SHAREHOLDER VALUE: A JOURNEY OF LEARNING

1
(No Transcript)
2
SHAREHOLDER VALUE A JOURNEY OF LEARNING
Focusing on Shareholder Value
Transforming Beliefs
Transforming Behaviour
Transforming Management Performance

• The ultimate test of management is value creation
• Top quality CEOs deliver consistently superior
  shareholder returns
• New fangled measures like EBITDA and EVA are not
  enough. There are no magic methodologies
• Each management team needs to set out on a
  journey of learning together which will transform
  their beliefs, their behaviour and their
  performance

3
WHAT IS THE DRIVING FORCE OF A COMPANY?

• Most companies agree that long-term profitable
  growth is their overarching objective
• But by profitable, do they mean economically
  profitable, i.e. after a capital charge has been
  applied to after-tax profit?
• Do Boards really believe that the ultimate test
  of management is value creation?
• If you can get well paid for a less demanding
  objective, why not take it?

4
WHAT CONSTITUTES SUCCESS?

• To be the biggest in the industry?
• To have the biggest market share?
• Global market leadership?
• Maximising customer satisfaction?
• Total shareholder return?

5
TRADITIONAL PERFORMANCE MEASURES

• PBT, PAT, EPS, ROA, Market Share, Customer
  Satisfaction etc. do not in themselves tell us
  whether value is being created
• If all these measures were positive and improved
  on the previous period, there might be an
  assumption that value is being created
• Not until we factor in the cost of capital can we
  measure whether there is a higher return on the
  capital than the cost of that capital
• Value is created when the return on capital is
  higher than the cost of capital value is not
  necessarily created even if PBT and EPS grow

6
RESTATING THE GOVERNING OBJECTIVE

• The governing objective of the company should be
  to maximise shareholder value, not growth
• Maximising good growth and eliminating bad growth
  is essential to achieving the governing objective
• Maximising strategic and organisational
  effectiveness is essential to achieving the
  governing objective

7
GOOD GROWTH AND BAD GROWTH

• GOOD GROWTH
• When ROE exceeds COE, a business will
• create value by growing
• forgo value by not growing
• BAD GROWTH
• When ROE is less than COE, a business will
• create value by eliminating underperforming
  investments
• destroy value by growing
• Maximising value is about maximising good growth

8
OBJECTIVES

• Set by the Board
• Why not try this?The mission of the Board of
  Directors of ABC plc is to help produce long-term
  value for its shareholders. The Board believes
  that ABC should rank in the top quartile of peer
  companies in total shareholder return as measured
  over 3, 5 and 10 year periods
• Even today, some Boards do not regularly measure
  total shareholders return relative to a peer
  group

9
ECONOMIC PROFIT DEFINITION AND USE

• Economic profit is the best single-period measure
  of value creationDefinition
• Economic profit is calculated by subtracting a
  charge for capital from post-tax profit
• Economic profit takes into account the
  risk-adjusted opportunity cost of capital
• Use
• Provides a single period signal of where value
  is potentially created or destroyed
• Is the best internal measure of short-term
  performance
• Is the primary building block used in calculating
  economic value
• Is a critical input to making decisions which
  maximise shareholder value

10
A FINANCIAL DISCIPLINE

• Economic Profit measures are an integral part of
  the strategy development process
• The strategy development process creates the
  conditions and enforces the financial standards
  for developing the highest-value strategies on a
  continuous basis in every business unit
• The strategy development process, using Economic
  Profit measures, instils a financial discipline
  into the company
• To avoid investing resources in areas of poor
  growth prospects or poor returns
• To encourage a continuous review of existing and
  alternative strategies that deliver demanding
  performance targets

11
DIAGNOSIS
In which products and markets are we creating
value?
Value creation

• Observations
• Most companies do not have the information needed
  to measure the value of their individual
  businesses
• Value tends to be concentrated
• Cross-subsidisation is common

12
SUSTAINABLE GROWTH IN ECONOMIC PROFIT

• Insist upon alternative, higher value, business
  strategies
• Each value centre needs as a strategy showing how
  they will obtain a competitive advantage and the
  effect on economic profit
• In any given year, some value centres may be
  growing rapidly while others are stable or
  declining
• For the group as a whole, the reallocation of
  resources by value centre, by product, by
  customers, by channel increases economic profit
  substantially when process fully implemented

13
THE RIGHT BEHAVIOUR
Managing to maximise profitable growth of the
business

• Constant pursuit of higher value alternatives
• Organisational alternatives
• Structure
• Processes
• Information
• Capabilities
• Strategic alternatives
• Participation
• Offering
• Operating
• Pricing
• Portfolio
• Affiliation benefits

• Superior discipline for eliminating unprofitable
  use of resources
• Unprofitable products
• Unprofitable customers
• Unprofitable markets
• Unprofitable activities
• RD
• Manufacturing
• Distribution
• Central services

14
TOP MANAGEMENT COMPENSATION
Figure 2 Companies that believe strongly in
aligning compensation with shareholders
interests have a higher market-to-book ratio than
those that do not
There is little or no need specifically to align
the compensation of senior executives with
shareholders interests
Response tying to Shareholder Value is of
average or little importance
42 higher Market-to-book
Compensation must align top management with the
interests of shareholders
Response tying to Shareholder Value is very
important
Market-to-book ratio
15
MANAGING FOR VALUE THE JOURNEY OF LEARNING
Focusing on Shareholder Value
Transforming Beliefs
Transforming Behaviour
Transforming Management Performance

• Over the 17 years ended December 2000, Lloyds
  Bank shareholders saw the value of their
  investment, with dividends reinvested, increase
  over 65 times, doubling and redoubling total
  shareholder return every 35 months
• There were no a priori prescriptions and no
  magic methodologies
• It involved a journey of learning together

16
STEPS TO VBM SUCCESS

• Define one objective
• Agree one definition of success and one way of
  measuring it
• Establish stretch goals
• When people achieve exceptionally demanding
  goals, they take pride in their achievement and
  want to stay on top
• Align your reward system behind your goals
• Cultivate learning and change minds
• You cant impose the value creation mindset.
  People need to be convinced through discussion,
  learning and debate
• Make the difficult choices

17
CONCLUSION

• Managing for value is different
• Managing for value must be tailored to each
  companys needs and style
• Managing for value works
• BUT
• Generating consistently superior shareholder
  returns is the most challenging task a company
  can set for itself
• It is a tough discipline to accept
• People will wriggle like mad to escape the
  discipline
• It requires extraordinary commitment and belief
  to stick to it over the long haul

18
(No Transcript)