You are on page 1of 13


Goals, Values
Values and
and Performance
• Strategy as a quest for value
• What is profit?
• The shareholder value approach
• The shareholder value and strategy
• Mission and values

3) Firms that do not 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. stock-market value will be acquired Hence: Strategy analysis is concerned with identifying and accessing the sources of profit available to the firm .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. 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).

V =  t Where: V Ct market value of the firm. free cash flow in time t r weighted average cost of capital Ct (1 + r)t . Economic Value Added: Post-tax operating profit less cost of capital Maximizing the value of the firm: Max.g. net present value of free cash flows: max. Rate of profit Over what time period? What measure of profit? Accounting profit versus economic profit (e.From From Profit Profit Maximization Maximization to to Value Value Maximization Maximization • Profit maximization an ambiguous goal – – – – Total profit vs.

9 23.0 (11.7 26.a.) NET INCOME ($BN) RETURN ON SALES (%) RETURN ON EQUITY (%) RETURN ON ASSETS (%) RETURN TO SHAREHOLDERS (%) Exxon Mobil 372 36.0 18.6 22.2 2.3 13. ($BN.1 19.7 13.1 (10.4 Royal Dutch Shell 211 25.7 11.1) Gazprom 196 7.5 4.3 9.0 4.4 10.3 30.8) Procter & Gamble 190 8.1 9.3) Toyota Motor 197 12.0 21.5 27.8 11.3 40.0 14.2 Bank of America 212 16.2 .The TheWorld’s World’sMost MostValuable ValuableCompanies: Companies: Performance PerformanceUnder UnderDifferent DifferentProfitability ProfitabilityMeasures Measures COMPANY MARKET CAP. HSBC 190 15.9 1.8 7.9 17.7 (1.2 14.2 5.4 7.6 11.4 8.7 6.1 n.9) Citigroup 239 24.5) Microsoft 281 12.3 14.8 (0.3 28.5 21.6 BP 233 22.7 17.8 (22.1 1.9 10.7 10.8 Wal-Mart 197 11.0 16.7 22.9 34.1 10.7 General Electric 363 16.3 1.9 27.

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 assets—maximize after-tax rate of return b) On new investment—seek 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 .

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 .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.

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 .

industry * Risk index * * * I1 Marketing I1 1.1.Vs.Dealer/distributor quality 2.Improve hardware and performance 2.2.Vs. Trading.Balanced BalancedScorecard Scorecardfor forMobil MobilN. Marketing Innovative products and services Innovative products and services 2. N. Logistics Reducing delivered cost Reducing delivered cost 2. 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. Trading. Inventory management ROCE on refinery *Total ROCE on refinery expenses (per gallon) Vs. 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 . competitors cost per gallon .Trading organization Trading organization 3.1. competition *Profitability Total expenses index(per gallon) Vs. and environmental performance I4 Improve health.Inventory management 3. safety. Improve hardware and performance * * * * I3 Supply. Supply. Manufacturing Lower manufacturing costs Lower manufacturing costs 2. industryto customer *Risk Volume indexgrowth rate Vs.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. competition *Yield Profitability index index * Yield index Delivered cost per gallon .1. Dealer/distributor quality I4 Improve health. safety. Logistics I3 1.

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 .

” weak financial controls—yet high profitability — Focus 1997-2003 : “creating shareholder value”—Outcome: loss of market leadership. ethical values. HP b) Boeing — Focus pre-1996: “to build great planes. e. Merck. Examples: a) “Visionary” companies studied by Collins & Porras. Disney. declining profitability . consistent.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 other than profitability and shareholder return. Wal-Mart. b) Have strong.g. Procter & Gamble.