CORPORATE FINANCE

CASE STUDY
STRYKER CORPORATION: CAPITAL BUDGETING

PREPARED BY: ATHIRA PILLAI

SNOBI ANNA SABU
SIDHARTH KANNAMPARAMBIL
RHEA PINTO
VISHNU T NAIR
REETHU RUGUS
AJAB
DONEL ALEX
RAHUL BABU
 TABLE OF CONTENTS

TOPIC PAGE NUMBER

INTRODUCTION 3

CASE BACKGROUND AND SUMMARY 3

IDENTIFICATION OF SYMPTOMS 5

PROBLEM STATEMENT 6

PROBLEM ANALYSIS 7

SWOT ANALYSIS 8

ALTERNATIVES 9

EVALUATION OF ALTERNATIVES 11

RECOMMENDED COURSE OF 14

ACTION

IMPLEMENTATION 16
 INTRODUCTION

Stryker Corporation is a fortune 500 company based in Kalamazoo, Michigan. Improving people’s

lives through meaningful innovations and cost-effective solutions is the basic mantra of the

company. The aim is to achieve 20% growth every year. The company’s strong operating results

show a continued growth. Stryker’s 13 divisions are headed by executive who are directly

accountable to the corporate office.

The capital budgeting process of Stryker was modified so that a formal process of requesting

capital expenditure for approval could be implemented. The investment process at Stryker is

dependent on the multi-year strategic plans of the company, which is decided at the beginning of

every financial year.

The given case study has been solved according to corporate finance theory and use of a strategic

tool like SWOT analysis. The recommended solutions are a combination of the alternative that

have been discussed and put forth accordingly.

CASE BACKGROUND AND SUMMARY

Stryker is a fast-paced pharmaceutical company that has made exceptional growth of 20% every

year. The company has a highly decentralized culture summarized as ‘Focus, Freedom and

Accountability’. The company has thirteen defined business divisions with considerable

autonomy. Making numbers is an important shared responsibility among each of the division. Over

the course of years the company’s strategic Mergers and Acquisitions have brought operational

efficiencies and expanded their key markets. This has significantly contributed towards their

phenomenal growth.
  Stryker Corporation benefitted from a favorable demographic trend where the baby boomer

generation matured and entered the prime age range for many orthopedic and other medical

procedures.

 Advances in medical science, computers and other technologies were bringing more

sophisticated procedures into mainstream practice.

Both of the above trends widened Stryker’s key markets, with industry analysts predicting current

trends to continue for the foreseeable future and there was continued healthy growth in the sector.

Stryker’s businesses also consistently outgrew the markets in which they participated.

Styker had an established pattern of using strategic acquisitions to enter new markets, which is one

of the driving factors behind their consistent 20% growth per year.

This paper is an attempt to scrutinize Stryker’s capital budgeting process (CER-Capital Expense

Request) and why the revised approval process has slowed down the company’s internal capital

requests from about 300 a year to 30 a year. Capital expenditure from 2000 to 2005 doubled;

however there was a drop of 20% in 2006, which was approximately one year after the CER

modifications were brought into place. Also the case study points out some instances where

employees don’t seem happy with the new modifications. This seems to be the crux of the problem

according to our understanding.

 IDENTIFICATION OF SYMPTOMS

 Stipulated timetable for CER submission and reviews were not always met.

 Number of CERs requiring centralized approval reduced from 300 in 2005 to 30 in 2006.

 Capital Expenditure decreased from nearly 272 million in 2005 to about 218 million in 2006

by 20%.

 The company focuses its growth through acquisitions but none of them were as large as

Howmedica.

 The capital budget reflected tradeoffs between spending on existing businesses and new

initiatives. For example: The split within Global Instruments had been 25-35% for existing

businesses and remainder on new initiatives.

 Total divisional capital spending was trimmed to meet cash flow targets.

 Research, development and Engineering expenses in 2006 totaled $325 million, and had grown

at a compounded average of 21% in recent years. Roughly 75-80% of RD&E expenses went

to development and engineering activities, with the remainder devoted to earlier stage research.
 PROBLEM STATEMENT

1. Misalignment between the Capital Committee and Authority thresholds at the Division

and Group levels in the case of large CERs.

Stryker was a decentralized organization with an entrepreneurial culture. The thirteen divisions

were made with the clear concept that they would have complete autonomy over their business

operations. But in 2005, Stryker redesigned their CER forms and underwent modified procedures.

This resulted in the formation of a ‘Virtual’ Capital Committee. The Capital Committee had to

approve all acquisitions, joint ventures, equity investments, and licensing, development or

distribution agreement in excess of $1 million.

2. The imbalance in the Budget allocation for existing businesses and new initiatives.

Stryker had established a pattern of using strategic acquisitions to enter new markets, reach new

customers and extend its core businesses. This ultimately meant that Stryker would incur high

costs and the revenue gained would decline on the long run. So total divisional capital spending

had to be trimmed to meet cash flow targets.

 PROBLEM ANALYSIS

1. Misalignment between the Capital Committee and Authority thresholds at the

Division and Group levels in the case of large CERs.

The new approval process for large CERs meant that there had to be more data, more depth, more

analysis, more standardization and rigor in the revised process. However due to this, the stipulated

timetable for CER submission were not always met. CERs weren’t submitted on time. The newly

formed Capital Committee were not always available and were not holding regular meetings as a

group. The requirements for standardization and documentation were unnecessarily bureaucratic

to some managers. Due to the complication process in CER submission and review, the number of

CERs reviewed by the Capital Committee reduced from 300 in 2005 to just 30 in 2006 and Capital

Expenditure reduced from $272 million in 2005 to $218 million in 2006.

2. The imbalance in the Budget allocation for existing businesses and new initiatives.

Stryker had a set benchmark of 20% growth per year, which was engrained in the corporate

culture. With each new acquisition the budget allocation becomes more complex. Total

divisional capital spending was trimmed to meet cash flow targets. On the other hand, due to a

moderate portion of the budget being allocated to existing businesses, the price of even the

largest acquisition of Stryker in 2006, Sightline was significantly less than 10% of Howmedica

bought in 1998. Even the Capital Expenditure reduced from nearly $272 million in 2005 to $218

million in 2006.
Please click the link for the ratio calculations of Stryker Corporation for the years, 2005 and

2006: Stryker Corporation Ratios.xlsx

 ALTERNATIVES

 Remove the ‘Virtual’ Capital Committee and introduce a Project management team at

the Divisional level, who are aware of both, all the matters regarding the entire business of

the Stryker group and the matters of the Division and report directly to the CEO. They can

form a direct link between the Divisions and the CEO without having to deal with the

designated sponsors or the majority vote in the company.

 The Capital Committee should have a regular weekly meetings. The Capital Committee

of Stryker operated like a ‘Virtual’ Committee with members contacting one another as

needed.

 Allow the divisions to make the CER templates simpler in terms of gathering information.

Previously followed template could be used to submit the CERs, as the divisions didn’t

seem to have a problem earlier. Make it so that the new template need not be followed

strictly for every CER unless deemed necessary by the CEO for more information or clarity.

 Prioritize the Divisional Capital spending over the cash flow targets. This would increase

the budget for Capital expenditure, which was trimmed earlier.

 Reduction in the amount spent on Research, Development & Engineering would reduce

the overall budget for existing businesses. The company focuses its growth through

acquisitions more than through existing businesses. This in-turn would increase the budget

allocation for Capital expenditure.

 Symptoms Problems Alternatives

 Stipulated timetable for CER
reviews and submissions were
not always met.
 Number of CERs requiring
centralized approval reduced
from 300 in 2005 to 30 in
2006.
 Capital Expenditure
decreased from nearly 272
million in 2005 to about 218
million in 2006 by 20%.
Misalignment between the
Capital Committee and
Authority thresholds at the
Division and Group levels
in the case of large CERs
 Remove the ‘Virtual’
Capital Committee and
introduce a Project
management team at the
Divisional level.
 The Capital Committee
should have a regular
weekly meeting.
 Previously followed
template could be used to
submit the CERs.

 Capital Expenditure The imbalance in the  Prioritize the Divisional

decreased from nearly 272 Budget allocation for Capital spending over the
million in 2005 to about 218 existing businesses and cash flow targets.
million in 2006 by 20%. new initiatives.  Reduction in the amount
 The company focuses its spent on Research,
growth through acquisitions Development &
but none of them were as Engineering.
large as Howmedica.
 The capital budget reflected
tradeoffs between spending
on existing businesses and
new initiatives. For example:
The split within Global
Instruments had been 25-35%
for existing businesses and
remainder on new initiatives.
 Total divisional capital
spending was trimmed to
meet cash flow targets.
 Research, development and
Engineering expenses in 2006
totaled $325 million, and had
grown at a compounded
average of 21% in recent
years.
 EVALUATION OF ALTERNATIVES

1) Remove the ‘Virtual’ Capital Committee and introduce a Project management team

at the Divisional level:

Benefits:

i. Reduction in Complexity. The process becomes more straight forward. The

Project Manager is directly linked to the CEO and to the Divisions. Hence the

message from the CEO can be directly sent to the people working in the

Divisions. In the absence of the Capital Committee, the opinion of only one

person has to be taken into consideration instead of the opinion of several

different people.

ii. Increased Efficiency. Without the ‘Virtual’ Capital Committee and their rare

meetings, the process is more direct and hence can be completed within the

stipulated timeframe.

Risks:

i. Delay in Enforcement. It would involve hiring the right people or assigning the

right people the duty of Project Management, which is hard. It isn’t easy for a

Project Manager to stay updated with the day to day internal work of a company

as large as Stryker. As, this involves a change in system, it is not easy to enforce

and the change could take a long time to undergo.

ii. Demoralization of Capital Committee Members. The Capital Committee members

apart from the CEO also include the CFO, Treasurer, Controller, General

Counsel, Vice Presidents for Tax and Business Development, and the Director of

IT. Demoralization of any of these people could be hazardous for a company.

2) The Capital Committee should have a regular weekly meetings:

Benefits:

i. The Capital Committee would stop being a ‘Virtual’ Committee once it starts

holding regular meetings. All the proposals for CERs and discussions regarding

the operational projects could be discussed during the meeting

ii. Increased Efficiency. Without the ‘Virtual’ Capital Committee and their rare

meetings, the process is more direct and hence can be completed within the

stipulated timeframe.

Risks:

i. Difficulty to spare time for the meetings. The Capital Committee includes the

CEO, the CFO, Treasurer, Controller, General Counsel, Vice Presidents for

Tax and Business and the Director of IT. Each of them are busy people with a

whole lot of responsibilities and it would be difficult for them to spare time for

these meetings on a weekly basis.

3) Previously followed template could be used to submit the CERs:

Benefits:

i. Easy to Re-Adopt. Having used it before and having been extremely

comfortable about it, the old format and template should be easy for the

Divisions to re-adopt.

ii. Uncomplicated. Some Managers found the requirements for standardization

and extensive documentation in the new CERs to be unnecessarily bureaucratic

 as they were ‘no-brainers’ and clearly assured of approval. Returning back to

the old format would feel simple and uncomplicated in comparison.

Risks:

i. Lack of Data and Standardization. The new CER format was created so that they

would have more data, depth, analyses, standardization and rigor. The old

format wouldn’t have any of those and may seem unprofessional in comparison.

ii. Capital Committee may not agree. The Capital Committee would probably need

more details for their documentation process so that they can keep track of the

approved CERs and their values and perform the required calculations on them.

4) Prioritize the Divisional Capital spending over the cash flow targets:

Benefits:

i. Increased Budget for Capital Expenditure. The Budget for Capital Expenditure

was reduced to achieve the cash flow targets. If Divisional Capital spending is

prioritized, then the Board can allocate more budget resulting in bigger

acquisitions.

Risks:

i. 20% Growth Rate at Risk. Growth of 20% per year was both a habit and a

corporate slogan for Stryker. So much so that the former President and CEO,

and current Chairman of the Board, John Brown had articulated it as ‘20%

growth forever’. By prioritizing Divisional Capital spending over the Cash

flow target, the Corporate Slogan is being put at risk. Only in 1998, when
 Stryker acquired Howmedica and in 1999, did Stryker fail to exceed this

standard.

5) Reduction in the amount spent on Research, Development & Engineering:

Benefits:

i. Reduced Budget for Existing Business. By reducing the amount spent on

Research, Development and Engineering, the overall budget for existing

businesses would reduce significantly. In 2006, Stryker spent $325 million on

RD&E alone and had grown on a compounded average of 21% in recent

years, which is too much. However, Stryker focuses its growth through

acquisitions than through existing businesses and hence would benefit from

this.

ii. 20% Growth Rate can be Achieved. Despite reduction of the amount spent on

Research, Development and Engineering, a 20% growth rate can be achieved

through the operations of the existing businesses, while increasing the budget

available for new acquisitions.

Risks:

i. Research, Development & Engineering suffers. The biggest challenge for

Stryker is to keep growing as a Company. Hence they feel the need to invest in

new markets as well as existing businesses due to which they invested $325

million on Research, Development and Engineering of which 75-80% went into

Development and Engineering. Due to this policy, RD&E won’t be getting as

much budget as they used to.

 RECOMMENDED COURSE OF ACTION

The CERs and capital budgeting process of Stryker are significantly characterized by the

elements of corporate finance theory.

All CERs submissions must provide the discounted cash flows and present value of inflows and

outflows, payback and discounted period and internal rate of return before approval. Ensure that

they have highlighted the anticipated cash outflow and the effect of earnings on the company.

They should also describe the risks that could affect the results of the projects.

Reduction in the amount spend on research, development, and engineering would reduce the

budget for capital expenditure. Analyzing the case has led us to believe that there is some

amount of excessive and wasteful spending in this regard. Therefore a smarter move is to cut

down unnecessary expenditure by evaluating the current and future requirements of expenditure

on R&D as the current level of expenditure is far too much on R&D. This would solve the

problem of imbalance in the budget by allocating more for acquisitions and improving the

existing businesses.

We also propose to have the capital committee conduct weekly meetings, as this would reduce a

lot of the complexities and simplify the decision making and implementation process. One of the

major reasons for the misalignment between the Capital Committee and Divisional heads is due

to the discrepancies between the two. With the Capital Committee having regular meetings, they

would be available as a whole group and not as a ‘Virtual’ Committee. The availability of the

Capital Committee would mean the prompt submission of the CERs within the stipulated

timeframe for review on the day of the meeting. During these Capital Committee meetings, then
can discuss all the proposals for new CERs between them and accept or reject them based on the

majority vote and the CEO’s approval.

Holding a meeting between the two is probably the best solution to the problem in the long-run.

This would eliminate the communication lag between the divisions and the committee. There

would be no confusion and dissatisfaction.

The committee should discuss with the divisional heads the importance of the new template of

CER submission. Some felt that the new templates required more standardization and rigorous

analysis. Giving them an opportunity to discuss would shed light on any other lurking problems

that would appear later on. To have continued growth of 20%, it is absolutely essential that the

CER process goes without a hitch, as strategic acquisitions are the key market builders for

Stryker. Even though the modification was intended for continued growth, it turned out to be

‘painful’. So it’s better to tackle it at its root before letting it crumble the system.

These are the proposed recommendations which would make the executives happy as well as the

committee members, and in turn the company flourishes. The success of a capital budgeting

process is by ensuring that the projects selected are beneficial and will increase the market value

of the company.
 IMPLEMENTATION

1) Reduction in budget for Research, Development and Engineering: The reduction in

budget for RD&E should be done by the Board of Directors at the start of the financial

year. Once the budget is allocated, changes shouldn’t be made. So the change can be

implemented only then.

2) Conduct Weekly Meetings for the Capital Committee: The Capital Committee must come

together and discuss an appropriate day of the week and time of the day during which

they can conduct the meetings every week or at least be available via Skype. On that

particular day, for the duration of the meeting they must put aside every other

commitment. This can be implemented within a week and it should be done by the CEO

as he is the most powerful person in the company and everyone will adhere to his wishes

and instructions.