To accompany contemprory strategy analysis concepts techiniques application chapter02slides

Goals,
Goals, Values
Values and
and Performance
Performance
OUTLINE
•
•
•
•
•

Strategy as a quest for value
What is profit?
The shareholder value approach
The shareholder value and strategy formulation
Mission and values


Strategy
Strategy as
as aa Quest
Quest for
for Profit
Profit
•

The stakeholder approach : The firm is a coalition of interest groups—it seeks to balance their

•

The shareholder approach : The firm exists to maximize the wealth of its owners.

•

Why is profit maximization a reasonable goal?

different objectives.

(1) Boards of directors legally obliged to pursue shareholder
interests.
(2) To replace assets, firm must earn return on capital > cost of
capital (difficult when competition intense).
(3) To avoid acquisition, firm must achieve stock-market
value > break-up value.


What
What is
is Profit?
Profit?
•

Profit maximization an ambiguous goal

•
•

Accounting profit versus Economic profit

•

From profit maximization to value maximization

– Total profit vs. Rate of profit
– Over what time period?
Economic Value Added (EVA) as a measure of economic profit:

— Post-tax operating profit less cost of capital
—Net present value of firm = Discounted future profits
over the life of the firm


How
How U.S.
U.S. Companies
Companies Perform
Perform Under
Under
Different
Different Profitability
Profitability Measures,
Measures, 1998
1998
Net Inc. ROS
($m)
General Motors
2,956
General Electric 6,573
Exxon
6,370

Philip Morris
5,450
IBM
6,328
Coca-Cola
3,533
Wal-Mart
4,430
Procter & Gamble 3,780
Microsoft4,490
31.0
Hewlett-Packard 2,945

(%)
1.8
9.4
6.3
10.3
7.7
18.8
3.2
10.2
27.0
6.3

ROE
(%)
19.7
22.2
14.6

39.0
32.6
42.0
21.0
12.2
3,776
17.4

EVA

Market
Return to
Value Added Shareholders
($m)
($m)
(%)
-5,525
-17,943
21.4
4,370
285,320
45.3
-2,262
114,774
22.4
5,180
98,657
64.8
2,541
-5,878

77.5
2,194
157,356
1.3
1,159
159,444
107.7
61,661 102,379
15.9
328,257
37.5
-593
45,464
10.7


Value
Value Maximization
Maximization
Maximizing the value of the firm:
Max. net present value of free cash flows :

max. V =

t

Ct
(1 + re)t
Where:
V

market value of the firm.
Ct free cash flow in time t
re+d weighted average cost
of capital


Applying
Applying Shareholder
Shareholder Value
Value
Maximization
Maximization to
to Strategy
Strategy Choice
Choice
•

Identify strategy alternatives

•

Estimate cash flows associated with cash strategy

•

Estimate cost of capital for each strategy

•

Select the strategy which generates the highest NPV

Valuing
Valuing Companies
Companies and
and Business
Business Units
Units
If net case flow growing at constant rate (g)

V=

C

1

(r-g)

With varying cash flows which can be forecasted
for 4 years:

V=C

0

+

C

1

+
(1 + r )

where: V

H

C
2

+

C

3

+

(1 + r )2 (1 + r )3

V

H

(1 + r )3

is the horizon value of the firm after 4 years

Problems
Problems of
of DCF
DCF Approaches
Approaches to
to
Strategy
Strategy Approach
Approach
•

Net Present Value of the Firm depends on option values as well as discounted cash
flow expectations

•

Estimating cash flows beyond 2-3 year horizon is
hazardous---especially in dynamic markets

HENCE: Some simple guidelines for maximizing
the value of the firm—

• On existing assets-- maximize after-tax rate
of return
• On new investment-- seek after-tax rate of
return > cost of capital


The
The six

six levers
levers of
of financial
financial and
and real
real options
options
Financial options

OPTION
VALUE

Real options

Comments

Present value of
returns to the
investment

The greater the NPV, the
higher the option value

Stock price

=

Exercise price

=

Investment cost

The higher the cost, the
lower the option value

Uncertainty

=

Uncertainty

Higher volatility
increases option values

Time to expiry
Dividends

= Duration of option
=

Time = opportunity to
learn about outcomes

Loss of cash flow to fully
Value lost over
duration of option -committed competitors
lowers option value

Risk-free

Interest rate

=

Risk-free
interest rate

Higher interest rate
increases option value
by increasing value of
deferring investment


Disaggregating
Disaggregating Return
Return on
on Capital
CapitalEmployed
Employed
COGS/Sales
Return on
Sales

Depreciation/
Sales
SGA expense/
Sales

ROCE

Fixed Asset Turnover
Sales/PPE
Inventory Turnover
Sales/Inventories
Sales/Capital
Employed

Creditor Turnover
Sales/Acct
Turnover of other
items of working
capital


Linking
LinkingValue
ValueDrivers
Driversto
to Performance
Performance Targets
Targets
Sales
Sales
Targets
Targets
Margin
Margin
Shareholder
Shareholder
value

value
creation
creation

Development
Development
Cost/Sales
Cost/Sales

ROCE
ROCE

Economic
Economic
Profit
Profit

cogs/
cogs/
sales
sales

Inventory
Inventory
Turnover
Turnover
Capital
Capital
Turnover
Turnover

Capacity
Capacity
Utilization
Utilization
Cash
Cash
Turnover
Turnover

CEO

Corporate/Divisional

Functional

Order Size
Customer Mix
Sales/Account
Customer Churn
Rate
Deficit Rates
Cost per Delivery
Maintenance cost
New product
development time
Indirect/Direct
Labor
Customer
Complaints

Downtime
Accounts Payable
Time
Accounts
Receivable Time

Departments & Teams


Balanced
BalancedScorecard
Scorecardfor
forMobil
MobilN.
N.American
AmericanMarketing
Marketing&&Refining
Refining
Strategic Objectives
Financially
Strong

Delight the
Consumer
Win-Win
Relationship

Safe and
Reliable

Competitive
Supplier
Good Neighbor

F
I
N
A
N
C
I
A
L

CO
UM
SE
TR
-

I
N
T
E
R
N
A
L

Motivated

and
Prepared

F1 Return on Capital Employed
Return
on Capital Employed
F2F1Cash
Flow
Cash Flow
F3F2Profitability
Profitability
F4F3Lowest
Cost
F4
Lowest Cost
F5 Profitable
Growth
Profitable
F6F5Manage
riskGrowth
F6 Manage risk

*
*
*
*
*
*

C1 Continually delight the targeted consumer

C1 Continually delight the targeted consumer

* Share of segment in key markets
Share of
segment
in key markets
* *Mystery
shopper
rating
* Mystery shopper rating

C2 Improve dealer/distributor profitability
C2 Improve dealer/distributor profitability

* Dealer/distributor margin on gasoline
Dealer/distributorsurvey
margin on gasoline
* *Dealer/distributor
* Dealer/distributor survey
Non-gasoline revenue and margin per square foot
*Dealer/distributor
Non-gasoline revenue
and margin
square
foot
acceptance
rate ofper
new
programs
*Dealer/distributor

Dealer/distributorquality
acceptance
ratingsrate of new programs
* Dealer/distributor quality ratings

I2 Manufacturing
I2 1.
Manufacturing
Lower manufacturing costs
Lower manufacturing
costs
2.1.Improve
hardware and performance
2. Improve hardware and performance

*
*
*
*

I3 Supply, Trading, Logistics
I3 1.
Supply,
Trading,
Logistics
Reducing
delivered
cost
Reducing
delivered cost

2.1.Trading
organization
Trading organization
3.2.Inventory
management
3. Inventory management

ROCE on refinery
*Total
ROCE
on refinery
expenses
(per gallon) Vs. competition
*Profitability
Total expenses
index(per gallon) Vs. competition
*Yield
Profitability
index index
* Yield index

Delivered cost per gallon .Vs. competitors
cost per gallon .Vs. competitors
* Delivered
Trading margin
Trading margin
* *Inventory
level compared to plan & to output rate
* Inventory level compared to plan & to output rate

I5 Quality
I5 Quality

L
E
A
R
N
I
N
G

&
G
R
O
W
T
H

ROCE
*Cash
ROCE
Flow
*Net
Cash
Flow
Margin
*Full
Netcost

Margin
per gallon delivered to customer
*Volume
Full cost
per gallon
delivered
growth
rate Vs.
industryto customer
*Risk
Volume
indexgrowth rate Vs. industry
* Risk index

*
*
*

I1 Marketing
I1 1.
Marketing
Innovative products and services
Innovative products
and services
2.1.Dealer/distributor
quality
2. Dealer/distributor quality

I4 Improve health, safety, and environmental performance
I4 Improve health, safety, and environmental performance

On Spec
On time

Strategic Measures

* Number of incidents
* Number
incidents
* Days
awayoffrom
work
* Days away from work
* Quality index
* Quality index

L1 Organization Involvement
L1 Organization Involvement

* Employee survey
* Employee survey

L2 Core competencies and skills
L2 Core competencies and skills

* Strategic competing (?) availability
* Strategic competing (?) availability

L3 Access to strategic information
L3 Access to strategic information

* Strategic information availability
* Strategic information availability


AAComprehensive
Comprehensive Value
Value Metrics
MetricsFramework
Framework

Shareholder
Value
Measures:
• Market value of the
firm
•Market value added
(MVA)
•Return to
shareholders

Intrinsic
Value
Measures:
• Discounted cash
flows
•Real option values

Financial
Indicators

Measures:
• Return on Capital
• Growth (of
revenues & operating
profits
•Economic profit (EVA)

Value
Drivers
Sources:
• Market share
• Scale economies
• Innovation
• Brands


The
The Paradox
Paradox of
of Value
Value
The companies that are most successful in creating
long term shareholder value are typically those that:

a)

Have a mission—They give precedence to goals

a)

Have strong, consistent, ethical values.

other than profitability and shareholder return;

Examples:
a) “Visionary” companies studied by Collins & Porras,
e.g. Merck, Wal-Mart, Procter & Gamble, Disney, HP
b) Boeing — Boeing’s focus pre-1996: “to build great planes”
with weak financial controls
— post-1996 focus: creating shareholder value
— after 2000, rapid decline in Boeing profitability


Values
Values and
and Mission
Mission
The role of (ethical) values :

• Place constraints on the means by which the firm
will pursue shareholder value max.
• Increase the effectiveness with which the firm builds
competitive advantage though reinforcing strategic
intent and building internal consensus and
commitment.
The role of mission:

• Foundation for strategy
Statement of what the
firm seeks to achieve and what it intends to become.