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Page 1: Making Value Happen

Making Value HappenMaking Value Happen

Jeremiah WorthingtonJeremiah Worthington

Finance 609Finance 609

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Focus of Chapter 6Focus of Chapter 6

Show how a company should create Show how a company should create value in an organization, not why it value in an organization, not why it shouldshould

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Questions to AnswerQuestions to Answer

How can companies set targets that reinforce How can companies set targets that reinforce our overall goal of creating shareholder our overall goal of creating shareholder value?value?

How can we align our management processes How can we align our management processes with the goal of value creation?with the goal of value creation?

How should we structure our incentive How should we structure our incentive programs?programs?

How can we promote a value emphasis How can we promote a value emphasis throughout our corporate culture?throughout our corporate culture?

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Value ThinkingValue Thinking Two components to value thinking:Two components to value thinking: Value MetricsValue Metrics

Does management really understand Does management really understand how how companies create value and how the companies create value and how the stock stock market values companies?market values companies?

Value MindsetValue MindsetRefers to how much management cares Refers to how much management cares about shareholder value creation. Do about shareholder value creation. Do

they really want to pursue value creation, they really want to pursue value creation, is is a long term commitment or short term a long term commitment or short term fad? fad?

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Six Areas of Value FocusSix Areas of Value Focus 1. 1. It must combine an inspiring aspiration with tough quantitative It must combine an inspiring aspiration with tough quantitative

targets linked to value creation.targets linked to value creation.

2. 2. It should adopt a rigorous approach to managing its portfolio of It should adopt a rigorous approach to managing its portfolio of businesses for maximum value creation, including radical businesses for maximum value creation, including radical

restructuring if necessary.restructuring if necessary.

3. 3. It must ensure that its organizational design and culture reinforce It must ensure that its organizational design and culture reinforce the value creation imperative.the value creation imperative.

4. 4. It must develop superior insight into the key value drivers of each It must develop superior insight into the key value drivers of each of of its businesses.its businesses.

5. 5. It must establish an effective approach to managing the It must establish an effective approach to managing the performance performance of it business units through sophisticated target setting of it business units through sophisticated target setting and and rigorous rigorous performance reviews.performance reviews.

6. 6. It must find ways to motivate managers and employees to work It must find ways to motivate managers and employees to work toward value creation through financial rewards and other toward value creation through financial rewards and other

incentives.incentives.

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Areas of Activity for Making Value Happen

Shareholder Value

Aspirations andTargets

Portfolio Management

Organization Design

Value Driver Definition

BusinessPerformanceManagement

IndividualPerformanceManagement

Metrics

ValueThinking

Mindset

Source: Reproduction of Exhibit 6.01 in the book, Valuation - Measuring and Managing the Value of Companies

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Setting Aspirations and TargetsSetting Aspirations and Targets

Inspiration Statement of IntentInspiration Statement of Intent

Value-Linked Quantitative TargetsValue-Linked Quantitative Targets

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Managing the Corporate Managing the Corporate PortfolioPortfolio

Three perspectives on portfolio Three perspectives on portfolio management follow:management follow:

1. 1. Strategy: Corporate Theme AnalysisStrategy: Corporate Theme Analysis

2.2. Performance: Performance: Outside-In Outside-In Restructuring Restructuring AnalysisAnalysis

3.3. Growth: Three Horizon AnalysisGrowth: Three Horizon Analysis

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Strategy: Corporate Theme Strategy: Corporate Theme Analysis Analysis

There There are seven corporate themes are seven corporate themes The Industry ShaperThe Industry Shaper The Deal MakerThe Deal Maker The Scarce Asset AllocatorThe Scarce Asset Allocator The Skill ReplicatorThe Skill Replicator The Performance ManagerThe Performance Manager The Talent AgencyThe Talent Agency The Growth Asset AttractorThe Growth Asset Attractor

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Performance: Outside-In Performance: Outside-In Restructuring Analysis Restructuring Analysis

The hexagon helps quantify the The hexagon helps quantify the impact of value creation levers: impact of value creation levers: investor communication; internal investor communication; internal improvements; disposal; growth improvements; disposal; growth opportunities, and financial opportunities, and financial engineering. engineering.

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Growth: Three Horizon Analysis Growth: Three Horizon Analysis

An analysis of companies with sustained above-average An analysis of companies with sustained above-average growth indicates that they manage their business portfolios growth indicates that they manage their business portfolios across three horizons.across three horizons.

Horizon 1Horizon 1 includes current core businesses, which generally includes current core businesses, which generally account for the greatest part of current profits and cash flowaccount for the greatest part of current profits and cash flow

Horizon 2Horizon 2 includes emerging opportunities, the “rising star” includes emerging opportunities, the “rising star” businesses of the company that already have customers and businesses of the company that already have customers and revenues, even if they do not yet generate positive cash flowrevenues, even if they do not yet generate positive cash flow

Horizon 3Horizon 3 includes future options, which are opportunities where includes future options, which are opportunities where initial activity has already begun, be it a pilot project, minority initial activity has already begun, be it a pilot project, minority stake, or memorandum of understanding stake, or memorandum of understanding

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Orienting the Organization Orienting the Organization Toward ValueToward Value

Having the correct organizational structure in Having the correct organizational structure in place is crucial to making value happen. There place is crucial to making value happen. There are hard and soft areas of organization design. are hard and soft areas of organization design.

Hard areas:Hard areas:StructureStructureDecision RightsDecision RightsPeoplePeopleCoordination MechanismsCoordination Mechanisms

Soft areas:Soft areas:BeliefsBeliefsValuesValues

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Understanding the Drivers of Understanding the Drivers of ValueValue

The process of defining value drivers can help The process of defining value drivers can help managers in three ways:managers in three ways:

It can help both business unit managers and their staff It can help both business unit managers and their staff understands how value is created and maximized in the understands how value is created and maximized in the businessbusiness

It can help in prioritizing these drivers and thus in It can help in prioritizing these drivers and thus in determining where resources should be placed (or determining where resources should be placed (or removed)removed)

It can align business unit managers and employees around It can align business unit managers and employees around a common understanding of top priorities.a common understanding of top priorities.

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DefinitionsDefinitions

Value Driver:Value Driver:A performance variable that has A performance variable that has

impact on the results of a impact on the results of a businessbusiness

Key Performance Indicators (KPIs):Key Performance Indicators (KPIs):Metrics associated with the value Metrics associated with the value driversdrivers

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Three principles in defining value Three principles in defining value drivers:drivers:

Value drivers should be directly linked to Value drivers should be directly linked to shareholder value creation and cascade shareholder value creation and cascade down throughout the organization.down throughout the organization.

Value drivers should be targeted and Value drivers should be targeted and measure by both financial and operational measure by both financial and operational KPIs.KPIs.

Value drivers should cover long-term Value drivers should cover long-term growth as well as operating growth as well as operating performance.performance.

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Three Phases of processing value Three Phases of processing value driver definitions:driver definitions:

IdentificationIdentification PrioritizationPrioritization InstitutionalizationInstitutionalization

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IdentificationIdentification

The first task is creating value trees The first task is creating value trees that systematically link the operating that systematically link the operating elements of the business to value elements of the business to value creation. creation.

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PrioritizationPrioritization

Two steps in prioritization: Two steps in prioritization:

building a discounted cash flow model for building a discounted cash flow model for testing sensitivity to change in each drivertesting sensitivity to change in each driver

Analyzing a limited number of value Analyzing a limited number of value drivers to determine the “real life” drivers to determine the “real life” potential and ease of capture for each potential and ease of capture for each improvement actionimprovement action

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InstitutionalizationInstitutionalization

Value drivers are incorporated into Value drivers are incorporated into the targets and scorecards of on-the targets and scorecards of on-going business performance going business performance managementmanagement

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Managing Business PerformanceManaging Business Performance

Business Performance Business Performance Management Management

is the process of setting targets for a is the process of setting targets for a performance unit and regularly performance unit and regularly reviewing progress against them, reviewing progress against them, with the goal that different layers of with the goal that different layers of the company will work together for the company will work together for enhanced performanceenhanced performance

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Components of successful business Components of successful business performance management performance management

A business unit must have a clear A business unit must have a clear strategy for creating valuestrategy for creating value

It should set targets with a clear link It should set targets with a clear link to specific value driversto specific value drivers

It needs a structured calendar of It needs a structured calendar of performance reviews to discuss performance reviews to discuss results against value-linked KPIs.results against value-linked KPIs.

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Crafting Business Strategy to Crafting Business Strategy to Create ValueCreate Value

Strategic planning is essential to Strategic planning is essential to creating value. There are great creating value. There are great benefits of making a direct link benefits of making a direct link between strategy and valuation.between strategy and valuation.

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Setting Value-Linked TargetsSetting Value-Linked Targets

Some approaches for setting Value -Linked Targets:Some approaches for setting Value -Linked Targets:

Set targets based on actual opportunities available by benchmarking competitors; Set targets based on actual opportunities available by benchmarking competitors; industry analysis; theoretical limits such as capacity utilization, and, where industry analysis; theoretical limits such as capacity utilization, and, where appropriate, benchmarking against comparable business units within the same appropriate, benchmarking against comparable business units within the same company.company.

Adjust the targets to reflect the changing environment if your key drivers are Adjust the targets to reflect the changing environment if your key drivers are influenced by externalities.influenced by externalities.

In order to find the right balance, goals must be negotiated by top management and In order to find the right balance, goals must be negotiated by top management and lower staff. Interaction between the two groups is key to finding the right fit for the lower staff. Interaction between the two groups is key to finding the right fit for the organization.organization.

Once targets are agreed upon, the organization can formalize this commitment in a Once targets are agreed upon, the organization can formalize this commitment in a performance contract. This contract should contain the milestones and quantitative performance contract. This contract should contain the milestones and quantitative and qualitative goals that each business unit needs to achieve.and qualitative goals that each business unit needs to achieve.

These targets and information on how to achieve them needs to disseminate These targets and information on how to achieve them needs to disseminate throughout the organizationthroughout the organization

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Regularly Reviewing Regularly Reviewing PerformancePerformance

A company needs a structured calendar of A company needs a structured calendar of performance reviewsperformance reviews

Create a scorecard incorporating value Create a scorecard incorporating value metrics and KPIs from the value driver metrics and KPIs from the value driver analysis to help with performance reviewsanalysis to help with performance reviews

A scorecard should be different for each A scorecard should be different for each business unitbusiness unit

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RCCU ScorecardRCCU ScorecardKPIs

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Managing Individual Managing Individual PerformancePerformance

Two value creation imperatives:Two value creation imperatives:

Make managers think like owners by Make managers think like owners by linking manager’s rewards to behavior that linking manager’s rewards to behavior that creates overall shareholder value.creates overall shareholder value.

An increasingly knowledge-based An increasingly knowledge-based economy, management talent is itself economy, management talent is itself an important source of value, and an important source of value, and therefore companies must attract and therefore companies must attract and retain talent by offering attractive retain talent by offering attractive incentives.incentives.

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Three Types of Motivation Levers:Three Types of Motivation Levers:

1.1. Financial IncentivesFinancial IncentivesHigh compensation and bonus schemesHigh compensation and bonus schemes

2.2. OpportunitiesOpportunitiesFast track career paths that rotate Fast track career paths that rotate strong performers through positions of strong performers through positions of increasing responsibilityincreasing responsibility

3.3. Values and BeliefsValues and BeliefsEmployees gain inherent satisfaction Employees gain inherent satisfaction from lining up to a distinctive “XYZ from lining up to a distinctive “XYZ way” of doing businessway” of doing business

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Making Value HappenMaking Value Happen

There is no one right way to construct your organization to There is no one right way to construct your organization to create value. However, there are factors for success:create value. However, there are factors for success:

Visible top management commitment is needed sot that employees realize Visible top management commitment is needed sot that employees realize that this is not just the latest fad, but an effort to change fundamental that this is not just the latest fad, but an effort to change fundamental attitudes and behaviorsattitudes and behaviors

Extensive participation by business units mangers, particularly in value Extensive participation by business units mangers, particularly in value driver analysis, is critical, both to capture insight and to ensure that they driver analysis, is critical, both to capture insight and to ensure that they have a feeling of ownershiphave a feeling of ownership

Links to existing processes are essential to ensure that the efforts to make Links to existing processes are essential to ensure that the efforts to make value happen can have impact on the strategic planning, capital allocation, value happen can have impact on the strategic planning, capital allocation, and promotion and compensation decisions of the company.and promotion and compensation decisions of the company.

A pragmatic, action oriented approach ensures that making value happen A pragmatic, action oriented approach ensures that making value happen is inspiring, rather than paper-generating and bureaucratic.is inspiring, rather than paper-generating and bureaucratic.

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Questions?Questions?


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