DEVELOPING STRATEGIES FOR COMPETITIVE ADVANATGE

Session 2Goals, Value and

Performance

Session 2Goals, Value and

Performance

1

• Strategy as a quest for value

• What is profit?

• The shareholder value approach

• The shareholder value and strategy formulation

• Performance appraising and diagnosis

• Values and Principles

• Corporate Social Responsibility

OUTLINE

1

The Concept of StrategyThe Concept of Strategy

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 interest2) 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

2

Strategy as a Quest for ProfitStrategy as a Quest for Profit

COMPANY

2008 Rank

MARKET CAP. ($BN.)

NET INCOME ($BN)

RETURN ON

SALES (%)

RETURN ON

EQUITY (%)

RETURN ON

ASSETS (%)

RETURN TO SHARE-

HOLDERS (%)

1 Exxon Mobil 453 40.61 17.42 33.35 29.69 24.30

2 PetroChina 424 20.75 24.48 19.99 18.85 28.90

3 General Electric 370 22.21 15.40 19.22 7.46 2.60

4 Gazprom 300 26.11 38.66 16.11 10.33 103.50

5 China Mobile 298 12.41 36.21 23.32 22.02 21.50

6 Microsoft 264 14.07 39.41 48.73 30.90 20.80

7 AT&T 231 11.95 15.31 10.36 7.40 20.50

8 Royal Dutch Shell 220 31.33 14.22 25.28 15.12 20.10

9 Procter & Gamble 216 10.34 19.25 17.38 11.86 16.60

10 Wal-Mart Stores 211 12.73 5.33 19.70 13.45 4.70

11 Berkshire Hathaway 207 13.21 17.05 10.94 8.08 28.70

12 Nestlè 197 10.72 12.57 20.99 13.10 31.60

3

The World’s Most Valuable Companies:Performance Under Different Profitability

Measures

The World’s Most Valuable Companies:Performance Under Different Profitability

Measures

©

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 Ct

(1 + r)t

Where: V market value of the firm.

Ct free cash flow in time t

r weighted average cost of capital

4

From Profit Maximization to Value Maximization

From Profit Maximization to Value Maximization

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 returnb) On new investment—seek rate of return > cost of capital

• Utilize qualitiative strategy analysis to evaluate future profit potential

5

Shareholder Value Maximization and Strategy Choice

Shareholder Value Maximization and Strategy Choice

ROCE

Margin(Return on

Sales)

Asset productivity(Sales/Capital

Employed)

COGS/Sales

Depreciation/Sales

SGA expense/Sales

Fixed asset turnover(Sales/PPE)

Inventory Turnover(Sales/Inventories)

Creditor Turnover(Sales/Receivables)

Turnover of other items of working capital

8

Performing Diagnosis:Disaggregating Return on Capital Employed

Performing Diagnosis:Disaggregating Return on Capital Employed

Shareholdervalue

creation

Shareholdervalue

creation ROCEROCE

Economic Profit

Economic Profit

MarginMargin

CapitalTurnover

CapitalTurnover

Sales Targets

Sales Targets

cogs/sales

cogs/sales

DevelopmentCost/Sales

DevelopmentCost/Sales

InventoryTurnover

InventoryTurnover

CapacityUtilization

CapacityUtilization

CashTurnover

CashTurnover

Order SizeCustomer MixSales/Account

Customer ChurnRate

Deficit Rates

Cost per DeliveryMaintenance cost

New productdevelopment time

Indirect/DirectLabor

Customer Complaints

Downtime

Accounts PayableTime

Accounts Receivable Time

CEO Corporate/Divisional Functional Departments & Teams

Linking Value Drivers to Performance TargetsLinking Value Drivers to Performance Targets

FINANCIAL

F1 Return on Capital EmployedF2 Cash FlowF3 ProfitabilityF4 Lowest CostF5 Profitable GrowthF6 Manage risk

F1 Return on Capital EmployedF2 Cash FlowF3 ProfitabilityF4 Lowest CostF5 Profitable GrowthF6 Manage risk

Strategic Objectives

Financially

Strong* ROCE* Cash Flow* Net Margin* Full cost per gallon delivered to customer * Volume growth rate Vs. industry* Risk index

* ROCE* Cash Flow* Net Margin* Full cost per gallon delivered to customer * Volume growth rate Vs. industry* Risk index

Strategic Measures

C OU MS ET R-

C1 Continually delight the targeted consumer

C2 Improve dealer/distributor profitability

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

* 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

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

INTERNAL

* 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

* 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

L E & A GR RN O I WN TG H

L1 Organization Involvement

L2 Core competencies and skills

L3 Access to strategic information

L1 Organization Involvement

L2 Core competencies and skills

L3 Access to strategic information

* Employee survey

* Strategic competitive availability

* Strategic information availability

* Employee survey

* Strategic competitive availability

* Strategic information availability

Safe and Reliable

Competitive Supplier

Good Neighbor

On SpecOn time

Motivated and

Prepared

10

Balanced Scorecard for Mobil North American Marketing & Refining

Balanced Scorecard for Mobil North American Marketing & Refining

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;

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 controls—yet high profitability

— Focus 1997-2003 : “creating shareholder value”—Outcome: loss of market leadership, declining profitability

11

The Paradox of ValueThe Paradox of Value