1. Goals, Values and Performance
OUTLINE
Strategy as a quest for value
What is profit?
The shareholder value approach
The shareholder value and strategy formulation
Mission and values

2. Strategy as a Quest for Profit
The stakeholder approach : The firm is a coalition of interest groups—it seeks to balance their different objectives
The shareholder approach : The firm exists to maximize the wealth of
its owners (= max. present value of profits over the life of the firm)
For the purposes of strategy analysis we assume that the primary goal of the firm is profit maximization.
Rationale:
Boards of directors legally obliged to pursue shareholder interest
To replace assets firm must earn return on capital > cost of capital
(difficult when competition strong).
Firms that do not max. stock-market value will be acquired
Hence: Strategy analysis is concerned with identifying and accessing the sources of profit available to the firm 13

3. From Profit Maximization to Value Maximization
Profit maximization an ambiguous goal
Total profit vs. Rate of profit
Over what time period?
What measure of profit?
Accounting profit versus economic profit (e.g. Economic Value Added: Post-tax operating profit less cost of capital
Maximizing the value of the firm:
Max. net present value of free cash flows: max. V = St Ct
(1 + r)t
Where: V market value of the firm.
Ct free cash flow in time t
r weighted average cost of capital

4. The World’s Most Valuable Companies:
Performance Under Different Profitability Measures
COMPANY
MARKET CAP. ($BN.)
NET INCOME ($BN)
RETURN ON SALES (%)
RETURN ON EQUITY (%)
RETURN ON ASSETS (%)
RETURN TO SHARE-HOLDERS (%)
Exxon Mobil
372
36.1
19.9
34.9
17.8
11.7
General Electric
363
16.4
10.7
22.2
14.7
(1.5)
Microsoft
281
12.3
40.3
30.0
18.8
(0.9)
Citigroup
239
24.6
22.0
21.9
1.5
4.6 BP
233
22.3
9.9
27.9
10.2
Bank of America
212
16.5
27.0
14.1
1.2
2.4
Royal Dutch Shell
211
25.3
26.7
11.6
11.8
Wal-Mart
197
11.2
5.5
21.4
8.1
(10.3)
Toyota Motor
12.1
13.0
4.8
(22.1)
Gazprom
196
7.3
28.1
9.8
7.1
n.a.
HSBC
190
15.9
23.0
16.3
1.0
(11.8)
Procter & Gamble
8.7
17.3
13.7
6.4
7.2

5. Shareholder Value Maximization and Strategy Choice
The Value Maximizing Approach to Strategy Formulation:
Identify strategy alternatives
Estimate cash flows associated with cash strategy
Estimate cost of capital for each strategy
Select the strategy which generates the highest NPV
Problems:
Estimating cash flows beyond 2-3 years is difficult
Value of firm depends on option value as well as DCF value
Implications for strategy analysis:
Some simple financial guidelines for value maximization
On existing assets—maximize after-tax rate of return
On new investment—seek rate of return > cost of capital
Utilize qualitiative strategy analysis to evaluate future profit potential

6. Valuing Companies and Business Units
If net case flow growing at constant rate (g)
V = C1
( r - g )
With varying cash flows which can be forecasted
for 4 years:
V = C C C C VH
(1 + r ) (1 + r )2 (1 + r )3 (1 + r )3
where: VH is the horizon value of the firm after 4 years

7. Financial options Real options Comments Present value of
returns to the
investment
The greater the NPV, the
higher the option value
Stock price =
Exercise price
The higher the cost, the
lower the option value =
Investment cost
OPTION
VALUE
Uncertainty
Uncertainty
Higher volatility
increases option values =
Time = opportunity to
learn about outcomes
Time to expiry
Duration of option =
Loss of cash flow to fully
-committed competitors
lowers option value
Dividends
Value lost over
duration of option =
Risk-free
Interest rate
Risk-free
interest rate
Higher interest rate
increases option value
by increasing value of
deferring investment =

8. The six levers of financial and real options
Financial options
Real options
Comments
Present value of
returns to the
investment
Higher NPV raises
option value
Stock price =
Exercise price
Higher cost
lowers option value =
Investment cost
OPTION
VALUE
Uncertainty
Uncertainty
Higher volatility
increases option value =
More time allows more
information to be taken
into account
Time to expiry
Duration of option =
As profit is lost to rivals,
option value is lowered
Dividends
Value lost over
duration of option =
Risk-free
Interest rate
Risk-free
interest rate
A higher interest rate
increases option value by
increasing the value of
deferring investment =

9. ROCE Performance Diagnosis: Disaggregating Return on Capital Employed
COGS/Sales
Margin
(Return on
Sales)
Depreciation/Sales
SGA expense/Sales
ROCE
Fixed asset turnover
(Sales/PPE)
Inventory Turnover
(Sales/Inventories)
Asset
productivity
(Sales/Capital
Employed)
Creditor Turnover
(Sales/Receivables)
Turnover of other items
of working capital

10. Corporate/Divisional
Linking Value Drivers to Performance Targets
Order Size
Customer Mix
Sales
Targets
Sales/Account
Customer Churn
Rate
Margin
cogs/
sales
Deficit Rates
Cost per Delivery
Development
Cost/Sales
Maintenance cost
Shareholder
value
creation
ROCE
New product
development time
Indirect/Direct
Labor
Inventory
Turnover
Customer
Complaints
Economic
Profit
Capital
Turnover
Downtime
Capacity
Utilization
Accounts Payable
Time
Cash
Turnover
Accounts
Receivable Time
CEO
Corporate/Divisional
Functional
Departments & Teams

11. Balanced Scorecard for Mobil N. American Marketing & Refining
Strategic Objectives
Strategic Measures F I N A C L
F1 Return on Capital Employed
F2 Cash Flow
F3 Profitability
F4 Lowest Cost
F5 Profitable Growth
F6 Manage risk
* ROCE
* Cash Flow
* Net Margin
* Full cost per gallon delivered to customer
* Volume growth rate Vs. industry
* Risk index
Financially
Strong
C O
U M
S E
T R -
C1 Continually delight the targeted consumer
C2 Improve dealer/distributor profitability
* Share of segment in key markets
* Mystery shopper rating
* Dealer/distributor margin on gasoline
* Dealer/distributor survey
Delight the Consumer
Win-Win Relationship I N T E R A L
I1 Marketing
1. Innovative products and services
2. Dealer/distributor quality
I2 Manufacturing
1. Lower manufacturing costs
2. Improve hardware and performance
I3 Supply, Trading, Logistics
1. Reducing delivered cost
2. Trading organization
3. Inventory management
I4 Improve health, safety, and environmental performance
I5 Quality
* Non-gasoline revenue and margin per square foot
* Dealer/distributor acceptance rate of new programs
* Dealer/distributor quality ratings
* ROCE on refinery
* Total expenses (per gallon) Vs. competition
* Profitability index
* Yield index
Delivered cost per gallon .Vs. competitors
* Trading margin
* Inventory level compared to plan & to output rate
* Number of incidents
* Days away from work
* Quality index
Safe and Reliable
Competitive Supplier
Good Neighbor
On Spec
On time L
E &
A G
R R
N O
I W
N T
G H
L1 Organization Involvement
L2 Core competencies and skills
L3 Access to strategic information
* Employee survey
* Strategic competing (?) availability
* Strategic information availability
Motivated and Prepared

12. A Comprehensive Value Metrics Framework
Shareholder
Value
Measures:
Market value of the
firm
Market value added
(MVA)
Return to
shareholders
Intrinsic
Value
Measures:
Discounted cash
flows
Real option values
Financial
Indicators
Measures:
Return on Capital
Growth (of
revenues & operating
profits
Economic profit (EVA)
Value
Drivers
Sources:
Market share
Scale economies
Innovation
Brands

13. The Paradox of Value
The companies that are most successful in creating
long term shareholder value are typically those that:
Have a mission—They give precedence to goals
other than profitability and shareholder return;
Have strong, consistent, ethical values.
Examples:
“Visionary” companies studied by Collins & Porras,
e.g. Merck, Wal-Mart, Procter & Gamble, Disney, HP
Boeing — Focus pre-1996: “to build great planes,” weak
financial controls—yet high profitability
— Focus : “creating shareholder
value”—Outcome: loss of market leadership,
declining profitability