CREATING SHAREHOLDER VALUE DURING ECONOMY DOWNTURN WITH VBM TOOLS AND STRATEGIES

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CREATING SHAREHOLDER VALUE DURING ECONOMY
DOWNTURN WITH VBM TOOLS AND STRATEGIES

• Chetan J Parikh

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Creating Shareholder Value
Introduction
Themes

• Owners of invested capital
• Stewards of invested capital
• Adapting to economic paradigms of the 21st
  Century
• The role of finance in determining shareholder
  value
• Cost leadership strategy and supporting tactics

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Owners of Invested Capital- The Shareholders
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Creating Shareholder Value
Owners of Invested Capital
What does ownership mean?

• Shrinking competitive advantage periods (CAPs)
  means that an investor has to understand
• The dynamics of organizational change
• The mental models that owners need to have to
  keep up
• with change

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Creating Shareholder Value
Owners of Invested Capital
Competences that owners need

• Owners must demonstrate
• Rational allocation of capital
• Reduction of fundamental business risks
• Develop systems thinking based on feedback loops

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Creating Shareholder Value
Owners of Invested Capital
Two fundamentally different ways of managing risk
Source Ownership and Value Creation by Rolf H.
Carlsson
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Creating Shareholder Value
Owners of Invested Capital
Different ways of reducing / eliminating
business-related risk
Source Ownership and Value Creation by Rolf H.
Carlsson
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Stewards of Invested Capital- The Corporate
Managers
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Creating Shareholder Value
Stewards of Invested Capital
Why is CEO performance difficult to measure?

• Two major differences between CEOs and other
  employees
• Standards for measuring CEOs performance are
  easy to
• manipulate, makes a CEOs performance harder to
  measure
• Relations between CEOs and board of directors
  are very
• congenial

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Creating Shareholder Value
Stewards of Invested Capital
Long term must be balanced with the short term

• Short term imperatives have forced CEOs to
• Meet the quarterly numbers
• Have a wrong implicit valuation model
• Disjointed the interests of shareholders from
  those of other stakeholders

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Creating Shareholder Value
Stewards of Invested Capital
Valuation model
Financial Statements

• GAAP

Managerial Skill
Feedback
Valuation Model

• Vision
• System Efficiency
• Innovative Environment
• Adaptability
• Learning Organisation

Feedback
Business Unit Measurements
Feedback
Stock Price

• Integration of Control Variables and Accounting
  Data
• Valuation/ Resource Allocation

Accounting Results

• Tangible Assets
• Intangibles

Control Variables

• Business Processes
• Employee Satisfaction
• Customer Satisfaction

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Adapting to economic paradigms of the 21st century
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Creating Shareholder Value
Adapting to 21st century economic paradigms
The Upside Down Corporation
Sales Push Focus
Customer Pull Focus
BRAND CAPITAL
Production Focus
Customer Focus
HUMAN CAPITAL
High (Work in Progress,Finished Goods
Low (Direct Delivery)
Outsourcing Network
WORKING CAPITAL
High (Ownership of Production
Low (Outsourcing)
PHYSICAL CAPITAL
Traditional Business Structure
E Business Structure
Source Meta Capitalism
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Creating Shareholder Value
Adapting to 21st century economic paradigms
Economic Paradigms of the 20th and 21st Centuries
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Creating Shareholder Value
Adapting to 21st century economic paradigms
Industry Clockspeeds
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Creating Shareholder Value
Adapting to 21st century economic paradigms
Industry Clockspeeds
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Creating Shareholder Value
Adapting to 21st century economic paradigms
Industry Clockspeeds
Source Charles Fine, Clockspeed
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The role of Finance in Determining Shareholder
Value
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Creating Shareholder Value
Using Finance to Determine Shareholder Value
What remains of his profits after deducting
interest on his capital at the current rate may
be called his earnings at undertaking or
management. - Alfred Marshall
A
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Creating Shareholder Value
Using Finance to Determine Shareholder Value
The calculation of economic profit
 The basic ingredients in the Economic Profit
calculation EP NOPAT - Capital
ChargeWhereRevenueLessProduction /
Operating ExpensesLessUnlevered Taxes
EqualsNOPAT   Capital Charge Capital
wacc
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Creating Shareholder Value
Using Finance to Determine Shareholder Value
Determining Wealth Creators
NPV Present value of expected EP, thus Wealth
Creator NPVgt0, EPgt0, RROCgt0   Wealth
Neutrality NPV0, EP0, RROC0   Wealth Waster
NPVlt0, EPlt0, RROClt0
RROC ROIC - wacc
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Creating Shareholder Value
Using Finance to Determine Shareholder Value
Determining Wealth Creators
V C NPV V/C 1 NPV/C 1
PV of Expected EP/C
Key NPV Net Present Value C Book Capital /
Invested Capital PV Present Value V Corporate
Value EP Economic Profit
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Creating Shareholder Value
Using Finance to Determine Shareholder Value
Determining Wealth Creators
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Creating Shareholder Value
Using Finance to Determine Shareholder Value
Criteria for capital commitment
Source James L Grant James A Abate, Focus on
Value
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Creating Shareholder Value
Using Finance to Determine Shareholder Value
Excess Returns Relative to Capital Growth
RateEconomically Profitable Reinvestment
Source James L Grant James A Abate,Focus on
Value
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Creating Shareholder Value
Creating Shareholder Value
Using Finance to Determine Shareholder Value
Questions Shareholders Ask..

• Is the company a major force in a growing market?
• Is the company holding or increasing its shares
  on those segments?
• Is it resulting in increasing cash flows?
• Is the cash flow being used in a wise manner?
• Does the management walk the talk?

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Cost Leadership and Supporting Tactics
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Creating Shareholder Value
Cost Leadership and Supporting Tactics
Sales Growth Rate

• Maintain competitive prices
• Pursue market share opportunities to gain scale
  economies in production and distribution

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Creating Shareholder Value
Cost Leadership and Supporting Tactics
Operating Profit Margin

• Achieve relevant economies of scale
• Introduce mechanisms to improve rate of learning
• Search for cost reducing linkages with suppliers
• Eliminate overhead that does not add value to the
  product

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Creating Shareholder Value
Cost Leadership and Supporting Tactics
Working Capital Investment

• Minimise cash balance
• Reduce accounts receivables
• Minimise inventory without impairing customer
  service

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Creating Shareholder Value
Cost Leadership and Supporting Tactics
Fixed Capital Investment

• Promote policies to increase utilization of fixed
  assets
• Obtain productivity-increasing assets
• Sell unused fixed assets
• Obtain assets at least cost, e.g. lease versus
  purchase

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Creating Shareholder Value
Cost Leadership and Supporting Tactics
Cost of Capital

• Target an optimal capital structure
• Select least-cost debt and equity instruments
• Reduce business risk factors in manner consistent
  with strategy

Source Alfred Rappaport, Creating Shareholder
Value
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Thank You