Strategy and Value Creation (DISCUSSION) For this discussion, you will explore the relationship between financial analysis and strategic analysis in a rev

 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:

  1. Read the case study to identify the key issues and underlying issues. These issues are the principles and concepts of the course modules which apply to the situation described in the case study.
  2. Record the facts from the case study which are relevant to the principles and concepts of the course modules. The case may have extraneous information not relevant to the current module. Your ability to differentiate between relevant and irrelevant information is an important aspect of case analysis, as it will inform the focus of your answers.
  3. Describe in detail the actions that would address or correct the situation.
  4. Consider how you would support your solution with examples from experience or current real-life examples or cases from textbooks.
  5. Complete this initial analysis and then read the discussion questions. Typically, you will already have the answers to the questions, but with a broader consideration. At this point, you can add the details and/or analytical tools required to solve the case.

In an original post, present a well-written answer and diagnosis for the following case study questions:

  1. Examine the reasons why Starbucks’ strategy has been so successful.
  2. Examine the threats to Starbucks’ success in the future. 
  3. How does Starbucks link organizational goals to measures of value?
  4. How does Starbucks link organizational goals to measures of performance?

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. 

 Required

1

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

CompanyMarket capitalization
($ billion)
Net income
($ billion)
ROS
(%)
ROE
(%)
ROA
(%)
Return to shareholders (%)
Apple82448.426.939.016.3+46.8
Amazon6893.02.39.63.1+27.4
Alibaba4806.229.821.99.1+94.1
JPMorgan Chase39724.450.2 9.51.4+24.6
ExxonMobil35819.75.211.85.7–5.8
Wal-Mart Stores, Inc.31013.64.114.911.9+45.2
Toyota204 15.8 7.613.2 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

RatioFormulaNotes
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 marginSales – cost of material inputs
Sales
Gross margin measures how much value a firm adds value to the goods and services it buys in.
Operating marginOperating profit / SalesOperating 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 marginNet 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

RatioFormulaNotes
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 marginSales – cost of material inputs
Sales
Gross margin measures how much value a firm adds value to the goods and services it buys in.
Operating marginOperating profit / SalesOperating 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 marginNet 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 MapPerformance
Measures
TargetsInitiatives
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

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