Abstract
Appraising firm performance is an important aspect of the strategic management process. Unfortunately, many students in strategic management courses do not have adequate financial analysis skills to do this task. This deficiency affects their ability to learn and perform the full scope of the strategic management process. This article presents an exercise designed to address this challenge. The exercise emphasizes the central objective of strategic management, that is, the achievement of superior levels of creating and capturing value. The brief lesson and exercise enable students to use simple accounting metrics to appraise the quality of a firm’s current strategy, execution capabilities, and resulting competitive position. Primarily for undergraduate courses in which numerous students are challenged by quantitative analysis tasks, this exercise alleviates the need for instructors to invest an inordinate amount of time reteaching financial analysis.
Keywords
The aim of strategic management (SM) is to achieve and prolong a superior level of firm performance, an outcome referred to as sustained competitive advantage (Barney, 2001; Porter, 1980; Rothaermel, 2013). Critical phases of strategic analysis focus on identifying a firm’s sources of sustainable competitive advantage. The resource-based view, for example, is a leading theory for explaining sustainable competitive advantage (Barney, 2001). Regardless of the source of advantage, improving performance requires an understanding of current performance. A critical task in the SM process therefore involves characterizing the focal firm’s current performance in terms of sustained superiority (Grant & Baden-Fuller, 2018; Rothaermel, 2013). Appraising a firm’s performance does not explain how it achieved that performance, but it is nevertheless a critical step in strategic analysis and one that students in a capstone SM course must perform competently.
Many undergraduate students, however, have inadequate financial analysis skills. Students’ inability to properly appraise performance in capstone cases impedes learning and can cause anxiety (Sizoo et al., 2008). Because instructors have limited time to cover topics beyond the core concepts, theories, and skills unique to SM (Greiner et al., 2003; Wren et al., 2007), building adequate student competence in even basic firm performance appraisal may be a challenge (Aupperle & Sarhan, 1995).
This article addresses this challenge by presenting an exercise designed for use early in the undergraduate capstone SM course when students are learning to analyze the current status of a focal firm. The purpose of the exercise is to provide students with a simple framework that uses only a few revenue and profitability measures for appraising a firm’s current performance status. For simplicity and relevance, the exercise emphasizes two core dimensions of performance: value creation and value capture. When examined over time and compared with industry benchmarks, these value-based concepts provide a straightforward and accessible means of appraising firm performance. The exercise does not address deeper diagnostic and recommendation issues.
The exercise was designed for a face-to-face class and takes about 90 minutes to complete (variations are described in Appendix A). The class session progresses from a lesson on concepts and methods to activities for experiential learning and reflection (Kolb & Kolb, 2005; Ryan & Ryan, 2013). The following section introduces the background concepts and validates their applicability for this use. The class lesson and exercise descriptions follow, with additional details contained in appendices and supplemental materials.
Performance Appraisal in Strategic Management
Improving long-term organizational performance is the main objective of SM. Formulating strategies to pursue those ends requires analyzing economic performance to appraise a firm’s strategic position (David & David, 2017; Grant & Baden-Fuller, 2018; Wheelen et al., 2015). Performance, however, is a complex construct, and there are many methods for measuring it. The content of SM textbooks on these topics, therefore, varies (see Table 1 for representative examples) with analysis of a set of financial ratios being the most common approach presented.
Representative Textbook Content Related to Performance Appraisal.
For many undergraduate students, however, even basic ratio analysis can be daunting due to its multidimensional complexity. Calculating a set of basic ratios can create challenges for synthesis and interpretation and induce fine-grained functional and tactical thinking (e.g., attention to capital structure decisions, pricing assumptions, inventory management, and advertising budget changes). In my experience, detailed ratio analysis causes some students to attempt to diagnose strategic issues and prescribe corrective action before performing a thorough and comprehensive strategic analysis.
Performance analysis can play two roles in strategic analysis and decision making (Grant, 2016; Grant & Baden-Fuller, 2018). A fundamental role of performance analysis is for appraising the quality of a firm’s current competitive performance (Gamble et al., 2019). The objective of performance appraisal is to draw conclusions about the quality of the firm’s SM, that is, the degree to which they have competitive advantage. A more detailed level of performance analysis, what can be described as diagnostics, helps identify specific financial and operational issues (David & David, 2017). The objective of this exercise is solely related to appraising a firm’s overall current performance as a gauge of their strategic effectiveness; it does not address diagnostics.
Value Creation and Value Capture
Economic profit is not the only measure of a commercial firm’s success. Profit is, however, a necessary outcome for survival. As such, even enlightened stakeholder theory and the business case for social responsibility emphasize that investments toward noneconomic ends contribute to economic performance (Carroll & Shabana, 2010; Jensen, 2010). Thus, a central objective of a business enterprise is a quest for value (Grant, 2016). Grant (2016) states, “We can generalize by saying that the purpose of business is, first, to create value for customers and, second, to appropriate some of that customer value in the form of profit—thereby creating value for the firm” (p. 37). These notions of creating and capturing value are well rooted in the academic literature (e.g., Bowman & Ambrosini, 2000; Lepak et al., 2007; Pitelis & Teece, 2009).
Value creation is assessed with measures of customers’ value and preference for a firm’s offerings (e.g., top-line metrics such as revenue growth, same-store sales growth, successful new product introductions, etc.). Value capture refers to profitability and can be assessed through gross, operating, and net profit margins. The overall efficiency of a firm’s system to create and capture value can be assessed by return on assets or return on capital.
There are also two important comparative aspects of a firm’s performance, superiority versus rivals and improvement over time. Comparing performance with rivals (i.e., industry average) is necessary to assess the degree to which superior performance has been achieved (Aupperle & Sarhan, 1995; Dess et al., 2016; Rothaermel, 2013). Analyzing performance over time is critical to understand the emergence and persistence of a firm’s performance superiority and thus the quality of ongoing SM (Gamble et al., 2019; Richard et al., 2009). Bringing these simple dimensions together forms the framework shown in Table 2.
Framework of a Value-Based Approach to Assessing Firm Performance.
The Exercise
Learning Objectives
The overall objective of the exercise is for students to be able to apply a basic appraisal method for characterizing the nature and direction of a firm’s economic performance. At the conclusion of this exercise, students will be able to
Distinguish between and articulate the concepts of value creation and value capture
Assess the trend and relative nature of a firm’s ability to create and capture value
Summarize their analysis into an overall appraisal of the firm’s performance status and trajectory
Preparation
The steps to prepare for this exercise are as follows:
Advise students beforehand to bring a calculating device for this lesson. It may also be useful to suggest that students review financial statement analysis through their prior textbooks or websites such as www.accountingtools.com/financial-statement-analysis.
A brief lesson is needed to situate performance appraisal in the SM process, to introduce the variety of analytical methods including the concepts of creating and capturing value, and to review basic income statement structure and math (see the Supplemental Materials for sample presentation slides and related instructor notes).
A simple multiyear income statement with revenue growth and profitability measures calculated (e.g., operating margin and return on assets, at a minimum) is also needed. The statements should provide at least 3 years of data so that multiyear trends can be examined.
A second version of the income statement with calculated fields left blank serves as the worksheet that students use when calculating growth and profitability metrics (see Appendix B for a sample income statement and corresponding worksheet).
The blank and completed income statements should be embedded individually in the presentation slides. To avoid students finding these answers on the internet, instructors should customize their own data.
Introducing and Conducting the Exercise
The time required for this lesson and exercise is 90 minutes (see Table 3 for a step-by-step suggested schedule). The introductory lesson (see Supplemental Materials) covers the rationale for appraising performance, describes the pros and cons of alternative methods, and introduces the concepts of creating and capturing value. Following the lesson and introductory discussion is the exercise and debriefing. Conducting the exercise involves the following steps:
Display the blank version of the income statement and distribute the printed worksheet to the class. Instruct students to individually calculate and fill in the blanks. This task takes 10 to 15 minutes.
Ask students to think about what their calculations tell them about this firm’s ability to create value and capture value. This question is designed to help them connect their calculations back to the concepts just covered in the introductory lesson. If time allows, pair-share or small group discussions can add value.
Reveal the calculated fields individually or via the full-income statement, identify and address any student errors or misunderstandings, and provide necessary corrective instruction.
Schedule/Timeline.
Debrief, Reflection, and Observations
The debriefing focuses on assessing students’ abilities to calculate and understand the appraisal analysis and their ability to interpret meaning about a firm’s ability to create and capture value. To conclude the exercise, students reflect on what they learned (the supplemental Instructor Notes provide suggested reflection questions). For example, I have them consider (a) the benefits and limitations of this exercise’s method compared with more detailed financial analysis, (b) how the two performance dimensions help them understand a firm’s current performance situation, and (c) what the appraisal suggests about the quality of a firm’s SM. The exercise concludes with an open discussion of these issues.
Some students may struggle with the most basic business math (i.e., calculating trends, calculating margins). Some will not have a clear understanding of the interpretation of gross, operating, and net margins. A review of such issues related to income statement structure, calculations, and content typically concludes the exercise.
Conclusion
This exercise helps develop student skills necessary for basic appraisal and understanding of a firm’s performance situation. It meets instructors’ needs for a relatively quick and direct lesson that minimally sacrifices time needed for core course content. Although it does not delve into diagnosing performance issues, it lays the essential groundwork for the later-phase diagnostic analysis and prioritization of alternative actions that are required of students in case analysis assignments occurring later in the course.
I have used this exercise in over a dozen class sections, and many students have enthusiastically expressed that the appraisal method is easily understood and is more straightforward than what they recall from prior financial analysis courses. This enthusiasm, I believe, indicates greater confidence and lowered anxiety some students experience about this task. Even students with well-developed financial analysis skills have expressed appreciation about how this approach provides a valuable new perspective on the character of a firm’s current performance. Most important, evidence of student learning is encouraging. The performance appraisal analyses within students’ major case analyses are consistently more valid and meaningful in course sections using this exercise compared with my prior sections in which the approach to performance appraisal was more ambiguous and based on more generalized ratio analysis.
Supplemental Material
MTR-19-0024-EE_FINAL_Instructor_Notes – Supplemental material for Tackling Weaknesses in Students’ Financial Analysis Capabilities: A Value-Based Exercise for Strategic Management Courses
Supplemental material, MTR-19-0024-EE_FINAL_Instructor_Notes for Tackling Weaknesses in Students’ Financial Analysis Capabilities: A Value-Based Exercise for Strategic Management Courses by William R. Carter in Management Teaching Review
Supplemental Material
PPt_Slides_Value_Creation_Value_Capture – Supplemental material for Tackling Weaknesses in Students’ Financial Analysis Capabilities: A Value-Based Exercise for Strategic Management Courses
Supplemental material, PPt_Slides_Value_Creation_Value_Capture for Tackling Weaknesses in Students’ Financial Analysis Capabilities: A Value-Based Exercise for Strategic Management Courses by William R. Carter in Management Teaching Review
Supplemental Material
Sample_Income_Statement_and_Worksheet – Supplemental material for Tackling Weaknesses in Students’ Financial Analysis Capabilities: A Value-Based Exercise for Strategic Management Courses
Supplemental material, Sample_Income_Statement_and_Worksheet for Tackling Weaknesses in Students’ Financial Analysis Capabilities: A Value-Based Exercise for Strategic Management Courses by William R. Carter in Management Teaching Review
Footnotes
Appendix A
Appendix B
Declaration of Conflicting Interests
The author declared no potential conflicts of interest with respect to the research, authorship, and/or publication of this article.
Funding
The author received no financial support for the research, authorship, and/or publication of this article.
References
Supplementary Material
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