Profit Maximization Vs Wealth Maximization Ppt

Document Sample
Profit Maximization Vs Wealth Maximization Ppt Powered By Docstoc
					Goals, Values and Performance


• Strategy as a quest for value
• What is profit?
• The shareholder value approach
• The shareholder value and strategy
• Mission and values
       Strategy as a Quest for Profit
• The stakeholder approach : The firm is a coalition of
  interest groups—it seeks to balance their different

• The shareholder approach : The firm exists to maximize the
  wealth of its owners.

• Why is profit maximization a reasonable goal?
  (1) Boards of directors legally obliged to pursue shareholder
  (2) To replace assets, firm must earn return on capital > cost of
      capital (difficult when competition intense).
  (3) To avoid acquisition, firm must achieve stock-market
      value > break-up value.
                    What is Profit?

• Profit maximization an ambiguous goal
   – Total profit vs. Rate of profit
   – Over what time period?
• Accounting profit versus Economic profit
• Economic Value Added (EVA) as a measure of
  economic profit:
   — Post-tax operating profit less cost of capital

• From profit maximization to value maximization
   —Net present value of firm = Discounted future profits
                                over the life of the firm
         How U.S. Companies Perform Under
         Different Profitability Measures, 1998

                 Net Inc. ROS   ROE    EVA       Market     Return to
                                              Value Added Shareholders
                 ($m)     (%)    (%)   ($m)        ($m)        (%)
General Motors   2,956    1.8   19.7   -5,525     -17,943     21.4
General Electric 6,573    9.4   22.2    4,370    285,320      45.3
Exxon            6,370    6.3   14.6   -2,262    114,774      22.4
Philip Morris    5,450   10.3   39.0    5,180      98,657     64.8
IBM              6,328    7.7   32.6    2,541      -5,878     77.5
Coca-Cola        3,533   18.8   42.0    2,194    157,356        1.3
Wal-Mart         4,430    3.2   21.0    1,159    159,444     107.7
Procter & Gamble 3,780   10.2   12.2   61,661 102,379         15.9
Microsoft        4,490   31.0   27.0    3,776    328,257      37.5
Hewlett-Packard 2,945     6.3   17.4     -593      45,464     10.7
             Value Maximization
Maximizing the value of the firm:

Max. net present value of free cash flows :

max. V =                (1 + re)t

                        V    market value of the firm.
                        Ct free cash flow in time t
                        re+d weighted average cost
                                of capital
     Applying Shareholder Value
    Maximization to Strategy Choice

• Identify strategy alternatives

• Estimate cash flows associated with cash

• Estimate cost of capital for each strategy

• Select the strategy which generates the highest
Valuing Companies and Business Units

If net case flow growing at constant rate (g)

              V=     C1

With varying cash flows which can be forecasted
for 4 years:

  V = C0 +     C1 +     C2 +       C3 + VH
             (1 + r ) (1 + r )2 (1 + r )3 (1 + r )3

  where: VH is the horizon value of the firm after 4 years
    Problems of DCF Approaches to
          Strategy Approach
• Net Present Value of the Firm depends on option
  values as well as discounted cash flow
• Estimating cash flows beyond 2-3 year horizon is
  hazardous---especially in dynamic markets

HENCE: Some simple guidelines for maximizing
        the value of the firm—
    • On existing assets-- maximize after-tax rate
      of return
    • On new investment-- seek after-tax rate of
      return > cost of capital
 The six levers of financial and real options
          Financial options        Real options          Comments

                                  Present value of     The greater the NPV, the
            Stock price     =      returns to the       higher the option value

                                                       The higher the cost, the
           Exercise price   =     Investment cost       lower the option value

                                                            Higher volatility
OPTION      Uncertainty     =       Uncertainty         increases option values
                                                          Time = opportunity to
           Time to expiry     = Duration of option       learn about outcomes

                                   Value lost over   Loss of cash flow to fully
             Dividends        =
                                  duration of option -committed competitors
                                                          lowers option value

              Risk-free                Risk-free           Higher interest rate
                            =                            increases option value
            Interest rate            interest rate
                                                         by increasing value of
                                                          deferring investment
 Disaggregating Return on Capital Employed


             Return on
                               SGA expense/

ROCE                        Fixed Asset Turnover
                             Inventory Turnover
                             Creditor Turnover
                             Turnover of other
                              items of working
         Linking Value Drivers to Performance Targets
                                                                 Order Size
                                                               Customer Mix
                                                              Customer Churn
                               Margin                           Deficit Rates
                                                              Cost per Delivery
                                            Development       Maintenance cost
Shareholder                                                     New product
  value       ROCE                                            development time
 creation                                                      Indirect/Direct
                                             Inventory           Customer
       Economic                              Turnover            Complaints
         Profit                                                  Downtime
                               Capital       Capacity
                              Turnover       Utilization      Accounts Payable
                                               Cash              Accounts
                                             Turnover          Receivable Time

      CEO            Corporate/Divisional   Functional     Departments & Teams
                Balanced Scorecard for Mobil N. American Marketing & Refining
                                       Strategic Objectives                                           Strategic Measures
  Financially      N
                        F1 Return on Capital Employed                              *   ROCE
                        F2 Cash Flow                                               *   Cash Flow
  Strong                F3 Profitability                                           *   Net Margin
                        F4 Lowest Cost                                             *   Full cost per gallon delivered to customer
                        F5 Profitable Growth                                       *   Volume growth rate Vs. industry
                        F6 Manage risk                                             *   Risk index

                  CO                                                               * Share of segment in key markets
 Delight the      UM    C1 Continually delight the targeted consumer
                                                                                   * Mystery shopper rating
 Consumer         SE
                  TR                                                               * Dealer/distributor margin on gasoline
  Win-Win               C2 Improve dealer/distributor profitability
                                                                                   * Dealer/distributor survey
 Relationship     -

                                                                                   * Non-gasoline revenue and margin per square foot
                        I1 Marketing
                                                                                   * Dealer/distributor acceptance rate of new programs
                            1. Innovative products and services
  Safe and                                                                         * Dealer/distributor quality ratings
                            2. Dealer/distributor quality
  Reliable         I                                                               *   ROCE on refinery
                        I2 Manufacturing
                   N                                                               *   Total expenses (per gallon) Vs. competition
                            1. Lower manufacturing costs
                   T                                                               *   Profitability index
                            2. Improve hardware and performance
                                                                                   *   Yield index
  Competitive      R    I3 Supply, Trading, Logistics
                                                                                   Delivered cost per gallon .Vs. competitors
   Supplier                 1. Reducing delivered cost
                   N                                                               * Trading margin
                            2. Trading organization
                   A                                                               * Inventory level compared to plan & to output rate
                            3. Inventory management
Good Neighbor      L
                                                                                   * Number of incidents
                        I4 Improve health, safety, and environmental performance
                                                                                   * Days away from work
  On Spec
                        I5 Quality
  On time                                                                          * Quality index

                  E &
   Motivated            L1 Organization Involvement                                * Employee survey
                  A G
                  R R
   Prepared             L2 Core competencies and skills                            * Strategic competing (?) availability
                  N O
                  I W   L3 Access to strategic information                         * Strategic information availability
                  N T
                  G H
           A Comprehensive Value Metrics Framework

 Shareholder              Intrinsic              Financial                Value
   Value                    Value                Indicators               Drivers
Measures:                                                              Sources:
                        Measures:             Measures:
• Market value of the                                                  • Market share
                        • Discounted cash     • Return on Capital
  firm                                                                 • Scale economies
                          flows               • Growth (of
•Market value added                                                    • Innovation
                        •Real option values     revenues & operating
 (MVA)                                                                 • Brands
•Return to
                                              •Economic profit (EVA)
              The Paradox of Value

The companies that are most successful in creating
long term shareholder value are typically those that:
a) Have a mission—They give precedence to goals
   other than profitability and shareholder return;
a) Have strong, consistent, ethical values.

a) “Visionary” companies studied by Collins & Porras,
   e.g. Merck, Wal-Mart, Procter & Gamble, Disney, HP
b) Boeing — Boeing’s focus pre-1996: “to build great planes”
               with weak financial controls
           — post-1996 focus: creating shareholder value
           — after 2000, rapid decline in Boeing profitability
              Values and Mission

The role of (ethical) values :
      • Place constraints on the means by which the firm will
        pursue shareholder value max.
      • Increase the effectiveness with which the firm builds
        competitive advantage though reinforcing strategic
        intent and building internal consensus and

The role of mission:
      • Foundation for strategy       Statement of what the
        firm seeks to achieve and what it intends to become.

Description: Profit Maximization Vs Wealth Maximization Ppt document sample