Goals,%20Values%20and%20Performance

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Goals, Values and Performance
OUTLINE

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

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Strategy as a Quest for Profit

• The stakeholder approach The firm is a
  coalition of interest groupsit seeks to balance
  their different objectives

• The shareholder approach The firm exists to
  maximize the wealth of
• its owners ( max. present value of profits
  over the life of the firm)

• For the purposes of strategy analysis we assume
  that the primary goal of the firm is profit
  maximization.
• Rationale
• Boards of directors legally obliged to pursue
  shareholder interest
• To replace assets firm must earn return on
  capital gt cost of capital
• (difficult when competition strong).
• Firms that do not max. stock-market value will be
  acquired

Hence Strategy analysis is concerned with
identifying and accessing the sources of profit
available to the firm
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From Profit Maximization to Value Maximization

• Profit maximization an ambiguous goal
• Total profit vs. Rate of profit
• Over what time period?
• What measure of profit?
• Accounting profit versus economic profit (e.g.
  Economic Value Added Post-tax operating profit
  less cost of capital

Maximizing the value of the firm Max. net
present value of free cash flows max. V St
Ct (1 r)t
Where V market value of the firm. Ct
free cash flow in time t r weighted
average cost of capital
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The Worlds Most Valuable Companies Performance
Under Different Profitability Measures
COMPANY MARKET CAP. (BN.) NET INCOME (BN) RETURN ON SALES () RETURN ON EQUITY () RETURN ON ASSETS () RETURN TO SHARE-HOLDERS ()
Exxon Mobil 372 36.1 19.9 34.9 17.8 11.7
General Electric 363 16.4 10.7 22.2 14.7 (1.5)
Microsoft 281 12.3 40.3 30.0 18.8 (0.9)
Citigroup 239 24.6 22.0 21.9 1.5 4.6
BP 233 22.3 9.9 27.9 10.7 10.2
Bank of America 212 16.5 27.0 14.1 1.2 2.4
Royal Dutch Shell 211 25.3 14.7 26.7 11.6 11.8
Wal-Mart 197 11.2 5.5 21.4 8.1 (10.3)
Toyota Motor 197 12.1 10.7 13.0 4.8 (22.1)
Gazprom 196 7.3 28.1 9.8 7.1 n.a.
HSBC 190 15.9 23.0 16.3 1.0 (11.8)
Procter Gamble 190 8.7 17.3 13.7 6.4 7.2
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Shareholder Value Maximization and Strategy Choice

• The Value Maximizing Approach to Strategy
  Formulation
• 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

• Problems
• Estimating cash flows beyond 2-3 years is
  difficult
• Value of firm depends on option value as well as
  DCF value

• Implications for strategy analysis
• Some simple financial guidelines for value
  maximization
• On existing assetsmaximize after-tax rate of
  return
• On new investmentseek rate of return gt cost of
  capital
• Utilize qualitiative strategy analysis to
  evaluate future profit potential

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Valuing Companies and Business Units

• If net case flow growing at constant rate (g)
• V C1
• ( r - g )
• With varying cash flows which can be forecasted
• for 4 years
• V C0 C1 C2 C3
  VH
• (1 r ) (1 r )2 (1 r )3
  (1 r )3
• where VH is the horizon value of the firm
  after 4 years

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Financial options
Real options
Comments
Present value of returns to the investment
The greater the NPV, the higher the option value
Stock price

Exercise price
The higher the cost, the lower the option value
Investment cost

OPTION VALUE
Uncertainty
Uncertainty
Higher volatility increases option values

Time opportunity to learn about outcomes
Time to expiry
Duration of option

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

Risk-free Interest rate
Risk-free interest rate
Higher interest rate increases option value by
increasing value of deferring investment

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The six levers of financial and real options
Financial options
Real options
Comments
Present value of returns to the investment
Higher NPV raises option value
Stock price

Exercise price
Higher cost lowers option value
Investment cost

OPTION VALUE
Uncertainty
Uncertainty
Higher volatility increases option value

More time allows more information to be taken
into account
Time to expiry
Duration of option

As profit is lost to rivals, option value is
lowered
Dividends
Value lost over duration of option

Risk-free Interest rate
Risk-free interest rate
A higher interest rate increases option value by
increasing the value of deferring investment


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Performance Diagnosis Disaggregating Return on
Capital Employed
COGS/Sales
Margin (Return on Sales)
Depreciation/Sales
SGA expense/Sales
ROCE
Fixed asset turnover (Sales/PPE)
Inventory Turnover (Sales/Inventories)
Asset productivity (Sales/Capital Employed)
Creditor Turnover (Sales/Receivables)
Turnover of other items of working capital
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Linking Value Drivers to Performance Targets
Order Size
Customer Mix
Sales Targets
Sales/Account
Customer Churn Rate
Margin
cogs/ sales
Deficit Rates
Cost per Delivery
Development Cost/Sales
Maintenance cost
Shareholder value creation
ROCE
New product development time
Indirect/Direct Labor
Inventory Turnover
Customer Complaints
Economic Profit
Capital Turnover
Downtime
Capacity Utilization
Accounts Payable Time
Cash Turnover
Accounts Receivable Time

CEO
Corporate/Divisional
Functional
Departments Teams
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Balanced Scorecard for Mobil N. American
Marketing Refining
Strategic Objectives
Strategic Measures
F I N A N C I A L
F1 Return on Capital Employed F2 Cash Flow F3
Profitability F4 Lowest Cost F5 Profitable
Growth F6 Manage risk
ROCE Cash Flow Net Margin Full cost
per gallon delivered to customer Volume
growth rate Vs. industry Risk index
Financially Strong
C O U M S E T R -
C1 Continually delight the targeted
consumer C2 Improve dealer/distributor
profitability
Share of segment in key markets Mystery
shopper rating Dealer/distributor margin on
gasoline Dealer/distributor survey
Delight the Consumer Win-Win Relationship
I1 Marketing 1. Innovative products and
services 2. Dealer/distributor
quality I2 Manufacturing 1. Lower
manufacturing costs 2. Improve hardware
and performance I3 Supply, Trading, Logistics
1. Reducing delivered cost 2.
Trading organization 3. Inventory
management I4 Improve health, safety, and
environmental performance I5 Quality
I N T E R N A L
Non-gasoline revenue and margin per square
foot Dealer/distributor acceptance rate of new
programs Dealer/distributor quality ratings
ROCE on refinery Total expenses (per gallon)
Vs. competition Profitability index Yield
index Delivered cost per gallon .Vs.
competitors Trading margin Inventory level
compared to plan to output rate Number of
incidents Days away from work Quality index
Safe and Reliable
Competitive Supplier
Good Neighbor
On Spec On time
L E A G R R N O I W N T G H
L1 Organization Involvement L2 Core
competencies and skills L3 Access to strategic
information
Employee survey Strategic competing (?)
availability Strategic information
availability
Motivated and Prepared
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A Comprehensive Value Metrics 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

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The Paradox of Value

• The companies that are most successful in
  creating
• long term shareholder value are typically those
  that
• Have a missionThey give precedence to goals
• other than profitability and shareholder
  return
• Have strong, consistent, ethical values.

• Examples
• Visionary companies studied by Collins
  Porras,
• e.g. Merck, Wal-Mart, Procter Gamble, Disney,
  HP
• Boeing Focus pre-1996 to build great
  planes, weak
• financial controlsyet high profitability
• Focus 1997-2003 creating
  shareholder
• valueOutcome loss of market leadership,
• declining profitability