Challenges and Choices for the Top Team in Relation to Shareholder Value
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Challenges and choices for the top team in relation to shareholder value hilary collins

Challenges and Choices for the Top Team in Relation to Shareholder Value

Hilary Collins


Challenges and choices for the top team in relation to shareholder value hilary collins

Infrastructure

People and Alignment

Focus, Agendas, Business Cases, and Decisions

Financial and strategic visibility and performance

Objectives and Targets

Challenges and choices for the top team related to shareholder value

  • Making trade-off decisions (now vs future; where to allocate resources; etc)

How should we structure the business?

How should we allocate roles and responsibilities to senior managers?

What management information is needed?

How will that be delivered?

How do we develop the management capabilities and motivation needed to deliver superior returns to shareholders?

How do we get the organisation to work together at different levels?

What do we want managers to focus on now?

How should we solve the problems and grasp the opportunities we face?

How should we take big decisions?

How should we measure and manage financial performance?

How should we think about strategy?

What are the objectives of the business?

What drives the value of the business?

What levels of performance do want to deliver and how will we measure that performance?

How will we set targets for parts of the company and for key individuals?


Challenges and choices for the top team in relation to shareholder value hilary collins

CVI Business Framework

  • The horse will run as fast as it’s slowest leg allows

Objectives and Targets

Financial and strategic visibility and performance

Infrastructure

Focus, Agendas, Business Cases, and Decisions

People and Alignment


Challenges and choices for the top team in relation to shareholder value hilary collins

“We are in business to maximise the returns to our shareholders over time”

Consequences for:

“The way we do things around here”

  • We set and use performance aspirations and targets based on measures that are relevant to our shareholders

  • We strive to get and use good visibility of the locations and sources of value creation and destruction in various ways across our business.

  • We focus our managers on the issues and opportunities that will have the biggest impact on the value of the business

  • We align the work of managers at different levels and in different parts of the business with shareholder value

  • We create robust value-based business cases to help us to take the big decisions

  • We equip and motivate our organisation to manage for value

  • We develop value-based managers

What is “managing for value”?

  • A distinctive approach to managing businesses

“Lloyds was a VBM pioneer in the mid-1980s and went on to create huge value for its shareholders. Indeed, its share price doubled every three years for about 15 years. Chairman Brian Pitman has no doubt where the credit lies: “Doubling the share price every three years can’t be accomplished by incremental change; it requires major change and scrapping the old ways of doing things...Managing for Shareholder Value (Lloyds VBM programme) was the driving force behind our success”


Challenges and choices for the top team in relation to shareholder value hilary collins

Overview of Managing For Value (MFV)

  • The development of MFV over time

  • MFV as a concept has been around since Adam Smith

  • But it has been operationalised only in the last 20 years

  • There are very few businesses (and even fewer consultancies) which have a good understanding of how to operationalise MFV

  • MFV is a rigorous and systematic management discipline which often requires decisions to be made which are seemingly at odds with “traditional” management thinking

  • The number of MFV exemplars has been small but it is growing rapidly, especially in the Anglo-Saxon area

  • “The Wealth of Nations”...

  • Late 1970’s

    • “We measure, therefore we know”

    • MFV = valuation using discounted cash flow techniques

  • The 1980’s and 90’s

    • “Strategy drives financial performance”

    • MFV = strategy from a value perspective

  • 2000 –

    • “The whole business needs to be aligned with value”

    • MFV = holistic approach to management focused on shareholder value


Challenges and choices for the top team in relation to shareholder value hilary collins

Banking

Lloyds TSB

Bank of America

Bank of Montreal

ABN Amro

Standard Chartered

Barclays

HSBC

Beverages

Coca-Cola

Cadbury Schweppes

Diageo

Entertainment

Disney

Property

Information

Reuters

BT

Slough Estates

Retailing

Boots Group

Coles Myer

Nordstrom

J Sainsbury

Ahold

Metro

Manufacturing

Boeing

Champion

GE

Alcan

Amcor

Chemicals

Dow Chemical

BP

Pharmaceuticals

Insurance

Services

Prudential

Centrica

Roche

Some well-known businesses have attempted to become value-based (in various ways)

  • Many industries; USA/UK predominance (up to now)


Challenges and choices for the top team in relation to shareholder value hilary collins

Market Value Added

The wealth that has been created or destroyed by management since the start of the company

Financial Times

MVA - any value that managers have created (above and beyond the money which has been invested)

(£3bn)

UK plc

number of shares (2bn)

x

the share price (£5)

=

the “market capitalisation”

(£10bn)

The money that investors (and managers) have invested (reinvested) in the business since it started

(£7bn)

Shareholder value: key external performance metric 1

  • Market Value Added (MVA) represents wealth created (or destroyed) since the founding of the company

Market

Book

MVA represents the current speed of the “Management treadmill”


Challenges and choices for the top team in relation to shareholder value hilary collins

Shareholder value: key external performance metric 2

  • Total Shareholder Returns (TSR) is an annual measure of return to shareholders

(Share Price(eoy) - Share Price(boy)) + Dividends per share

Total Shareholder Returns (TSR)

=

Share Price(boy)

= Share Price Appreciation plus Dividend Yield

  • Share prices are driven by investors’ expectations of future cash flows (or economic profits)

  • “Meet expectations” = deliver cost of equity capital (ke): share price stable : MVA = 0

  • “Positive surprises”: share price rises: increase in MVA

  • “Negative surprises”: share price falls: decrease MVA

  • Short-term results (positive or negative surprises) change expectations of future performance and can result in large swings in share prices

  • Investor expectations need to be managed very carefully

  • But financial performance is the only thing that matters in the longer term

Shareholders

TSR represents the speeding up or slowing down of the “Management treadmill”


Challenges and choices for the top team in relation to shareholder value hilary collins

CEOs are coming under increasing pressure to deliver TSR performance, especially in Europe and Japan

  • CEO’s who do not deliver superior TSR’s are being fired both more often and faster than before

The 2500 largest quoted companies worldwide were studied. In these companies, 253 CEO’s retired, died or got fired in 2002

39% of these CEO departures appear to be “firings” caused by unacceptable performance, up from 25% in 2001

CEO’s who were dismissed in 2002 had generated median shareholder returns 6.2 percentage points lower than those generated by CEOs who retired voluntarily

“Failing” CEO’s seem to be getting fired sooner

* “CEO Succession 2002 – Deliver or Depart” Booz Allen Hamilton, strategy+business magazine, summer 2003


Challenges and choices for the top team in relation to shareholder value hilary collins

Infrastructure

People and alignment

Focus, agendas, business cases and decisions

Financial and strategic visibility and performance

Objectives and Targets

Infrastructure

People and Alignment

Focus, Agendas, Business Cases, and Decisions

Financial and strategic visibility and performance

Objectives and Targets

Challenges and choices for The Top Team

  • How can you get consensus around the right Governing Objective?

  • Do we have consensus on what drives the value of the Group on the stock market?

  • What is the governing objective for the Group?

    • What are we trying to maximise?

    • How do we trade-off competing objectives when we make big decisions?

  • What is our performance aspiration for the Group?

    • Relative to a set of competitors or an index?

    • Other?

What terms should we use to express that aspiration?

What financial performance over time is likely to be required to meet this aspiration?

Is there a gap between this level of performance and our current forecasts?

How do we cascade our performance targets in ways that are meaningful for the main operating companies and then further down to line managers?

Do our KPIs match well with the drivers of Group value? Have the KPIs been cascaded appropriately?


Challenges and choices for the top team in relation to shareholder value hilary collins

Infrastructure

People and alignment

Focus, agendas, business cases and decisions

Financial and strategic visibility and performance

Objectives and Targets

Executives are subjected to pressure from many other stakeholders

  • How should the trade-offs be made?

Customers

Employees and unions

Personal

needs

Government

Analysts and the media

Banks

(and advisors)

Environmental groups

Shareholders (large and small)

Suppliers


Challenges and choices for the top team in relation to shareholder value hilary collins

Infrastructure

People and alignment

Focus, agendas, business cases and decisions

Financial and strategic visibility and performance

Objectives and Targets

And internal functional priorities and preferences often conflict with each other as well

  • An illustration...

Sales

“Maximise revenue growth”

R&D

“Maximise the technical differentiation of our products”

Marketing

“Maximise market profile and awareness”

Production

“Lowest cost of production”

Purchasing

“Minimise the cost of purchased goods and services”

Finance

“Cost cutting”

Logistics

“Maximise availability of product with lowest stockholding”

IT

“”Do what our users want/need”

“Do the sexy stuff”


Challenges and choices for the top team in relation to shareholder value hilary collins

Infrastructure

People and alignment

Focus, agendas, business cases and decisions

Financial and strategic visibility and performance

Objectives and Targets

Market share-driven behaviour and business models

Market share goals and targets

Market share objectives

“Profit”–driven behaviour and business models

“Profit” objectives

“Profit” goals and targets

Multiple objectives

Confused behaviour and business models

Multiple goals and targets

Shareholder Value-driven behaviour and business models

Shareholder Value objective

Shareholder Value goals and targets

Businesses need a clear Governing Objective to guide decision-making

  • The Governing Objective dictates goals, targets, management decisions and performance

Governing Objective

Performance Goals and Targets

Management Behaviour, Decisions and Business Models

The “objective function” of the Group and each business unit - the primary decision criterion

The type and level of performance goals which are used to direct managers towards achieving the governing objective

The decisions managers take about where and how to compete in order to achieve the performance goals


Challenges and choices for the top team in relation to shareholder value hilary collins

Infrastructure

People and alignment

Focus, agendas, business cases and decisions

Financial and strategic visibility and performance

Objectives and Targets

Stakeholder

Revenue

Customers

- COGS

Suppliers

- Wages

Employees

- Overheads

Employees and Suppliers

- Interest

Providers of debt

- Tax

Government/community

- leaves

if there is anything left!

- funds for shareholders

“Maximise value over time” is what the owners of most – if not all - publicly-quoted businesses are paying their managers to do.

“Maximise value over time” is the best Governing Objective for all stakeholders

  • It is the only Governing Objective that facilitates decision-making which is forced to consider the impact on all stakeholders

  • Companies must balance the interests of its stakeholder groups (employees, customers, community and shareholders) to maximise value over time

  • Company profitability is directly linked to whether or not it has an advantage over competitors on its offer; its economic costs; and/or its pricing

  • Therefore, the intent of a company which maximises its value has to be to treat its employees, customers, and community in a manner that improves its relative competitive advantage

  • And value maximisation is unlikely to be sustained if a company chooses strategies, organisational structures, or decision-making processes that:

    • cause the customers’ perceptions of the company and its offer to deteriorate over time

    • cause the company’s relationship with employees and the community to weaken over time

    • diminishes the attractiveness of its offer to customers over time

    • incur excessive costs relative to competitors over time

  • So our view is that “maximise value over time” is a win-win game for all stakeholders over time – increments to total welfare can only come from creating wealth


Challenges and choices for the top team in relation to shareholder value hilary collins

Infrastructure

People and alignment

Focus, agendas, business cases and decisions

Financial and strategic visibility and performance

Objectives and Targets

Competing Governing Objectives are sometimes adopted either explicitly or implicitly

  • Other Governing Objectivesmay or may not be well aligned with maximising value

  • Financial Objectives

    • Maximizing earnings or eps growth

    • Minimizing total cost

    • Stabilizing earnings over a cycle

NOPAT

Misguided view of customer satisfaction vs profit

Highly Profitable Customer Group

  • Strategic Objectives

    • Maximizing market share

    • Maximizing customer satisfaction

    • Building brand equity

Typical Customer Group

Charge for Capital

Unprofitable Customer Group

  • Organizational Objectives

    • Maximizing company size

    • Balancing “stakeholder” interests

Customer Satisfaction

While achieving these objectives may be consistent with maximising value, pursuing any one as the primary

objective is unlikely to maximise value over time


Challenges and choices for the top team in relation to shareholder value hilary collins

Infrastructure

People and alignment

Focus, agendas, business cases and decisions

Financial and strategic visibility and performance

Objectives and Targets

Managers’ views on the financial drivers of shareholder value have changed over time

  • These changes have also changed the focus of – and priorities for – line managers over time

Earnings focus (“history”)

  • Based on accounting measures and conventions

  • Earnings; EBIT; EBITDA; P?E ratio

  • Earnings are not the same as cash flow

  • Easy to manipulate

  • Excludes capital and it’s costs

  • Excludes risk

  • Excludes time value of money

The value of the business is driven over time by the market taking the current earnings per share (EPS) for the business and multiplying that by a P/E ratio which is based on market expectations of the future growth and quality of those earnings

Therefore, managers should focus on finding and implementing the strategies that will maximise earnings and earnings growth.

Return on Assets focus (“1980’s on)

  • Emphasised the use of return metrics such as ROI, ROE, RONA, ROCE

  • Same issues as Earnings, plus calculation of capital base

  • Excludes growth - can stunt value creation

There is an emerging awareness of the need to use capital effectively. Ratios such as return on assets are used to take some account of capital. However, the measures that underpin decisions are still based on the accounting paradigm. Managers are driven to hit target (or hurdle) rates of return

Discounted cash flow focus (“more recent”)

  • Based on economic measures and conventions using cash flow

  • Or using other metrics such as Economic Profit; Cash Value Added; etc

  • Demands good forecasts of future performance

The value of the business is driven over time by the market’s expectations for the future cash flows (or EP’s) the business will generate which are discounted back to the present at a cost of capital.

Therefore, managers need to focus on finding and implementing the strategies that will maximise the NPV of cash flows or EP’s. In addition, they should find ways of reducing the cost of capital.


Challenges and choices for the top team in relation to shareholder value hilary collins

Setting performance targets

  • A value-based approach to setting and cascading aspirations and targets

  • Group sets out Value Goals (eg double value in 5 years;or position in the peer group)

  • Group figures out the financial performance likely to be needed to achieve the Value Goals (stream of EP into the future)

  • Group cascades the Value Goal requirements (EP over time) down into the OpCos eg:

    • top down: "share the pain out" based on sales revenue; or EP; or assets employed; or some such algorithm

    • "share the pain out" based on top management judgement

    • bottom up: careful consideration of Market Economics and Relative Competitive Position for each OpCo; plus consideration of the likely impact of each strategic management agenda

    • a combination of the above

  • Why cascade?

    • Because the value of the Group is the sum of the value of its current OpCos

    • And the Group needs to calibrate each OpCo on the amount of stretch in performance it needs to achieve to contribute to Group aspirations

      • which means that each OpCo needs to have the right Issues on Agendas, etc

  • What then?

    • Each OpCo reviews its issues/strategy in the light of their share of the Value Goals

    • They rework their issues/agendas in an attempt to reach these goals

    • When they are convinced (and the Group CEO is convinced) that the value-maximising actions are being taken then these actions form the core of the business plan and set the performance targets against which performance is monitored

  • If there is a gap between the Group Value Goal and the sum of the OpCo performance targets (and there probably will be such a gap) then:

    • the OpCos are asked to look again at their issues/agendas (although his runs the risk of becoming unrealistic if the earlier work on issues/agendas has been done well) and/or

    • the Group has to find ways of plugging the gap by changing the portfolio of OpCos


Challenges and choices for the top team in relation to shareholder value hilary collins

Calibrating managerial expectations….

  • External Measures

  • TSRs relative to a peer set of companies

  • Time to double shareholder value

  • Financial Targets

  • Growth of EP over time

  • Growth of revenue and capital

  • ROC or ROE

  • ECF or TCCF

  • Strategic Targets

  • Market share

  • Like-for-like growth

  • Price position

  • CBR or CSI

  • Economic cost position

  • Organisational Targets

  • Market share

  • Like-for-like growth

  • Price position

  • CBR or CSI

  • Economic cost position

Internal proxies for external measures

Aligning external aspirations with internal targets

  • The linkage between external measures of shareholder value creation and internal measures of performance


Challenges and choices for the top team in relation to shareholder value hilary collins

Infrastructure

People and alignment

Focus, agendas, business cases and decisions

Financial and strategic visibility and performance

Objectives and Targets

Challenges and choices for the Top Team

  • We can manage only what we can see and understand

Organisation and People

Business Cases and Decisions

Focus and Alignment

Financial and strategic visibility and performance

Objectives and Targets

  • Which financial measures will give us comfort in understanding where value is (and is likely to be) created and destroyed in the business?

    • Measures that include all the costs of doing business

    • Measures that recognize the particular nature of the property business (asset revaluations etc)

    • Measures that our managers can use to improve decision-making

  • How should we understand “strategy” from a value perspective:

    • Common, value-based frameworks?

    • Common, value-based language and terminology?

    • Information and expertise?

  • Understanding the “where's” and “whys” of value creation and destruction:

    • Customers?

    • Competitors?

    • Asset types?

    • Geographies?

    • Other?

  • Understanding and prioritising the key issues and opportunities we face


Challenges and choices for the top team in relation to shareholder value hilary collins

Infrastructure

People and alignment

Focus, agendas, business cases and decisions

Financial and strategic visibility and performance

Objectives and Targets

Financial visibility and performance (“where value is created and destroyed”)

  • MVA (represented by EP over time) is the best internal proxy for shareholder value

Financial Times

Any value that managers have created (above and beyond the money which has been invested) (£3m)

Britain plc

number of shares (2m)

x

the share price (£5)

=

the “market capitalisation” (£10m)

The money that investors (and managers) have invested (reinvested) in the business since it started

(£7m)

Market Value Added (MVA)

This what the owners of the business want managers to maximise

EP

(£)

Stock market view

Shareowner view

The best proxy for this is the future stream of cash flow or Economic Profit; including a terminal value; discounted back to today

Market Value Added

(MVA)

time


Challenges and choices for the top team in relation to shareholder value hilary collins

Infrastructure

People and alignment

Focus, agendas, business cases and decisions

Financial and strategic visibility and performance

Objectives and Targets

Shareholder value: key internal performance metric

  • Value-based businesses use three main value-based financial measures (on top of other financial measures needed to manage the business)

Uses of Financial Measures

Annual value creation

(Economic profit)

Economic profit over time (Market Value Added)

Total shareholder returns (TSR)

  • Creating strategic insights

  • Making strategic choices

  • Targeting, measuring and rewarding realised performance

  • Reinforcing the Governing Objective

  • Yes

  • No

  • Yes

  • Yes

  • Yes

  • Yes

  • No

  • Yes

  • Yes

  • No

  • Yes

  • (Group-level only)

  • Yes

  • (Group-level only)

Financial measures should be thought of (like pay) as a way of communicating with managers about what matters…


Challenges and choices for the top team in relation to shareholder value hilary collins

Infrastructure

People and alignment

Focus, agendas, business cases and decisions

Financial and strategic visibility and performance

Objectives and Targets

PROFIT & LOSS ITEMS

Net Operating Profit After Tax

(NOPAT)

  • NOPAT factors in all expenses, including deductions for taxes and depreciation (which are both genuine costs that have to be managed) in order to provide a complete picture of operating profitability

  • NOPAT = EBIT x (1 - tax rate)

Economic

Profit

minus

BALANCE SHEET ITEMS

  • Capital charge is the minimal acceptable returns that both debt holders and shareholders expect to earn from the company on their investment

A charge for capital

Economic Profit includes all the costs of doing business

  • EP combines information from the P&L and the Balance Sheet

It can be used across the business in many ways, for example:

  • It can be used to understand where value has been created or destroyed in a single period so that managers can take appropriate decisions:

    • by business

    • by business unit (eg Value Centre)

    • by geography

    • by asset type, size or age

    • by product category

    • by product

    • by customer or customer segment

    • by supplier

  • It can be used to show managers where we are experience “good growth” and “bad growth” so that they can take appropriate decisions

  • It can be used to set single- and multi-period targets for performance (where the period is often a year)

  • It can be used to reward managers for achieving single-period performance


Challenges and choices for the top team in relation to shareholder value hilary collins

Infrastructure

People and alignment

Focus, agendas, business cases and decisions

Financial and strategic visibility and performance

Objectives and Targets

Operating

profit

per unit.

Economic

profit

per unit

Units

Units

Economic Profit can give very different signals to management

  • EP is not the same as Operating Profit

  • Signal to management:

    • most of the business is profitable

      • products/segments

      • sq. ft

    • we have a growth issue

    • most growth is good

  • Impact on management behaviour:

    • search for growth dominates decisions

  • Signal to management:

    • most of the business is unprofitable

      • products/segments

      • sq. ft

    • we have growth issues and profitability issues and we know where they are

  • Impact on management behaviour:

    • search for growth dominates some decisions

    • search for profitability improvement dominates other decisions


Challenges and choices for the top team in relation to shareholder value hilary collins

Internal Measure

External Measure

External Measure

TSR

EP

MVA

ΔEP

ΔMVA

TSR

Market Value Added (MVA)

  • Re-cap

Market value

of equity

(market

capitalisation)

Equity market value added

(MVA)

Warranted MVA (ie in the grounded judgement of managers) is what managers should be seeking to grow and maximise

And they should do this by taking decisions which maximise the NPV of the future stream of Economic Profits

Book value

of equity

Book value of equity, as shown in the accounts, plus some adjustments for things like allowances for bad debts, amortisation of goodwill, and amortisation of R & D

Warranted equity value (WEV)

Market

Capitalisation

Equity Capital Invested

Market value added


Challenges and choices for the top team in relation to shareholder value hilary collins

Market Value Added (MVA)

  • MVA and EP over time

Terminal Value (TV)

EP

The best proxy

for

MVA is the

future stream

of EP

(including a

terminal value)

discounted back to

today at the

cost of capital

TV = terminal value (calculated as a perpetuity)

ke = the cost of equity capital

g = growth rate in perpetuity

Time


Challenges and choices for the top team in relation to shareholder value hilary collins

Infrastructure

People and alignment

Focus, agendas, business cases and decisions

Financial and strategic visibility and performance

Objectives and Targets

Direct

Competition

EP

Segment B

Value

creation

Profitable

Segment B

Customer

Pressure

Market Economics

0

Investment

Market

Growth

Segment A

Value

destruction

Segment A

Unprofitable

Supplier

Pressure

Disadvantaged

Advantaged

Relative Competitive Position

Participation strategy – decisions about where to compete

Indirect

Competition

Competitive strategy – decisions about how to compete

Threat of

Entry

Regulatory

Pressure

Strategic insights (“why value is created and destroyed”)

  • Value is a consequence o of market economics and our relative competitive position in those markets

Strategy.........................linked to.......................Finance

Business model(s)

Relative

Differentiation

Position

Relative

Price

Position

Relative

Economic Cost

Position

Relative

Competences


Challenges and choices for the top team in relation to shareholder value hilary collins

Infrastructure

People and alignment

Focus, agendas, business cases and decisions

Financial and strategic visibility and performance

Objectives and Targets

1980 1990

WalMart

EP$30m$528m

MVA$664m$28.3bn

Gross margin23%23%

Kmart

EP-$43m-$172m

MVA-$505m-$1.3bn

Gross margin28%28%

Change in investment (1981 - 1990)

Average EP as a % of Capital

Illustration*

General Electric

(Good Growth)

General Motors

(Bad Growth)

Sales Growth

Change in Market Value

$13.7bn

$13.4bn

Annual Shareholder Returns*

5%

(6%)

125%

126%

$6.7bn

$47.0bn

1

21%

11%

*US market average was 18%

* from: “The Value Imperative”

Managing the growth/return trade-off

  • Managers need to differentiate between ”good” and “bad” growth

  • The Governing Objective is to maximise shareholder value at al;l points in time; not to grow market share; to maximise EPS; to maximise revenue, etc

  • Maximising top line or bottom line growth may or may not be consistent with the objective of maximising value

  • Managing to maximise value means that managers need to able to identify and implement “good growth” strategies and to be effective in eliminating “bad growth” strategies at all levels


Challenges and choices for the top team in relation to shareholder value hilary collins

Infrastructure

People and alignment

Focus, agendas, business cases and decisions

Financial and strategic visibility and performance

Objectives and Targets

EP Capital*(ROI - WACC)

Value =

(perpetuity)

=

(Ke - g) (Ke - g)

Managing the growth/return trade-off

  • The value-maximising answer may not be obvious (and may may not align well with company “legend”) – it depends on the starting point

Low-return business

High-return business

Growth in capital

Growth in capital

3%

4%

5%

3%

4%

5%

1% more growth, or

1% more return?

35%

7%

£37 bn

£1.9 bn

36%

8%

ROI

ROI

37%

9%

ke7.2%

WACC6.5%

Capital£4bn


Challenges and choices for the top team in relation to shareholder value hilary collins

Infrastructure

People and alignment

Focus, agendas, business cases and decisions

Financial and strategic visibility and performance

Objectives and Targets

Managing the growth/return trade-off

  • The value-maximising answer may not be obvious (and may may not align well with company “legend”) – it depends on the starting point

Low-return business

High-return business

Growth in capital

Growth in capital

3%

4%

5%

3%

4%

5%

7%

35%

£0.5bn

£0.6bn

£0.9bn

£27bn

£36bn

£52bn

£37bn

£54bn

£2.7bn

£1.9bn

ROI

8%

ROI

36%

£28bn

£1.4bn

£38bn

£3.1bn

9%

£2.4bn

£4.5bn

37%

£29bn

£55bn

For high-return business, trade-off

typically favours growth

For low-return business, trade-off

typically favours return


Challenges and choices for the top team in relation to shareholder value hilary collins

Infrastructure

People and alignment

Focus, agendas, business cases and decisions

Financial and strategic visibility and performance

Objectives and Targets

Direct

Competition

Customer

Pressure

Market

Growth

Supplier

Pressure

Indirect

Competition

Threat of

Entry

Regulatory

Pressure

Strategic Threats Agenda

  • A Strategic Threat is one that will cause an unwanted reduction in Market Economics and/or a deterioration in our Relative Competitive Position

Illustrations of potential Strategic Threats

Arrival of a new competitor

Value

creation

Profitable

Individual customers taking a very large proportion of output

Market Economics

Market growth declining or contracting

Value

destruction

Unprofitable

Disadvantaged

Advantaged

Suppliers consolidating

Relative Competitive Position

Participation strategy – decisions about where to compete

New technologies emerging

Competitive strategy – decisions about how to compete

Business model(s)

Relative

Differentiation

Position

Relative

Price

Position

Relative

Economic Cost

Position

Entry barriers dropping

Relative

Competences

Government becoming activist

Offer becoming less attractive or differentiated (CBR falling)

Lower-cost competitors fighting on price

Economic costs rising faster than competitors


Challenges and choices for the top team in relation to shareholder value hilary collins

Infrastructure

People and alignment

Focus, agendas, business cases and decisions

Financial and strategic visibility and performance

Objectives and Targets

Infrastructure

People and Alignment

Focus, Agendas, Business Cases, and Decisions

Financial and strategic visibility and performance

Objectives and Targets

Challenges and choices for the Top Team

  • Applying our efforts and resources in the right places

What are our current priorities at Group level?

What are our current priorities at Operating Company level?

What are our current priorities at function level?

How far down into the business do we want to drive these agendas?

Who is leading the charge on each of these opportunities and threats?

What is the best way for us to go about producing value-based business cases and applying an activist approach to decision-making?

Methodology?

Tools?

Decision-making process?


Challenges and choices for the top team in relation to shareholder value hilary collins

Infrastructure

People and alignment

Focus, agendas, business cases and decisions

Financial and strategic visibility and performance

Objectives and Targets

  • Profitable Growth Agenda

  • Developing and delivering the highest value-at-stake Profitable Growth opportunities:

    • A limitless appetite for profitable growth

    • Profitable = returns greater than the cost of capital

    • Profitable = NPV of future EP or cash flows >0

  • Strategic Threats Agenda

  • Identifying and dealing with the highest value-at-stake strategic threats facing the business:

    • No appetite for unprofitable growth and value destruction

    • Threats: falling Market Economics and/or deteriorating Relative Competitive Position

Focusing managers

  • “Management Agendas” are the priorities for action for senior managers – these agendas develop and evolve over time

Opportunities and threats

Opportunities and threats

Opportunities and threats

Opportunities and threats

Opportunities and threats

Opportunities and threats

Opportunities and threats

Opportunities and threats

Opportunities and threats

Opportunities and threats

Opportunities and threats

Strategic and Financial Insights

  • Criteria for inclusion

  • High value at stake

  • Management control

  • Timing


Challenges and choices for the top team in relation to shareholder value hilary collins

Infrastructure

People and alignment

Focus, agendas, business cases and decisions

Financial and strategic visibility and performance

Objectives and Targets

Opportunities for “activist” decision-making

Analysis

Analysis

Creativity

Analysis

Creativity

Planning

CVI Business Cases

  • The Top Team is helped to develop CVI Business Cases to resolve each issue on the two agendas

Factbase

Insights

Creation of alternatives

Learning, synthesis, and evaluation

Alternative approaches to implementation

Performance commitments; resource requirements; PIR

The where and why of value creation and destruction

Financial analysis

Strategic analysis

Business insights drawn from the factbase

Fundamental issues and opportunities identified and prioritised

“Diseases not symptoms”

“Maximise” requires choosing from alternatives

Alternatives evaluated using forecasts with robust assumptions

Key learning points identified

Synthesis of the value-maximising alternative

Alternative approaches to implementation developed and evaluated

Implementation plan or contract created based on performance commitments and resource requirements

Strategic, operational, and financial milestones set

Post Implementation Review mechanism specified


Challenges and choices for the top team in relation to shareholder value hilary collins

Infrastructure

People and alignment

Focus, agendas, business cases and decisions

Financial and strategic visibility and performance

Objectives and Targets

  • Correct timing being used?

    • “Why now”?

  • Fact-based approach adopted

    • “What do we need to know”?

  • Insights generated?

    • “What’s new”?

    • “Analysis/judgement/intuition”?

  • Fundamental issue(s) identified

    • “Diseases not symptoms”

  • Alternatives-based solutions created and appropriate?

    • “Not just the old favourites”?

  • Value-maximising alternative proposed and selected?

    • “Objective evaluation”?

  • Implementation plan clear and feasible?

    • “The best way to go about this…..who, what, when”?

Value-based criteria for effective decision-making

  • Criteria; and attributes of effective decision0making in a managing for value environment

  • A continuous process

    • Decision-making is recognised as a continuous and on-going process

  • Activist decision-making

    • Senior managers take an activist role in taking decisions on the highest value-at-stake issues and opportunities at several stages during their resolution

  • A systematic value-based approach

    • A “facts /issues /alternatives /evaluation /implementation” approach is used to take important decisions

  • Focussed and prioritised management

    • Management decisions are focussed on the highest value-at-stake issues and opportunities facing the business

  • Systematic decision-making

    • Decision Dialogues are the events at which senior managers become activist in decision-making

  • Decisions and priorities aligned up and down the organisation

    • Management Agendas are used to structure issues and opportunities according to their particular characteristics and to ensure that different levels of management are aligned in their priorities and efforts

  • High-quality decision-making

    • Specific criteria are used to communicate the quality standards expected of decisions


Challenges and choices for the top team in relation to shareholder value hilary collins

Infrastructure

People and alignment

Focus, agendas, business cases and decisions

Financial and strategic visibility and performance

Objectives and Targets

Infrastructure

People and Alignment

Focus, Agendas, Business Cases, and Decisions

Financial and strategic visibility and performance

Objectives and Targets

Challenges and choices for the Top Team

  • The skill and will to manage for value

What is the best way for us to go about producing the managerial capabilities needed to deliver superior returns to shareholders?

How should we align the priorities of managers at different levels in the business?


Challenges and choices for the top team in relation to shareholder value hilary collins

“Managing for value is more about the people than about the numbers”

– continuous upgrading of people capabilities

John Sunderland, Group CEO

People in value-based companies

  • Cadbury Schweppes perspective


Challenges and choices for the top team in relation to shareholder value hilary collins

Infrastructure

People and alignment

Focus, agendas, business cases and decisions

Financial and strategic visibility and performance

Objectives and Targets

Management skill and capability to manage for shareholder value

  • Typical changes that are required

From...

To...

  • Ambition

  • Accountability

  • Capabilities

Last years performance plus whatever small increment I can get away with

A cog in the wheel

Building/protecting functional expertise

We can be the best in the world

I am on the hook

General Manager

Implementation

Decisions

Leadership

Performance

Micro-managed

Big decisions, check everything has been analysed

Commander, policeman

Lots of targets in lots of detail

Set objectives; let them figure out how to achieve the objectives; monitor rigorously

Frequent decisions. Check appropriate analysis has been carried out

Mentor, facilitator, standard-setter

Set broad goals and high standards


Challenges and choices for the top team in relation to shareholder value hilary collins

Being able to apply the MFV framework and the related analytical tools and techniques (Knowledge)

Using sound judgement in setting stretching goals (Judgement/ambition)

Being able to produce insights and then to prioritise issues from the factbase (Interpretation/synthesis)

Being able to produce innovative alternative ways of resolving issues (Innovation)

Being able to communicate complex value-based information effectively (Communication)

Understanding and using high standards of decision-making (Decision-making/Standards)

People in value-based companies

  • Developing value-based General Managers

Elements of value-based decision-making

Types of capability needed

  • Specifying and creating the FACTBASE

  • Developing INSIGHTS

  • Setting stretching GOALS

  • Identifying and prioritising the ISSUES

  • Producing innovative ALTERNATIVES

  • Objective EVALUATION of alternatives

  • Disciplined PLANNING of implementation

  • Ongoing MANAGEMENT of implementation and short-term performance


Challenges and choices for the top team in relation to shareholder value hilary collins

Being able to apply the MFV framework and the related analytical tools and techniques (Knowledge)

Using sound judgement in setting stretching goals (Judgement/ambition)

Being able to produce insights and then to prioritise issues from the factbase (Interpretation/synthesis)

Being able to produce innovative alternative ways of resolving issues (Innovation)

Being able to communicate complex value-based information effectively (Communication)

Understanding and using high standards of decision-making (Decision-making/Standards)

People in value-based companies

  • Developing value-based General Managers

Desired attributes

  • Factual, rigorous, analytical

  • Ambitious, pragmatic

  • Rounded, experienced, imaginative

  • Innovative, open

  • Risk-taking

  • Persuasive, articulate

  • Delegating, training

  • Disciplined, demanding, accountable


Challenges and choices for the top team in relation to shareholder value hilary collins

Management reward in value-based companies

  • Objectives

  • To communicate the Governing Objective to managers (again)

  • To align management and shareholder interests by giving managers the motivation to choose strategies and take decisions that maximise shareholder wealth

  • To provide sufficient incentive - as measured by the relativity of fixed and variable rewards - to motivate managers to apply their time and energy; to take considered risks; and to make necessary but occasionally unpalatable decisions

  • To retain the services of valued managers over time

  • To keep costs to shareholders of management reward at reasonable levels

Incentive compensation schemes (rules, metrics)

Management focus and decisions

  • The way we set targets for incentive compensation schemes

  • What managers do to achieve the incentive targets

Market share metrics

Earnings metrics

Confused metrics

Market share-based decisions

Earnings-based decisions

Confused decisions

Shareholder Value-based behaviour and decisions

Shareholder Value metrics

(Economic Profit, MVA, TSR)


Challenges and choices for the top team in relation to shareholder value hilary collins

Management reward in value-based companies

  • Principles

  • Pay for increasing EP

    • EP needs to be measured at levels which the employee can affect

  • No threshold or caps

    • but bonuses can be negative if EP falls

  • A target bonus

    • based on peer companies compensation

    • probably larger than conventional target bonuses because there is potential for downside in EP bonuses

  • A bonus bank

    • to limit swings in bonus

    • to ensure that bonuses re;ate to sustainable improvements in shareholder value

    • to permit negative bonuses

  • Performance targets set by formula, not by negotiation

    • typical formula is to pay target bonus for prior years EP

    • formula often forecasts EP improvement per year for 5 years

    • but the base to which the expected improvement is added is reset each year based on actual experience

Boots

The Long Term bonus scheme for executive directors is based on the company’s TSR performance relative to a peer group of ten retail and FMCG companies over a four year cycle. The bonus is paid on a sliding scale if Boots achieves a level of eighth or above in the peer group.

Cadbury Schweppes (1999 Annual Report)

Directors: Annual incentive based on growth in EP (target is 60% of base, rising to 90% (paid 59% and 64% in 1998 and 1999). LTIP: 3-to-6 year cycle; up to 100% of base vs weighted average TSR of a peer group (not listed) Two awards: 1. TSR - No award for mid-peer group performance; full award for 80th percentile; 2. EPS - award paid if EPS > inflation + 4%

Tesco

Tesco states that its Long Term bonus is based on a number of measures including comparative TSR performance against peer companies. No other details are disclosed.

Kingfisher

The Long Term bonus scheme for executive directors and certain other senior managers is based on TSR performance relative to a peer group of fifteen retail companies over a three year period. A bonus is paid on a sliding scale for performance in the top half of the peer group.


Challenges and choices for the top team in relation to shareholder value hilary collins

“Management Agendas” align management priorities up and down the business

  • “Management Agendas” drive the strategies of the business and its key components in a coordinated and systematic way

Group

The BU strategy is driven by the BU management agendas

BU

Which

drive

Value Centre 1

Value Centre 2

Value Centre 3

Shared

Services

Value Centre

Agendas

Which

drive

PMUs

PMUs

PMUs

Support

Centres

PMU

Agendas


Challenges and choices for the top team in relation to shareholder value hilary collins

Infrastructure

People and alignment

Focus, agendas, business cases and decisions

Financial and strategic visibility and performance

Objectives and Targets

Organisation and People

Business Cases and Decisions

Focs and Alignment

Financial and strategic visibility and performance

Objectives and Targets

Infrastructure

People and Alignment

Focus, Agendas, Business Cases, and Decisions

Financial and strategic visibility and performance

Objectives and Targets

Challenges and choices for the Top Team

  • The organisational and personal skill and will to manage for value

  • Organisation structure

    • Clarify who is accountable for managing the value of the business

  • Roles and responsibilities

    • Best decision-making process

    • Personal responsibility for value

  • Management information

    • Provision

    • Use


Challenges and choices for the top team in relation to shareholder value hilary collins

Organisation structure: building blocks

  • The key objective of organisation structure is to maximise the clarity of accountability for managing the value of the business

Chairman

Value centres

  • the level at which the CEO manages the value of the Group (using Dialogues)

  • the smallest units that have - or could have - essentially independent strategies, with their “own” cash flows and economic profits

  • Group manages the portfolio of Value Centres and makes trade-offs between Value Centres

    Product market units

  • sub-units of a Value Centre with separate groupings of products or customers or both

  • units which have significant interdependencies with other PMUs in the Value Centre

  • units with no significant interdependency with any unit outside the Value Centre

  • Value Centres make trade-offs between the PMUs which they control

    Support centres

  • Cost Centres are often created by the Group to provide economy of scale, or to retain particular competences in-house

  • units which have no independent strategy - they exist to serve Value Centres and PMUs

  • units which usually do not sell their services outside the Group

  • units which have economic cost targets rather than economic profit targets

Group CEO

Value Centre

Value Centre

Value Centre

PMU

PMU

Support Centre


Challenges and choices for the top team in relation to shareholder value hilary collins

Organisation structure

  • Three “maps” of organisation structure help us to think through the best way to structure the business

Objectives of structure

Three structural “maps”

  • Structure should facilitate the use of the best decision processes so we create and implement the best strategies

  • (right process)

  • Structure should make it clear where opportunities to create value are to be found in the business

  • (right boundaries)

  • Structure should maximise clarity of responsibility and accountability for managing the value of the business

  • (right accountability)

Economic map

(Where and why value is created and destroyed)

Decision-making map

(How and where we make decisions)

Administration map

(How we choose to organise ourselves - structure, roles, responsibilities, etc)


Challenges and choices for the top team in relation to shareholder value hilary collins

Organisation structure

  • Economic map – how much “sharing” takes place?

  • We begin to identify the economic map by considering how much sharing takes place between current organisational units:

    • sharing of customers (internal and external)

    • sharing of assets

    • sharing of the brand (as a particular type of asset)

  • Little or no sharing:

    • may well be a Value Centre

  • Limited sharing

    • may well be a PMU

  • Significant sharing

    • may well be a Cost Centre

Economic map

(Where and why value is created and destroyed)

Decision-making map

(How and where we make decisions)

Administration map

(How we choose to organise ourselves - structure, roles, responsibilities, etc)


Challenges and choices for the top team in relation to shareholder value hilary collins

Economic map

(Where and why value is created and destroyed)

Decision-making map

(How and where we make decisions)

Administration map

(How we choose to organise ourselves - structure, roles, responsibilities, etc)

Organisation structure

  • Decision-making map – where is the best place to take decisions?

Strategy decisions

Participation (where to compete)

Competitive (how to compete)

Resource allocation decisions

People and money

Performance management decisions

Goal setting

Agreeing targets and measures

Monitoring and managing delivery of performance


Challenges and choices for the top team in relation to shareholder value hilary collins

Other external audiences

Stock market

Economic map

(Where and why value is created and destroyed)

Chairman

Decision-making map

(How and where we make decisions)

Group CEO

Value Centre

Value Centre

Value Centre

Administration map

(How we choose to organise ourselves - structure, roles, responsibilities, etc)

PMU

PMU

Support Centre

Organisation structure

  • Administration map – who is “on the hook” for delivery of performance?

  • Each Value Centre, PMU, or Cost Centre has only one Manager assigned and accountable

  • But a Manager can be responsible for more than one Value Centre, PMU, or Cost Centre

  • Line role/responsibility

  • Company leader role/responsibility


Challenges and choices for the top team in relation to shareholder value hilary collins

Infrastructure

People and alignment

Focus, agendas, business cases and decisions

Financial and strategic visibility and performance

Objectives and Targets

Organisation and People

Business Cases and Decision

Focus and Alignment

Financial and strategic visibility and performance

Objectives and Targets

Infrastructure

  • Some key principles; and implications for managers

Structure

Organise around businesses, not functions

Clear roles and responsibilities

Profit centres at lower levels

Structure lets us use the best process

No wiggle room on value creation and destruction

Decision Processes

Dialogues with businesses, not functions

Performance measured often

Clear understanding about who decides what and how

Group sets process and standards

Zero tolerance for value creation and destruction

Information

Info. tailored to BU needs

Performance measured often

More info. At lower levels

Info supports the best process

Info a “corporate resource” :EP widely available

People

Focus on General Managers

Performance accountable managers

Expertise at lower levels

Selected and developed based on strategy

Short-term and long-term focus

  • Focus on businesses, not functions

  • Maximum clarity of accountability for value

  • Push decisions close to the customer

  • Process drives strategy drives structure

  • Focus on delivering EP


Challenges and choices for the top team in relation to shareholder value hilary collins

Stock market

Other external audiences

Chairman

Group CEO

Value Centre

Value Centre

Value Centre

PMU

PMU

Support Centre

The CEO of the Group

  • Three key responsibilities

1. Creating the best conditions for value creation

  • Governing objective and performance goals

  • Policies and standards

  • Cultural norms and values

  • External and internal communication of Group strategy, values, and performance

    2. Creating the best organisation for value creation

  • Organisation structure

  • Roles and responsibilities for managing value

  • Decision-making processes and standards

  • Management information

  • Motivated and capable people

    3. Ensuring that the best strategies are in place at all levels to maximise value creation (using the Management Agendas and Decision Dialogues)

  • Portfolio of Value Centres and Support Centres

  • Value Centre participation strategies

  • Value Centre competitive strategies

  • Support Centre service and cost strategies


Challenges and choices for the top team in relation to shareholder value hilary collins

The role of the Group

  • The Centre can create or destroy value: its role needs to be clear: there are four main options

The Portfolio Manager

  • Acts as an agent of the financial markets

  • Identify, acquire, improve under-valued businesses

  • High degree of autonomy for Business Units within financial constraints

  • Low central costs

  • Strong financial control

  • GEC under Weinstock; Berkshire Hathaway; KKR

    The Restructurer

  • Similar to Portfolio Managers; but the Centre itself delivers the restructuring and drives performance improvement

  • Centre has “turnround” staff

  • Tomkins

The Synergy Manager

  • The whole is greater than the parts

  • Shared activities, assets, competences

  • Requires BU managers to participate

  • And for synergies to be real and achievable

  • Tata Tetley; Primedia and About.com

    The Parental Developer

  • The Centre has competences which it deploys in BUs in order to add value

  • Competences could be functional, eg global marketing; or processes, eg managing for shareholder value

  • Financial muscle

  • Cadbury Schweppes; Lloyds TSB; GE; 3M, Shell


Challenges and choices for the top team in relation to shareholder value hilary collins

Stock market

Other external audiences

Chairman

Group CEO

Value Centre

Value Centre

Value Centre

PMU

PMU

Support Centre

Management information

  • Requirements in different parts of the organisation

Clear linkage up and down the organisation between performance measures at different levels

Performance targets clearly linked to Group performance aspirations

Performance measures expressed at all levels in ways which are relevant to the decisions managers take at those levels (“balanced scorecard”)

Managers comfortable with the origin and use of the measures and targets

Value Centres need full economic profit information

targets (WV, or time to double value)

budgets (EP)

rewards (EP)

EP for our business plus competitors

EP history, current, forecast

Product Market Units need full economic profit information

targets (WV, or time to double value, or EP)

budgets (EP)

rewards (EP)

Cost Centres need full economic cost information

targets

budgets

rewards


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