CREATING SHAREHOLDER VALUE DURING ECONOMY DOWNTURN WITH VBM TOOLS AND STRATEGIES

1. CREATING SHAREHOLDER VALUE DURING ECONOMY DOWNTURN WITH VBM TOOLS AND STRATEGIES Chetan J Parikh

2. 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

3. Owners of Invested Capital- The Shareholders

4. 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

5. 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

6. Creating Shareholder Value Portfolio Managers Active Owners Risk perspective Risks are predetermined, cannot be influenced Risks can be reduced/ eliminated Risk management Strategy Spreading the risks Allocation of capital to risks one can handle Portfolio optimization Active/proactive reduction/elimination of risks ~Owners of Invested Capital Two fundamentally different ways of managing risk Source: “Ownership and Value Creation” by Rolf H. Carlsson

7. Creating Shareholder Value ~Owners of Invested Capital Different ways of reducing / eliminating business-related risk Source: ‘Ownership and Value Creation’ by Rolf H. Carlsson

8. Stewards of Invested Capital- The Corporate Managers

9. 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 CEO’s performance are easy to manipulate, makes a CEOs performance harder to measure • Relations between CEOs and board of directors are very congenial

10. 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

11. 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

12. Adapting to economic paradigms of the 21st century

13. 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

14. Creating Shareholder Value ~Adapting to 21st century economic paradigms Economic Paradigms of the 20th and 21st Centuries

15. Creating Shareholder Value ~Adapting to 21st century economic paradigms Industry Clockspeeds

16. Creating Shareholder Value ~Adapting to 21st century economic paradigms Industry Clockspeeds

17. Creating Shareholder Value ~Adapting to 21st century economic paradigms Industry Clockspeeds Source: Charles Fine, Clockspeed

18. The role of Finance in Determining Shareholder Value

19. 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

20. 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 ChargeWhere:RevenueLess:Production / Operating ExpensesLess:Unlevered Taxes Equals:NOPAT $ Capital Charge = $ Capital – wacc

21. Creating Shareholder Value ~Using Finance to Determine Shareholder Value Determining Wealth Creators NPV = Present value of expected EP, thus Wealth Creator :NPV>0, EP>0, RROC>0 * Wealth Neutrality :NPV=0, EP=0, RROC=0 Wealth Waster :NPV<0, EP<0, RROC<0 * RROC = ROIC - wacc

22. 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

23. Creating Shareholder Value ~Using Finance to Determine Shareholder Value Determining Wealth Creators

24. Creating Shareholder Value ~Using Finance to Determine Shareholder Value Criteria for capital commitment Source: James L Grant & James A Abate,’ Focus on Value’

25. Creating Shareholder Value ~Using Finance to Determine Shareholder Value Excess Returns Relative to Capital Growth Rate’Economically’ Profitable Reinvestment Source :James L Grant &James A Abate,’Focus on Value’

26. 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?

27. Cost Leadership and Supporting Tactics

28. 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

29. 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

30. Creating Shareholder Value ~Cost Leadership and Supporting Tactics Working Capital Investment • Minimise cash balance • Reduce accounts receivables • Minimise inventory without impairing customer service

31. 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

32. 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’

33. Thank You