We would like to open up your thinking to the power and the potential of shareholder value in this text. Before we begin, let us explore with you a short example from a real life discussion that occurred some years ago.
But it appeared — rapidly — that he was. It is open to the public but we are looking to expand our business — to get more punters in. We had the idea of buying two zebras for the park, but I cannot get my head around how to do a business case for the investment decision. What are your thoughts? Are you principally wanting to decorate the gardens a little more? Or are you trying to reposition it as a kind of a mini Chessington Park — which was formerly a zoo but is now a credible theme park with premium rates?
If you can achieve that then your reward could be a far more customers, b higher prices, and c more sales of merchandise, meals, and other objects of dubious value. A couple of years later the author actually encountered a park which had a stunning resemblance to this vision. At first sight shareholder value and strategy may not seem easy bedfellows.
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Eventually, they realize that they are both in agreement having used up an entire mountain in their pointless battle. Shareholder value and strategy are in precisely the same situation — rather than being schizophrenic they are essentially complementary. More than this, each one needs the other to ensure that strategies create, rather than destroy, economic value. Managing strategy for shareholder value thus makes finance the essential handmaiden of strategy, rather than being peripheral. Shareholder value can help guide strategy towards choices which produce a virtuous cycle of improving business performance, further opportunities, and higher quality capabilities and resource base.
This section is not heavily quantitative as the key concepts of shareholder value are actually based in economics and strategy — numbers and equations merely capture the end products of our thinking. Because of the volatility of share prices, proponents of shareholder value management tend to emphasize the importance of getting the internal view of value creation right rather than massaging the external share price.
In their view, positive share price movements will follow excellence by the company in generating superior future cash flows, rather than primarily by investor PR exercises or by smoothing the annual profits, earnings per share and dividend growth. In order to improve EVA, then, one could either generate more operating income, reduce the tax charge, or reduce the cost of capital.
The key point of EVA is that it actually provides a better focus for measuring and managing both corporate and business performance than conventional accounting measures. My son James has always been shrewd with his money. Once when he was eight I tried to borrow from him. I will pay you back on Monday when I have gone to a cash machine. Whilst not all investors are as aggressive as my son was otherwise capital markets would seize up , the case nicely illustrates that over and above pure riskiness, investors still need a return. But where does value come from?
Let us now look at value added and costs drivers. For example, acute competitive rivalry can often lead to discounting, price wars, and severe reduction in margins. Margin is a most important value driver which follows on from competitive rivalry. Margin levels are particularly sensitive to the degree of competitive rivalry in the market.
The Dome — critical success factors and value drivers In the very late s, the UK government decided to celebrate the Millennium with an exciting, visionary project. Situated in Docklands, the Dome was set up to be a magnificent experience — a huge structure housing themed exhibits. In reality, only a fraction of the UK population that was originally assumed actually came. Many of those who came were attracted by discounted tickets.
Conventional life cycle analysis suggests a number of stages which run more or less sequentially over time: emerging, growth, maturing, decline, renewal. Each stage demands a different competitive strategy and a different focus of investment. Table 2. Or, it may be high because it has secured venture capital. However, much of this funding may be in effect quasi-capital for instance, where loans can be converted to shares requiring a high return because of the high business risk.
Hence the cost of capital will be invariably high. Second, in the growth phase, the cost of capital may be substantially lower, as the business has become established and because investors perceive it to be an attractive venture to invest in. Once again, there is a high importance of revenue planning, and of both product and customer profitability during this phase. Third, in the maturity and decline phases, investment requirements decline, dividends rise as a proportion of earnings, and there may even be special dividends declared in effect capital repaid. This reduces the capital base and thus helps improve return on capital.
There is increasing pressure to achieve a better rate of return in these phases through better product and customer profitability and cost management. We can now relate competitive advantages and their financial impact directly see Table 2. In a force field analysis each force positive or negative is drawn in proportion to its perceived importance and its direction of positive or negative impact. A performance driver an upward arrow is any factor externally or internally which will positively impact on financial performance.
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Performance drivers here are drawn as upward arrows and performance brakes are shown as downward arrows. Figure 2.
May enhance prices Increased volume Higher increases in volume existing and new businesses Increased volume Product value for money Innovation Customer service Increases prices Increased volume Market share Probably neutral May require lower prices Higher prices Increased volume Brand Prices Sales volumes Avoids discounting Avoids discounting Avoids discounting Avoids discounting May require discounting Value drivers Discounting The impact of competitive advantage on the value drivers.
Competitive advantage Table 2.
Doing a performance driver analysis to understand the underlying drivers of financial performance can and should be married to qualitative analysis. In root cause analysis you begin by defining what the core symptoms of the problem are. This is then written to the far right of the page. Obviously some root causes might be more fundamental than the others, so you might decide to be selective in your analysis. Some of its major implicit assumptions can be challenged as follows.
They may well increase at a lower rate than turnover due to economies of scale and experience curve effects. Frequently sales staff may reduce price to gain market share and volume, or introduce discounts or other less obvious incentives such as special payment terms or service concessions sources of value dilution or destruction. All of these tactics reduce revenues or increase costs, or both, raising the break-even point. Also, as break-even is typically based on accounting-based measures, it does not represent genuine shareholder value creation. The essence of managing for shareholder value is that.
This occurs by analyzing discounted cash flows. Management processes which are important include conventional planning, budgeting, investment appraisal, performance review, and rewards and recognition processes. These need to be fundamentally thought through again so that shareholder value imperatives are reflected in everyday routines. BP Amoco, for example, took many years to bed down these changes from to , and the full impact of shareholder value creation was felt only between and see Chapter 7.
Figure 3. Whilst financial economic thinking has come to dominate many of the texts on shareholder value management, there was an important, if less vocal, input from the industrial economics school of thought, and also from strategic management. Although primitive in its accuracy and richness, accounting profit became the established and legitimate measure through which business and corporate performance was judged.
When the author qualified as an accountant — over 25 years ago — this simple concept had become quite an industry. The main thrust was then from financial economics, which argued that cash flow generation was the only sensible measure against which shareholder value creation could be judged. In unison, industrial economists hinted that to a large extent economic value creation was largely down to the competitive interaction successful or otherwise between a business and its markets.
So by the time was ripe for the first real synthesis of Shareholder Value Management. Rappaport was also involved in devising value-based management software — so that financial analysis of stakeholder value could be achieved effectively. Around the same time, Marakon Associates, a US value-based strategy consultancy was formed, and began to work with major US companies.
Its goal was to help them refocus decision-making from accountingbased measures.
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Once some major blue-chip companies like Coca-Cola began to adopt the new decision-making and performance control framework, value-based management began to catch on elsewhere. Marakon Associates have been joined in this market by the traditional consulting firms like McKinsey, and more latterly by some of the key large accounting firms — although after a significant time lag. Marakon still operate very much on a niche consultancy — without armies of consultants. Copeland et al.