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Accounting & Financial Management
AFM 241
Theophanis Stratopoulos

Chapter 2: Business Strategy 1 Temporary vs. Sustainable Competitive Advantage a Firms ability to resist competitor’s attempt to imitate/improve on source of its competitive advantage 2 Relative Performance a Competitive Advantage i Able to perform value activities at lower cost or perform them in a way that lead to differentiation and premium price (more value) ii Possess resources and capabilities, which are valuable, rare and costly to imitate, and they are able to exploit these resources and capabilities in order to develop and implement sustainable competitive advantage and positive economic profit a If rare and valuable, but easy to imitate, then temporary competitive advantage b Competitive Parity i Valuable, but not rare c Competitive Disadvantage i No firm will want to invest in resources and capabilities that are not valuable → increase cost and not revenue 3 Business vs. Corporate Strategy a Neutralize (cope best with its industry) and/or exploit opportunities (influence environment in company's favour) by leveraging resources and capabilities in order to gain competitive advantage within PARTICULAR (business) or ACROSS SEVERAL (corporate) markets/industries 4 Firm Performance Measures a Normal vs. Economic Profit i Minimum level of profit owner would consider necessary in order to make it worthwhile to run business (covers cost of inputs and opportunity cost → competitive parity) ii Generates revenue above opportunity cost and cost of inputs (competitive advantage) → In a perfectly competitive market, economic profit is zero! b Measure of Efficiency (Ability To Leverage Assets) i Operating Income to Asset/Sales/Employee (profit generated per dollar or … or per employee) ii Fixed Asset/Total Asset Turnover (Sales/FA or TA - sales generated per dollar of …) iii Inventory Turnover (COGS/Average Inventory) c Measure of Cost (Management) i COGS to Sales (widen its gross margin?) ii SGA to Sales (control expenses?) iii Operating Expense to Sales (efficiency of cost structure - measures total overhead employed per dollar of revenue) d Measure of Profitability i ROA = NI/TA (net profit generated per dollar of TA) ii ROE = NI/Equity (net profit generated for every unit of SHQ) iii ROI = (gains-investments)/investments (profitability of investment for every dollar invested) iv ROS or Operating Profit Margin = OI/Sales (profit generated per dollar of sales) v Growth in Net Sales = [sales (t=0) - sales (t=1)]/sales (t=0) (year to year basis) 1 vi Gross Profit Margin = (Sales - COGS)/COGS (proportion of money in excess of revenues after accounting for COGS) vii Net Profit Margin = NI/Sales (amount of profit generated for each dollar of sales, after accounting for other expenses) e Alternative: Economic Profit Per $ of Capital Employed (EP) i EP/CE = (NOPAT/CE) - WACC ROIC NOPAT = Net Operating Profit After Tax WACC = Weighted Average Cost of Capital) CE (Capital Employed) = Sum of Equity and Debt Capital ii If ROIC is greater than WACC, then EP/CE is positive and firm creates value → Therefore, ability to add, regardless of size, depends on its ability to earn positive return spread iii Used to examine if strategies create value for SH iv Reflects concept of residual income and economic performance v Not bound by accounting conventions 5 Business Model a Defines how firm delivers value to its customers, entices customers to pay for value and convert these payments into profits b Defines how an enterprise interacts with its environment to define an unique strategy, attract resources and build capabilities to execute it and in the process, create value for all SH c Successful business models aligns organization with its environment d Function: i Articulate value proposition ii Select appropriate tech. and features iii Identify target market segments iv Define structure of value chain v Estimate cost structures and profit potential e Walmart’s Business Model i Locate in small/relatively isolated towns (can match or beat prices that is offered in metropolitan areas → shop locally, too small to support more than 1 large retailer, superstore logic to sales of general merchandise → willing to give up service for lower price) ii “Everyday Low Prices” (made efficiency and cost reduction through innovation in purchasing, logistics and information management) iii Business Model = Discount Retailing (offer branded goods for less to carefully targeted customer base) f Increase Change of Designing Successful Business Model i Analyze multiple alternatives ii Deep understanding of user needs iii Analyze value chain - deliver “wants” in cost effective and timely fashion iv Adopt neutrality or relative efficiency perspective to outsourcing desicisons v Development of business model requires an exercise in due diligence (resources/capabilities/knowledge + understanding of industry and position in market) 6 Porter’s Five Forces/Industry Structure a Determine competitive intensity and attractiveness of market (overall, profitability) b Threat of New Entry (Increase Threat/Barrier = Decrease Attractiveness) 2 i Economies of Scale ii Demand Side Benefits of Scale (Networking Effect) iii Customer Switching Cost iv Capital Requirement v Incumbent Advantage Independent of Size vi Access to Distribution Channel vii Government Policy viii Implicit Barrier: entry to past reaction of incumbents to new entrants or expected reaction of incumbent to new entrants → the more aggressive the retaliation = higher the barrier to entry, reaction depends on market growth and capital structure ix Proxies For Competition From Potential Entrants: IND-PPE, IND-R&D, IND-CPX (Capital Expenditure) → necessary investments that must be made by new entrant to compete against average existing firm in the industry (IND is Calculated by taking weighted average of … of all firms in the industry) c Power of Suppliers (Decrease Profit = Increase Price or Decrease Quality) i Suppliers are an oligopoly ii Their products are unique or differentiated and/or there is no substitute for the product they offer iii Can credibly threaten to integrate forward iv Industry is not an important customer in terms of revenue generated for suppliers v Industry participants face substantial switching costs d Power of Buyers (Able to negotiate price/quality that they buy from industry - Higher Power = Stronger Downward Pressure On Level Of Profits) i Small number of buyers (oligopsony) which buy in large volumes ii Products that industry produces (what customers buy) is not differentiated iii Buyers face no switching costs iv Buyers can credibly threaten to integrate backward v Industry product is not significant to quality of buyer’s product/service e Threat of Substitutes (product/service that performs the same or similar function as industry’s product/service but through different means) i Price to performance trade off that the substitute offers relative to product of industry ii Buyer’s cost of switching to a substitute product/service f Rivalry Among Existing Competitors (Competitive Actions: Advertising, Price Discounts, New Products, New Features on Existing Products/Service → Higher Rivalry Intensity = Lower Overall Profitability) i Number of existing competitors ii Industry growth iii Exit barriers iv Rivals commitment to the business v Competitive Reaction: price competition is the most destructive to industry profit (likely to engage in price based competition if the product are commodity-like, firm have high fixed costs and products are perishable) vi Proxies For Competition Among Existing Rivals: a Herfindahl-Hirschman Index (IND-HHI) - sum of squared market shares of all firms in an industry b Four Firm Concentration Ratio (IND-CON4) - sum of market shares of four largest firms in the industry 3 c IND-NUM (total number of firms in industry) d IND-MKTS (product market size, measured as natural log of industry aggregate sales)
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