Question

Describe at least two potential problems associated with an over-reliance on various performance measures like profitability, stock price, or market share.

Answer 1

Problems associated with over reliance on market share

It always does not follow that "more" is always going to be "better". A large market share can spell more trouble as well as more profit for a company; a given project promising higher returns than others will surely entail greater risks as well. Given this direct link between profit and risk, it behooves companies to manage their market shares with the same diligence as they manage any other facet of their businesses.Although most companies can profit by attempting to increase their market shares, some conclude that they are at (or possibly beyond) the point at which expected costs and risks outweigh expected gains. The company that acquires a very high market share exposes itself to a number of risks that its smaller competitors do not encounter. A larger market share usually means greater public visibility; consumer groups may choose the more visible companies as the targets of their complaints, demonstrations, and lawsuits. The high market-share company also has to cope with antitrust initiatives taken by the government.

Problems associated with over reliance on profitability

There is many a times lack of comparability between companies and requires further investigation.

No indication of causes of change is shown and business owners must dig deeper into the numbers to determine why ratios are changing from year to year.

Profitability ratio does not measure the management's quality. It do not capture all of the important information that tells stakeholders how the business is doing today and helps them predict where it is going in the future. One of the key determinants of business success is the quality and experience of the management team. This information cannot be derived directly from financial ratios although large ratio swings can give an indication.

Problems associated with over reliance on stock price

Stock price is very volatile and is affected by various factors like:

Systemetic risk which takes into consideration day to day price fluctuations of market.

Business risk is there i.e if business is not doing well it may fluctuate the stock price.

Liquidity risk also comes into play when company with high debt may find it hard to pay their bills

Taxability risk arises when government changes tax all the time which may increase or decrease the stock price.

Trying to predict future price of the stock is difficult because of above associated risks.