1、Author: Patrick Cote,Contributors: Kate McGreevy Julian Critchlow,bc,Corporate Performance Measurement,April 1999,Copyright 1999 Bain & Company, Inc.,2,CorporatePerformanceMeasurement,Executive SummaryObjectivesBackgroundPerformance Measurement FrameworkMarket Value Added (MVA)Economic Profit (EP)Ca
2、sh Flow Return on Investment (CFROI)Exercises MVAEconomic ProfitCase Study - Diageo,Agenda,3,CorporatePerformanceMeasurement,Corporate performance evaluation has evolved from the 1960s focus on ROE to the current variations of economic profit that measure impact on shareholder valuemany firms have d
3、evised their own variations of economic profitStern Stewarts Economic Value Added (EVA)TM is best known of these measures Holt/BCGs Cash Flow Return on Investment (CFROI) is a similar concept presented in % return formatBoth ROE and EP are business metrics, tools used to measure the performance of t
4、he businessseparate from fundamental business drivers, the actual factors that influence shareholder value, and output measures the backward-looking records of overall company performanceFocusing on EP instead of ROE decreases the likelihood of destructive behavior by managersBy evaluating managers
5、based on EP, manager behavior can be altered such that only projects that add value (with NPV0) are undertaken, which does not always occur with ROE,Executive Summary (1 of 2),4,CorporatePerformanceMeasurement,Executive Summary (2 of 2),End goal of EP exercises is consistent with traditional Bain fo
6、cus of maximising shareholder valueBain has measured historical performance with Total Shareholder ReturnStern Stewart devised Market Value Added (MVA)TM as means of measuring market expectations of EP that managers will add in the futuremanagers objective should be to maximise MVAAll economic profi
7、t measures deduct charge for use of equity capital from accountings typical net income or profit after tax to reflect the opportunity cost associated with equity investmentsStern Stewart has trademarked EVATM by specifying adjustments to make to EP,5,CorporatePerformanceMeasurement,Agenda,Executive
8、SummaryObjectivesBackgroundPerformance Measurement FrameworkMarket Value Added (MVA)Economic Profit (EP)Cash Flow Return on Investment (CFROI)Exercises MVAEconomic ProfitCase Study - Diageo,6,CorporatePerformanceMeasurement,Objectives,There are three objectives of the Corporate Performance Measures
9、Module:,To define the most popular measures of corporate performanceTo explain the significance of these measures in the corporate environment and potential applications in Bains strategy workTo outline calculations of each performance measure,7,CorporatePerformanceMeasurement,Agenda,Executive Summa
10、ryObjectivesBackgroundPerformance Measurement FrameworkMarket Value Added (MVA)Economic Profit (EP)Cash Flow Return on Investment (CFROI)Exercises MVAEconomic ProfitCase Study - Diageo,8,CorporatePerformanceMeasurement,With the rise of conglomerates, most companies focused on Return on Equity, or RO
11、E, as their primary measure of performance led most managers to undertake acquisitions solely to manipulate accounting figures,1960s/70s,1980s/90s,With the increased focus on delivering shareholder value, managers have accepted systems that measure the change in value managers realised equity is not
12、 freeeconomic profit (EP) meets these needs by telling managers where value has been created and where it has been destroyedAs aligning interests between owners and managers has become more important, tying management compensation to EP provided a popular solution,Corporate performance evaluation ha
13、s evolved from the 1960s focus on ROE to the current variations of economic profit (EP) that measure impact on shareholder value,Background,Corporate Performance Evaluation,9,CorporatePerformanceMeasurement,Bain was the first of major consulting firms to focus on creating shareholder valueTo achieve
14、 this, Bain has used the output measure of Total Shareholder Return and the accounting measures of ROE and ROIModified accounting measures, such as EP, provide an alternative means of measuring the creation of shareholder value,Background,Relevance to Bain,10,CorporatePerformanceMeasurement,To illus
15、trate the role of corporate performance measures and resource allocation to strategy work, an examination of Marakons “program” is usefulMarakon applies the following program, which can take several years to complete, to all of its clients:assess the economic profit of all customer segments and prod
16、uct linescompare company performance to industry performanceinvestigate three or more strategies for each business every planning cycleshift resource allocation from economically unprofitable products/customers to economically profitableleads to yield loss for Marakon and clients since additional sc
17、enarios frequently evaluated,Marakon has made economic profit (EP) the central focus of the program they apply to every case,Background,Link to Strategy,11,CorporatePerformanceMeasurement,EVA is a registered trademark of Stern Stewart,A century ago, Alfred Marshall explained that for a company to ha
18、ve genuine profits, the profits must be sufficient to cover the cost of capital as well as the firms operating costsStern Stewart has re-packaged the concept into EVA, which is essentially a more palatable form of the same ideaMcKinsey has been using economic profit for many yearsBCG uses Cash Flow
19、Return on Investment (CFROI) for a similar analysisTo avoid infringing upon Stern Stewarts trademark, many consulting firms have developed their own terms for the same concept,How new is Economic Value Added (EVA)?,EVATM is one variation of EP,Background,Economic Value Added,12,CorporatePerformanceM
20、easurement,Agenda,Executive SummaryObjectivesBackgroundPerformance Measurement FrameworkMarket Value Added (MVA)Economic Profit (EP)Cash Flow Return on Investment (CFROI)Exercises MVAEconomic ProfitCase Study - Diageo,13,CorporatePerformanceMeasurement,Measures,* For a discussion of WACC and discoun
21、t rates, please see the Investment Appraisal Module in the BVU,Description:,EVA/MVA,EP,and CFROI are modified accounting measures used to measure the performance of the business,Inputs/ Measures:,Fundamental Business Drivers,Business Metrics,Output Measures,Primary business-specific factors influenc
22、ing shareholder value,Tools used to measure performance of business,Backward-looking measures of overall company performance as viewed by market,Operating profitsvolumepricecostsFinancial Cost of Capital Employedfixed assetsworking capitalWACC*,Accounting ROEROAModified accountingEVA/MVAEPCFROICVA,T
23、otal Shareholder Return (TSR)Total Business Return (TBR),Framework,14,CorporatePerformanceMeasurement,The fundamental business drivers provide a framework for identifying the sources of shareholder value creation or destruction,Shareholder Value Creation/Destruction,Operating Profit,Cost of Capital,
24、Volume,Price,Costs,Working Capital,WACC,Fixed Assets,X,+,X,Direct costsmateriallabourIndirect costsSG & ADepreciation,Average selling price,# of units sold,Weighted average cost of capital based on market values of debt and equityUse after-tax cost of debt,Current assets less current liabilities,Pro
25、perty, plant & equipmentIntangibles,LIFO vs FIFODepreciation estimates,Cost of equity for private firms,Intangible measurement,Components:,Issues:,Framework,Fundamental Business Drivers,15,CorporatePerformanceMeasurement,* Sometimes referred to as Return on Investment (ROI),ROE measures returns to s
26、hareholders, while ROA measures returns to investors of all forms of capital,Formula:,Measures:,ROA,Profitability of all capital employed, including debt,Uses:,Return on Assets (ROA)*,Return on Equity (ROE),Net Income,Assets,=,ROE,Net Income,Equity,=,Profitability of equity invested in business (net
27、 equity issued plus retained earnings),Returns of enterprise as a whole,Returns to shareholders,Framework,Accounting Business Metrics,16,CorporatePerformanceMeasurement,The DuPont formula is used to separate ROE into its components in order to assess the performance of the business,ROE,Net Income,Eq
28、uity,=,Net Income,Sales,=,Sales,Assets,Assets,Equity,X,X,ROS,Asset Turnover,Leverage,ROE,=,Profitability,Asset Turnover,Leverage,X,X,=,ROA,Framework,Accounting Business Metrics - DuPont Formula,17,CorporatePerformanceMeasurement,* EVA=EVA with depreciation added back,Many consulting companies attemp
29、t to brand the modified accounting business metrics they use,Economic Profit,Measure,Consulting Companies,Bain McKinseyMarakon (through Value-Based Management)LEK,EVA / MVA ,Stern StewartAT KearneyAccounting firms,BCG,HoltBCG,Cash Value Added* (CVA),Cash Flow Return on Investment (CFROI),Framework,M
30、odified Accounting Business Metrics,18,CorporatePerformanceMeasurement,* only backward -looking,The modified accounting business metrics, which include EP, enable relatively accurate levels of corporate performance measurement at lower levels of decision making in the organisation,Accuracy as Measur
31、e of Corporate Performance,Level of Decision Making,High,Low,Low,High,MVA,Modified Accounting Business Metrics,TSR*,ROE/ROA,Fundamental Business Drivers,EP/EVA/CFROI,Role in Organisation,Framework,19,CorporatePerformanceMeasurement,* Adjusted for all stock splits and assuming all dividends reinveste
32、d,While TSR calculates return to shareholders for publicly-listed companies, BCGs TBR calculation estimates equivalent returns for privately-held firms,Total Shareholder Return (TSR) in CAGR Format,Market value of share at end of period *,Market value of share at beginning of period,=,Total Business
33、 Return (TBR),=,Estimated market value of shares of privately-held company at end of period*,number of years,1,number of years,1,1,1,Estimated market value of shares of privately-held company at beginning of period*,Framework,Output Measures,20,CorporatePerformanceMeasurement,Bains client stock perf
34、ormance slide is calculated using TSR, which is used to measure the shareholder value created,Framework,Output Measures,21,CorporatePerformanceMeasurement,Agenda,Executive SummaryObjectivesBackgroundPerformance Measurement FrameworkMarket Value Added (MVA)Economic Profit (EP)Cash Flow Return on Inve
35、stment (CFROI)Exercises MVAEconomic ProfitCase Study - Diageo,22,CorporatePerformanceMeasurement,Market Value Added (MVA),Invested Capital,Goal of Managers should always be to create more shareholder value, or maximise MVA,Total Market Value of Firm(includes all debt and equity),Bains focus has alwa
36、ys been to help the management of the firm to maximise shareholder value, which is equivalent to maximising MVA,Market Value Added,Definition (1 of 2),23,CorporatePerformanceMeasurement,MVA equals the total market value of the company less invested capital or net assets. Either the Operating or Fina
37、ncing Approach can be used, but Bain typically uses the Operating approach,Note: *Short-term non-interest bearing liabilities,Operating Approach (Typically used by Bain),Financing Approach,Market Value Added,Definition (2 of 2),24,CorporatePerformanceMeasurement,The first step required to calculate
38、Net Assets with the Operating Approach is to identify excess cash, which is total cash less cash required in the operating cycle,Note: *Short-term non-interest bearing liabilities,Amount ($),Market Value Added,Operating Approach - Excess Cash,25,CorporatePerformanceMeasurement,Next, The working capi
39、tal requirements are the firms net investments in the operating cycle, or the net amount of short-term investment required to fund operations,Amount ($),WorkingCapitalRequirements,Market Value Added,Operating Approach - Working Capital Requirements,26,CorporatePerformanceMeasurement,When calculating
40、 MVA, Net Fixed Assets is defined as Net PP&E plus other Investment (tangible and intangible). The third and final step to calculate Net Assets is Net PP&E, which is the amount of long-term investment required to fund operations,Amount $,Net PP&E,Market Value Added,Operating Approach - Net Fixed Ass
41、ets,27,CorporatePerformanceMeasurement,Market value added (MVA) reflects the markets expectations of the EP managers will add in the future,Percent of Total,MVA is the markets expectation of discounted future EPs,Market Value Added,Link to EP,28,CorporatePerformanceMeasurement,After extensive work b
42、y a diligent Bain team, Acme Industries is expected to generate $25M in economic profits next year, which is expected to grow at 3% forever. If the cost of capital is 13% and the invested Capital is $100M, what is the MVA and the market value of the company?,Market Value Added,Link to EP - Example,2
43、9,CorporatePerformanceMeasurement,After extensive work by a diligent Bain team, Acme Industries is expected to generate $25M in economic profits next year, which is expected to grow at 3% forever. If the cost of capital is 13% and the invested Capital is $100M, what is the MVA and the market value o
44、f the company?,MVA = PV of EPs,= $ 25 M,13% - 3%,= $ 250 M,= MVA + Invested Capital,= $ 250 M + $100 M,= $350M,Market Value of the Company,Market Value Added,Link to EP - Solution,30,CorporatePerformanceMeasurement,EP measures managers performance in the past, since it represents the market value ad
45、ded created over one year,Note: *Assumes Invested Capital Constant,Market Value Added,Link to EP (1 of 2),31,CorporatePerformanceMeasurement,EP is used to evaluate manager performance because the change in MVA over a period of time is measured,Goal of companys managers should always be to maximise M
46、VAWhen managers make any investment decisions, if the project is:value-creatingNPV 0MVA increasesvalue-destroyingNPV 0MVA decreasesReason that EP is the focus of most attention is because MVA is a stock or wealth measure, so MVA will show how much value has been added at that point in timeEP measure
47、s the amount of value added over a period of time, which is far more useful when measuring manager performance,Market Value Added,Link to EP (2 of 2),32,CorporatePerformanceMeasurement,Which UK sectors would you expect to have the highest market value added?and the lowest?Which UK companies would yo
48、u expect to have the highest market value added?and the lowest?,Market Value Added,Actual Performance,33,CorporatePerformanceMeasurement,Banks, integrated oil and drugs were the UK sectors with the highest market value added,Source: Stern Stewart, Sunday Times,Sector Market Value Added (Sept 98),Mar
49、ket Value Added,UK Sector Performance - 10 Best,34,CorporatePerformanceMeasurement,Distributors, print and packaging and construction had the lowest market value added in the UK,Source: Stern Stewart, Sunday Times,Sector Market Value Added (Sept 98),Market Value Added,UK Sector Performance - 10 Worst,
