Download - Value Base Management
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VALUE BASE MANAGEMENT
PRSSENTED BY :-PRESENTED TO:-
PROF. SANDHYA HARKWAT
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FLOW OF PRESENTATION
WHAT IS VBM
WHY NEED ARISE OF VBM
HOW WE CAN USE VBM
APPROCHES OF VBM
MARAKON APPROACH ALCAR APPROACH
MCKINSEY APPROACH
STERN STEWART APPROACH
BCG APPROACH
LESSONS FROM THE EXPERIENCES OF VBM ADOPTERS
POTENTIAL AND HURDLES FOR VBM IN INDIA
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WHAT IS VBM
VALUE BASE MANAGEMENT IS THE MANAGEMENT
APPROACH THAT ENSURES CORPORATION ARE RUN CONSISTENTLY ONVALUE.(NORMALLY :- MAXIMIZING SHAREHOLDERS VALUE).
IT IS USEFUL TO UNDERSTAND THAT VALUE BASED MANAGEMENT
INCLUDE ALL 3 OF FOLLOWING
1. CREATING VALUE
2. MANAGING FOR THE VALUE
3. MEASURING VALUE(VALUATION)
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VBM AIMS TO PROVIDE CONSISTENCY OF
THE CORPORATE MISSION
THE CORPORATE STRATEGY
CORPORATE GOVERNANCE
CORPORATE CULTURE
CORPORATE COMMUNICATION
ORGANIZATION OF THE CORPORATION
DECISION PROCESS & SYSTEM
PERFORMANCE MANAGEMENT PROCESS & SYSTEM
REWARD PROCESS & SYSTEM
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WHY VBM NEEDED?
VALUE BASE MANAGEMENT IS IMPORTANT TO REALIZE THAT YOUR ORGE.
IS OPERATING & COMPETING IN 4 MARKET
1. THE MARKET FOR ITS PRODUCT & SERVICE.
2. THE MARKET FOR CORPORATE MANAGEMENT & CONTROL.
3. THE CAPITAL MARKET
4. THE EMPLOYEE & THE MANAGERS MARKETVBM CAN HELP ORGE. TO WIN IN EACH OF THESE 4 MARKETS.
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METHOD & KEY PREMISES OF VBM
THE 3 PRINCIPAL METHODS OF VBM ARE:
1. THE FREE CASH FLOW METHOD PROPOSED BY MCKINSEY AND ALCARGROUP.
2. THE ECONOOMIC VALUE ADDED/ MARKET VALUE ADDED METHOD
PIONEERED BY STERN STEWRT AND COMPANY.
3. THE CASH FLOW RETURN ON INVESTMENT/CASH VALUE
ADDED(CFROI/CVA) METHOD DEVELOPED BY BCG AND HOLT VALUE
ASSOCIATES.
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MARAKON APPROACH
SPECIFY THE FINANCIAL DETERMINANTS OF VALUE
UNDERSTAND THE STRATEGIC DRIVERS OF VALUE
FORMULATE HIGHER VALUE STRATEGIES
DEVELOP SUPERIOR ORGANIZATIONAL CAPABILITIES
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SPECIFY THE FINANCIAL DETERMINANTS OF VALUE
Market to book ratio model
Shareholders wealth is measured as a difference
in the market value and the book value of the
firms equity. Book value the capital contributed by the
shareholders
Market value how productively the firm has
employed the capital contributed by the
shareholders
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Specify the financial determinants of value-cont
If M exceeds B :- management creates value for theshareholders
If M is less than B :- decimates value
If M is equal to B :- maintains value M/B= r-g/k- g
Value is created when there is a positive spread
between the return on equity and the cost of capital.
Higher the g the higher M/B ratio.
Ie. When the spread is positive a higher growth rate
contributes more to value creation.
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Understand the strategic drivers of value
Market economics
Competitive position
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Understand the strategic drivers of value-cont
Market economicsLimiting forces:-
Intensity of indirect competition
Threat of entry Suppliers pressures
Regulatory pressures
Direct forces:-
Intensity of direct competition
Customer pressure
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Understand the strategic drivers of value-cont
Competitive position Product differentiation
Economic cost position
- access to cheaper raw material
- Efficient process technology
- Superior management
- Economic of scale in some markets
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Formulate higher value strategies
Participation strategy
Competitive strategy
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Formulate higher value strategies-
cont
Participation strategy:-the product markets
in which it will compete. (Enter and Exit)
Competitive strategy :- strategy
management will use to build competitive
advantage or to overcome competitivedisadvantage in the market.
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Develop superior organizational
capabilities
Competent and energetic chief executive
Corporate governance
Compensation plan- relative pay for relative
performance
Resource allocation
Performance management process
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Alcar Approach
Determinants of shareholder value
Assessment of the shareholder value
impact of the business unit
Shareholder value management cycle
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Determinants of shareholder value
Value drivers
Rate of sales growth
Operating profit margin Income tax rate
Investment in working capital
Fixed capital investment Cost of capital value growth duration
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Assessment of the shareholder value impact of the
business unit (strategy)
Steps:-
Forecast the operating cash flow
Discount the forecasted operating cash flow using WACC
Estimate the residual value of the firm at the end of theplanning period and find its present value( perpetuity cash
flow/ cost of capital)
Determine the total shareholders value (PV of the operating
cash flow + PV of the residual value - market value of the debt)
Establish the pre-strategy value ( cash flow before new
investment / cost of capital
Infer the value created by the strategy ( total shareholder value
pre strategy value)
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Shareholder value management cycle
Select the strategy that maximizes the
expected shareholders value
Finds the highest valued use for all assets
Bases performance evaluation and incentive
compensation on shareholder value added
Returns cash to shareholders when value
creating investments do not exist.
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McKinsey Approach
Properly executed, value based management is an approach to
management whereby the companys overall aspirations, analytical
techniques, and mngt. Processes are all aligned to help the company
maximize its value by focusing decision making on the key drivers of value.
VALUE THINKING:- TO MAKE VALUE HAPPEN, A CO.S ACTION SHOULD BE
BASED ON A FOUNDATION OF VALUE THINKING.
DIMENSION
-VALUE METRICS
-VALUE MINDSET
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AREA OF ACTIVITY FOR MAKING VALUE HAPPEN
1. ASPIRATIONS AND TARGET
2. PORTFOLIO MANAGEMENT
3. ORGANISATIONAL DESIGN
4. VALUE DRIVER IDENTIFICATION
5. BUSINESS PERFORMANCE MANAGEMENT6. INDIVIDUAL PERFORMANCE MANAGEMENT
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Find the value drivers
Generic level:- the return on invested
capital is analyzed in terms of operating
margin and invested capital Business unit level:- product mix, customer-
mix, operating leverage
Grass roots level:- capacity utilization,revenue generated , cost per delivery.
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EVA APPROACH
IT IS ALSO KNOWN AS STERN STEWART APPROACH. ECONOMIC VALUE
ADDED IS CURRENTLY A VERY POPULAR IDEA.
EVA US ESSENTIALLY THE SURPLUS LEFT AFTER MAKING AN APPROPRIATE
CHARGE FOR THE CAPITAL EMPLOYED IN BUSINESS.
FORMULA OF CALULATING EVA ARE AS UNDEREVA= NOPAT-C*.CAPITAL
EVA= CAPITAL(r-c*)
EVA= [PAT+INT(1-T)]-C*.CAPITAL
EVA= PAT-KE. EQUITY
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WHAT CAUSES EVA TO INCREASE
THE RATE OF RETURN ON EXISTING CAPITAL INCREASES BECAUSE OF
IMPROVEMENT IN OPERATING PERFORMANCE.
ADDITIONAL CAPITAL IS INVESTED IN PROJECTS THAT EARN A RATE
OF RETURN GREATER THAN THE COST OF CAPITAL.
CAPITAL IS WITHDRAWN FROM ACTIVITIES WHICH EARNINADEQUATE RETURNS.
THE COST OF CAPITAL IS LOWERED BY ALTERING THE FINANCING
STRATEGY.
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COMPONENTS OF EVA
NOPAT(NET OPERATING PROFIT AFTER TAX)
C*(COST OF CAPITAL)
CAPITAL(CAPITAL EMPLOYED IN BUSINESS)
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Economic Value Added (EVA)
Residual income measure that subtracts the cost of capital fromthe operating profits generated in the business
Accounts properly for all the ways in which corporate value maybe created or destroyed
Only performance measure to tie directly to the intrinsic marketvalue of a company
EVA = [rate of return (r) cost of capital (c*)] x Capital EmployedEVA = NOPAT c* x Capital EmployedEVA = Operating Profits a Capital Charge
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EVA Basics
one should as soon compute earnings without a
capital charge as play tennis with the net down.
All EVA does is simply lift the net back up where itbelongs.
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EVA Value Creation Strategies
Improve operating profits without tying up any morecapital.
Increase capital only if return on investment more thancovers the charge for additional capital.
Liquidate capital where the earnings lost are more thanoffset by a savings on the capital charge.
Structure balance sheet in a way that lowers the cost ofcapital.
EVA = ( r c*) x Capital Employed
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EVA Example - 3 Ways to Add Value
BASE
CASE
NOPAT $250Capital Employed $1,000
Return on Capital - r 25.0%
Cost of Capital - c* 15.0%
NOPAT $250
Cost of Capital $150EVA $100
IMPROVE
OPERATING
EFFICIENCY
$300
$1,000
30.0%
15.0%
$300
$150$150
ACHIEVE
PROFITABLE
GROWTH
$450
$2,000
22.5%
15.0%
$450
$300$150
RATIONALIZE
BUSINESS
$250
$667
37.5%
15.0%
$250
$100$150
Each Adds Shareholder Value in a Different Way.Only
Performance Measure to Identify Each
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EVA Example Stop Destroying
Value
BASE
CASE
NOPAT $50
Capital Employed $1,000
Return on Capital - 5.0%
Cost of Capital - c* 15.0%
NOPAT $50
Cost of Capital $150EVA ($100)
NEW
BUSINESS
OPPORTUNITY
$180
$2,000
9.0%
15.0%
$180
$300($120)
Turning off the spigot on unrewarding projectsis the last way to add value.
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The MVA Valuation Formula
Market Value Added (MVA) = Market Value Capital
MVA = Present Value of all Future EVA
Market Value = Capital + Present Value of all Future EVA
r / c* > 1.0 company will be valued at a premium to itseconomic book value (capital)
r / c* < 1.0 then company will be valued at a discount to itseconomic book value (capital)
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Graphical Example of EVA and
Value Creation
Return onCapital - r
Cost of Capital -c*
r = 15% & c* = 15%EVA = $0Value = Capital
r = 25% & c* = 15EVA = $100Value > Capital
r = 5% & c* = 15EVA = ($100)
Value < Capital
CapitalEmployed
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Key Benefits of EVA Framework
Links strategic, operating, and financial planning
Helps managers make better decisions
Capital charge converts the balance sheet into anotherline-item expense
EVA = Sales Operating Costs Capital Costs
Easy to communicate to all employees
Performance expressed in a single profit measureexpressed in dollars
EVA IS THE MOST RELIABLE UNAMBIGUOUS CONTINUOUS-IMPROVEMENT METRIC
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Four Applications of EVA
MEASUREMENT Most accurate measure of corporate performance
Translates accounting profits to economic reality
MANAGEMENT Four ways to increase value
MOTIVATION Cause managers to think and act like owners
Bank bonuses to insure sustainability and long-term thinking
MINDSET Transforms corporate culture
Internal corporate governance
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BCG Approach
Total shareholders return Total business return
Two performance metrics are used:- cash
flow return on investment and cash valueadded.
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Total shareholders return (TSR)
TSR is the rate of return shareholders earn from owning acompanys stock over a period of time:
TSR = Dividend/Beginning market value + Ending market value
Beginning market value / Beginning market value
TSR include dividends as well as capital gains
TSR is not biased by size
TSR is used by the investment community
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Total Business Return
If TSR is what matters to investors, an internal counterpart to it Is needed
for managerial purposes. For BCG, the total business return(TBR) is the
internal counterpart of TSR.
The TBR can be computed as follows:-
TBR=(free cash flow/Beginning value)+(Ending value-Beginning value
/Beginning value)
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LESSONS FROM THE EXPERIENCES OF VBM ADOPTERS
Top management support and involvement is
essential.
A good incentive plan is necessary.
Employees should be properly educated. VBM works well in certain cases.
One size doesnt fit all.
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