What is Strategy

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What is Strategy? What is Performance?
Dr. W. Scott Sherman
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Defining Strategy
War
The Search for Economic Rent
The Search for Previously Unrecognized Patterns
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Resource-based Model of Above Average Returns
Ricardian Rents
The Land Example
Price
Price
Price
MC
MC
ATC
S
ATC
P
D
q2
q1
Q
Market SD_at_P
Normal Fertile Land
More Fertile Land
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Four Assumptions of the I/O Model

• 1. The external environment is assumed to possess
  pressures and constraints that determine the
  strategies that would result in above-average
  returns
• 2. Most firms competing within a particular or
  within a certain segment of it are assumed to
  control similar strategically relevant resources
  and to pursue similar strategies in light of
  those resources

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Four Assumptions of the I/O Model

• 3. Resources used to implement strategies are
  highly mobile across firms
• 4. Organizational decision makers are assumed to
  be rational and committed to acting in the firms
  best interests, as shown by their
  profit-maximizing behaviors

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Strategy

• Most definitions of strategy focus on
• Formulation of organizational objectives
• What decisions should be made to achieve
  objectives
• Most definitions of strategic management focus on
• Processes needed to produce and implement
  strategies
• All definitions focus on strategies impact on
  performance

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Performance as a concept

• An organization is
• an association of productive assets (including
  individuals) who voluntarily come together to
  obtain economic advantages
• labor, management, entrepreneurial skill,
  physical capital, financial capital
• A measure of performance should
• compare the value that an organization creates
  using its productive assets with the value that
  the owners of such assets expect to obtain

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Survival as performance measure

• Rationale
• Organizations that dont survive create market
  space for others to persevere
• Strength
• Apparently easy to use, ex post
• Weakness
• Not so easy after all. When does an organization
  die?
• Not very suitable for decision making

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Accounting performance measures

• Most popular and easy to observe
• Profitability ratios (ROE, ROA etc.)
• Liquidity ratios (current assets/current
  liabilities)
• Leverage ratios (total debt/total assets etc.)
• Activity ratios (sales/inventory etc.)
• Limitations
• Bias caused by managerial discretion
• Bias caused by dynamic instability
• Undervalues intangibles
• Not all of them are fundamental objectives

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Net present-value performance measures

• Present value of future cash flows
• Net cash flow in period t
• NCF (1-t)(Revenues-Costs)
• tdepreciation - investments
• t tax rate
• NPV SNCVt /(1k)t
• k is cost of capital or the expected rate of
  return

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Net present-value and technicalmeasures of
performance

• The capital asset pricing model CAPM
• k RFR bERm-RFR
• -b the firms systematic risk
• RFR risk free rate of return (government
  securities)
• ERm expected rate of return on a fully
  diversified portfolio (Dow Jones)

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Net present-valueperformance measures

• Strengths
• NPV is a shareowner criterion and the shareowners
  are important stakeholders
• Weaknesses
• Difficult to predict cash flows
• Difficult to estimate b (beta long term risk),
  extended time data series are needed

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Market Value Added

• MVA (market value of equity
• market value of debt)
• economic book value
• Approximates economic rent

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Tobins Q

• Firm market value
• market value of common stock
• market value of preferred stock
• book value of firms short-tern debt
• book value of a firms long-term debt

q Firm market value . Book
value of total assets
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Tobins q

• May be most accurate approximation of firms
  economic rent gained over time
• Not discriminate to short-term bumps versus
  systematic shifts

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Multiple stakeholder view of performance

• Comes closest to the conceptual definition of
  performance
• The organizational performance should be
  evaluated relative the preferences and desires of
  the stakeholders that provide resources to the
  firm
• Different firms will choose different criteria
  for evaluating their performance
• Different individuals within the same firm will
  choose different criteria as well