Maximizing Competitive Advantage: Assessing Firm Performance Through Revenue Growth and Profitability Trends

Abstract

MGMT 475 FALL 2022 PERFORMANCE ANALYSIS READING Our objective of this task is to understand the current state of the firm’s performance and the expected direction of their future performance if no strategic level changes are made. Keep this end in mind. To plan a trip, you must know – precisely - both your desired destination and your starting point. The same is true for any endeavor. There are many reasons to assess a firm’s performance, each involving different parties using different methods. Examples: Investors consider performance, earning per share, dividend payout ratios, etc. to assess if the firm is a good investment. Banks analyze cash flow, coverage ratios, level of debt, etc. to assess if the firm is a good credit risk. But we aren’t evaluating their credit rating or their investment attractiveness …. We want to assess how well their current strategic choices and their ability to execute those choices are delivering competitive advantage and sustainable, superior performance. That is, after all, our ultimate goal of a for-profit business enterprise. How can we get a good, simple definition of what ‘superior performance’ means for this purpose? Firm performance can have many dimensions such as revenue, profits, employee satisfaction, customer loyalty, market share, investor sentiment, reputation, etc. But let’s keep it simple for our purposes and focus on economic performance. After all, nothing else matters if the firm (an economic entity) cannot pay its bills, invest for the future, and sustain its existence. With that, the ideal state of economic performance can be argued to look like this: * Revenue growth, and a rate (NOT the amount of dollars) of growth (trend) over several years that is superior to the industry average. This condition says that the firm is creating value for their market, people like and want what they offer and how they deliver it. Their strategy has a strong appeal and attracts an above-average rate of buyer response. * Profitability that is stable or increasing and is consistently above industry average. This condition tells you that the operating ‘system’ of the firm (the assets and activities used to execute their strategy) is well-designed and well-managed. The best overall measure of ‘strategic’ profitability is Operating Profit/Income MARGIN (not absolute $, but operating profit/sales). (Net profit accounts for many accounting and legal decisions unrelated to strategy, so we don’t go that deep). Some might describe creating value as being effective, while capturing value is being efficient. Both must be achieved in an optimum balance. With just these two dimensions, you can thus categorize a firm’s performance like so: Revenue Growth:Increasing or Decreasing Above or Below industry average Profitability:Stable/Up or DecliningAbove or Below Industry average Again, the IDEAL state is growing and growing faster than industry with stable or increasing profitability that is above industry average. I think you can figure out the worst case!! With just that, you have a good feel for how the firm is doing and where their performance may go if there are no strategic changes. Many of you can go ahead now and do the exercise. Some of you may need to review income statement analysis. Here are, regardless, a few reminders/tips: How precise? For our purposes, high precision data is not needed. We are only looking for a accurate assessment of performance quality and direction (e.g. positive, negative, decreasing, increasing, above or below average, etc.). So you can round dollars, say to thousands, and you can round percentages to just one decimal point. When evaluating your calculations, avoid making too much of small changes. Example: If three years of revenue change is 4.5%, 4.7%, and 4.8% - that is stable, not increasing. Increasing would be something like going from 4.5% to 5.6%, to 7.0%. Likewise, operating margins of 10.3% and 10.6% are likely not that meaningful as a ’trend’. So, be careful to not OVER analyze small differences. Revenue Growth analysis: - Revenue might be called Sales or Net Sales by some, but the concept is always meant to be the net amount of funds taken in from selling products/services to customers. - Because size does...