October 2015

HCM Viewpoint"What is Success?“: Key Question for a Robust Owner Strategy

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About HCM

HCM Hostettler & Company is a leading independent international advisory firm specializing in the strategic aspects of Governance, Finance, and Compensation, with deep experience across various industries and in the advising of boards, board committees, senior management, and control functions.

HCM’s partners, managers, consultants, and analysts work in its offices in Zurich, Geneva and Kiev. They are bolstered by our global partners in the US, UK, Australia, Singapore, and China, which allow us to reach all major markets and support companies of all sizes, from large multinationals and public institutions, to mid-sized and smaller companies, including those preparing for an IPo.

Our mission is to support companies and other organizations tackle the ever important question: «How to measure, steer and allocate value creation?». We also cover risk and compliance as these also affect value. The «value question» is of core interest not only to owners, board of Directors and senior management, but also increasingly to institutional investors, proxy advisors, HR and control functions, regulators, and international standard setters.

As part of its services, HCM works with companies on topics relating to the owner strategy to support - along with governance and compensation strategies - sustainable success for its clients.

HCM is Chair of the Global Governance and Executive Compensation Network (GECN).

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What is success? under which conditions should this success be achieved? What is the quality of our success? At a first glance, these questions to owners, Board members or the management team may appear to be rather apparent. However, for a lot a companies, the mentioned stakeholders do not have a consistent and concrete common understanding of success. In HCM's experience, sometimes more than 30 - 40 different definitions of success are used

within the same company. These differences make it difficult to decide upon strategic planning, investment decisions and financial operations but also leadership questions and compensation strategy. therefore, success needs to be clearly defined in the respective components. HCM uses a holistic approach corresponding to the different elements of the owner strategy in order to establish a common language.

the use of an illustrative example for a robust owner strategy reveals the key elements that are essential for success. When designing an owner strategy, it is essential to define the “reason to be” of the company in a comprehensive and motivating statement that can be communicated

across the whole organization. This statement would ideally reflect the current culture and business model as well as future aspirations, as it will then build the basis for the definition of the financial goals.

An increasingly accepted instrument to create a common understanding of success within a company is the owner strategy. In contrast to business strategies, the owner strategy is a long-term living document based on the general purpose of a company that is translated into financial targets as well as balance sheet and operational framework conditions. by enabling a consistent, enterprise-wide anchoring of the key goals and framework conditions, the owner strategy develops a mutual understanding of the strategic direction within the company, which is in line with the company culture, governance and profit aspirations.

by involving critical stakeholders in this process, the owner strategy creates a common language and goes far beyond the short-term, quantitative steering. this includes setting clear targets, motivating managers and rewarding

them accordingly. Summarized, the question becomes: “How should one measure, steer and allocate success?” However, this question is often overlooked or assumed to be self-evident, thereby foregoing valuable company opportunities. Last but not least, a well-defined owner statement makes it often easier to handle governance issues and internal as well as external regulation requirements.

to ensure that the management is aiming to achieve the defined goals of the owners, the compensation system can be linked to performance indicators of this strategy. by linking employee incentives to the owner strategy of the company, the strategy is not only anchored effectively and sustainably within the organization, but also the employees' and the owners' interests are aligned.

How can the owner strategy support sustainable success?

The key elements of the owner strategyFormulation of a communicable owner statement

Implementation of an owner strategy as a basis for business strategy, governance and compensation

Our company is a best-in-class producer of sustainable, client-focused solutions.

This requires Leads to and

Illustrativeexample

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Topic Measurement Minimum Requirement

Equity Dilution Zero

Dividends Dividend payout ratio 25%-30% of Net Profit

Leverage Equity quota > 40%

Liquidity Sufficient liquidity for operations > CHF 15m Bal

ance

she

etco

ndit

ions

Sustainable, profitable growth, e.g. measured by Long-term growth in Net Sales: 5%-8%

Economic Profit Margin: 3%-7%

The owner statement and financial targets build the basis and provide a common direction for steering the company,

measuring the relevant KPIs and rewarding employees accordingly.

Few companies have a well-articulated owner strategy or they foster an explicit communication of required framework conditions. The crux lies in defining the financial and quantitative as well as the qualitative conditions for success.

From a financial perspective, owners often, deep down, expect an adequate long-term return on their investment. the balance sheet parameter conditions are therefore defined to support the achievement of general company targets.

Consequently, the owner strategy lies the foundation of aligned processes in controlling, strategy, HR and other business functions. Hence, if carried out well throughout

the organization, the owner strategy fosters a mutual understanding of company goals and establishes a common language.

Establishment of a common language and direction

Operationalization of the owner strategy

CommonLanguage

Measurement Steering

Compensation

based on the owner statement, the key targets in terms of financial goals of the company are defined. These financial goals reflect the general strategy and owner interest that can be communicated throughout the company. thereby it is essential to choose meaningful and adequate financial

targets that support the general strategic tendency of the owner statement. For instance, Sales or EbIt might be adequate and frequently used measures, but should be adapted to specific company requirements including risk, capital charges or inventory/capital turnover.

Definition of financial goals

Illustrativeexample

Illustrativeexample

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However, in order to measure sustainable success, the profit dimension as a typical financial target is usually insufficient to satisfy owner expectations. Along with financial success, the owners may also desire such factors as high quality, innovation, satisfied employees, an excellent reputation, etc. Next to balance sheet conditions, the owner strategy also includes operational conditions that reflect qualitative environmental parameters that need to be met by the company in order to

make the financial goals legitimate. Though the content of this non-financial part of the owner strategy highly depends on the specific situation of the company, non-financial topics can typically be clustered around the following dimensions: suppliers, customers, competitors, employees and company reputation. Each of these categories is then specified using adequate KPIs as well as minimal (“threshold”) and target requirements for each section.

The different elements of the owner strategy are then combined to form a holistic and communicable one-pager that serves as a point of reference and living document for

owners as well as members of the Executive board and board of Directors.

Topic Measurement Minimum Requirement

Suppliers On-time delivery performance

Complaint rate

> 95%

< 5%

Customers Net Promoter Score > 60%

Competitors Market growth > Market growth rate

Employees Fluctuation rate

Internal succession rate

< 7%

> 50%

Reputation Stakeholder engagement

1% of revenue donated as social contributions

Close relationship with stakeholders at key production sites

Ope

rati

onal

con

diti

ons

Illustrativeexample

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Conditions are minimum requirements for each dimension and often support the strategy with distinct target requirements. For each KPI, an observable point of measurement is then defined as well as the intended frequency (e.g. monthly, yearly). Using “employee satisfaction” as an example, the difference between goals and conditions becomes obvious. "Happy"

employees are crucial for the long-term success of a company. However, maximizing this condition does not make sense, as at one point costs would be too high. therefore, it is integrated as an operational condition of the owner strategy using specific measurement tools such as yearly internal employee surveys or the participation in external benchmarking surveys.

In order to set up the owner strategy at our clients, HCM reviews existing governance documentation as well as owner statements and conducts individual interviews with relevant participants in order to systematically assess the

meaning of "success". the outcome is then consolidated in workshops and presented to management, board members and owners. thereby, the owner strategy becomes a living document for regular review and assessment of "success".

How to implement the owner strategy?

Distinction between performance KPIs and condition KPIs

Review of existing governance documentation and owner statements

Individual meetings with owners, members of the board of Directors and Executive board

Analysis of the interviews, systematic assessment of parameters, targets and expectations

Preparation and moderation of a joint workshop to establish a mutual understandingof the dimensions of the owner strategy

Integration of the workshop feedback and formulation of the owner strategy as a one-page-document that allows easy communication

Definition of steps to integrate the owner strategy within corporate steering and management

on-going review of the owner strategy and establishment as a tool for periodic assessmentof company performance

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About tHE AutHoRS

Dr. Stephan Hostettler Managing PartnerDr. Stephan Hostettler has been active as an entrepreneur and consultant in Switzerland, the U.S., Europe and other international markets since 2002. Prior to this, he worked in Switzerland for a major bank in the area of financial analysis and in the USA in consulting on corporate finance and corporate governance. under his leadership, the consulting firm he founded has enjoyed sustained growth. His consulting work, his teaching at the university of St. Gallen, his research and publications, and his regular public commentary on current issues has established him as a thought leader on incentive compensation and value-based management. He holds a doctorate degree in finance. He is the author, among others, of the books "Das Value Cockpit" and "Managersaläre".

Marcus CathomasAnalystMarcus Cathomas holds a bachelor and Master degree from the university of St. Gallen in Accounting & Finance. During his studies, he had the opportunity to spend a semester at the bI Norwegian business School in oslo. While still a student, Marcus Cathomas was employed at Ernst & Young where he gained practical experience in risk-management, financial analysis and auditing. Additionally, he has successfully passed the CMA-exams and is qualified to be a Certified Management Accountant.

Claudia WuerstleAnalystClaudia Wuerstle holds a Master degree from the university of St. Gallen in General Management and a bachelor of Science in General Management/business Law from EbS university, oestrich-Winkel. During her Master studies at University of St.Gallen (HSG) she focused on financial analysis and personnel management. Claudia Wuerstle has gained work experience at, amongst others, A.T. Kearney in Frankfurt, the mergers and acquisitions department of Perella Weinberg in London, Horváth & Partners and Siemens AG in Munich. She has been an active member of the EbS student-lead consultancy, supporting small and medium sized companies in Germany and Switzerland.

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