VALUE BASE MANAGEMENT

PRESENTED TO:PROF. SANDHYA HARKWAT

PRSSENTED BY :-

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

WHAT IS VBM
VALUE BASE MANAGEMENT IS THE MANAGEMENT APPROACH THAT ENSURES CORPORATION ARE RUN CONSISTENTLY ON VALUE.(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)

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

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 MARKET VBM CAN HELP ORGE. TO WIN IN EACH OF THESE 4 MARKETS.

METHOD & KEY PREMISES OF VBM

THE 3 PRINCIPAL METHODS OF VBM ARE: 1. THE FREE CASH FLOW METHOD PROPOSED BY MCKINSEY AND ALCAR GROUP. 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.

MARAKON APPROACH
SPECIFY THE FINANCIAL DETERMINANTS OF VALUE UNDERSTAND THE STRATEGIC DRIVERS OF VALUE FORMULATE HIGHER VALUE STRATEGIES DEVELOP SUPERIOR ORGANIZATIONAL CAPABILITIES

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

Specify the financial determinants of value-cont

If M exceeds B :- management creates value for the shareholders 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.

Understand the strategic drivers of value

Market economics Competitive position

Understand the strategic drivers of value-cont

Market economics Limiting forces: Intensity of indirect competition Threat of entry Suppliers pressures Regulatory pressures Direct forces: Intensity of direct competition Customer pressure

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

Formulate higher value strategies

Participation strategy Competitive strategy

Formulate higher value strategiescont

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 competitive disadvantage in the market.

Develop superior organizational capabilities

Competent and energetic chief executive Corporate governance Compensation plan- relative pay for relative performance Resource allocation Performance management process

Alcar Approach
Determinants of shareholder value Assessment of the shareholder value impact of the business unit Shareholder value management cycle

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

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 the planning 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)

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.

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

AREA OF ACTIVITY FOR MAKING VALUE HAPPEN

1. 2. 3. 4. 5. 6. ASPIRATIONS AND TARGET PORTFOLIO MANAGEMENT ORGANISATIONAL DESIGN VALUE DRIVER IDENTIFICATION BUSINESS PERFORMANCE MANAGEMENT INDIVIDUAL PERFORMANCE MANAGEMENT

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

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 UNDER EVA= NOPAT-C*.CAPITAL EVA= CAPITAL(r-c*) EVA= [PAT+INT(1-T)]-C*.CAPITAL EVA= PAT-KE. EQUITY

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 EARN INADEQUATE RETURNS. THE COST OF CAPITAL IS LOWERED BY ALTERING THE FINANCING STRATEGY.

COMPONENTS OF EVA
NOPAT(NET OPERATING PROFIT AFTER TAX) C*(COST OF CAPITAL) CAPITAL(CAPITAL EMPLOYED IN BUSINESS)

Economic Value Added (EVA)

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

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

Only performance measure to tie directly to the intrinsic market

value of a company

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

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 it belongs.

EVA Value Creation Strategies

EVA = ( r c*) x Capital Employed

Improve operating profits without tying up any more

capital. Increase capital only if return on investment more than covers the charge for additional capital. Liquidate capital where the earnings lost are more than offset by a savings on the capital charge. Structure balance sheet in a way that lowers the cost of capital.

EVA Example - 3 Ways to Add Value

IMPROVE ACHIEVE OPERATING PROFITABLE RATIONALIZE EFFICIENCY GROWTH BUSINESS $300 $1,000 30.0% 15.0% $300 $150 $150 $450 $2,000 22.5% 15.0% $450 $300 $150 $250 $667 37.5% 15.0% $250 $100 $150

BASE CASE NOPAT Capital Employed Return on Capital - r Cost of Capital - c* NOPAT Cost of Capital EVA $250 $1,000 25.0% 15.0% $250 $150 $100

Each Adds Shareholder Value in a Different Way.Only Performance Measure to Identify Each

EVA Example Stop Destroying Value

BASE CASE NOPAT Capital Employed Return on Capital - r Cost of Capital - c* NOPAT Cost of Capital EVA $50 $1,000 5.0% 15.0% $50 $150 ($100)
NEW BUSINESS OPPORTUNITY $180 $2,000 9.0% 15.0% $180 $300 ($120)

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

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 its

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

Graphical Example of EVA and Value Creation

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

Return on Capital - r

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

r = 5% & c* = 15% EVA = ($100) Value < Capital Capital Employed Cost of Capital c*

Key Benefits of EVA Framework

Links strategic, operating, and financial planning Helps managers make better decisions Capital charge converts the balance sheet into another
line-item expense EVA = Sales Operating Costs Capital Costs Easy to communicate to all employees Performance expressed in a single profit measure expressed in dollars

EVA IS THE MOST RELIABLE UNAMBIGUOUS CONTINUOUSIMPROVEMENT METRIC

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

BCG Approach
Total shareholders return Total business return Two performance metrics are used:- cash flow return on investment and cash value added.

Total shareholders return (TSR)

TSR is the rate of return shareholders earn from owning a companys 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

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)

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.