Maximizing Portfolio Profit: An EVA Approach Mark Lundeen & Shane Johnson Septem

1. Maximizing Portfolio Profit: An EVA ApproachMark Lundeen & Shane Johnson September 21, 2007

2. Mark Lundeen • Undergrad: University of Illinois Urbana-Champaign; B.A.—Int’l Trade & Consumer Economics • MBA: 2007 Ross School of Business, University of Michigan, Finance & Corporate Strategy • Prior to Business School: Grain Trader/Exporter, Archer Daniels Midland, Brazil & Paraguay • Current position at Kraft: Senior Financial Analyst, Pizza Category Finance • Summer Internship: Johnson & Johnson Depuy Orthopaedics

3. Shane Johnson • Undergrad: 1998 Gonzaga University, B.A—History • MBA: 2005 Ross School of Business, University of Michigan, Finance • Prior to Business School: Manager, Technical Sales, Advanced Data Exchange, Palo Alto, CA • Current position at Kraft: Finance Manager, Customer Development Organization—Safeway Sales Team, Livermore, CA • Prior Kraft positions: Sr. Financial Analyst, Customer Service & Logistics, Chicago • Summer Internship: K-Mart Holding Corp.

4. Agenda • Finance Overview • Introduction • New Product Analysis • Business Proposition Example • Key Areas Of Focus • Earning Variance Analysis • Definition & Example • Other Applications: Distribution Expense • Sales Profitability Analysis • Q&A

5. Finance What is the role of Finance? How is Finance involved with new product development? What are key financial measures to remember when developing a new product? • Margin • Raw material costs • Unit cost • Estimated volume • Cannibalization

6. P&L Overview

7. What is a Business Proposition? A BP (Business Proposition) identifies the strategic rationale and financial implications for a project. The BP is often used to present the project to senior management, gain cross-functional alignment and once approved, is the record of what was agreed to. The objectives of the BP process are to ensure that: • There is a clear record of the objectives of the project • Approvals for investments are clear and well documented • Investments get the benefit of appropriate multi-functional and multi-level input • Departments throughout the company are aware of the investment and take appropriate actions to support that investment • Senior management is aware of any risks associated with the investment • Proposed investments with unsatisfactory projected returns are restructured or canceled • Resources are allocated to projects with the greatest chances of success/highest return

8. When is a BP Required? The BP process must be followed, with the appropriate levels of authorization received for any change in execution resulting in: • New product launches • Line extensions • Product changes (only those that affect the value proposition to the consumer) Formulation Packaging • Flavor extensions Small flavor extensions that do not require capital spending will follow a simplified process

9. Financial Justification - Key Areas of Focus In order to ensure a complete and sound economic analysis of a business proposition, special consideration should be given to the following: • Volume assumptions • Impact of cannibalization • Pricing / Trade spending • Competitive response • Product cost • A&C Spending • Capital Expenditures • Sensitivity analysis • Comparison to like businesses

10. Financial Justification - Key Areas of Focus cont. The primary measures used to analyze the financial attractiveness of investments are: • Net Present Value (NPV) • Internal Rate of Return (Hurdle Rates) • Nominal Payback Period Both are Discounted Cash Flow techniques using the time value money concept However, we must keep in mind that making a decision on a business proposition always requires careful weighting of many parameters, including strategic/defensive needs, financial attractiveness, risk profile, . . . and cannot be narrowly based on financial return measures alone

11. Summary The business proposition is the end result of a long iterative process that starts early in the new product development process and requires continuous refinement of assumptions Business Proposition Process Idea Generation • Make some assumptions • Challenge your assumptions • Continually revisit your assumptions • Tighten up your assumptions • Finally, feel good about your assumptions and put them forward in your “final” business proposition Product Development Business Proposition

12. Earnings Variance Analysis (EVA) Overview • EVA analysis is a basic methodology for analyzing business results vs. some base case (usually prior year or plan) • The main components of EVA are:

13. EVA Example The EVA framework can be used to analyze a variety of business situations

14. Problem: With Transportation and Distribution expenses increasingly volatile, Kraft must have correct transfer pricing by product group. • Logistics Group must manage internal costs accurately and locate areas of inefficient spend • Required to match expenses with rebill to business units • Business Units need to know T&D impact on their products for profitability analysis • Need a tool which can accurately forecast T&D costs for new products With over 1,700 product groups, 40 Manufacturing locations and 20 distribution centers, some sort of overall, activity-based system is needed.

15. Hire a Michigan MBA to figure it out Kraft had Two Options to Address this Issue Invest several hundred thousand dollars in IT resources to track product movement in and between all facilities OR

16. Distribution & Transportation • Cost Changes in distribution can be caused by multiple issues: • Changes in cost structure of Distribution Centers • Changes in network flow path of products • Changes in handling required per sales unit (pallet density) By replacing Rate, Volume and Mix with these drivers, we were able to identify and correct inefficient product handling in the Kraft network and find areas of potential cost savings.

17. Distribution & Transportation--Examples • Deli Shaved Meat—Rapid growth of new product line led to mis-aligned transfer price • Which products have achieved enough scale to ship direct from plant, bypassing distribution centers? • Which distribution sites are more efficient? What best practices can be shared across the network? This is an example of how finance can make a meaningful impact on the operations of a large organization

18. Sales Profitability Due-To • Cheese (1) • Grocery (1) • Beverage(2) Profitable categories becoming a larger percentage of total segment revenue • Cheese 5 • Grocery 4 • Beverage 6

19. Next Steps 1. Q&A 2. Visit our website: www.kraft.com 3. Contact us with questions • Shane.Johnson@Kraft.com or MLundeen@kraft.com