Chapter 5 Competitive Advantage, Firm Performance, and Business Models © 2021 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. Because learning changes everything.® Learning Objectives Conduct a firm profitability analysis using accounting data to assess and evaluate competitive advantage. Apply shareholder value creation to assess and evaluate competitive advantage. Explain economic value creation and different sources of competitive advantage. Apply a balanced scorecard to assess and evaluate competitive advantage. Apply a triple bottom line to assess and evaluate competitive advantage. Use the why, what, who, and how of business models framework to put strategy into action. © McGraw Hill The AFI Strategy Framework Access the text alternative for slide images. © McGraw Hill Case Study: Microsoft vs. Apple Both founded in the mid-1970’s, (Bill Gates/Steve Jobs) Microsoft dominated the PC industry with Windows, the defacto OS 90% of PC’s. Preloaded onto IBM and other PC’s, they created applications to run seamlessly for all. Microsoft Office Suite , (Word, Excel, Outlook, PowerPoint) Duplicated this in the corporate world using servers. By 2000, Microsoft was most valuable company globally at $510B Microsoft Market Cap today: $1.6T After struggling with less than 5% of the PC market, Apple was revitalized in 2001 Introduction of the Ipod and digital portable music. Followed quickly by iTunes. 2007 introduced the smartphone, 2010 introduced the iPad By 2012, Apple was most valuable company globally at $620B 2015: Apple Watch 2017: iPhone 10x $1000.00 Apple Market Cap today: $1.9T © McGraw Hill M vs. A shows that overtime, competitive advantage is transitory. It is hard to gain a competitive edge in the first place, and even harder to sustain it. 4 An Overview of Frameworks Discussed Three traditional frameworks to measure and assess firm performance: Accounting profitability. Shareholder value creation. Economic value creation. Two integrative frameworks, combining quantitative data with qualitative assessments: Balanced scorecard. Triple bottom line. © McGraw Hill 5 Three Traditional Performance Dimensions What is our accounting profitability? Uses standard financial metrics. What is our shareholder value? Stock price How much economic value does the firm generate? Difference between what a buyer is willing to pay and the cost to produce. 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. © McGraw Hill 6 Accounting Profitability Accurately assesses firm performance. Compares firm performance to competitors / industry average. Available through: Standardized accounting metrics (GAAP, FASB). Form 10-K ...

1. Chapter 5
Competitive Advantage, Firm Performance, and Business
Models
© 2021 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.
Because learning changes everything.®
Learning Objectives
Conduct a firm profitability analysis using accounting data to
assess and evaluate competitive advantage.
Apply shareholder value creation to assess and evaluate
competitive advantage.
Explain economic value creation and different sources of
competitive advantage.
Apply a balanced scorecard to assess and evaluate competitive
advantage.
Apply a triple bottom line to assess and evaluate competitive
advantage.
Use the why, what, who, and how of business models framework
to put strategy into action.
© McGraw Hill
The AFI Strategy Framework

2. Access the text alternative for slide images.
© McGraw Hill
Case Study: Microsoft vs. Apple
Both founded in the mid-1970’s, (Bill Gates/Steve Jobs)
Microsoft dominated the PC industry with Windows, the defacto
OS 90% of PC’s.
Preloaded onto IBM and other PC’s, they created applications to
run seamlessly for all.
Microsoft Office Suite , (Word, Excel, Outlook, PowerPoint)
Duplicated this in the corporate world using servers.
By 2000, Microsoft was most valuable company globally at
$510B
Microsoft Market Cap today: $1.6T
After struggling with less than 5% of the PC market, Apple was
revitalized in 2001
Introduction of the Ipod and digital portable music. Followed
quickly by iTunes.
2007 introduced the smartphone, 2010 introduced the iPad
By 2012, Apple was most valuable company globally at $620B
2015: Apple Watch 2017: iPhone 10x $1000.00
Apple Market Cap today: $1.9T
© McGraw Hill

3. M vs. A shows that overtime, competitive advantage is
transitory. It is hard to gain a competitive edge in the first
place, and even harder to sustain it.
4
An Overview of Frameworks Discussed
Three traditional frameworks to measure and assess firm
performance:
Accounting profitability.
Shareholder value creation.
Economic value creation.
Two integrative frameworks, combining quantitative data with
qualitative assessments:
Balanced scorecard.
Triple bottom line.
© McGraw Hill
5
Three Traditional Performance Dimensions
What is our accounting profitability?
Uses standard financial metrics.
What is our shareholder value?
Stock price
How much economic value does the firm generate?
Difference between what a buyer is willing to pay and the
cost to produce.
These performance dimensions generally correlate over time:
Accounting profitability and economic value creation tend to be

4. reflected in the firm’s stock price.
Determines the stock’s market valuation.
© McGraw Hill
6
Accounting Profitability
Accurately assesses firm performance.
Compares firm performance to competitors / industry average.
Available through:
Standardized accounting metrics (GAAP, FASB).
Form 10-K statements.
Profitability ratios.
Return on invested capital (ROIC), return on equity (ROE),
return on assets (ROA), and return on revenue (ROR).
© McGraw Hill
One of the most commonly used metrics in assessing firm
financial performance is return on invested capital (ROIC),
where ROIC = Net profits / Invested capital. ROIC is a popular
metric because it is a good proxy for firm profitability. In
particular, the ratio measures how effectively a company uses
its total invested capital, which consists of two components: (1)
shareholders’ equity through the selling of shares to the public,
and (2) interest-bearing debt through borrowing from financial
institutions and bondholders.
7

5. Drivers of Firm Performance
Exhibit 5.1
Source: Analysis of publicly available data.
Access the text alternative for slide image.
© McGraw Hill
Apple’s ROIC is 17.3 percent, which is 8.5 percentage points
higher than Microsoft’s (8.8 percent). This means that for every
$1.00 invested in Apple, the company returned $1.17, while for
every $1.00 invested in Microsoft, the company returned $1.09.
Since Apple was almost twice as efficient as Microsoft at
generating a ROIC, Apple had a clear competitive advantage
over Microsoft. Although this is an important piece of
information, managers need to know the underlying factors
driving differences in firm profitability.
8
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.
© McGraw Hill
This limitation of accounting data is nicely captured in the
adage: Not everything that can be counted counts. Not
everything that counts can be counted. Although accounting
data capture some intangi ble assets, such as the value of

6. intellectual property (patents, trademarks, and so on) and
customer goodwill, many key intangible assets are not captured.
Today, the most competitively important assets tend to be
intangibles such as innovation, quality, and customer
experience, which are not included in a firm’s balance sheets.
9
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.
10
© McGraw Hill
All public companies in the United States are required to report
total return to shareholders annually in the statements they file
with the Securities and Exchange Commission (SEC). In
addition, companies must also provide benchmarks, usually one
comparison to the industry average and another to a broader
market index that is relevant for more diversified firms.
Investors also adjust their expectations over time. Since the
business in the slow-growth industry surprised them by
delivering higher than expected growth, they adjust their

7. expectations upward. The next year, they expect this firm to
again deliver 4 percent growth. On the other hand, if the
industry average is 10 percent a year in the high-tech business,
the firm that delivered 8 percent growth will again be expected
to deliver at least the industry average growth rate; otherwise,
its stock will be further discounted.
10
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.
© McGraw Hill
Microsoft was the most valuable company worldwide (in
December 1999 with close to $600 billion in market cap), but
its market valuation dropped in the following decade. The
valuation declined because Microsoft struggled with the
transition from desktop to mobile and cloud-based computing.
CEO Satya Nadella, however, is moving Microsoft away from
its Windows-only business model to compete more effectively
in a “mobile-first, cloud-first world.” Nadella’s strategic
initiative is starting to bear fruit as investors appear to be
pleased with how well Microsoft is performing in future growth
areas such as cloud computing. As Exhibit 5.3 shows that since
Nadella took the helm at Microsoft in 2014, the company’s
market cap has been increasing at a steep clip, even overtaking
Apple at the end of the time period, making Microsoft again the
most valuable company globally.
11

8. 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.
© McGraw Hill
For the firms in the S&P 500 (the 500 largest publicly traded
companies by market capitalization in the U.S. stock market, as
determined by Standard & Poor’s, a rating agency), the
importance of a firm’s book value has declined dramatically
over time. This decline mirrors a commensurate increase in the
importance of intangibles that contribute to growth potential
and yet are not captured in a firm’s accounting data.
12
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.
What do you feel stock prices really say about the economy?
© McGraw Hill

9. 13
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).
What is another word for the result of this equation?
© McGraw Hill
Competitive advantage can be based on: economic value
creation because of superior product differentiation, or a
relative cost advantage over rivals.
What is the difference between a Macy’s brand polo shirt and
Ralph Lauren
14
Economic Value Creation
From an economic context, strategy is about:
Creating economic value and
Capturing as much of it as possible
A large difference between V and C gives the firm two distinct
pricing options:
1. Charge higher prices to reflect the higher product value and

10. increase profitability
OR
2. Charge the same price as rivals and gain market share
The strategic objective is to maximize (V – C), which is the
economic value created.
15
© McGraw Hill
$1M menu
http://www.king5.com/video/news/local/seattle/this-seattle-
cocktail-menu-includes-a-200-martini/281-8095610
15
Economic Value Creation
Apple watch at entry level when introduced retailed for $349.
Material and Labor is approximately $84
Apple’s profit for each watch sold is estimated to be $265 with
a profit margin of 315%.
Apple creates economic value and captures as much of it as
possible.
16

11. © McGraw Hill
Baah, sheep.
16
Economic Value Creation
Creates large value for customers and 3rd party sellers, but
captures very little.
Retail drives little or no profit
AWS is said to be a profit engine, but margins are -1%
Whole Foods? Grocery store margins are thin
Amazon can create negative margins and still their stockholders
applaud.
Bezos is focused on long-term performance vs. short term.
Investors approve as Market Cap is $906B
17
© McGraw Hill
Amazon prime membership
17
Competitive Advantage and Economic Value Created: The Role
of Value, Cost, and Price
Exhibit 5.7
Source: Adapted from N. Siggelkow (2002), “Evolution toward
fit,” Administrative Science Quarterly 47: 146.
Access the text alternate of slide image.

12. © McGraw Hill
Value denotes the dollar amount (V) a consumer attaches to a
good or service. Value captures a consumer’s willingness to pay
and is determined by the perceived benefits a good or service
provides to the buyer. The cost (C) to produce the good or
service matters little to the consumer, but it matters a great deal
to the producer (supplier) of the good or service since it has a
direct bearing on the profit margin.
18
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.
© McGraw Hill
Example of Opportunity Costs of an Entrepreneur: (1) forgone
wages if employed elsewhere; (2) the cost of capital invested in
the business vs. the stock market vs. U.S. Treasury bonds.
19
The Two Integrative Frameworks
The Balanced Scorecard
The Triple Bottom Line

13. 20
© McGraw Hill
The Balanced Scorecard
Managers tool which harnesses multiple internal and external
performance metrics in order to balance financial and strategic
goals
21
© McGraw Hill
Just as airplane pilots rely on a number of instruments to
provide constant information about key variables—such as
altitude, airspeed, fuel, position of other aircraft in the vicinity,
and destination—to ensure a safe flight, so should managers
rely on multiple yardsticks to more accurately assess company
performance in an integrative way.
21
Balanced-Scorecard Approach to Creating and Sustaining
Competitive Advantage
Exhibit 5.8

14. © McGraw Hill
This image depicts the balanced-scorecard framework. Strategic
leaders using the balanced scorecard develop appropriate
metrics to assess strategic objectives by answering four key
questions. Brainstorming answers to these questions ideally
results In measures that give managers a quick but also
comprehensive view of the firm’s current state. The four key
questions are:
How do customers view us?
How do we create value?
What core competencies do we need?
How do shareholders view us?
22
Examples of Metrics for the Balanced Scorecard
Customers:
Revenue, profit, customer satisfaction.
Value Creation, (Learning):
Competitiveness, innovation, organizational learning.
Core Competencies, (Internal):
Key business processes.
Shareholders, (Financial):
Cash flow, operating income, ROIC, ROE, total returns to
shareholders.
© McGraw Hill
Customer view: In the air-express industry, for example,
managers learned from their customers that many don’t really
need next-day delivery for most of their documents and

15. packages; rather what they really cared about was the ability to
track the shipments. This discovery led to the development of
steeply discounted second-day delivery by UPS and FedEx,
combined with sophisticated real-time tracking tools online.
Value Creation: For example, 3M requires that 30 percent of
revenues must come from products introduced within the past
four years.
Core Competencies: Honda’s core competency is to design and
manufacture small but powerful and highly reliable engines. Its
business model is to find places to put its engines. Beginning
with motorcycles in 1948, Honda nurtured this core competency
over many decades and is leveraging it to reach stretch goals in
the design, development, and manufacture of small airplanes.
23
Example: SWA
24
© McGraw Hill
24
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.

16. Alerts to needed strategic goal adaptation.
© McGraw Hill
Implementing a balanced scorecard allowed FMC’s managers to
align their different perspectives to create a more focused
corporation overall. General managers now review progress
along the chosen metrics every month, and corporate executives
do so on a quarterly basis. Implementing a balanced-scorecard
approach is not a onetime effort. It requires continuous tracking
of metrics and updating of strategic objectives, if needed. It is a
continuous process, feeding performance back into the strategy
process to assess its effectiveness.
25
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?
© McGraw Hill
Implementing a balanced scorecard allowed FMC’s managers to
align their different perspectives to create a more focused
corporation overall. General managers now review progress
along the chosen metrics every month, and corporate executives
do so on a quarterly basis. Implementing a balanced-scorecard
approach is not a onetime effort. It requires continuous tracking

17. of metrics and updating of strategic objectives, if needed. It is a
continuous process, feeding performance back into the strategy
process to assess its effectiveness.
26
The Triple Bottom Line
Focus: economic, social and ecological performance.
Three dimensions:
Profits: Economic Dimension.
People: Social Dimension.
Planet: Ecological Dimension.
27
© McGraw Hill
Rather than emphasizing sustaining a competitive advantage
over time, sustainable strategy means a strategy that can be
pursued over time without detrimental effects on people or the
planet. Using renewable energy sources such as wind or solar
power, for example, is sustainable over time. It can also be
good for profits, or, simply put, “green is green,” as Jeffrey
Immelt was fond of saying while CEO at GE. GE’s renewable
energy business brought in more than $9 billion in revenues in
2016 (up from $3 billion in 2006). Immelt retired in 2017.
Instructors:
The digital companion to this book McGraw-Hill Connect has a
video case exercise from a mining industry executive on this
section of the textbook. It builds student confidence on the
triple bottom line.

18. 27
Stakeholder perspective
Economic, social and ecological dimensions make up the triple
bottom line.
Noneconomic factors can have a significant impact on a firm’s
financial performance, as well as its reputation and goodwill.
Extended producer responsibility – In anticipation of
government regulation – proactively addressing social or
ecological issues
28
© McGraw Hill
Corporate Social Responsibility
Historically, economic performance has been the focus of firm
performance.
More recently, society and investors require companies to also
address social and ecological concerns.
Millennials (1980-1995) and Gen Z expect firms to be socially
responsible and have a strong interest in working for companies
that match their values.
Research studies – CSR and firm performance relationship:
Some find CSR improves financial performance.
Others conclude superior financial performance makes CSR
possible.
29

19. © McGraw Hill
What Is a Business Model?
A plan that details the firm’s competitive tactics and initiatives.
A business model explains how the firm intends to make money
AND how the firm conducts its business with buyers, suppliers,
and partners.
Business model innovation may be more important in achieving
superior performance than product or process innovation.
© McGraw Hill
How companies do business can sometimes be as important, if
not more so, to gaining and sustaining competitive advantage as
what they do. Indeed, a slight majority (54 percent) of senior
executives responded to a recent survey stating that they
consider business model innovation to be more important than
process or product innovation. This is because product and
process innovation is often more costly, is higher risk, and takes
longer to come up with in the first place and to then implement.
Moreover, business model innovation is often an area that is
overlooked in a firm’s quest for competitive advantage, and
thus much value can be unlocked by focusing on business model
innovation.
30
The Why, What, Who, and How of Business Models Framework

20. © McGraw Hill
31
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.
© McGraw Hill
Razor-razorblade: Invented by Gillette, which gave away its
razors and sold the replacement cartridges for relatively hi
prices. HP charges little for its laser printers but imposes hi
prices for its replacement toner cartridges.
Subscription: MS uses subscription-based model for its new
Office 365 suite of application software. Other industries that
use this model presently are cable television, cellular providers,

21. satellite radio, internet service providers, and health clubs.
Netflix.
Pay as you go: most widely used by utilities providing power
and water and cell phone service plans, but it is gaining
momentum in other areas such as rental cars and cloud
computing such Microsoft’s Azure.
Freemium: examples include Spirit Airlines (in the United
States), Ryanair (in Europe), or AirAsia, which provide minimal
flight services but allow customers to pay for additional
services and upgrades à la carte, often at a premium.
Wholesale: book publishers sell books to retailers at a fixed
price (usually 50 percent below the recommended retail price).
Retailers, however, were free to set their own price on any book
and profit from the difference between their selling price and
the cost to buy the book from the publisher (or wholesaler).
Agency: long used in the entertainment industry, where agents
place artists/artistic properties and then take a commission.
More recently we see this approach at work in a number of
online sales venues, as in Apple’s pricing of book products or
its app sales.
Bundling: In the Microsoft Office Suite, a user might value
Word more than Excel and vice versa. Instead of selling both
products for $120 each, Microsoft bundles them in a suite and
sells them combined at a discount, say $150.
32
Dynamic Nature of Business Models
Business Models
Can be combined…Carriers started with Rzr/Rzr blade and
combined with Subscription.
Can evolve….Freemium is an evolution of Rzr/Rzr blade.

22. Can be disrupted…Amazon disrupted wholesale model of
publishers.
Businesses must respond to disruption and adapt.
Legal conflicts can arise.
© McGraw Hill
Examples:
Business models can be combined: AT&T uses both razor-
razorblade & subscription models
Business models can evolve: Freemium is an evolution of razor -
razorblade
Business models can be disrupted: Amazon disrupted wholesale
models of publishers
Businesses must respond to disruption & adapt: Many book
publishers worked with Apple on an agency approach, in which
the publishers would set the price for Apple and receive 70
percent of the revenue, while Apple received 30 percent.
Publishers inked their deals with Apple, but how could they get
Amazon to play ball? For leverage, publishers withheld new
releases from Amazon. This forced Amazon to raise prices on
newly released e-books in line with the agency model to around
$14.95
Legal conflicts can arise: In 2012 the Department of Justice
determined that Apple and major publishers had conspired to
raise prices of e-books. A year later, Apple was found guilty of
colluding with several major book publishers to fix prices on e -
books and had to change its agency model.

23. 33
Pizza Wars
© McGraw Hill
What is the overall Business Model for these players?
https://www.fastcompany.com/video/how-andpizza-is-
reinventing-your-traditional-pizza-parlor/4oR7kfMf
34
End of Main Content
© 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.
Because learning changes everything.®
www.mheducation.com