Value Creation under Low Growth Condition

During an economic boom, when the market demand exceeds the industry capacity, it is easier for firms to grow, remain profitable and create value. There is not much of a need to understand what a competitive advantage is and where and how value is created. Firms can easily create value without a competitive advantage.

In contrast, the recent economic crisis has resulted in lower growth and lesser profitability to firms across all industries. In an economic downturn, there is less demand for industry products, which leads to higher industry capacity. Although, there can be other reasons in which capacity can exceed market demand. This unfavorable market condition alters a company’s competitive position (if there is any) and erodes the structural attractiveness of industries–resulting in poor performance with lower sales, lower profits, or even losses. Lower demand and excess industry capacity also lead to price wars among competitors that ultimately reduce the industry profitability. To stop the bleeding and stabilize the situation, companies have been responding by taking reactive measures like downsizing & across-the-board cost-cutting to improve short-term performance without thinking of the long-term consequences of these actions. The contraction and consolidation strategies, if not used carefully, can further weaken the firm’s competitive position and delay its recovery. As short-term measures are equally important to improve performance, companies should also look for new opportunities and focus on value creation. Michael Porter defines value as, “in competitive terms, the amount buyers are willing to pay for what a firm provides them. Value is measured by total revenue… A firm is profitable if the value it commands exceeds the costs involved in creating the product” (Porter, 1985: 38).

When industry capacity exceeds demand, firms must have a competitive advantage to survive. A firm’s ability to create value under this condition and enjoy a competitive advantage over other firms depends on how it repositions itself within its industry. To outperform competitors, companies first need to understand where and how value is created and destroyed. Then, by selecting value-driven goals and strategies, a firm can create the best fit between its abilities and market opportunities to maximize firm value. Research indicates that firms that systematically focus on creating value first are able to achieve higher value performance with respect to their competitors over the long-run. To realize a competitive advantage, a firm must create additional value than competitors to remain profitable and grow. This means earning a return that exceeds the firm’s cost of capital and the competitors’ return.

References and Further Reading

1. M. Porter, Competitive Advantage (New York: Free Press, 1985), Chapter 2.
2. T. L. Wheelen & J. D. Hunger, Strategic Management & Business Policy (NJ: Prentice-Hall, 2000), Chapters 5 and 6.