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Strategic Management/ Business Policy
Power Point Set #2Performance Measurement
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Fundamentals of Competitive Strategy
Superior Long-Run Performance
Attractive Industry Structure
Competitive Advantage
Superior Competitive Position
Operational Effectiveness
Do different things than rivals
Do the same things as rivals but better
The central goal
High returns for the average participant
Outperform the average industry participant
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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 CostsMarket Share is not competitive advantage
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The First Rule of Strategy
A Good Strategy Is “Coherent.”Functional pieces of strategy support the whole
(Michael Porter: HBR, 1996)
Oper.Strategy
Finance
Acctg. H.R.
Mktg.
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Strategic Coherence
The Logic of How The Business Fits Together:
Southwest AirlinesLow PriceShort Routes
No FrillsPoint-to-PointOne Aircraft -- Boeing 737High number of Aircraft per RouteNo MealsFlexible/ Lower Staffing
American AirlinesPremium Price
Short, Long, & Int’l
Variety
Hub & Spoke System
Multiple Aircraft
Low number of Aircraft per Route
Meals & Service
Higher Staffing
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Southwest Airline’s Activity System
Limitedpassengeramenities
Short-haul,point-to-pointroutes betweenmidsize cities
and secondaryairports
Highaircraft
utilization
Frequent,reliable
departures
Lean, highlyproductiveground andgate crews
Very lowticket prices
No meals
No seatassignments
No baggagetransfers
No connectionswith other
airlines
15-minutegate
turnarounds
Limited useof travelagents
Automaticticketingmachines
Standardizedfleet of 737
aircraft
Flexibleunion
contracts
High levelof employee
stockownership
“Southwest,the low-fare
airline”
Highcompensationof employees
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SWOT Analysis
Strengths, Weaknesses, Opportunities, and Threats
Strengths &Weaknesses
Opportunities& Threats
Values OfManagement
Values OfStakeholder
s
StrategyInternalFactors
ExternalFactors
Objectives
Drivers
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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
9Copyright 1998 by Houghton Mifflin Company. All rights reserved.
2-20
Tradeoff Between Profitability Tradeoff Between Profitability and Growth Rate and Growth Rate
G0
P1
P2
PMAX
G1 G2
Growth Rate
Profitability
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Shareholdervalue
creation
Shareholdervalue
creation ROCEROCE
Economic Profit
Economic Profit
MarginMargin
CapitalTurnover
CapitalTurnover
Sales Targets
Sales Targets
cogs/sales
cogs/sales
DevelopmentCost/Sales
DevelopmentCost/Sales
InventoryTurnover
InventoryTurnover
CapacityUtilization
CapacityUtilization
CashTurnover
CashTurnover
Order SizeCustomer MixSales/Account
Customer ChurnRate
Deficit Rates
Cost per DeliveryMaintenance cost
New productdevelopment time
Indirect/DirectLabor
Customer Complaints
Downtime
Accounts PayableTime
Accounts Receivable Time
CEO Corporate/Divisional Functional Departments & Teams
Linking Value Drivers to Performance TargetsLinking Value Drivers to Performance Targets
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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 ProfitsROA, ROE, ROC
Financial Measures of Performance
NPV Methods
Discounting Cash Flows
NPV =CF1
1+r +CF2
(1+r)2 +CF3
+ …CFt
+ +
Horizon Valuet+1
NPV: Net Present Value
CFt: Cash Flow at time t
r: Discount rate
Horizon Value: Value of ongoing enterprise after time t
(1+r)3 (1+r)t (1+r)t+1
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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.
-
+
0
Cash Flow
Time
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Net Cash Flow
EBT - t (EBT) EBT (1-t) = NET INCOMEEBT (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 NPVDCF ApproachMaximize Economic Profits (EVA)Sustainable Competitive Advantage (SCA)
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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.
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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).
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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
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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 = $235 million EVA
Company Valuation ratio
Country Company Valuation ratio
Country
Yahoo! Japan 72.0 Japan Coca-Cola 7.8 US
Colgate-Palmolive 20.8 US Diageo 7.4 UK
Glaxo Smith Kline 13.4 UK 3M 7.3 US
Anheuser-Busch 12.6 US Nokia 6.7 Finland
eBay 11.2 US Sanofi-Aventis 6.3 France
SAP 10.8 Germany AstraZeneca 5.9 UK
Yahoo! 10.7 US Johnson & Johnson 5.7 US
Dell Computer 10.0 US Boeing 5.7 US
Sumitomo Mitsui Financial 8.8 Japan Eli Lily 5.6 US
Procter & Gamble 8.4 US Cisco Systems 5.5 US
Qualcomm 8.3 US Roche Holding 5.5 Switz.
Schlumberger 8.2 US L’Oreal 5.3 France
Unilever 8.1 Neth/UK Altria 5.2 US
PepsiCo 8.0 US Novartis 5.1 Switz.
Firms with the Highest Ratios of Market Value to Book Value (December 2005)Firms with the Highest Ratios of Market Value to Book Value (December 2005)
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Net Inc. ROS ROE EVA Market Return to Value Added Shareholders
($m) (%) (%) ($m) ($m) (%)General Motors 2,956 1.8 19.7 -5,525 -17,943 21.4General Electric 6,573 9.4 22.2 4,370 285,320 45.3Exxon 6,370 6.3 14.6 -2,262 114,774 22.4Philip Morris 5,450 10.3 39.0 5,180 98,657 64.8IBM 6,328 7.7 32.6 2,541 -5,878 77.5Coca-Cola 3,533 18.8 42.0 2,194 157,356 1.3Wal-Mart 4,430 3.2 21.0 1,159 159,444 107.7 Procter & Gamble 3,780 10.2 12.2 61,661 102,379 15.9Microsoft 4,490 31.0 27.0 3,776 328,257 37.5Hewlett-Packard 2,945 6.3 17.4 -593 45,464 10.7
How U.S. Companies Perform Under Different Profitability Measures, 1998
How U.S. Companies Perform Under Different Profitability Measures, 1998
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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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The Four Perspectives of the Balanced ScorecardThe Four Perspectives of the Balanced Scorecard
© The McGraw-Hill Companies, Inc., 1998Irwin/McGraw-Hill
Slide 4-5Exh. 4.8
Financial
Customer
Operations
Organizational
EVAProfitabilityGrowth
DifferentiationCostQuick Response
Product DevelopmentDemand ManagementOrder Fulfillment
LeadershipOrganizational LearningAbility to Change
Perspective Assessed through analysis of:
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Putting Performance in PerspectiveNarrow
Stakeholder Perspective
Past Future
Stakeholders View
Balanced Scorecard
Accounting Profit
Economic Profit DCFSurvival
Share Price
BroadStakeholder Perspective