1. capitalideasonline.com CREATING SHAREHOLDER VALUE DURING ECONOMY DOWNTURN WITH VBM TOOLS AND STRATEGIES Chetan J Parikh

2. capitalideasonline.com Owners of invested capital Stewards of invested capital Adapting to economic paradigms of the 21 st Century The role of finance in determining shareholder value Cost leadership strategy and supporting tactics Creating Shareholder Value ~Introduction Themes

3. capitalideasonline.com Owners of Invested Capital - The Shareholders

4. capitalideasonline.com Shrinking competitive advantage periods (CAPs) means that an investor has to understand – The dynamics of organizational change – The mental models that owners need to have to keep up with change Creating Shareholder Value ~Owners of Invested Capital What does ownership mean?

5. capitalideasonline.com Owners must demonstrate –Rational allocation of capital –Reduction of fundamental business risks Develop systems thinking based on feedback loops Creating Shareholder Value ~Owners of Invested Capital Competences that owners need

6. capitalideasonline.com Portfolio ManagersActive Owners Risk perspectiveRisks are predetermined, cannot be influenced Risks can be reduced/ eliminated Risk management Strategy Spreading the risksAllocation of capital to risks one can handle Portfolio optimizationActive/proactive reduction/elimination of risks Source: “Ownership and Value Creation” by Rolf H. Carlsson Creating Shareholder Value ~Owners of Invested Capital Two fundamentally different ways of managing risk

7. capitalideasonline.com Source: ‘Ownership and Value Creation’ by Rolf H. Carlsson Creating Shareholder Value ~Owners of Invested Capital Different ways of reducing / eliminating business- related risk

8. capitalideasonline.com Stewards of Invested Capital - The Corporate Managers

9. capitalideasonline.com Two major differences between CEOs and other employees – Standards for measuring CEO’s performance are easy to manipulate, makes a CEOs performance harder to measure – Relations between CEOs and board of directors are very congenial Creating Shareholder Value ~Stewards of Invested Capital Why is CEO performance difficult to measure?

10. capitalideasonline.com Short term imperatives have forced CEOs to –Meet the quarterly numbers –Have a wrong implicit valuation model –Disjointed the interests of shareholders from those of other stakeholders Creating Shareholder Value ~Stewards of Invested Capital Long term must be balanced with the short term

11. capitalideasonline.com Valuation Model Stock Price Financial Statements Managerial Skill Business Unit Measurements Accounting Results Control Variables Business Processes Employee Satisfaction Customer Satisfaction Tangible Assets Intangibles Integration of Control Variables and Accounting Data Valuation/ Resource Allocation Vision System Efficiency Innovative Environment Adaptability Learning Organisation GAAP Feedback Creating Shareholder Value ~Stewards of Invested Capital Valuation model

12. capitalideasonline.com Adapting to economic paradigms of the 21 st century

13. capitalideasonline.com Traditional Business StructureE Business Structure Creating Shareholder Value BRAND CAPITAL HUMAN CAPITAL WORKING CAPITAL PHYSICAL CAPITAL Outsourcing Network Sales Push Focus Production Focus High (Work in Progress,Finished Goods High (Ownership of Production Customer Pull Focus Customer Focus Low (Direct Delivery) Low (Outsourcing) ~Adapting to 21 st century economic paradigms The Upside – Down Corporation Source: Meta Capitalism

14. capitalideasonline.com Creating Shareholder Value ~Adapting to 21 st century economic paradigms Economic Paradigms of the 20 th and 21 st Centuries

15. capitalideasonline.com Creating Shareholder Value ~Adapting to 21 st century economic paradigms Industry Clockspeeds

16. capitalideasonline.com Creating Shareholder Value ~Adapting to 21 st century economic paradigms Industry Clockspeeds

17. capitalideasonline.com Source: Charles Fine, Clockspeed Creating Shareholder Value ~Adapting to 21 st century economic paradigms Industry Clockspeeds

18. capitalideasonline.com The role of Finance in Determining Shareholder Value

19. capitalideasonline.com Creating Shareholder Value ~Using Finance to Determine Shareholder Value “What remains of his profits after deducting interest on his capital at the current rate may be called his earnings at undertaking or management”. - Alfred Marshall A

20. capitalideasonline.com The basic ingredients in the Economic Profit calculation: EP = NOPAT - $ Capital Charge Where: Revenue Less: Production / Operating Expenses Less: Unlevered Taxes Equals: NOPAT $ Capital Charge = $ Capital – wacc ~Using Finance to Determine Shareholder Value Creating Shareholder Value The calculation of economic profit

21. capitalideasonline.com NPV = Present value of expected EP, thus Wealth Creator :NPV>0, EP>0, RROC>0 * Wealth Neutrality :NPV=0, EP=0, RROC=0 Wealth Waster :NPV<0, EP<0, RROC<0 * RROC = ROIC - wacc ~Using Finance to Determine Shareholder Value Creating Shareholder Value Determining Wealth Creators

22. capitalideasonline.com ~Using Finance to Determine Shareholder Value Creating Shareholder Value Determining Wealth Creators V = C + NPV V/C = 1 + NPV/C = 1 + [PV of Expected EP]/C Key NPV : Net Present Value C : Book Capital / Invested Capital PV : Present Value V : Corporate Value EP : Economic Profit

23. capitalideasonline.com ~Using Finance to Determine Shareholder Value Creating Shareholder Value Determining Wealth Creators

24. capitalideasonline.com ~Using Finance to Determine Shareholder Value Creating Shareholder Value Criteria for capital commitment Source: James L Grant & James A Abate,’ Focus on Value’

25. capitalideasonline.com Source :James L Grant &James A Abate,’Focus on Value’ Creating Shareholder Value ~Using Finance to Determine Shareholder Value Excess Returns Relative to Capital Growth Rate ’Economically’ Profitable Reinvestment

26. capitalideasonline.com Is the company a major force in a growing market? Is the company holding or increasing its shares on those segments? Is it resulting in increasing cash flows? Is the cash flow being used in a wise manner? Does the management walk the talk? Creating Shareholder Value ~Using Finance to Determine Shareholder Value Questions Shareholders Ask..

27. capitalideasonline.com Cost Leadership and Supporting Tactics

28. capitalideasonline.com Maintain competitive prices Pursue market share opportunities to gain scale economies in production and distribution Creating Shareholder Value ~Cost Leadership and Supporting Tactics Sales Growth Rate

29. capitalideasonline.com Achieve relevant economies of scale Introduce mechanisms to improve rate of learning Search for cost reducing linkages with suppliers Eliminate overhead that does not add value to the product Creating Shareholder Value ~Cost Leadership and Supporting Tactics Operating Profit Margin

30. capitalideasonline.com Minimise cash balance Reduce accounts receivables Minimise inventory without impairing customer service Creating Shareholder Value ~Cost Leadership and Supporting Tactics Working Capital Investment

31. capitalideasonline.com Promote policies to increase utilization of fixed assets Obtain productivity-increasing assets Sell unused fixed assets Obtain assets at least cost, e.g. lease versus purchase Creating Shareholder Value ~Cost Leadership and Supporting Tactics Fixed Capital Investment

32. capitalideasonline.com Target an optimal capital structure Select least-cost debt and equity instruments Reduce business risk factors in manner consistent with strategy Creating Shareholder Value ~Cost Leadership and Supporting Tactics Cost of Capital Source: Alfred Rappaport, ‘Creating Shareholder Value’

33. capitalideasonline.com Thank You