For this discussion, you will explore the relationship between financial analysis and strategic analysis in a review of the case study Case 9: Starbucks Corporation, p.462 (from your textbook)A case study is a puzzle to be solved, so before reading and answering the specific questions, develop your proposed solution by following these five steps:
In an original post, present a well-written answer and diagnosis for the following case study questions:
Embed course material concepts, principles, and theories (which require supporting citations) in your initial response along with at least one scholarly, peer-reviewed journal article. Keep in mind that these scholarly references can be found in the Saudi Digital Library by conducting an advanced search specific to scholarly references. Use Saudi Electronic University academic writing standards and APA style guidelines.You are required to reply to at least two peer discussion question post answers to this weekly discussion question and/or your instructor’s response to your posting. These post replies need to be substantial and constructive in nature. They should add to the content of the post and evaluate/analyze that post’s answer. Normal course dialogue doesn’t fulfill these two peer replies but is expected throughout the course. Answering all course questions is also required.
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CONTEMPORARY STRATEGY ANALYSIS
tenth edition
Robert M. Grant
John Wiley & Sons Ltd., 2019
Chapter 2
Goals, Values, and Performance
Strategy as a quest for value
Putting performance analysis into practice
Beyond profit: values and corporate social responsibility
Beyond profit: strategy and real options
OUTLINE
Goals, Values, and Performance
Copyright © 2019 John Wiley & Sons, Inc.
Every business has a unique purpose—typically this reflects the motives of the entrepreneurs who created these businesses
E.g. Henry Ford (Ford Motor Company), Steve Jobs (Apple), Jack Ma (Alibaba) were each motivated by a distinct vision.
Common to every business enterprise: the desire/need to create value
Value is the monetary worth of a product. Hence, the purpose of business is
to create value for customers
to appropriate some of that value in the form of profit—in order to ensure the survival of the firm
Copyright © 2019 John Wiley & Sons, Inc.
What is Business For?
STRATEGY AS A QUEST FOR VALUE
The stakeholder approach
The firm is a coalition of interest groups —it must create value for them all
The shareholder approach
The firm exists to maximize the wealth of its owners
For the purposes of strategy analysis we assume that the
primary goal of the firm is maximizing profit over its lifetime
Rationale:
Competition: To survive a firm must earn return on capital > cost of capital. This is difficult when competition is strong.
Acquisition: Firms that do not maximize profits are vulnerable to acquisition.
Convergence of interests: long run profitability requires satisfied customers, motivated employees, and good relations with governments and communities.
Hence: Strategy analysis is concerned with identifying and accessing the sources of profit available to the firm
STRATEGY AS A QUEST FOR VALUE
Copyright © 2019 John Wiley & Sons, Inc.
Value for Whom? Shareholders vs Stakeholders
13
Value Creation
Value created: total customer value less real cost of production
Value created: consumer surplus plus producer surplus
STRATEGY AS A QUEST FOR VALUE
What is Profit? Different Measures Give Different Rankings (data for 2017)
Copyright © 2019 John Wiley & Sons, Inc.
PROFIT, CASH FLOW, AND ENTERPRISE VALUE
Company Market capitalization
($ billion) Net income
($ billion) ROS
(%) ROE
(%) ROA
(%) Return to shareholders (%)
Apple 824 48.4 26.9 39.0 16.3 +46.8
Amazon 689 3.0 2.3 9.6 3.1 +27.4
Alibaba 480 6.2 29.8 21.9 9.1 +94.1
JPMorgan Chase 397 24.4 50.2 9.5 1.4 +24.6
ExxonMobil 358 19.7 5.2 11.8 5.7 –5.8
Wal-Mart Stores, Inc. 310 13.6 4.1 14.9 11.9 +45.2
Toyota 204 15.8 7.6 13.2 4.1 +5.8
Profit maximization an ambiguous goal:
Total profit vs. Rate of profit
Over what time period?
What measure of profit?
Accounting profit versus economic profit
Estimating the value of the enterprise:
Net present value of free cash flows: V = Σt Ct
(1 + WACC)t
Where: V market value of the firm.
Ct free cash flow in time t
WACC weighted average cost of capital
Copyright © 2019 John Wiley & Sons, Inc.
Linking Profit to Enterprise Value
PROFIT, CASH FLOW, AND ENTERPRISE VALUE
In principle, DCF approach to enterprise value maximization is the correct approach to choosing a strategy:
Identify strategy alternatives
Estimate cash flows and cost of capital for each strategy
Select the strategy which generates the highest NPV.
But in practice:
Difficult to estimate cash flows more than 2 or 3 years ahead
Hence, value maximization may encourage short-termism.
Implications for strategy analysis:
Simple guidelines can approximate value maximization, e.g.
On existing assets—seek to maximize rate of return
On new investment—seek rate of return > cost of capital
Use qualitative strategy analysis to evaluate future profit potential.
Copyright © 2019 John Wiley & Sons, Inc.
Value Maximization and Strategy Choice
PROFIT, CASH FLOW, AND ENTERPRISE VALUE
Profitability Ratios
Ratio Formula Notes
Return on Capital Employed (ROCE) Operating profit, before interest, after tax,
Equity + Debt The return on the capital invested in a business. ROCE is also known as return on invested capital. The numerator can be is operating profit or earnings (EBIT).
Return on Equity (ROE) Net income
Shareholders’ equity Measures the firm’s success in using shareholders’ capital to generate profits that are available to remunerate investors.
Return on Assets (ROA) Operating profit
Total assets The numerator should be the return on all the company’s assets—e.g. operating profit, EBITDA (earnings before interest, tax, depreciation, and amortization), or EBIT (earnings before interest and tax).
Gross margin Sales – cost of material inputs
Sales Gross margin measures how much value a firm adds value to the goods and services it buys in.
Operating margin Operating profit / Sales Operating margin and net margin measure a firm’s ability to extract profit from its sales, but influenced by differences in capital intensity between different types of business.
Net margin Net income / Sales
Copyright © 2019 John Wiley & Sons, Inc.
PROFIT, CASH FLOW, AND ENTERPRISE VALUE
Enterprise Value and Shareholder Value
Copyright © 2019 John Wiley & Sons, Inc.
Enterprise value =
Market capitalization of equity
+ Market value of debt
Reasons for preferring maximization of enterprise value over maximization of shareholder value:
Not always easy to distinguish debt from equity
Shareholder value maximization has become discredited by its misapplication by managers (e.g. in emphasizing short-term profits and in seeking to manipulate reported earnings).
PROFIT, CASH FLOW, AND ENTERPRISE VALUE
Profitability Ratios
Ratio Formula Notes
Return on Capital Employed (ROCE) Operating profit, before interest, after tax,
Equity + Debt The return on the capital invested in a business. ROCE is also known as return on invested capital. The numerator can be is operating profit or earnings (EBIT).
Return on Equity (ROE) Net income
Shareholders’ equity Measures the firm’s success in using shareholders’ capital to generate profits that are available to remunerate investors.
Return on Assets (ROA) Operating profit
Total assets The numerator should be the return on all the company’s assets—e.g. operating profit, EBITDA (earnings before interest, tax, depreciation, and amortization), or EBIT (earnings before interest and tax).
Gross margin Sales – cost of material inputs
Sales Gross margin measures how much value a firm adds value to the goods and services it buys in.
Operating margin Operating profit / Sales Operating margin and net margin measure a firm’s ability to extract profit from its sales, but influenced by differences in capital intensity between different types of business.
Net margin Net income / Sales
Copyright © 2019 John Wiley & Sons, Inc.
PUTTING PERFORMANCE ANALYSIS INTO PRACTICE
ROA
Sales
Margin
Sales/Assets
Inventory Turnover
(Sales/Inventories)
Creditor Turnover
(Sales/Receivables)
Turnover of other items
of working capital
Copyright © 2019 John Wiley & Sons, Inc.
Performance Diagnosis: Disaggregating ROA
PUTTING PERFORMANCE ANALYSIS INTO PRACTICE
COGS/Sales
Depreciation/Sales
SGA expense/Sales
Fixed asset turnover
(Sales/PPE)
ROA
U: 16.7%
F: 7.6%
Operating
Margin
U: 11.2%
F: 6.3%
Sales/Assets
U: 1.49
F: 1.21
Labor costs/Sales
U: 54.8% F: 36.3%
Depreciation/Sales
U: 3.4% F: 5.2%
Maintenance/Sales
U: 2.3% F: 4.2%
PPE turnover
U: 3.02 F: 2.03
Receivables turnover
U: 10.23 F: 6.80
Cash turnover
U: 9.51 F: 15.50
Fuel costs/Sales
U: 7.5% F: 5.8%
Other costs/Sales
U: 21.4% F: 42.5%
Disaggregating
ROA for UPS (U)
and Fedex (F)
PUTTING PERFORMANCE ANALYSIS INTO PRACTICE
Copyright © 2019 John Wiley & Sons, Inc.
13
Economic
Profit
Capital
Turnover
Inventory
Turnover
Capacity
Utilization
Cash
Turnover
Order Size
Customer Mix
Sales/Account
Customer Churn
Rate
Deficit Rates
Cost per Delivery
Maintenance cost
New product
development time
Indirect/Direct
Labor
Customer
Complaints
Downtime
Accounts Payable
Time
Accounts
Receivable Time
CEO
Corporate/Divisions
Functions
Depts. & Teams
Linking Value Drivers to
Performance Targets
Shareholder
value
creation
ROCE
Margin
Development
Cost/Sales
Sales
Targets
cogs/
sales
PUTTING PERFORMANCE ANALYSIS INTO PRACTICE
Simplified Strategy Map Performance
Measures Targets Initiatives
Financial • Market Value
• Seat Revenue
• Plane Lease Cost
25% per year
20% per year
5% per year
• Optimize routes
• Standardize planes
Customer
• FAA on-time
arrival rating
• Customer ranking
• No. customers
• First in industry
• 98% satisfaction
• % change
• Quality management
• Customer loyalty program
Internal • On Ground Time
• On-Time Departure
• <25 Minutes
• 93%
• Cycle time
optimization program
Learning
• % Ground crew
stockholders
• % Ground crew trained • Year 1, 70%
• Year 4, 90%
• Year 6, 100%
• Stock
ownership plan
• Ground crew training
Increase
Profitability
Lower
Cost
Increase
Revenue
On-time
Flights
More Cust-omers
Low
Prices
Improve turnaround
time
Align
Ground
Crews
Balanced Scorecard for a Regional Airline
PUTTING PERFORMANCE ANALYSIS INTO PRACTICE
Copyright © 2019 John Wiley & Sons, Inc.
1970-1995. Boeing’s strategy based upon “building great planes”
—despite little emphasis on financial management, its financial
performance was strong as a result of huge investments in a series
Of highly successful planes: 707, 737, 747, 777
1996-2004. Under Phil Condit and Harry Stonecipher, Boeing
focused on creating shareholder value. Outcome: R&D in commercial
aircraft was cut, Boeing diversified into electronics and defense, it
lost market leadership to Airbus, and its share price stagnated.
Lesson: Long-run profitability is achieved not by pursuing profit,
but by pursuing the factors that create profit.
Copyright © 2019 John Wiley & Sons, Inc.
The Pitfalls of Pursuing Shareholder Value: Boeing
PUTTING PERFORMANCE ANALYSIS INTO PRACTICE
Values and Principles
Values and principles commit an organization to certain ethical
precepts, provide guidelines for the behavior of its members,
and shape its character and identity.
Deeply-held, widely-shared values and principles are conducive
to superior organizational performance through:
Motivating employees
Reinforcing strategic direction
Enhancing organizational unity
BEYOND PROFIT: VALUES AND CORPORATE SOCIAL RESPONSIBILITY
Copyright © 2019 John Wiley & Sons, Inc.
Efficacy Arguments for Corporate
Social Responsibility
The Evolutionary Argument:
The firm as embedded within an ecosystem of social and natural
environments, sensitivity to this ecosystem enhances the firm’s
adaptability (Arie De Geus, The Living Company)
Michael Porter and Mark Kramer’s “Shared Value”:
Firms should “create economic value in a way which also creates value
for society.”
The benefits to the firm include:
By sustaining its natural and social environment, the firm improves
its opportunities for survival and growth
Enhancing the firm’s reputation
Endowing the firm with a license-to-operate.
BEYOND PROFIT: VALUES AND CORPORATE SOCIAL RESPONSIBILITY
Copyright © 2019 John Wiley & Sons, Inc.
Real Options
What are real options?
They are investments whose value is in that creating opportunities for a firm.
In a turbulent world, strategy is increasingly about creating and managing
options.
How do we value real options?
[1] Black-Scholes formula. Values real options the same way as financial options
(e.g. option value increases with volatility, time, project value, interest rate)
[2] Binomial pricing model creates an event tree for a project that is converted
into a decision tree which allows project value to be calculated.
BEYOND PROFIT: STRATEGY AS OPTIONS MANAGEMENT
What are the main types of real option?
Growth options: small investments to create the right but not the obligation
to make bigger subsequent investments (e.g. research)
Flexibility options: investments that permit adaptability to a wider range of
circumstances (e.g. a dual-fuel power plant).
Topic Summary
Strategy as a quest for value
Creating value is the core purpose of business: but value for whom: shareholders
or all stakeholders?
For the purpose of strategy formulation, it’s helpful to view firms as seeking to
maximize lifetime profits—or equivalently, enterprise value
Putting performance analysis into practice
Starting point for strategy formulation is to appraise the firm’s current performance
and diagnose sources of underperformance
Setting performance targets: better to target the drivers of long-term performance
than the performance indicators themselves.
Beyond profit: values and corporate social responsibility
Values and principles valuable in shaping an organization’s character and
and identity, motivating employees, and reinforcing unity and direction
CSR not only a goal in itself, it help a firm create long-term profit through
Enhancing adaptability, reputation, and legitimacy.
Beyond profit: strategy and real options
Strategy creates value not only by generating cash, but also creating real options
Chapter 2 GOALS, VALUE AND PERFORMANCE
