Copyright © 2012 Pearson Canada Inc. 00 Chapter 7 Performance of the Strategy

Copyright © 2012 Pearson Canada Inc. 1 LEARNING OBJECTIVES 1. Understand how owners evaluate the performance of a business. 2. Describe how to determine the value of a business. 3. Describe how to conduct stakeholder analysis. 4. Understand the five approaches to corporate social responsibility. 5. Explain the four approaches to performance management. 6. Describe how to map strategy and produce a scorecard for it.

Copyright © 2012 Pearson Canada Inc. 2 Performance of the Strategy We examined designing a strategy in Chapter 5 and changing a strategy in Chapter 6. We are now ready to consider how to determine whether a particular strategic choice, or changing an existing one, is a good decision. This depends on being able to select one strategy from several alternatives and, at a minimum, compare a change in strategy with the existing strategy.

Copyright © 2012 Pearson Canada Inc. 3 Selecting a Strategy The selection of a strategy is heavily influenced by the metric used to evaluate the performance of the business. Many different metrics have been used over time (financial measures, stakeholder measures, and corporate social responsibility measures). The correct measure is value of the business since the purpose of strategy is to direct the company so that it produces as much value as possible.

Copyright © 2012 Pearson Canada Inc. 4 Selecting a Strategy Calculating the value of the business under a given strategy has three components: 1. the cash flow it generates into the future 2. the terminal value of the business at a point in the future 3. the cost of capital invested in the business

Copyright © 2012 Pearson Canada Inc. 5 Selecting a Strategy CASH FLOW Cash flow is the net flow of dollars into and out of a business within a period. The calculation of cash flow for a particular strategic alternative uses data taken from the projected financial statements for the business over time.

Copyright © 2012 Pearson Canada Inc. 6 Selecting a Strategy TERMINAL VALUE The terminal value is the present value of a perpetual stream of future cash flows growing at a specific constant rate, g. The terminal value is used because it is unrealistic to think that one can accurately forecast cash flows in the distant future.

Copyright © 2012 Pearson Canada Inc. 7 Selecting a Strategy COST OF CAPITAL The discount rate is the weighted average cost of capital (WACC) for the business. It is the weighted after-tax cost of equity and interest-bearing debt, so it reflects the cost of money invested in the business.

Copyright © 2012 Pearson Canada Inc. 8 Performance Management – Dashboard Example

Copyright © 2012 Pearson Canada Inc. 9 Performance Management DUPONT ANALYSIS DuPont analysis was created by Donaldson Brown, who served as the chief financial officer at General Motors in Brown realized that the return on assets (ROA, a common corporate goal at the time) was affected by both profitability and efficiency. Based on this insight, he developed a system that tied together the balance sheet and income statement. This system was later modified to focus on return on equity (ROE) rather than ROA.

Copyright © 2012 Pearson Canada Inc. 10 Performance Management MANAGEMENT BY OBJECTIVES (MBO) Management by objective was first outlined in 1954 by Peter Drucker, who has been called the “father of management.” MBO seeks to achieve alignment between individual goals and the goals of the business. The method uses the organizational hierarchy of the business to structure goals, providing everyone in the organization with specific objectives that, if achieved, contribute to the overall success of the business.

Copyright © 2012 Pearson Canada Inc. 11 Performance Management VALUE-BASED MANAGEMENT (VBM) Value-based management (VBM) focuses on the creation of value. Different approaches to VBM have measured value four ways: 1. discounted cash flow valuation 2. returns to shareholders 3. economic profit 4. the market-to-book ratio (equivalent to the q ratio and market value added (MVA)) Though the metrics are different, in practice, the four are highly correlated, so which is used is not crucial

Copyright © 2012 Pearson Canada Inc. 12 Performance Management BALANCED SCORECARD (BSC) The balanced scorecard is called a scorecard because it is a combination of metrics that reflect the strategy of the business. The metrics relate to four different facets of the business: 1. Finance: How do we look to the owners? Examples of metrics are operating income and ROE. 2. Customer: How do we look to customers? Examples of metrics are on-time delivery and percent of sales from new products. 3. Internal: What must we excel at? Examples of metrics are cycle time, yield, and efficiency. 4. Innovation and learning: Can we continue to improve and create value? Examples of metrics are time to develop the next generation of products and new product introductions relative to competitors.

Copyright © 2012 Pearson Canada Inc. 13 Stakeholders STAKEHOLDER ANALYSIS A stakeholder is an individual or group whom the business seeks to cooperate with because they have or control something the business needs as it pursues its strategy. Satisfying stakeholders’ expectations about what they should receive is not easy. Each stakeholder has different expectations about what the firm should do for it and the ability to exert influence. Management is often caught in the crossfire of stakeholders who have competing expectations.

Copyright © 2012 Pearson Canada Inc. 14 Stakeholders STAKEHOLDERS AND STRATEGY Top management’s challenge when crafting deals with various stakeholders is doing so without losing sight of the company’s strategy. Management has to negotiate a deal with each stakeholder that satisfies that stakeholder while still allowing the business to create value when pursuing its chosen strategy.

Copyright © 2012 Pearson Canada Inc. 15 Stakeholders Step 1: Identify the Value Chain When setting strategy, decisions made about the arena of the business determine where it comes in contact with the environment. Step 2: Identify the Stakeholders The stakeholders who interact with the value chain are identified. Step 3: Determine the Stakeholders’ Expectations Stakeholders have expectations about what they will receive from cooperating with the business. Their expectations for the present and in the future need to be assessed.

Copyright © 2012 Pearson Canada Inc. 16 Stakeholders Step 4: Determine Stakeholders’ Power and Influence over Decisions How hard the stakeholder bargains depends on two factors: how important a deal is to it and how much power it has. Not all stakeholders are affected equally by the strategy. Step 5: Determine Which Stakeholders Will Be Satisfied and How Now the relevant issues need to be prioritized according to their impact on the company in the present and in the future.

Copyright © 2012 Pearson Canada Inc. 17 Stakeholders Corporate Social Responsibility (CSR) The business finds itself operating in society that has greater demands than simply those of stakeholders. Society includes those who do not have a direct relationship with the business but are interested in it creating social good. Many companies think that CSR is the “right thing to do.” In some cases, CSR is very much a part of the corporate identity.

Copyright © 2012 Pearson Canada Inc. 18 Stakeholders ALTERNATIVE PERSPECTIVES Perspective 1: Moral Obligation A moral obligation requires that the business take actions based on a code of conduct that defines right or wrong. Doing the “right thing” makes the business a good “citizen” of society. Perspective 2: Sustainability Sustainability is a characteristic of a process or a state that can be maintained indefinitely at a certain level. For businesses, sustainability means operating in ways that meet their present needs without compromising the ability of future generations to meet their own needs.

Copyright © 2012 Pearson Canada Inc. 19 Stakeholders Perspective 3: Licence to Operate A “licence to operate” is an informal licence that goes beyond what is legally permissible to what is socially acceptable both today and tomorrow. A business with a licence has continued access to those demanding its products and services and those supplying the inputs it needs. Perspective 4: Reputation A good reputation is thought to improve a company’s image, strengthen its brand, enliven morale, and even raise the value of its stock. It is also seen as a form of insurance that can buffer the company from negative perceptions of their industry.

Copyright © 2012 Pearson Canada Inc. 20 Stakeholders Perspective 5: Mutual Interest In this approach, a business focuses on actions that have the most significant social impact while providing the greatest business benefits. Doing this advances social conditions while reinforcing the company’s strategy.

Copyright © 2012 Pearson Canada Inc. 21 Stakeholders THE TRIPLE BOTTOM LINE Ever increasing concern about the sustainability of the ecological environment and society has led some to argue that each business is accountable for its impact on the ecological environment and society as well as for producing a profit. This has been captured with the concept of the triple bottom line (TBL, 3BL, or “people, planet, profit”), which considers the economic, ecological, and social impacts of business. When using the triple bottom line approach, the business sets goals with respect to each dimension to ensure that it is creating a profit for its shareholders while protecting the environment and improving the lives of those with whom it interacts.