Rubric for Case Analysis:
As you are probably aware, case analysis is the most essential part of a business analyst’s toolbox. As such, it is of paramount importance that you learn how to do case analysis thoroughly. As with any analysis we follow a certain framework when we conduct case analysis. Please understand that the framework that we are going to follow in this class is one of many and there is disagreement among the academic and professional communities as to which one of these frameworks is the best. That said, in my humble opinion, the framework that follows is a good start to the case analysis process. What we gather from the initial analysis can then be used to direct ...view middle of the document...
On the other hand, economic measures of performance are compared to a firm’s own cost of capital to determine if that firm has a competitive advantage. If a firm earns a 20 percent return on equity and the firm calculates that its cost of capital is only 12 percent, then we would conclude that the firm has a competitive advantage. Both of these methods of assessing the competitive advantage of a firm point back to our definition of a competitive advantage: the ability to create more economic value than competitors.
Normal Economic Return
When a firm just earns its cost of capital it is said to be earning a normal economic return. Such a firm is meeting the expectations of the market with regard to the level of risk an investment in such firm entails. Another way of looking at this idea is that if a firm is earning a normal return, investors are just barely willing to keep investing in the firm. If the firm were to earn any less, investors would pull their capital out of the firm.
Above Normal Economic Return
Specifically, a firm is said to be earning an above normal economic return if the firm is earning more than its cost of capital. An above normal economic return is indicative of a competitive advantage. By definition, such a firm is said to be exceeding the expectations of the market. This is another important indicator of competitive advantage. The firm is doing better than the market expects a firm to do in its particular industry. Such a firm will likely attract new capital as investors will be eager to get in on the higher returns of this firm.
Below Normal Return
Of course, a firm earning less than its cost of capital is said to be earning a below normal economic return. Firms cannot survive long if they are earning below normal economic returns. Investors will take their capital elsewhere.
The relationships between types of competitive advantage, accounting performance, and economic performance are fairly straightforward. A competitive advantage is said to lead to above average accounting performance and above normal economic performance. Competitive parity leads to average accounting performance and normal economic performance. Of course, competitive disadvantage is said to lead to below average accounting performance and below normal economic performance.
Once you have completed the above analysis, you should be able to say whether your firm possesses competitive advantage over other firms in the industry. Remember we want Imperfect competition, as oppose to perfect competition.
B) External Analysis:
Financial analysis tells you whether your firm has competitive advantage. External and internal analysis tell you where that competitive advantage comes from. Begin with a firm’s value chain. We discussed a generic value chain in the class. But, companies might not have all of the steps discussed in the value chain. A company might have vertically integrated forward or backward, thus have...