios (ROR): 3) SG&A/Revenue

Indicates how much of each dollar that the firm earns in sales is invested in SG&A expenses.

37 important questions on Competitive Advantage and Firm Performance

What are the 3 Traditional Frameworks to Measure and Assess Firm Performance?

- Accounting Profitability
- Shareholder Value Creation
- Economic Value Creation

What are the 2 integrative frameworks which combine qualitative data with qualitative assessments?

- The Balanced Scorecard
- The Triple Bottom Line

What are some Profitability Ratios used in Strategic Management?

ROIC - Return On Invested Capital
ROE - Return On Equity
ROA - Return On Assets
ROR - Return On Revenue

Profitability Ratios: What is ROIC?

A popular metric because it is a good proxy for firm profitability.

What are the Two Components of which Total Invested Capital consists?

1) Shareholders' Equity
2) Interest-Bearing Debt

Profitability Ratios: ROIC - Rule of thumb

if a firm's ROIC > Cost of capital, it generates value
if a firm's ROIC < Cost of capital, it destroys value

Profitability Ratios: ROR

ROR indicates how much of the firm's sales is converted into profits.

(ROR = first component of ROIC)

ROR can be split up into 3 Financial ratio's

1) COGS/ Revenue
2) R&D expense / Revenue
3) SG&A / Revenue

Financial Ratios (ROR): 1) COGS/Revenue

Indicates how efficiently a company can produce a good.

Financial Ratios (ROR): 3) SG&A/Revenue

Indicates how much of each dollar that the firm earns in sales is invested in SG&A expenses.

What is Working Capital Turnover?

A measure of how effectively capital is being used to generate revenue.

(ROR = second component of ROIC)

Working Capital Turnover can be split into 4 other Ratios:

1. Fixed asset Turnover
2. Inventory Turnover
3. Receivables Turnover
4. Payables Turnover

What is Fixed asset Turnover? + Formula

Measures how well a company leverages its fixed assets. (particularly PPE)

Revenue/Fixed Assets

What are Higher Ratios of Receivables Turnover? + Formula

Implying more efficient management in collecting accounts receivable and shorter durations of interest-free loans to customers.

Revenue/Accounts Receivable

What are Payables Turnover? + Formula

It indicates how fast the firm is paying its creditors and how much it benefits from interest-free loans extended by its suppliers.

Revenue/Acc Payable

--> A low ratio indicates more efficient management in paying creditors and generating interest-free loans from suppliers.

What are limitations of Accounting Data?

Accounting data are...
-Historical & backward-looking
- Do not consider off-balance sheet items
- Focus mainly on tangible assets (no longer most important)

What is Risk Capital?

The money shareholders provide in return for an equity share. It is money that they cannot recover if the firm goes bankrupt.

What is Total Return To Shareholders?

The return on risk capital (incl. stock price appreciation + dividends received over a specific period)

It indicates how the stock market views all availablr public information about a firm's past, current state and (mostly) expected future performance.

What is The Efficient-Market Hypothesis?

The idea that all available info about a firm's past, current state and expected future performance is embedded in the market price of the firm's stock.

What is Market Capitalisation? + Formula

A firm performance metric that captures the total dollar market value of a company's total outstanding shares at any given point in time.

Nr of outstanding shares x Share price

What are limitations of shareholder value creation?

1) Stock prices can be highly volatile, making it difficult to assess firm performance (particularly in the short term)

2) Overall macroeconomic factors have a direct influence on stock prices

3) Stock prices frequently reflect the psychological mood of investors which can be irrational

What is Economic Value Created?

The difference between a buyer's willingness to pay for a product/service and the firms total cost to produce it. (V-C)

What is the 'Reservation Price'?

The maximum price a consumer is willing to pay for a product/service based on the total perceived consumer benefits.

Which 3 Components are needed in calculating competitive advantages?

1) Value (V)
2) Price (P)
3) Cost (C)

Calculation Competitive Advantages: Value

The amount a consumer attaches to a good/service.
A consumers WTP(reservation value)

Calculation Competitive Advantages: Cost

The cost to produce the good/service matters little to the consumer but is a great deal to the producer since it has a direct influence on the profit margin.

What is Consumer Surplus?

The difference between the value a consumer attaches to a good/service and what he/she paid for it.

(V minus P)

According to the Economic Value Creation Framework, Strategy s about...

1) Creating economic value
2) Capturing as much economic value as possible

What are the two possible pricing options due to the large difference between Value and Cost?

1) Charge higher prices to reflect the higher value (and increase profitability)
2) Charge the same price as competitors (and gain market share)

What are the Two Types of Opportunity Costs? (Example Entrepreneur)

1) Forgone Wages (if working elsewhere)
2) The Cost of Capital (invested in business)

What are the Limitations of Economic Value Creation?

1) It's hard to determine the value of a good in the eyes of the consumer
2) The value of a good in the eyes of a consumer changes based on income, preferences, time, etc.
3) To measure firm-level competitive advantage, we must estimate the economic value created for all products/services offered by the firm

What is 'The Balanced Scorecard?

A framework to help managers achieve their strategic objectives more effectively.

What are the 4 Key Questions of the Balanced Scorecard?

1) How do customers view us?
2) How do we create value?
3) What core competencies do we need?
4) How do shareholders view us?

What are advantages of the Balanced scorecard?

- Communicate & Link strategic vision to responsible parties (@organisation)
- Translate vision into measurable operational goals
- Design and Plan business processes
- Implement feedback and Organisational Learning (to modify and adapt strategic goals)

What are Disadvantages of the Balanced Scorecard?

- Tool for strategy implementation not formulation
- Up to the firm's manager to formulate a strategy
- The framework is only as good as the skills of the managers using it

TRIPLE BOTTOM LINE: What are the 3 P's?

Profits - Economic dimension - Businesses must be profitable to survive

People - Social Dimension - ??
Planet - Ecological Dimension - Relationship between businesses and the natural environment

What is a Sustainable Strategy?

A strategy along the economic, social and ecological dimensions that can be pursued over time without detrimental effects on people or the planet.

The question on the page originate from the summary of the following study material:

Strategic Management | 1259913747 | Frank T Rothaermel

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