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Excerpts from the Book > Chapter 4

Chapter 4 : Analyzing Competitive Strategy

Excerpt from Chapter 4

Competitive strategy analysis lies at the heart of security analysis. The surest way for investors to anticipate expectations revisions is to foresee shifts in a company's competitive dynamics. These shifts lead to a revised outlook for sales, costs, or investments—the value triggers—and initiate the expectations investing process. For investors, competitive strategy analysis is an essential tool to play the expectations game successfully.

The competitive strategy literature focuses on prescriptions for management action. But investors can use the same strategic tools, albeit in a different way.

Management's objective is to create value by investing at above the cost of capital. Indeed, sustainable value creation is the signature of competitive advantage. And since a company's competitive advantage hinges squarely on the quality and execution of its strategies, competitive strategy analysis is vital to planning and decision-making.

Investors play a very different game. They generate superior returns when they correctly anticipate revisions in market expectations in a company's performance. Investors do not earn superior rates of return on stocks that are priced to fully reflect future performance—even for the best value-creating companies—which is why great company are not always great stocks. Investors use competitive strategy analysis as a means to foresee expectations revisions.

Questions Addressed in Chapter 4

To explore the power and relevance of competitive strategy analysis, Chapter 4 answers the following questions:

  • How can a company's historical results help investors know what to anticipate?
  • How does relative industry stability make historical results more or less useful in anticipating future results?
  • Four competitive strategy frameworks—Porter's Five Forces, Porter's Value Chain Analysis, Christensen's "disruptive technology" model, and Shapiro and Varian's "information rules" framework—are particularly useful for anticipating expectations changes. When is each framework most useful? How does each framework work?

Essential Ideas in Chapter 4

  • The surest path to anticipating expectation shifts is to foresee shifts in a company's competitive dynamics.
  • Management and investors have different performance hurdles. Management tries to achieve returns above the cost of capital. Investors try to anticipate changes in market expectations correctly.
  • Historical performance provides insight into potential value driver variability by showing which operating value drivers have been most variable in the past. This type of analysis provides a reality check on expectations ranges.
  • Four competitive strategy models can help investors better anticipate expectations changes:
    1. Five Forces
    2. Value chain
    3. Disruptive technology
    4. Information rules
  • Although the laws of economics haven't changed, the characteristics of knowledge companies differ from those of physical companies.


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