“The Blue Line Imperative is compelling, fun and provocative It is a must-read!” W Chan Kim, bestselling author of Blue Ocean Strategy, The BCG Chair Professor of INSEAD and the Co-director of the INSEAD Blue Ocean Strategy Institute “Professors Kaiser and Young bring a unique, entertaining and irreverent approach to teaching executives what it really means to create value – including the dangers of relying on conventional wisdom about performance measurement.” Tim Koller, author of Valuation: Measuring and Managing the Value of Companies “Kaiser and Young introduce a fresh perspective on what value really means and how to manage toward it This is an indispensable new look at the most important business issue all companies face.” Merlin Swire, Director, John Swire & Sons, Ltd “In our firm, we implemented a new culture emphasizing that Each of Us Counts to get everyone motivated to contribute When we added the focus on value creation as outlined by Kaiser and Young in The Blue Line Imperative, it ensured those contributions were oriented in the right direction for long-term success!” Alberto Grua, Senior Vice President, Grünenthal Europe, US & Australia and Management Board member “The Blue Line Imperative provides valuable lessons about what value is, how to measure it, and how to create it Many companies follow the red line, thinking it is the right thing to This book explains why the red line ultimately does not work and why the blue line does.” Steve Kaplan, Neubauer Family Distinguished Service Professor of Entrepreneurship and Finance, The University of Chicago Booth School of Business “The Blue Line Imperative is insightful, impactful, humorous and unique – and the first guide that I have ever come across that gets to the core of why leaders, managers and companies fail Embrace and apply these concepts.” Douglas Rosefsky, Managing Director at Alvarez & Marsal and two-time winner of the Turnaround of the Year Award (Turnaround Management Association, 2003 and 2010) “Kaiser and Young’s The Blue Line Imperative connects the dots in the customer–shareholder value puzzle and delivers a resonating message on the necessity of building a data-driven company In other words, stop chasing KPIs and start focusing on value creation that lasts.” Martin Heijnsbroek, Managing Partner, MICompany The Blue Line Imperative The Blue Line Imperative What Managing for Value Really Means By Kevin Kaiser and S David Young © 2013 John Wiley & Sons, Ltd Under the Jossey-Bass imprint, Jossey-Bass, 989 Market Street, San Francisco CA 94103-1741, USA www josseybass.com Registered office John Wiley & Sons Ltd, The Atrium, Southern Gate, Chichester, West Sussex, PO19 8SQ, United Kingdom For details of our global editorial offices, for customer services and for information about how to apply for permission to reuse the copyright material in this book please see our website at www.wiley.com All rights reserved No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, except as permitted by the UK Copyright, Designs and Patents Act 1988, without the prior permission of the publisher Wiley publishes in a variety of print and electronic formats and by print-on-demand Some material included with standard print versions of this book may not be included in e-books or in print-on-demand If this book refers to media such as a CD or DVD that is not included in the version you purchased, you may download this material at http://booksupport.wiley.com For more information about Wiley products, visit www.wiley.com Designations used by companies to distinguish their products are often claimed as trademarks All brand names and product names used in this book are trade names, service marks, trademarks or registered trademarks of their respective owners The publisher is not associated with any product or vendor mentioned in this book Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose It is sold on the understanding that the publisher is not engaged in rendering professional services and neither the publisher nor the author shall be liable for damages arising herefrom If professional advice or other expert assistance is required, the services of a competent professional should be sought Library of Congress Cataloging-in-Publication Data Kaiser, Kevin The blue line imperative : what managing for value really means / Kevin Kaiser and S David Young online resource Includes index Description based on print version record and CIP data provided by publisher; resource not viewed ISBN 978-1-118-51089-6 (ebk) – ISBN 978-1-118-51090-2 (ebk) – ISBN 978-1-118-51088-9 (hbk) 1. Management. 2. Value. 3. Strategic planning. I. Young, S David, 1955– II. Title HD31 658.4'01–dc23 2013020502 A catalogue record for this book is available from the British Library ISBN 978-1-118-51088-9 (hbk) ISBN 978-1-118-51089-6 (ebk) ISBN 978-1-118-51091-9 (ebk) ISBN 978-1-118-51090-2 (ebk) Set in 11/15 pt ITC Garamond Std Book by Toppan Best-set Premedia Limited Printed in Great Britain by CPI Group (UK) Ltd, Croydon, CR0 4YY Table of Contents Preface Acknowledgments ix xiii Chapter Chapter Chapter Chapter Chapter Chapter Chapter Chapter Chapter Chapter 10 Chapter 11 Chapter 12 Appendix 23 45 71 93 115 135 159 195 219 233 269 289 Index What is Value? The Global Capital Market The Opportunity Cost of Capital The Expected Future Free Cash Flows Blue Line Management Shifting to Blue The Hazard of Growth Creating a Blue Line Culture Trust and Hierarchy in Blue Line Management Value and Decision-Making Getting Net Present Value Right Becoming a Blue Line Manager Blue Line Questions 297 vii Kevin Kaiser To the thousands of MBA, EMBA and executive participants I have taught who have inspired me, driven me, and helped me over so many years to develop countless insights and concepts And to the thousands more I hope to teach in the future S David Young To my daughter Adiva 292 The Blue Line Imperative Questions about the four types of Resources your company uses – people, intellectual capital, physical capital, and finance – delve into the sources of energy the business depends on to deliver its value proposition to customers People • How many people we employ? • Through what incentives we motivate our people to well? Are there any counterproductive behaviors encouraged by our pay policies? • Which performance indicators are linked to senior management pay? • Do we have a stock option program? How far down the corporate hierarchy does it go? How is the size and value of option grants determined? What are the vesting rules, and they encourage long-term, value-oriented thinking? • Do we have an employee stock-ownership program? Does it cover all employees? • How much division of labor is there within the company? Does the average employee perform a narrow or broad range of tasks? • How many people per function we have compared to the competition? Can we explain the differences? • Are we effective at maintaining high morale and enthusiasm? What steps we take to achieve this on an ongoing basis? • How we ensure that employees are receiving “value” from their jobs such as intellectual stimulation, autonomy, development, training, recognition for performance, a sense of acknowledgment, and respect for their contribution and effort? • How steep is the organizational chart? How many steps exist between the Chief Executive Officer and the lowest-level employees? How many direct reports does the CEO have?1 What are our key values and beliefs? Are they documented and disseminated? How? • What constitutes acceptable and unacceptable behavior in our organization? Are these behavioral norms well understood? • To what extent we help our employees get the skills, knowledge, and tools they need to perform better at their jobs? 1 Note that, in general, the greater the number of direct reports to the CEO, the flatter the organization Appendix: Blue Line Questions 293 • Do the senior HR staff know the different headcounts at which various pieces of regulation kick in? Are systems in place to ensure compliance with health, safety, and employment laws? • How often are performance reviews conducted? What criteria are evaluated and discussed in these reviews? What is the link, if any, between these reviews and compensation? • To what extent are our employees computer-literate? • Do we maintain a good safety record? Is there a process in place to ensure that accidents are reported swiftly to top management? What procedures are documented and enforced to ensure that processes and procedures are updated and improved to reduce accidents? Intellectual Capital • What are our key intangible assets – brands, patents, copyrights, trademarks, licenses, human capital (“know-how”), customer relationships, supplier relationships, employee relationships, government relationships, etc? • How much we spend on intangibles each year? What measures we use to track how effectively we manage these assets? • Do we know what we want our website to accomplish? How well we feel it satisfies this aim? • How much we rely on customized software? Do we maintain intellectual rights over it? Is the documentation written down and up to date? • Do we have a logo or wordmark? Is it distinct and easy to recognize? Do we measure how much our logo and other branding resonates with customers? • How much we invest in R&D each year? How effective is our research program in terms of product or process innovation? • How we encourage innovation from our employees? Do we know if we’re good at it? How we measure this? • Do we tend to lead or lag within the industry in terms of innovation? Physical Capital • What fixed assets we have? • How quickly we turn over inventory? How many days of purchases we have in raw materials inventory? How many days for work-inprocess and finished goods? 294 The Blue Line Imperative • Are our facilities clean, well-lit, and secure? • Do those in Operations understand inventory management concepts such as “safety stock” and “economic order quantity”? • How common are back orders? How quickly are they cleared? • Do we provide our customers effective IT support? Do we have a Help Desk? Do we have a disaster recovery plan? Do we have offsite or “cloud” storage of critical files? • Do we have significant underutilized capacity? If so, we have a plan for using it? • What measures we use to track capital efficiency? How are we helping managers to understand and deliver on capital-efficiency improvements? Finance • How much cash are we sitting on? • Do we have a specific cash-management policy? • What is our capital structure? Are debt levels high or low relative to competitors? • Does our capital structure allow us to respond decisively to pricing threats from competitors? • Can we raise large amounts of financing if needed to fund significant value-creating capital investments? • Do we rely extensively on leasing? If so, why? • What sort of risks we face (e.g., foreign exchange, commodity price, interest rate, technological, political)? • Do we have a hedging program in place? If not, why not? What instruments we use for hedging? • Is there evidence that corporate treasury uses derivatives for purposes other than hedging? • Are our finance professionals able to explain their use of derivatives and other financial instruments clearly and convincingly? • How we assess capital-investment opportunities? What measures are used? NPV? Internal rate of return? Payback periods? • Are our financial reporting policies clear and appropriate? Do they differ in significant ways from those of our rivals? If so, why? • Is there evidence of any earnings management or unscrupulous accounting practices? Appendix: Blue Line Questions 295 • Have our financial statements received an unqualified audit opinion from a reputable accounting firm? Is there any evidence of “opinionshopping”? • Do we produce financial statements in a timely fashion? Questions about your Collaborators describe the relationships you maintain with suppliers and other partners Companies may also form joint ventures to reduce the risks associated with developing new businesses, or may form strategic partnerships with competitors who share a common interest (e.g., industry lobbying or agreeing on technical standards) • What we define as our “core” processes? • For non-core processes, which are done in-house and which are outsourced? • Why are the non-core processes done in-house not outsourced? • Who are our suppliers? • Which key suppliers are domiciled domestically, and which in other countries? • How efficiently we manage our supply chain? What benchmarks we use? What kind of terms and working arrangements have we negotiated with suppliers? • Do we have a just-in-time inventory system in any part of the business? If we don’t, is our supply chain sufficiently responsive and efficient to support one? • Do we have emergency plans in place in the event of supply-chain disruptions? • Do we maintain any collaborative arrangements with competitors? What purposes these arrangements serve? How we determine their effectiveness? Questions regarding your company’s Cost Model deal with how you compensate your collaborators and resources for giving you the energy 2 Opinion-shopping refers to the practice of dropping one auditor for another because the incumbent auditor has significant disagreements with company management on financial reporting policy, potentially compromising the ability of the company to get the unqualified opinion it is looking for 296 The Blue Line Imperative you need to deliver happiness to your customers Another way of putting it is they describe all of the costs you incur to operate your business, including operating leverage (the relative importance of fixed versus variable costs), economies of scale (cost advantages from growth in output), and economies of scope (cost advantages from a larger scope of operations) • What are our organization’s major costs? • How these costs compare, on a percentage basis, with our competitors? Can we explain these differences? • How have cost percentages trended in recent years? What factors account for these changes? • How much operating leverage (fixed vs variable costs) we have? Are efforts (e.g., outsourcing) underway to make more of our fixedcosts variable? • What steps have we taken, or are we taking, to improve operating efficiency? • What systems are in place to ensure continuous improvement in our key processes? • What is the nature of our regulatory environment? What are the primary regulations (environmental, labor law, worker safety) that apply to our company? Through what means we stay current on regulatory changes? • Do we have the necessary compliance capabilities to deal with regulatory and legal changes when they happen? • How our tax rates compare to others in our industry? If our rates are higher or lower, why? • How business-friendly is our home base? • How efficient is the business infrastructure in our home base? If there are important inefficiencies, how we work around them? Index accountability 216–18 accounting hidden reserves 100, 119–20 improved standards 30 joint standards 124n6 sale-and-leaseback 122–3 Accounts Payable 244, 249–50, 251 Accounts Receivable 244, 250, 251 acquisitions and mergers 34, 36–7, 118, 138, 209 Adjusted Present Value (APV) 254, 255 adverse selection 122 agency costs 33–4, 270–1 Alcoa 206–7 Amariutei, Frederic 211–12 Amazon 19, 39, 185–6, 228 AMC Entertainment 123–4 Anglo Irish Bank 37 Apple 19 APV see Adjusted Present Value arbitrage 78 Arcelor 36–7 Argentina 57–8, 125–6 Armstrong, Neil 25 assets 123, 251, 266–7 assumptions 166, 174, 187, 190, 238, 284 Australia 257 Baker, John 154n13 balance sheets 251, 262 banks 16, 29, 37–8, 54–5, 56 Barlow, Cynthia 41–2 basketball 269–74 Battier, Shane 269–70, 273–5 Baumol, William 13 Beinhocker, Eric 38, 97–8 benchmarking 155, 156–7 Bernstein, Peter 76 Bernstein, William 27, 30–1 The Big Bang Theory (TV show) 279 Bilstein, Frank 151 blue line culture 159–94 Alcoa 207 decision-making 171–3, 174–5 fairness 175–8, 182, 183–5 feelings and thoughts 167–8 human mind 161–5 learning from failure 212 objective and subjective thinking 165–6 trust 197, 199, 209 see also organizational culture Blue Line Imperative 93, 111, 133, 142, 267, 286–7 applying the concepts 275 culture and management systems 179 decision-making 172, 174 instinct 163 key performance indicators 124 setting an example 281 shift in thinking 134 subconscious-level thinking 165, 168 Sustainable Competitive Advantage 139 three pillars 175, 219 Toyota 227 two-sided accountability 217 value creation 96, 98, 199 value drivers 221 value-oriented companies 194, 195 297 298 The Blue Line Imperative blue line management 3, 93–114 becoming a blue line manager 275–86 blueshifting 115–34 key performance indicators 105–11, 124 non-observability 222 questions to ask 172, 275–6, 277, 289–96 relationship with red line management 111–14 trust 199 value-based decisions 224 “blue-ocean strategies” 153n12 Bohr, Niels 76–7, 220, 222 bonds 64, 126, 257–8, 259–61 bonuses 104, 133, 153–4, 157, 275, 279, 284 see also incentives Boston Consulting Group 152 Braudel, Fernand 26 Brin, Sergey 227 British East India Company 18, 140 Bryant, Kobe 273–4 Buchan, John 27 Buffett, Warren 3–4, 72, 120 business schools 152 Canada 4, 257 Canon 8–9 Canton, Mark 179 Capex see Capital Expenditures capital allocation of 31, 35, 39, 42 finance 294–5 intellectual 293 physical 293–4 as stored energy 47 see also Opportunity Cost of Capital Capital Asset Pricing Model (CAPM) 68, 262, 264 Capital Expenditures (Capex) 80, 81, 237 cash flow statement 252 forecasting 253 growth 143–4, 147 sale-and-leaseback 123 capital markets 21, 23–43, 45–6, 47, 258 economic growth 57 fairness 176 Opportunity Cost of Capital 50–1, 52–3, 68 risk 60–1, 66–7 short-termism 78 capitalism 19–20 CAPM see Capital Asset Pricing Model cartels 136 cash flow forecasts 234, 237–8, 250–4 cash flow statements 252 Caulkin, Simon 129–30 CEMEX 41 CEOs see chief executive officers “channel stuffing” 119 channels 291 cheating 131–2, 204–5 chief executive officers (CEOs) 34, 52, 60, 193 executive pay 33, 153–7 Swissair 209, 210 China 13, 14, 53 choice 4–5, 6–7, Chrysler 118, 174 coaching 167–8 COF see Cost of Funding COGS see Cost of Goods Sold collaborators 295 commodities exchanges 197 “commodity” interactions 197–8 Companies Act 27 compensation executive pay 33, 153–7 indicator-driven pay 275, 278–81 transactional and trust-based environments 198 transparency 202 see also incentives competition 136, 138, 139 competitive advantage 139–42, 143, 145–6, 152, 211, 229, 286–7 complexity 105, 106 “confirmation bias” 192 conscious-level thinking 161–2, 165, 172, 187, 188 consolidations 138 consultants 230–2 consumerism 4, 12, 17–21, 23 consumption 2, 5, 13–14, 46, 257 contracts 278, 279–80 corporate social responsibility 40 corporations, formation of 16 Index Cost of Funding (COF) 24, 32, 45–6 Opportunity Cost of Capital 50–1, 68, 256 Weighted-Average Cost of Capital 91–2 Cost of Goods Sold (COGS) 79–81, 237, 244, 245 forecasting 253, 266 growth 143–4 income statement 248 costs agency 33–4, 270–1 cost model 295–6 customer happiness estimating 242–6 investment in inventories 249 sunk 77, 121, 237, 283 see also Cost of Funding; Opportunity Cost of Capital “credibility bucket” 202–3 Culbert, Samuel 216, 217 culture see organizational culture customers 5–6, 8–9, 39, 138, 228–9 beliefs about 208–9, 231–2 Blue Line Imperative 111 market share 136 questions to ask about 290 signals from 206, 284 Toyota 199–200 CVS Corporation 123–4 Daimler-Benz 116–18, 154, 174 Damodaran, Aswath 61–2 data and logic 165–7, 169–71, 173, 216, 267 Battier’s blue line approach to basketball 273–4 data-gathering 189, 230–1 data integrity 276 expected future free cash flows 238 Google 228 Toyota 226, 227 De Vries, Jan 5, 19 debt balance sheet 251 cash flow statement 252 cost estimates 244 debtors’ prisons 27–8 estimation of debt beta 262, 263 expected future free cash flows 87–90 interest on 247 299 pre-modern times 15 relative riskiness 261–2 sale-and-leaseback 122 shareholder liability 27 technical default 112–13 Weighted-Average Cost of Capital 91 decision-making 93, 171–3, 174–5, 190, 191–2, 219–32 blue line attributes 282 experience 186–8 hierarchical structure 216 Net Present Value 83–4 trust leading to quicker 214–15 value diagram 285–6 default risk 257–8 delayering 215 depreciation 79–81, 237, 246–7 balance sheet 251 cash flow statement 252 forecasting 253 growth 143–4, 147 income statement 248 desire Dickens, Charles 27 disclosure requirements 30 discount rate 91, 92, 234, 235, 237–8, 254–65, 283 dissent 218, 284 diversification 29, 30, 33, 60–1, 65, 262 Dollé, Guy 36 Drucker, Peter Duncan, Tim 273 DuPont 213 Dutch East India Company 18, 19, 26, 29, 31–2, 36 Earnings Before Interest and Tax (EBIT) 79–81, 237 forecasting 253, 266 growth 143–4 income statement 248 Earnings Per Share (EPS) 99–100, 104 EBIT see Earnings Before Interest and Tax economic growth 55–8, 125–6, 259–61 Economic Profit (EP) 116–17 Economic Value Added (EVA) 104, 116, 153, 157 Edison, Thomas 178n2, 229 Einstein, Albert 76, 77, 223–4 Eisenhower, Dwight D. 233 300 The Blue Line Imperative Emerson, Ralph Waldo 17 employees 34, 104–5, 111, 192–3 company objectives 280–1 costs 243, 245–6 Daimler-Benz 117–18 empowerment of 215–16 fairness 175–6, 177–8, 182 lack of trust in managers 183–4 opinions by 170–1 pay increases 136–8 performance indicators 134 questions to ask about 292–3 sense of pride 283 Swissair 209–11 Toyota 200 trust 197–8, 200–2, 209 turnover 220 W L Gore & Associates 211–13 energy 46–9, 50, 56, 69, 159 instinct 164 rate of return 58 “risk-free rate” 54, 65 risk premium 58–9 England 16, 19, 20, 26, 27 Enron 1, 42, 119 entrepreneurs 12–13, 14, 16, 257 capital markets 23–4, 45–6 pre-modern times 28 red line management 112 EP see Economic Profit EPS see Earnings Per Share equity estimation of equity beta 262, 263 expected future free cash flows 87–8 relative riskiness 261–2 Weighted-Average Cost of Capital 91 equity markets 62–3, 66 European Union (EU) 204 EVA see Economic Value Added executive pay 33, 153–7 expected future free cash flows 71, 73–81, 94, 159, 233, 235 assumptions about 190 discounting 82–90, 91, 264 dishonest projections 150 Economic Profit 116–17 forecasting 250, 254 investment in inventories 249 see also Free Cash Flow experience 186–8 “experience curve” 151–2 experiments 223–4, 228–9 failure, learning from 106, 107, 175, 207–8, 212–14, 229, 277, 284 fairness 164, 175–8, 182, 192, 205, 209 blue line attributes 283 fair process 183–5 information sharing 207 Pixar 218 value-based culture 219, 224 value diagram 285–6 W L Gore & Associates 211 family ties 38 Farmer, Doyne 97 FCF see Free Cash Flow FDP see Fully Diversified Portfolio feelings 165, 167–8, 173 finance 294–5 Ford Motor Company 189 forecasts cash flow 234, 237–8, 250–4 EBIT/Revenues ratio 266 sales 240–1 France 10, 11–12, 14 Free Cash Flow (FCF) 79–81, 84–5, 86–90 forecasting 250, 253 growth 143–4, 146–7 mechanics of 235, 237–54 sale-and-leaseback 123 see also expected future free cash flows Frito Lay Fully Diversified Portfolio (FDP) 60–1, 62, 64, 67, 78, 87 funding 14–16, 23–4 see also Cost of Funding; investors “future”, meaning of 77–8 G7 countries 57 Galbraith, John Kenneth 19–20 GAP 40–1 Gardner, Dan 179 GDP see gross domestic product GE see General Electric GE Capital 107–8, 111 General Electric (GE) 119–20 General Motors (GM) 135, 153–4, 203 Germany 204, 257 Gerstner, Lou 193 Index Gillette 5–6 GM see General Motors Goetzmann, William N. 62 Goodhart, Charles 127–9 Google 39–40, 181n6, 194, 227–8, 281 Gore, Bill 213 see also W L Gore & Associates government bonds 64, 126, 257–8, 259–61 Greece ancient 14 modern 203–4, 205 gross domestic product (GDP) 55–7, 125–6, 257, 259–61 growth 135–57, 283 executive pay 156–7 obsession with 135–6, 151–3 Swissair 209 versus value 142–50 value-destroying 150–1 see also economic growth guesses 186–8 Haidt, Jonathan 196 “halo effect” 37 Hamel, Gary 202 happiness 2–7, 8, 20–1, 71, 159–60, 235 Harford, Tim 201, 228–9 Harrison, John 24 Hayek, Friedrich 121 Heisenberg, Werner 127, 220, 221, 222 Hewlett-Packard 201 hierarchy 190–1, 208–14, 215–18 HiPPOs (Highest-Paid Person’s Opinions) 186 Hoff, Karla 38 Honegger, Eric 210–11 Hoseus, Michael 202 Hoskin, Keith 129 Howard, Dwight 272–3 Huizinga, John 272 human mind 160, 161–5 Hume, David 128–9 hypothesis testing 221, 224–5, 228 IBM 155, 193 incentives 24–6, 31, 110, 208, 284 blue line culture 160 executive pay 153–5, 156, 157 301 indicator-driven pay 278–81 problem with performance indicators 103, 104 value diagram 285–6 see also bonuses income statements 247–9 incorporation 16 Industrial Revolution 9, 26 inflated earnings 118–19 inflation 58, 65–6, 125–6, 259, 261 information asymmetry 30 information flows 205–11 innovation 20, 24–5, 152 insights 187, 188 instinct 161, 163–4, 165 intellectual capital 293 interest cash flow statement 252 estimating 246–7 impact on value 254 income statement 248 interest tax shields 264 investment decisions 54, 55, 56 pre-modern times 15, 16 “risk-free rate” 66 Internet 35, 228 intuition 165, 168, 187, 188–9 inventories 244, 249, 251 investment 28–30 blue line attributes 283 cash flow statement 252 depreciation 247 expected future free cash flows 74, 94 growth 145–8 inventories 249 as movement of energy 46, 47, 48 Net Fixed Assets 266–7 Net Present Value 84–6 Opportunity Cost of Capital 50–3 risk 53–64 sale-and-leaseback 123 investors 14, 29–30, 35, 45, 78–9 Cost of Funding 24 red line management 111, 112 risk 60–1 securities 258 see also capital markets; shareholders iPad 6, 19 Ireland 37–8 302 The Blue Line Imperative Jews 15 Jo-Ann Fabric and Craft Stores 228 Jobs, Steve Johnson, Ross 34n13 Jorion, Philippe 62 Judt, Tony 10, 12 Kahneman, Daniel 188–9 Kennedy, John F 25 key performance indicators (KPIs) 73, 95–6, 116, 222–3 blue line approach to 105–11, 124, 284 Goodhart’s Law 127–9 honest measurement of 277 hypothesis testing 224–5 indicator-driven pay 275, 278–81 non-profit sector 129–33 observability 220–1 problem with 100–5, 125–6 value destruction 133–4 see also targets Keynes, John Maynard 76 Kim, Chan 153n12, 183–4 KKR 34 Klitschko, Vitali Kohavi, Ron 186 KPIs see key performance indicators Lansing, Sherry 178–9 Layard, Richard 2, 195 learning 105, 109–10, 168, 175, 217 Alcoa 207 blue line attributes 284 continuous 106, 224 data-driven 227 experience 186–8 from failure 106, 107, 207–8, 212–14, 229, 277, 284 forecasting process 238 value-based culture 219 value diagram 285–6 W L Gore & Associates 211 leasebacks 122–4 leisure 11 Levering, Robert 197–8, 199 Levy, Steven 227 Lewis, Michael 37, 203–4, 269–70, 271, 274 LG 19 liabilities 251 liability, limited 27 Liker, Jeffrey 9, 202 Limberg, T. 184 limited liability 27 Lindbergh, Charles 24–5 Linden, Greg 185–6 liquidity 29, 30 loans 15–16, 24 sale-and-leaseback 122, 123 technical default on 112–13 local governments 132 Longitude Prize 24, 25–6 Luby, Frank 151 luck 177–8 lying 181–2, 204–5 Mamet, David 219 management consultants 230–2 management positions 227–8 market capitalization 28, 34, 262 market share 135–6, 151–2, 153n12, 220 Mauborgne, Renée 153n12, 183–4 McDonald’s 6, 126, 229 McKinsey & Company 7, 218 mergers and acquisitions 34, 36–7, 118, 138, 209 Miller, Merton 86–8, 91, 92 mission statements 103, 192–3, 194 mistakes 207–8, 214 Mittal Steel 36–7 Modigliani, Franco 86–8, 91, 92 Mokyr, Joel 20 money 49, 50, 58 moral hazard 38–9 morale 104, 117–18, 176, 182, 200 Mordashov, Alexey 36 Morris, Ian 45, 46 Moskowitz, Tobias 273 Napoleon Bonaparte 24 National Health Service (NHS) 129–30 nature 47, 48–9, 56, 258 competitive advantage 142 opportunity cost 52, 53–4 physics 77 “risk-free rate” 256 risk premium 61, 65, 66–7 Index RONIC 138–9 value creation as conspiracy against 138 Nature’s Risk Premium (NRP) 67, 68, 69 nepotism 38–9 Net Fixed Assets (NFA) 251, 266–7 Net Operating Profit After Tax (NOPAT) 80, 81, 237 forecasting 253 growth 143–4, 145, 146–8 Net Present Value (NPV) 82–6, 94, 103, 171, 177, 233–67, 281 economics of the business 266–7 estimating an appropriate discount rate 254–65 growth targets 150 mechanics of discounting 235–6 mechanics of Free Cash Flow 237–54 relevance of 121 Netherlands 12, 19, 24, 26, 257 New York Police Department 130 NFA see Net Fixed Assets non-profit sector 129–33 NOPAT see Net Operating Profit After Tax Nortel Networks 120–1 NPV see Net Present Value NRP see Nature’s Risk Premium objective thinking 165–6, 168 “obligation to dissent” 218 OCC see Opportunity Cost of Capital oil industry 150–1 Olympus 119 O’Neill, Paul 207 opinion 94–5, 165, 170–1, 185–92, 226, 227, 231, 284 opportunity cost 47–8, 51–2, 53–4, 229 Opportunity Cost of Capital (OCC) 32, 43, 50–3, 65–6, 233 blue line attributes 283 calculating the 66–9 competitive advantage 142 Economic Profit 116–17 estimating an appropriate discount rate 254–65 expected future free cash flows 71, 73, 77, 82–9, 159, 235 303 growth 146, 149 risk 54–5, 58–61, 262, 264 RONIC relationship to 136–40, 148 value diagram 285–6 Weighted-Average Cost of Capital 91 option programs 154 organizational culture continuous learning 106 Toyota 200 trust 197, 199, 200–1 value-driven 219, 224 see also blue line culture organizational structure 195, 208–14, 215–16 Orteig Prize 24–5 Page, Larry 227 Parmalat 119 pay see compensation performance measurement 127, 284, 285–6 see also key performance indicators performance reviews 217 Peters, Tom 141 physical capital 293–4 physics 69, 76–7, 220–2, 223–4 “PIMS study” 151 Pixar Animation Studios 218 Pope, Alexander portfolio risk 59–61, 62, 66–8, 262 Prepaid Expenses 244, 250, 251 prices blue line attributes 283 observability 95 red line management 96–8 value distinction 72–3, 77, 94 value of money 58 willingness to pay 8, 9, 71 see also inflation prizes 24–6, 31 probability 75–6, 222, 284 productivity 58, 104, 229 profit 220 proto-industry 18 public ownership 26 public sector 129–33 quality 8, Quality Circles 199 quantum physics 76–7, 220 304 The Blue Line Imperative randomized experiments 229 randomness 178–80, 284 rate of return 50, 52, 56–7, 58, 66 Fully Diversified Portfolio 67–8 “risk-free rate” 66 risk premium 59, 66–7 see also Return on Invested Capital; Return on New Invested Capital Red Gate Software 213–14 red line management 3, 93, 96–100, 111–14 behaviors 118–24 breaking away from 115 Daimler-Benz 118 decision-making 171–2 growth 135–6 information flows 205 key performance indicators 102, 104–5 non-profit sector 129–33 organizational culture 159 promotions 175–6 questions to ask 276 share price 116, 120–1 targets 168, 180–2 relationship management 108–10 relationships 35–7 reserves, hiding 100, 119–20 resources 292 Return on Equity 104 Return on Invested Capital (ROIC) 118–19, 122–3, 266 Return on New Invested Capital (RONIC) 136–40, 145, 146, 147–8, 149 revenue model 291 risk 53–64, 283 capital markets 45–6 discount rate 92 diversification 29, 30, 33, 60–1, 65 expected future free cash flows 87–9 Opportunity Cost of Capital 50, 52, 66–9 relative riskiness 261–2 “risk-free rate” 54–8, 59, 64, 65, 66–7, 256–61 risk premium 58–64, 65, 66–7, 264 Weighted-Average Cost of Capital 254 RJR Nabisco 33–4 Robb, Graham 10–11 Roberts, John 203, 278 ROIC see Return on Invested Capital “roll-ups” 138 Romans 13, 14 RONIC see Return on New Invested Capital Rosga, A. 127–8 Rousseau, Jean-Jacques 19–20 Ruelfi, T.W. 141 ruling class 257 Russia 4, 11, 13 safety 207 SAirGroup 209–11 sale-and-leaseback 122–4 sales forecasts 240–1 Samsung 19 Satterthwaite, M.L. 127–8 Satyam 119 SCA see Sustainable Competitive Advantage scandals, corporate 119 SCF see Statement of Cash Flows schools 131–2 Schrempp, Jürgen 116–18, 154 Schumpeter, Joseph 20 securities 258 Selling, General and Administrative (SG&A) 79–81, 143–4, 237, 253 Sen, Arijit 38 setting an example 281 SG&A see Selling, General and Administrative share price 72–3, 111 blue line attributes 283 red line management 96–100, 120–1 sale-and-leaseback 122–3 value creation 115–16 shareholders 27, 29, 32 Arcelor/Mittal merger 36 Opportunity Cost of Capital 51 red line management 111 shareholder value 72–3 see also investors shares 26 Shermer, Michael 179–80 shipping 24 signals 42–3, 206, 284 Simon, Hermann 151, 152 Sinclair, Upton 133 Singapore 257 Index Six Sigma 174, 221, 242 small teams 174, 213 Smith, Mark 176 Sony Walkman 140 Spence, Michael 23 spreadsheets 172–3, 174–5, 234, 281 Statement of Cash Flows (SCF) 123 stock exchanges 28, 31, 176 stock market 61–2 stock options 154, 156 “straight-talk relationships” 217 Strathern, Marilyn 132 “stretch” targets 181 subconscious-level thinking 161, 162–3, 165, 167–8, 172, 174, 186–8 subjective thinking 165–6, 168, 173, 174 subsistence 10–11, 17 sunk costs 77, 121, 237, 283 suppliers 138, 203 Surowiecki, James 35 Sustainable Competitive Advantage (SCA) 139–42, 149, 152, 211, 229, 286–7 Sweden 257 Swissair 209–11 targets 104–5, 106–7, 108, 110, 168, 180–2, 277 blue line attributes 284 Daimler-Benz 117 Goodhart’s Law 127–8 growth 135–6, 142, 146–7, 149, 150–1 indicator-driven pay 278–9 lack of trust in managers 184 local governments 132 National Health Service 129–30 Nortel Networks 120–1 police departments 130–1 value-based 281 value destruction 133–4 see also key performance indicators taxes 82, 247, 250 on EBIT 80, 81, 143–4, 237, 253 impact of interest on value 254 inflated earnings 118–19 interest deductibility 86, 89–90 interest tax shields 264 teams 174, 201–2, 212, 213 thoughts 167–8 Time Value of Money 256 305 Timpson 201 Tokyo police department 130–1 Toyota 9, 181n6, 199–200, 202, 203, 225–7 Trader Joe’s 7–8 transactional environment 198 trial-and-error 106 trust 175, 183, 192, 195–218 blue line attributes 283 decision-making 214–15 examples of trust-based companies 199–203 hierarchy as obstacle to 216 impact of contracting on 279–80 importance of 196–7 information flows 205–11 lack of 183–4, 195, 196, 203–5 money 49 organizational structure 208–14 transactional and trust-based environments 198–9 value-based culture 219, 224 value diagram 285–6 two-sided accountability 217–18 uncertainty 105, 106, 127, 220 United Kingdom 26, 132 see also England United States debtors’ prisons 28 economic growth 55–7, 257, 259–61 executive pay 153, 155 government bonds 257, 259–61 share-trading 26 stock market 61–2 value 1–3, 53 adding basketball 270–2, 273 debt and equity 88–9 definitions of 72, 235 estimating 233 executive pay 153 expected future free cash flows 73–81, 89–90, 92 happiness 159 key performance indicators 102, 103–4 managing for 93 non-observability 95 physics and 220–2 306 The Blue Line Imperative red line management 96–8, 113–14 value audit 282–5 value drivers 100–2, 221, 276–7, 284 versus growth 142–50 Weighted-Average Cost of Capital 91 see also Net Present Value; value creation; value destruction value chain 281–2 value creation 1–2, 5, 8, 286 Battier’s approach to basketball 270, 273 blue line approach 94–5, 96, 98, 111, 134, 159–60, 164, 180, 282 capital markets 27 competitive advantage 141–2 competitive/economic forces 137 as conspiracy against nature 138 distinguishing from value destruction 180, 280 employees 34 energy 69 fairness 164, 177, 182 growth 140, 149 happiness 20–1, 71 learning from failure 212 Opportunity Cost of Capital 50, 51 removal of personal biases 39 share price 115–16 uncertainty management 106 value drivers 100–1 W L Gore & Associates 211, 212 value destruction 42, 53, 75, 114 agency problems 270 basketball 272 Daimler-Benz 117 distinguishing from value creation 180, 280 growth 140, 149, 150–1 instinct 163–4 key performance indicators 104, 133–4 lack of fairness 175–6 lack of trust 183–4, 195, 196 Net Present Value 84 Opportunity Cost of Capital 50 pay policies 153 recognizing 282 red line management 96, 98 value diagram 284–6 Value Gap 286 value proposition 289–90 Van der Heyden, Ludo 183, 184 vision 192–3 W L Gore & Associates 193, 194, 202–3, 211–13, 214–15 WACC see Weighted-Average Cost of Capital “waterline” concept 213 Waterman, Robert 141 Watson, Thomas 155 WCR see Working Capital Requirement Weber, Eugen 11, 16–17 Weighted-Average Cost of Capital (WACC) 91–2, 254, 255, 256 Weil, Sandy 272 Welch, Jack 73, 119–20 Wertheim, Jon 273 Whole Foods 201–2 Wiggins, R.R 141 Wilde, Oscar 72 Wilkinson Sword willingness to pay 8, 9, 71 wisdom of crowds 35 Working Capital Requirement (WCR) 81, 143–4, 147, 237, 252, 253 X Prize Foundation 25 Xerox 8–9 Zak, Paul 197 Zobrist, Jean-Franỗois 199, 200 ... start focusing on value creation that lasts.” Martin Heijnsbroek, Managing Partner, MICompany The Blue Line Imperative The Blue Line Imperative What Managing for Value Really Means By Kevin Kaiser... Index What is Value? The Global Capital Market The Opportunity Cost of Capital The Expected Future Free Cash Flows Blue Line Management Shifting to Blue The Hazard of Growth Creating a Blue Line. .. unlikely they will successfully manage for value in their organizations We noticed that when we would ask a class of 40 participants ix x The Blue Line Imperative to write down a definition for value,