Linking Competitive Strategy and Shareholder Value Analysis

Linking competitive strategy and shareholder value analysis

Corporate management have always been under pressure to increase shareholder value by creating value adding strategies for shareholders. Whether management often has to defend traditional accounting-based metrics or having to restrict hostile takeovers, often the best argument can be related to the increase in shareholder value.

The strength of strategy valuation lies in the formulation effort i.e; identifying financial factors that create value in business. This can be divided into three categories:  

1. Rationale for shareholder value approach: The most sustainable businesses today are the ones that create the greater value for shareholders. Although corporate management is seen as a balancing act between various stakeholders, it is the financial relationship between the firm and these stakeholders that brings value to an organization. Whether it is employees who want better wages or shareholders seeking cash dividends, all parties in this relationship seek a financial motive. Thus, a firm seeking to be sustainable must strive to increase its cash generating ability. Whether it is raising finance via debt or equity, it is the ability of a firm to generate cash that determines how much it can borrow or how much the market will value it’s shares.
2. Strategy valuation: In the modern world, firms are eager to formally evaluate their strategic planning results. While different organizations adopt different methods, the commonly accepted methods is to forecast projected financial statement generally over the next five year period. Essentially this approach helps in answering questions around will there be value for shareholders, which segments/ units are creating value, what alternative strategies can be used? This method of projecting statements allows top management to evaluate their strategies against each other and approve ones that maximise value for shareholders. It is important to stress that this is not a replacement to qualitative analysis and that both quantitative and qualitative analysis are required to improve shareholder value.
3. Competitive Analysis Framework: Effective business planning requires an in-depth analysis of both formulating business strategies and on valuing them. Amongst the many systematic frameworks within the industry, the competitive strategy framework developed by Michael E. Porter has had the greatest impact. Porter through his framework first assess industries and competitors and then develops an overall competitive strategy. The core of his work revolves around analysing the five well known competitive forces that drive industry structure which in return drive the long-run rates of returns that firms expect. The five forces include:

1. The threat of new entrants
2. The threat of substitute products
3. Bargaining power of suppliers
4. Bargaining power of buyers
5. Rivalry among current competitors.

These five forces are critical in establishing shareholder return as they influence prices, quantities sold, costs, investment and riskiness of firms in an industry. These variables can also be referred to as the building blocks for the value driver determinants of shareholder value. It is interesting to also note that the five forces described by Porter have a close link with the value drivers listed above. For instance, the higher the barriers of entry into an industry the lower the threat of new entrants. The scale of barriers to entry depends on factors such as economies of scales, switching costs, product differentiation, capital requirements and government policy. Scale economies will restrict potential future entrants due to either having to enter at a large scale or face a competitive disadvantage. Another barrier to entry, product differentiation can affect sales growth and operation profit due to higher prices of goods because of product differences, advertising and superior customer service.