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 (r-g) With varying cash flows which can be forecasted for years: V=C + C + (1 + r ) where: V H C + C + (1 + r )2 (1 + r )3 V H (1 + r )3 is the horizon value of the firm after 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 Manufacturing Lower manufacturing costs Lower manufacturing costs 2.1.Improve hardware and performance Improve hardware and performance * * * * I3 Supply, Trading, Logistics I3 Supply, Trading, Logistics Reducing delivered cost Reducing delivered cost 2.1.Trading organization Trading organization 3.2.Inventory management 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 Marketing Innovative products and services Innovative products and services 2.1.Dealer/distributor quality 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  ... 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. .. 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... dealer/distributor profitability C2 Improve dealer/distributor profitability * Dealer/distributor margin on gasoline Dealer/distributorsurvey margin on gasoline * *Dealer/distributor * Dealer/distributor