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 Shareholder Value
Making Value Happen
Aspirations and
Targets
Portfolio Management
Organization Design
Value Driver Definition
Business Individual
Performance Performance
Management Management
Value
Thinking
Mindset
Metrics
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
KPIs RCCU Scorecard
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?
