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 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:
1) Boards of directors legally obliged to pursue shareholder interest
2) To replace assets firm must earn return on capital > cost of capital
(difficult when competition strong).
3) 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

From
From Profit
Profit Maximization
Maximization to
to Value
Value Maximization
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 = t
Where:

V
Ct

market value of the firm.

free cash flow in time t

weighted average cost of capital

Ct
(1 + r)t

The
TheWorlds
WorldsMost
MostValuable
ValuableCompanies:
Companies:
Performance
PerformanceUnder
UnderDifferent
DifferentProfitability
ProfitabilityMeasures
Measures
COMPANY

MARKET
CAP.
($BN.)

NET
INCOME
($BN)

RETURN
ON
SALES
(%)

RETURN
ON
EQUITY
(%)

RETURN
ON
ASSETS
(%)

RETURN
TO
SHAREHOLDERS
(%)

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

Shareholder
Shareholder Value
ValueMaximization
Maximization and
andStrategy
StrategyChoice
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

a) On existing assetsmaximize after-tax rate of return
b) On new investmentseek rate of return > cost of capital
Utilize qualitiative strategy analysis to evaluate future profit
potential

Valuing
Valuing Companies
Companies and
and Business
Business Units
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 +
(1 + r )

C2 +

C3

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

VH
(1 + r )3

where: VH is the horizon value of the firm after 4 years

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

The
Thesix
sixlevers
leversof
of financial
financialand
andreal
realoptions
options
Financial options

OPTION
VALUE

Real options

Comments

Stock price

Present value of
returns to the
investment

Higher NPV raises

option value

Exercise price

Investment cost

Higher cost
lowers option value

Uncertainty

Uncertainty

Higher volatility
increases option value

Time to expiry

Duration of option

More time allows more

information to be taken
into account

Dividends

Value lost over

duration of option

As profit is lost to rivals,

option value is lowered

Risk-free
Interest rate

Risk-free
interest rate

A higher interest rate

increases option value by
increasing the value of
deferring investment

Performance
Performance Diagnosis:
Diagnosis: Disaggregating
Disaggregating
Return
Returnon
onCapital
CapitalEmployed
Employed
COGS/Sales
Margin
(Return on
Sales)

ROCE

Depreciation/Sales
SGA expense/Sales
Fixed asset turnover
(Sales/PPE)

Inventory Turnover
Asset
productivity
(Sales/Capital
Employed)

(Sales/Inventories)

Creditor Turnover
(Sales/Receivables)

Turnover of other items

of working capital

Linking
LinkingValue
ValueDrivers
Driversto
to Performance
PerformanceTargets
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
ComprehensiveValue
ValueMetrics
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 missionThey give precedence to goals

other than profitability and shareholder return;

b)

Have strong, consistent, ethical values.

Examples:
a) Visionary companies studied by Collins & Porras,
e.g. Merck, Wal-Mart, Procter & Gamble, Disney, HP
b) 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