Value Base Management

8/4/2019 Value Base Management

1/39

VALUE BASE MANAGEMENT

PRSSENTED BY :-PRESENTED TO:-

PROF. SANDHYA HARKWAT


2/39

FLOW OF PRESENTATION

WHAT IS VBM

WHY NEED ARISE OF VBM

HOW WE CAN USE VBM

APPROCHES OF VBM

MARAKON APPROACH ALCAR APPROACH

MCKINSEY APPROACH

STERN STEWART APPROACH

BCG APPROACH

LESSONS FROM THE EXPERIENCES OF VBM ADOPTERS

POTENTIAL AND HURDLES FOR VBM IN INDIA


3/39

WHAT IS VBM

VALUE BASE MANAGEMENT IS THE MANAGEMENT

APPROACH THAT ENSURES CORPORATION ARE RUN CONSISTENTLY ONVALUE.(NORMALLY :- MAXIMIZING SHAREHOLDERS VALUE).

IT IS USEFUL TO UNDERSTAND THAT VALUE BASED MANAGEMENT

INCLUDE ALL 3 OF FOLLOWING

1. CREATING VALUE

2. MANAGING FOR THE VALUE

3. MEASURING VALUE(VALUATION)


4/39

VBM AIMS TO PROVIDE CONSISTENCY OF

THE CORPORATE MISSION

THE CORPORATE STRATEGY

CORPORATE GOVERNANCE

CORPORATE CULTURE

CORPORATE COMMUNICATION

ORGANIZATION OF THE CORPORATION

DECISION PROCESS & SYSTEM

PERFORMANCE MANAGEMENT PROCESS & SYSTEM

REWARD PROCESS & SYSTEM


5/39

WHY VBM NEEDED?

VALUE BASE MANAGEMENT IS IMPORTANT TO REALIZE THAT YOUR ORGE.

IS OPERATING & COMPETING IN 4 MARKET

1. THE MARKET FOR ITS PRODUCT & SERVICE.

2. THE MARKET FOR CORPORATE MANAGEMENT & CONTROL.

3. THE CAPITAL MARKET

4. THE EMPLOYEE & THE MANAGERS MARKETVBM CAN HELP ORGE. TO WIN IN EACH OF THESE 4 MARKETS.


6/39

METHOD & KEY PREMISES OF VBM

THE 3 PRINCIPAL METHODS OF VBM ARE:

1. THE FREE CASH FLOW METHOD PROPOSED BY MCKINSEY AND ALCARGROUP.

2. THE ECONOOMIC VALUE ADDED/ MARKET VALUE ADDED METHOD

PIONEERED BY STERN STEWRT AND COMPANY.

3. THE CASH FLOW RETURN ON INVESTMENT/CASH VALUE

ADDED(CFROI/CVA) METHOD DEVELOPED BY BCG AND HOLT VALUE

ASSOCIATES.


7/39

MARAKON APPROACH

SPECIFY THE FINANCIAL DETERMINANTS OF VALUE

UNDERSTAND THE STRATEGIC DRIVERS OF VALUE

FORMULATE HIGHER VALUE STRATEGIES

DEVELOP SUPERIOR ORGANIZATIONAL CAPABILITIES


8/39

SPECIFY THE FINANCIAL DETERMINANTS OF VALUE

Market to book ratio model

Shareholders wealth is measured as a difference

in the market value and the book value of the

firms equity. Book value the capital contributed by the

shareholders

Market value how productively the firm has

employed the capital contributed by the

shareholders


9/39

Specify the financial determinants of value-cont

If M exceeds B :- management creates value for theshareholders

If M is less than B :- decimates value

If M is equal to B :- maintains value M/B= r-g/k- g

Value is created when there is a positive spread

between the return on equity and the cost of capital.

Higher the g the higher M/B ratio.

Ie. When the spread is positive a higher growth rate

contributes more to value creation.


10/39

Understand the strategic drivers of value

Market economics

Competitive position


11/39

Understand the strategic drivers of value-cont

Market economicsLimiting forces:-

Intensity of indirect competition

Threat of entry Suppliers pressures

Regulatory pressures

Direct forces:-

Intensity of direct competition

Customer pressure


12/39

Understand the strategic drivers of value-cont

Competitive position Product differentiation

Economic cost position

- access to cheaper raw material

- Efficient process technology

- Superior management

- Economic of scale in some markets


13/39

Formulate higher value strategies

Participation strategy

Competitive strategy


14/39

Formulate higher value strategies-

cont

Participation strategy:-the product markets

in which it will compete. (Enter and Exit)

Competitive strategy :- strategy

management will use to build competitive

advantage or to overcome competitivedisadvantage in the market.


15/39

Develop superior organizational

capabilities

Competent and energetic chief executive

Corporate governance

Compensation plan- relative pay for relative

performance

Resource allocation

Performance management process


16/39

Alcar Approach

Determinants of shareholder value

Assessment of the shareholder value

impact of the business unit

Shareholder value management cycle


17/39

Determinants of shareholder value

Value drivers

Rate of sales growth

Operating profit margin Income tax rate

Investment in working capital

Fixed capital investment Cost of capital value growth duration


18/39

Assessment of the shareholder value impact of the

business unit (strategy)

Steps:-

Forecast the operating cash flow

Discount the forecasted operating cash flow using WACC

Estimate the residual value of the firm at the end of theplanning period and find its present value( perpetuity cash

flow/ cost of capital)

Determine the total shareholders value (PV of the operating

cash flow + PV of the residual value - market value of the debt)

Establish the pre-strategy value ( cash flow before new

investment / cost of capital

Infer the value created by the strategy ( total shareholder value

pre strategy value)


19/39

Shareholder value management cycle

Select the strategy that maximizes the

expected shareholders value

Finds the highest valued use for all assets

Bases performance evaluation and incentive

compensation on shareholder value added

Returns cash to shareholders when value

creating investments do not exist.


20/39

McKinsey Approach

Properly executed, value based management is an approach to

management whereby the companys overall aspirations, analytical

techniques, and mngt. Processes are all aligned to help the company

maximize its value by focusing decision making on the key drivers of value.

VALUE THINKING:- TO MAKE VALUE HAPPEN, A CO.S ACTION SHOULD BE

BASED ON A FOUNDATION OF VALUE THINKING.

DIMENSION

-VALUE METRICS

-VALUE MINDSET


21/39

AREA OF ACTIVITY FOR MAKING VALUE HAPPEN

1. ASPIRATIONS AND TARGET

2. PORTFOLIO MANAGEMENT

3. ORGANISATIONAL DESIGN

4. VALUE DRIVER IDENTIFICATION

5. BUSINESS PERFORMANCE MANAGEMENT6. INDIVIDUAL PERFORMANCE MANAGEMENT


22/39

Find the value drivers

Generic level:- the return on invested

capital is analyzed in terms of operating

margin and invested capital Business unit level:- product mix, customer-

mix, operating leverage

Grass roots level:- capacity utilization,revenue generated , cost per delivery.


23/39

EVA APPROACH

IT IS ALSO KNOWN AS STERN STEWART APPROACH. ECONOMIC VALUE

ADDED IS CURRENTLY A VERY POPULAR IDEA.

EVA US ESSENTIALLY THE SURPLUS LEFT AFTER MAKING AN APPROPRIATE

CHARGE FOR THE CAPITAL EMPLOYED IN BUSINESS.

FORMULA OF CALULATING EVA ARE AS UNDEREVA= NOPAT-C*.CAPITAL

EVA= CAPITAL(r-c*)

EVA= [PAT+INT(1-T)]-C*.CAPITAL

EVA= PAT-KE. EQUITY


24/39

WHAT CAUSES EVA TO INCREASE

THE RATE OF RETURN ON EXISTING CAPITAL INCREASES BECAUSE OF

IMPROVEMENT IN OPERATING PERFORMANCE.

ADDITIONAL CAPITAL IS INVESTED IN PROJECTS THAT EARN A RATE

OF RETURN GREATER THAN THE COST OF CAPITAL.

CAPITAL IS WITHDRAWN FROM ACTIVITIES WHICH EARNINADEQUATE RETURNS.

THE COST OF CAPITAL IS LOWERED BY ALTERING THE FINANCING

STRATEGY.


25/39

COMPONENTS OF EVA

NOPAT(NET OPERATING PROFIT AFTER TAX)

C*(COST OF CAPITAL)

CAPITAL(CAPITAL EMPLOYED IN BUSINESS)


26/39

Economic Value Added (EVA)

Residual income measure that subtracts the cost of capital fromthe operating profits generated in the business

Accounts properly for all the ways in which corporate value maybe created or destroyed

Only performance measure to tie directly to the intrinsic marketvalue of a company

EVA = [rate of return (r) cost of capital (c*)] x Capital EmployedEVA = NOPAT c* x Capital EmployedEVA = Operating Profits a Capital Charge


27/39

EVA Basics

one should as soon compute earnings without a

capital charge as play tennis with the net down.

All EVA does is simply lift the net back up where itbelongs.


28/39

EVA Value Creation Strategies

Improve operating profits without tying up any morecapital.

Increase capital only if return on investment more thancovers the charge for additional capital.

Liquidate capital where the earnings lost are more thanoffset by a savings on the capital charge.

Structure balance sheet in a way that lowers the cost ofcapital.

EVA = ( r c*) x Capital Employed


29/39

EVA Example - 3 Ways to Add Value

BASE

CASE

NOPAT $250Capital Employed $1,000

Return on Capital - r 25.0%

Cost of Capital - c* 15.0%

NOPAT $250

Cost of Capital $150EVA $100

IMPROVE

OPERATING

EFFICIENCY

$300

$1,000

30.0%

15.0%

$300

$150$150

ACHIEVE

PROFITABLE

GROWTH

$450

$2,000

22.5%

15.0%

$450

$300$150

RATIONALIZE

BUSINESS

$250

$667

37.5%

15.0%

$250

$100$150

Each Adds Shareholder Value in a Different Way.Only

Performance Measure to Identify Each


30/39

EVA Example Stop Destroying

Value

BASE

CASE

NOPAT $50

Capital Employed $1,000

Return on Capital - 5.0%

Cost of Capital - c* 15.0%

NOPAT $50

Cost of Capital $150EVA ($100)

NEW

BUSINESS

OPPORTUNITY

$180

$2,000

9.0%

15.0%

$180

$300($120)

Turning off the spigot on unrewarding projectsis the last way to add value.


31/39

The MVA Valuation Formula

Market Value Added (MVA) = Market Value Capital

MVA = Present Value of all Future EVA

Market Value = Capital + Present Value of all Future EVA

r / c* > 1.0 company will be valued at a premium to itseconomic book value (capital)

r / c* < 1.0 then company will be valued at a discount to itseconomic book value (capital)


32/39

Graphical Example of EVA and

Value Creation

Return onCapital - r

Cost of Capital -c*

r = 15% & c* = 15%EVA = $0Value = Capital

r = 25% & c* = 15EVA = $100Value > Capital

r = 5% & c* = 15EVA = ($100)

Value < Capital

CapitalEmployed


33/39

Key Benefits of EVA Framework

Links strategic, operating, and financial planning

Helps managers make better decisions

Capital charge converts the balance sheet into anotherline-item expense

EVA = Sales Operating Costs Capital Costs

Easy to communicate to all employees

Performance expressed in a single profit measureexpressed in dollars

EVA IS THE MOST RELIABLE UNAMBIGUOUS CONTINUOUS-IMPROVEMENT METRIC


34/39

Four Applications of EVA

MEASUREMENT Most accurate measure of corporate performance

Translates accounting profits to economic reality

MANAGEMENT Four ways to increase value

MOTIVATION Cause managers to think and act like owners

Bank bonuses to insure sustainability and long-term thinking

MINDSET Transforms corporate culture

Internal corporate governance


35/39

BCG Approach

Total shareholders return Total business return

Two performance metrics are used:- cash

flow return on investment and cash valueadded.


36/39

Total shareholders return (TSR)

TSR is the rate of return shareholders earn from owning acompanys stock over a period of time:

TSR = Dividend/Beginning market value + Ending market value

Beginning market value / Beginning market value

TSR include dividends as well as capital gains

TSR is not biased by size

TSR is used by the investment community


37/39

Total Business Return

If TSR is what matters to investors, an internal counterpart to it Is needed

for managerial purposes. For BCG, the total business return(TBR) is the

internal counterpart of TSR.

The TBR can be computed as follows:-

TBR=(free cash flow/Beginning value)+(Ending value-Beginning value

/Beginning value)


38/39

LESSONS FROM THE EXPERIENCES OF VBM ADOPTERS

Top management support and involvement is

essential.

A good incentive plan is necessary.

Employees should be properly educated. VBM works well in certain cases.

One size doesnt fit all.


39/39

Value Base Management

Documents

Transcript of Value Base Management