A firm's internal resources, external resources, and external environment affect firm performance (Han, Chao and Chuang, 2012). Mainstream strategic management research attributes the persistence of superior performance to sustained competitive advantage, the sources of which lie in industrial structure (Porter, 1985) or firm-specific factors such as idiosyncratic and imitable resources (Barney, 1991), knowledge management (Grant, 1996), and capabilities (Teece, Pisano, and Shuen, 1997). Notwithstanding the diverse views of scholars regarding these sources, all suggestions share the characteristic of invisibility. Investigation of long-term observed outcomes, especially annual financial performance, is a feasible solution to investigate the latent sources of sustained competitive advantage (Tang and Liou, 2010). Empirical studies in this field have connected sustained competitive advantage to financial metrics, with
Table 4
Winners’ Club in the Computer-based Business Services Industry
Company Obs. Percentage of years achieving superior performance
years ROA ROE ROIC PM MTB EPS PE
Table 5
Percentage of years achieving superior performance after millennium
Performers Period ROA ROE ROIC PM EPS MTB PE
Winners 2000-2012 97.3% 75.4% 62.7% 95.6% 80.9% 92.9% 66.6%
2009-2012 95.9% 79.1% 56.1% 95.9% 75.0% 93.2% 56.1%
Non-winners 2000-2012 25.6% 18.4% 15.3% 24.4% 18.8% 13.9% 15.5%
2009-2012 25.7% 9.9% 8.4% 23.7% 13.8% 9.7% 14.3%
performance as the interface. Denoting sustained competitive advantage as the attained position of a firm undertaking strategies to create, capture, and retain value over an extended time, thereby propelling growth, our paper strengthens the connection between sustained competitive advantage and observed long-term value, in order to better serve the major objective of strategic management research.
The proposition that competitive advantage determines the value created by a firm is not unique to strategy research; it also appears in financial studies.
Financial scholars indicate that the value of GO depends on the permanent competitive advantage created as a result of strategy planning (Myers, 1984:
130), and provides a basis to explain the heterogeneity within an industry (Kogan and Papanikolaou, 2010: 532). In dynamic competition, the financial literature attributes sustained high stock returns during periods of environmental turmoil to invisible factors such as business model (Chen, Chu and Huang, 2012;
Fahlenbrach, Prilmeier, and Stulz, 2012), entrepreneurship (Gompers et al., 2010), and other managerial explanations (Rouse and Daellenbach, 1999; Spanos and Lioukas, 2001; Qi, 2015).
Myers (1984: 130) states that ‘Finance theory and strategic planning could be viewed as two cultures looking at the same problem.’ Sustained competitive advantage is about the ability of a firm to create future value. The future value will be generated from a firm’s decisions and activities on new investment projects that bring products/services to the marketplace. These physical projects must both satisfy consumers’ needs and generate positive net present value (NPV) to the firm. Although strategy theory refers to the value created in terms of consumers’ willingness to pay (V), the value captured by the firm (i.e., P - C ) could be a minimum measurement of competitive advantage. Just as financial
analysts evaluate whether the firm’s investment projects meet positive-NPV criterion, managers should always check the valuation results with a strategic analysis before making a decision (Myers, 1984: 130). To extend the valuation of individual investment projects to growth opportunities of the entire firm, strategic management factors such as sustained competitive advantage should be incorporated into the valuation model.
In the PVGO model, the status of sustained competitive advantage should be determined before a firm can be evaluated. Strategy theory provides a theoretical background to infer the status of sustained competitive advantage by observing the long-term persistence of superior financial performance. Prior studies use performance changes between consecutive years to examine persistence.
According to the proposition that sustained competitive advantage correlates with persistent superior performance, firms that present a smaller variation of financial performance are more sustained than others. Ironically, greater growth opportunities are usually associated with more volatile performance (Bartram, Brown, and Stulz, 2012). Examining the variation of annual performance changes therefore might not identify firms with great opportunities to grow, especially in emerging industries. Instead of using performance changes between two years, our paper uses the LCGA with logit model to derive the latent performance trajectories in the sample over the entire observed period. LCGA identifies the group of firms with persistent superior performance and a homogenous growth trajectory.
One of our main findings is that choosing a different financial variable to measure performance changes the memberships of the different groups identified by the LCGA model. This is because firm’s strategic choices do not affect all financial indicators in the same way. For example, return-type indicators favor firms with low employment of fixed assets, while dollar-based indicators ignore tangible costs. The diverse results obtained using different financial indicators are also evident in previous studies. For instance, Powell (2003: 70) found that the frequency of wins changes depending on whether one measures performance in terms of profits or returns on sales, for IBM, Dupont, and entire industries.
Wiggins and Ruefli (2002: 93) also identify different groups of persistent superior performers using the ROA and Tobin’s q measures. Relying on a single
financial ratio to identify high performers can therefore lead investors to misleading inferences about the intrinsic superiority of firms.
To avoid this ambiguity, we define winners as firms classified in the superior trajectory group under all the seven performance indicators, each of which reflects a different aspect of resource employment. The market share of these 37 winners increased from 26% in 2000 to 58% in 2012, confirming their domination of the computer-based services industry.
The results of our paper imply that although one may not be privy to the strategies of a firm or the sources of superior performance, so long as the firm continues to effectively manage resources and create value it will display persistent financial superior performance. This implication supports the proposition of equifinality: even without knowing their underlying strategic differences, firms can be grouped simply by their observed performance (von Bertalanffy, 1968; Katz and Kahn, 1978).
Our research can be extended for various purposes. Firstly, we can use the performance trajectories of the groups to estimate the expected growth level of a firm and thereby determine its value. This approach can be complimentary to conventional financial valuation models. Secondly, the computer-based services industry is still new and has been growing fast since the millennium. The number of years in this study is only 12, after excluding the first year for the lagged performance. It is interesting to apply this analysis to mature industries with longer sample periods, such as food and beverage, airline, and telecommunications. With a longer series, the LCGA model can investigate transitions between value-creating strategies by incorporating a time-varying resource configuration factor. A longer study period can also be divided into phases corresponding to economic environmental shocks, such as the Internet bubble in 2000 and the financial crisis in 2007, in order to distinguish firms that successfully sustained their competitive advantage across phases from those with only a temporary advantage. Thirdly, the LCGA groups can be used as a basis for growth mixture models or other growth models in order to examine the common factors within groups and heterogeneous factors between different groups. This extension of the model would help identify sources for the observed differences in performance trajectories. Finally, the winners identified by LCGA are useful benchmarks for case studies to investigate the possible sources of competitive
advantage in individual firms. One of the constraints of LCGA is that it assumes that all individual differences in estimated suicidality trajectories are characterized by class membership. This assumption might underestimate the heterogeneity within class in a large sample size.