Jeremiah Worthington Finance 609 Making Value Happen Jeremiah Worthington Finance 609

Focus of Chapter 6 Show how a company should create value in an organization, not why it should

Questions to Answer How can companies set targets that reinforce our overall goal of creating shareholder value? How can we align our management processes with the goal of value creation? How should we structure our incentive programs? How can we promote a value emphasis throughout our corporate culture?

Value Thinking Two components to value thinking: Value Metrics Does management really understand how companies create value and how the stock market values companies? Value Mindset Refers to how much management cares about shareholder value creation. Do they really want to pursue value creation, is a long term commitment or short term fad?

Six Areas of Value Focus 1. It must combine an inspiring aspiration with tough quantitative targets linked to value creation. 2. It should adopt a rigorous approach to managing its portfolio of businesses for maximum value creation, including radical restructuring if necessary. 3. It must ensure that its organizational design and culture reinforce the value creation imperative. 4. It must develop superior insight into the key value drivers of each of its businesses. 5. It must establish an effective approach to managing the performance of it business units through sophisticated target setting and rigorous performance reviews. 6. It must find ways to motivate managers and employees to work toward value creation through financial rewards and other incentives.

Areas of Activity for Making Value Happen Source: Reproduction of Exhibit 6.01 in the book, Valuation - Measuring and Managing the Value of Companies

Setting Aspirations and Targets Inspiration Statement of Intent Value-Linked Quantitative Targets

Managing the Corporate Portfolio Three perspectives on portfolio management follow: 1. Strategy: Corporate Theme Analysis 2. Performance: Outside-In Restructuring Analysis 3. Growth: Three Horizon Analysis

Strategy: Corporate Theme Analysis There are seven corporate themes The Industry Shaper The Deal Maker The Scarce Asset Allocator The Skill Replicator The Performance Manager The Talent Agency The Growth Asset Attractor

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

Growth: Three Horizon Analysis An analysis of companies with sustained above-average growth indicates that they manage their business portfolios across three horizons. Horizon 1 includes current core businesses, which generally account for the greatest part of current profits and cash flow Horizon 2 includes emerging opportunities, the “rising star” businesses of the company that already have customers and revenues, even if they do not yet generate positive cash flow Horizon 3 includes future options, which are opportunities where initial activity has already begun, be it a pilot project, minority stake, or memorandum of understanding

Orienting the Organization Toward Value Having the correct organizational structure in place is crucial to making value happen. There are hard and soft areas of organization design. Hard areas: Structure Decision Rights People Coordination Mechanisms Soft areas: Beliefs Values

Understanding the Drivers of Value The process of defining value drivers can help managers in three ways: It can help both business unit managers and their staff understands how value is created and maximized in the business It can help in prioritizing these drivers and thus in determining where resources should be placed (or removed) It can align business unit managers and employees around a common understanding of top priorities.

Definitions Value Driver: A performance variable that has impact on the results of a business Key Performance Indicators (KPIs): Metrics associated with the value drivers

Three principles in defining value drivers: Value drivers should be directly linked to shareholder value creation and cascade down throughout the organization. Value drivers should be targeted and measure by both financial and operational KPIs. Value drivers should cover long-term growth as well as operating performance.

Three Phases of processing value driver definitions: Identification Prioritization Institutionalization

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

Prioritization Two steps in prioritization: building a discounted cash flow model for testing sensitivity to change in each driver Analyzing a limited number of value drivers to determine the “real life” potential and ease of capture for each improvement action

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

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

Components of successful business performance management A business unit must have a clear strategy for creating value It should set targets with a clear link to specific value drivers It needs a structured calendar of performance reviews to discuss results against value-linked KPIs.

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

Setting Value-Linked Targets Some approaches for setting Value -Linked Targets: Set targets based on actual opportunities available by benchmarking competitors; industry analysis; theoretical limits such as capacity utilization, and, where appropriate, benchmarking against comparable business units within the same company. Adjust the targets to reflect the changing environment if your key drivers are influenced by externalities. 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 organization. Once targets are agreed upon, the organization can formalize this commitment in a performance contract. This contract should contain the milestones and quantitative and qualitative goals that each business unit needs to achieve. These targets and information on how to achieve them needs to disseminate throughout the organization

Regularly Reviewing Performance A company needs a structured calendar of performance reviews Create a scorecard incorporating value metrics and KPIs from the value driver analysis to help with performance reviews A scorecard should be different for each business unit

RCCU Scorecard KPIs

Managing Individual Performance Two value creation imperatives: Make managers think like owners by linking manager’s rewards to behavior that creates overall shareholder value. An increasingly knowledge-based economy, management talent is itself an important source of value, and therefore companies must attract and retain talent by offering attractive incentives.

Three Types of Motivation Levers: 1. Financial Incentives High compensation and bonus schemes 2. Opportunities Fast track career paths that rotate strong performers through positions of increasing responsibility 3. Values and Beliefs Employees gain inherent satisfaction from lining up to a distinctive “XYZ way” of doing business

Making Value Happen There is no one right way to construct your organization to create value. However, there are factors for success: Visible top management commitment is needed sot that employees realize that this is not just the latest fad, but an effort to change fundamental attitudes and behaviors Extensive participation by business units mangers, particularly in value driver analysis, is critical, both to capture insight and to ensure that they have a feeling of ownership Links to existing processes are essential to ensure that the efforts to make value happen can have impact on the strategic planning, capital allocation, and promotion and compensation decisions of the company. A pragmatic, action oriented approach ensures that making value happen is inspiring, rather than paper-generating and bureaucratic.

Questions?