Goals, Value and Performance

Dilipchandra. S

“If you don’t have a strategy, you will be a part

of someone else’s strategy.” – Alvin Toffler

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 Goals, Value & Performance

• Strategy as a quest for value

• Putting performance analysis into practice

• Organizational vision, mission and objectives

• Beyond profit: Values and corporate social
responsibility

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 Strategy as a Quest for Value
• The stakeholder approach
o The firm is a coalition of interest groups – it seeks to balance
their different objectives
• The shareholder approach
o The firm exists to maximize the wealth of its owners
o = 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
interest
2. 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
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How do the World’s Leading Companies Perform
Using Different Profitability Measures?

Company Market Net ROS( ROE ROA Return to

Capitalization income Op (%) (%) Shareholders
($ bn) ($ bn) Prof
Mar
gin)
(%)

ExxonMobil 354 30.5 15.2 20.7 17.5 10.1

Apple 338 14.0 31.2 29.3 29.0 53.1
PetroChina 226 22.9 10.6 15.3 11.7 -8.4
General 155 11.6 12.7 9.8 18.9 23.9
Electric
J.P. Morgan 108 17.4 28.5 9.9 11.8 2.3
Chase
Wal-Mart 196 30.5 5.9 23.5 14.1 3.2
Stores
Volkswagen 64 9.1 7.5 32.9 3.6 123.2
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 From Profit Maximization to Value
Maximization
• Profit maximization an ambiguous goal
o Total profit vs. rate of profit
o Over what time period?
o What measure of profit?
o Accounting profile vs. economic profit (e.g. Economic Value
Added: Post-tax operating profit less cost of capital
• Maximizing the value of the firm
o Max. net present value of free cash flows:

Where:
V = market value of the firm
Ct = free cash flow in time t
r = weighted average cost of capital
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 Profitability Ratios
Ratio Formula Notes
Return on Operating profit, before The return on the capital invested in the
Invested interest, after tax business. ROIC is also known as return on
Capital Equity + Debt capital employed (ROCE). The numerator can
(ROIC) be is operating profit or earnings (EBIT), and
can be pre-tax or post-tax.

Return on Net income ROE measures the firm's success in using

Equity (ROE) Shareholders’ equity shareholders’ capital to generate profits that
are available for remunerating investors.

Return on Operating profit e numerator should correspond to the return

Assets (ROA) Total assets on all the company’s assets—e.g. operating
profit, EBITDA (earnings before interest, tax,
depreciation, and amortization), or EBIT
(earnings before interest and tax).

Gross margin Sales – cost of material inputs Gross margin measures how much value a firm
Sales adds value to the goods and services it buys in.

Operating Operating profit Operating margin and net margin measure a

margin Sales firm's ability to extract profit from its sales, but
not very good for interfirm comparisons
Net margin Net income because of differences in capital intensity
Sales

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 Shareholder Value Maximization and
Strategy Choice
• The value maximizing approach to strategy
formulation
o Identifying strategy alternatives
o Estimate cash flows associated with each strategy
o Estimate cost of capital for each strategy
• Problems:
o Estimating cash flows beyond 2-3 years is difficult
o Value of firm depends on option value as well as DCF value
• Implications for strategy analysis
o 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
o Utilize quantitative strategy analysis to evaluate future
profit potential

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 Setting Performance Targets: Linking Value
Drivers to Performance Targets
Sales Targets Order size
Margin COGS/Sales Customer Mix

Development Sales/Account
Cost/Sales Customer Churn Rate
Deficit Prices
Shareholder
Cost Per Delivery
Value ROCE
Creation Maintenance Cost
Inventory New Product Development Time
Turnover
Indirect/Direct Labor
Economic Capital Capacity Customer Complaints
Profit Turnover Utilization
Downtime
Cash Turnover
Accounts Payable Time
Accounts Receivable Time

CEO Corporate/Divisional Functional Departments & Teams

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 Setting Performance Targets: Balanced
Scorecard for a Regional Airline
Simplified Strategy Performance Targets Initiatives
Map Measures
Financial • Market Value • 25% per year • Optimize routes
Increase • Seat Revenue • 20% per year • Standardize planes
Profitability • Plane Lease Cost • 5% per year
Lower Increase
Cost Revenue

Customer More • FAA on-time • First in industry • Quality management

Cust- arrival rating • 98% satisfaction • Customer loyalty
On-time omers • Customer ranking • % change program
Flights • No. customers
Low
Prices

Internal • On Ground Time • <25 Minutes • Cycle time

Improve • On-Time Departure • 93% optimization program
turnaround
time

Learning • % Ground crew • Year 1, 70% • Stock

stockholders • Year 4, 90% ownership plan
Align • % Ground crew trained • Year 6, 100% • Ground crew training
Ground
Crews

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 Pitfalls of Pursuing Financial Targets:
The Paradox of Value
• Empirical research shows that firms which are most
successful in creating long-term shareholder value
o Have a mission – They give precedence to goals other than
profitability and shareholder value
o Have strong, consistent, ethical values
• Examples:
a) “Visionary” companies studied by Collins & Porras, e.g
Merck, Wal-Mart, Proctor & 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
• Lesson:
o Profit is created not by pursuing profit but by pursuing the
factors that create profit
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 Vision and Mission
• Provides a framework or context within which
strategies are formulated that includes:

Mission – The reason for existence – what an

Organization does

Vision – A statement of some desired future state

Values – A statement of key values that an organization

is committed to

Major Goals – The measurable desired future state that

an organization attempts to realize
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Abel’s Framework of defining the Business

Source: D. F. Abell, Defining the Business: The Starting Point of Strategic

Planning (Englewood Cliffs, Prentice Hall, 1980), p. 7
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 The Vision
It is about what would the company like to
achieve? A good vision is meant to stretch a
company by articulating an ambitious but
attainable future state.
The vision of Ford is “to become the world’s
leading consumer company for automotive
products and services.”
Nokia is the world’s largest manufacturer of
mobile phones and operates with a simple but
powerful vision: “If it can go mobile, it will!”
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 Values
The values of a company should state:
• How managers and employees should conduct
themselves
• How they should do business
• What kind of organization they need to build to help
achieve the company’s mission
• Organizational culture
– The set of values, norms, and standards that
control how employees work to achieve an
organization’s mission and goals
– Often seen as an important source of competitive
advantage
In high-performance organizations, values respect
the interests of key stakeholders.
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 Values at Nucor- Example
 “Management is obligated to manage Nucor in such a way
that employees will have the opportunity to earn according
to their productivity.”
 “Employees should be able to feel confident that if they do
their jobs properly, they will have a job tomorrow.”
 “Employees have the right to be treated fairly and must
believe that they will be.”
 “Employees must have an avenue of appeal when they
believe they are being treated unfairly.”
At Nucor, values emphasizing pay for performance, job security,
and fair treatment for employees help to create an
atmosphere that leads to high employee productivity.

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 Major Goals
A goal is a precise and measurable desired future state
that a company must realize if it is to attain its vision
or mission.
Key characteristics of well-constructed goals:
1. Precise and measurable – to provide a
yardstick or standard to judge performance
2. Address crucial issues – with a limited
number of key goals that help to maintain focus
3. Challenging but realistic – to provide
employees with incentive for improving
4. Specify a time period – to motivate and
inject a sense of urgency into goal attainment
Focus on long-run performance and competitiveness.
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 Beyond Profit:
Corporate Social Responsibility
• Even if we believe that the primary objective of the firm
should be long-run profit maximization, no firm can ignore
its relationship with society. For survival and success a
firm needs to:
o Maintain its reputation
o Ensure that it has a license to operate
o Be sensitive to its external environment – including its social,
political and natural environments
• Michael and Mark Kramer argue that firms should re-
conceptualize their businesses towards the creation of
“Shared Value”: “creating economic value in a way which
also creates value for society” This requires the firm to
recognize its co-dependence with its natural and social
environment.
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 Questions?

“The essence of strategy lies in creating

tomorrow’s competitive advantage faster
than competitors mimic the ones you possess
today.” – Gary Hamel and C K Prahalad

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