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Leading Your Business to Maximum Results

Three Questions Every Executive Needs to Answer, First -and the Tools for Getting the Answers

Executives are finding it harder to meet investors’ rising expectations. Owners want companies to produce maximum results. And they’re serious.

Delivering those maximum results means that the company’s leaders, the CEO, division presidents and the general managers in those divisions, first have to answer 3 key questions:

1. What are we being scored on?

2. What should we do to maximize our score?

3. Is the wealth-creation ability of our current businesses better than that of others we can create, or migrate into?

New tools, described here, will let executives find the answers. They underlie what we call Insight-Based Management—start by finding the best ways to boost results, then do them.

1. What are we being scored on?

What type of performance do owners and influential analysts expect? What do their valuation models emphasize:

a. Revenue growth?

b. Higher profits? (Increasingly that doesn’t mean accounting profit. Investors want to see economic profit, which accounts for both risk and capital costs.)

c. Increases in the company’s value? (Some of the elements that determine value are within management’s control, like what the business invests in, the markets it pursues and the manage­ment of its portfolio of businesses. Others, like the stock market’s “take” on the company’s future cash flows, lie outside it. But for the value elements you do control, what wealth-creation measure should you use? We’ll address that in the context of question 3.)

For private companies, agreeing on scoring measures requires a discussion with the owners, particularly if the company might be sold or go public in the foreseeable future.

The rest of this section applies to public companies. They need to know what type of performance the stock market expects. Specifically, which will create more shareholder value: another percentage point of revenue growth or another point of profit margin? How should you weight the two in defining results goals for your company as a whole and for an individual business within it? Pursuing the wrong course can decrease your company’s value, just as the right one can raise it.

In the late Nathaniel J. Mass’s April 2005 Harvard Business Review article, The Relative Value of Growth ® (RVG), he explains how to determine what the revenue versus profit emphasis should be for any public company and how to manage its portfolio of businesses from that perspective.

Understanding RVG starts with the company’s Enterprise Value (EV)—how much it would cost to buy the company, i.e. to purchase all outstanding shares and pay off all of the debt—market cap (total equity) plus debt. EV can be found using a discounted cash-flow model. RVG is the ratio of the increase in EV from a 1% increase in revenue growth rate divided by the EV increase from a 1% boost in operating profitability. The sidebar Figuring The Relative Value of Growth shows the calculations involved.

Dr. Mass cited General Electric (RVG=11.4) and Proctor and Gamble (RVG=7.2) among the companies for which the market (circa 2004) held strong growth expectations and Office Depot (RVG=0.7) as one that the market first wanted to improve its profitability.

Mass’s article also provides several examples of companies whose priorities at the time appeared to be at odds with what would best create shareholder value. Among them, Merrill Lynch (RVG=10.5) and Kellogg (RVG=5) had what he calls “stated or implied strategic priorities” to improve profitability, while Office Depot (at .7) had a revenue-growth objective.

Once you have the RVG value that applies to your company, you and your fellow executives can use it to maximize the value your company derives from its operations, as explained in the next section.

2. What should we do to maximize our score?

What leaders decide to do largely determines how well their businesses will do. If the leaders don’t get the “what to do” right, the only thing that will help is to get lucky—even if all the followers follow and they execute perfectly. And luck is like a cat; it doesn’t always come when you call it.

Leaders have not had much help in deciding what to do. Most of the leadership advice focuses on how to lead—getting followers to follow, once a destination has been determined. Figuring out where to lead (i.e., what to do) has received little ink, thus far…

What needs to happen to create maximum results depends on your role:

CEOs and division heads:

We won’t discuss the obvious, like picking executives. But you will need to:

- Ensure that your company’s RVG figure is appropriately adjusted for each of your businesses and that the resulting values are passed on to their general managers.

- Decide whether and when to address the performance of the businesses in your portfolio—that is, make the needed keep, fix or sell decisions.

General managers of individual businesses:

What management actions can you take to increase your business’s RVG-weighted profit and revenue the most? So you’re more likely to beat expectations.

Background

Progress in the field of management has produced more than 60 legal and above-board actions that executives can take to increase profits, grow revenue or both.



Figuring The Relative Value of Growth

Let’s take as an example a company with

Enterprise Value (Market Cap + Debt)

$5 billion

Revenue

$4 billion

Cash Flow

$200 million

Cost of Capital

7%

Corporate Tax Rate

35%

Revenue Growth Increases

We first need to understand how important revenue growth is to investors. We can quantify that importance by looking at the growth assumption embedded in the stock price. Analysts use discounted cash flow models to determine a company’s value. The simpler models are based on a perpetual stream of projected earnings and assume an average revenue-growth rate. So all we have to do is to find out what that growth rate is, and how the company’s value changes when the growth rate increases by 1%.

The discounted cash-flow model is

Solving this for Revenue Growth Rate gives

Increasing Revenue Growth Rate to 4% in the Enterprise Value equation above gives:

Profit Margin Increases

To get the Enterprise Value of 1% higher profitability, we first find the increase in Cash Flow by multiplying Revenue by .01 (1%) and reduce the result by the Corporate Tax Rate.

Adding that increase into the Cash Flow term in our Enterprise Value equation gives

The Relative Value of Growth

So

This means that it’s worth more than 2.5 times as much in Enterprise Value to try to grow sales by 1% as it is to grow profitability by 1%.

These management actions are the things that executives can do, or set in motion, to improve results—also known as working on your business. A few of these actions are:

- Optimizing prices.

- Improving, and competing on, product/service design.

- Crafting a marketing message that drives sales like no other.

- Cutting costs (this is actually a category consisting of several separate actions).

- Leveraging technological progress (including, obviously, the Internet) to deliver new or improved products and services for less.

- Designing, then delivering, a killer customer experience.

- Creating high-value business models, like Dell’s (‘80s), eBay’s (‘90s), Google’s, etc.

Depending on the particular business, even one of these actions can provide a dramatic uptick. (The trick is to find the best ones for a particular business.)

But for example, according to a March 27, 2007 front-page article in The Wall Street Journal, since Parker Hannifin set out to optimize its pricing in 2002, the effort has boosted operating income by $200 million. In the fiscal year ending June 30, 2006, the gain represented 30% of its $673 million total Net Income. This pricing-related gain exceeds Parker’s entire Net Income ($130 million) for FY 2002. As of the article date, Parker’s share price was up 88% since 2001, compared with a 25% average rise in the S&P 500. (For details, see: T. Aeppel, “Changing the Formula: Seeking Perfect Prices Tears Up the Rules, Parker’s Washkewicz Weighs Market Power of 800,000 Parts.)

Pricing had a potent effect on Parker’s results because it was appropriate for the company, as The Journal’s article explains. In another company, price optimization might not have had much effect.

Taking Your Best Shots Matters

Getting back to choosing your actions, with your management time scarce (and your sanity sacred) you’re not going to tackle 60+ initiatives. So you need to find the handful that will boost your results the mostand that you can really pull off. We’ll call this handful of management actions your best shots.

The first question an executive can ask is, Does finding those best shots matter? Can’t I just do what seems to make sense to me (to follow my gut, or wet thumb)?

From what we’ve seen, finding your best shots matters a lot. The $22 million US division of a booming traditional marketing and distribution company had gone from 0 to $22 million in annual sales in 6 years under Roger, its talented president. (Roger has asked that his last name and company name not be used so competitors won’t become aware of what he’s doing. Requests for a conversation with him can be made through the author.)

Roger’s business was well run: growing 30% per year, with an operating margin of 16%.

Of the 60+ ways to increase results, Roger found 6 that would bring the highest increase in his results and that he could really implement—his best shots.

As shown in the graph at right, over the next 3 years those best shots would:

- Increase his 30% annual revenue growth rate by another 14.5%.

- More than double profits.

- Lift operating profit margins from 16 to 23%.

These gains would come solely from hisbest shots. Had he not found them the gains shown would be left on the table.

The management actions that turn out to be best shots are different for every business, because every business has unique talents, opportun­ities, constraints and financial characteristics.

A Tool for Finding Your Best Shots—The Fortune Finder SM

The Fortune Finder is designed for working on a single business—one that sells a related group of products and/or services to a similar group of customers. This is because, among other things, it focuses on the business’s value proposition and how compellingly it’s communicated. That can’t be done effectively when the attention is on a mix of businesses, like an entire company’s or division’s portfolio.

So we’ll assume that the CEO or division head is responsible for managing a portfolio of businesses, and that different people we’ll call general managers run each of the portfolio’s businesses.)

To find the best ways to get that single business’s numbers up, the general manager will need to assess the revenue and profit gains that will come from each management action we consider, and what it will take to tackle each one.

In this section, we’ll use as examples just two management actions:

- Using more compelling and effective ads.

- Harnessing design to both make our products more attractive to customers and to lower the cost of making and supporting them.

To assess an action’s gains, we’ll need to know how price affects demand and, to figure profit gains, parameters that we call Profit Power.

Revenue Gains

Revenue = Average Price x Units Sold

Revenue Gain is the change in Average Price times the change in Sales Volume.

If an improved ad campaign boosted unit sales 5%, its Revenue Gain would be 5% (because there was no change in average price).

How about design? We’ll assume that without a price increase, Unit Sales would grow 10%. But because our product is more attractive, we’ll also raise our average price by 2%. And we know that historically, demand declines by .5% for every 1% increase in price.

With this data, our revenue would change as shown.

New Sales Volume

x New Average Price

x Sales Volume Adjusted for Price-hike, or

(100% + 10%)

x (100% + 2%)

x (100% – (2% x .5) ) or

110%

x 102%

x 99% or

1.1

x 1.02

x .99 or

1.11

So for the design initiative, our Revenue Gain would be 11%.

Profit Gains and Profit Power

To assess Profit Gain, we need to introduce the concept of Profit Power. Profit Power is the percent increase in profit that will come from a 1% change in each of a business’s profit drivers: average price, unit sales, the cost of what’s sold, etc. The Profit Power values can be readily derived from the business’s operating financials and sales data.

The graph below shows the Profit Power values for the marketing and distribution company discussed above, based on a full year’s financials. (Corporate overhead costs are not assumed to be under the general manager’s direct control, so they’re not shown.)

Not surprisingly, the most powerful way for this business to boost profits is to raise prices. The rub is often that a business can’t raise prices that much. What we call the range of a price increase is limited.So the overall profit gain from raising prices might not be the highest of all the actions they can take. And in cutthroat-competitive industries, it can be, well, zilch.

Next highest of Roger’s Profit Power values is the cost of what’s sold. Often, such costs can be cut to a greater degree than prices can be increased. So the resulting profit gain can be larger, even though the COGS Profit Power Value is a bit lower than that for Price.

Boosting Sales Volume (unit sales) helps, and it helps more in high-margin businesses. It’s why, in software companies like Microsoft (2006 gross margin: 82.7%), that marketing is Job 1.

For Roger’s business, other variable costs and fixed costs won’t have much impact on profitability unless they can be reduced dramatically, which is unlikely.

Profit-power values in hand, we can move on to assessing the Profit Gains of improving our ads and of harnessing design.

We said that a more effective ad campaign can boost Unit Sales 5%, and that the ad campaign won’t affect price. Nor will it affect Cost of Goods Sold. We’ll assume it won’t affect Other Variable Costs (we’ll just run the improved ads, but that won’t cost any more than running the originals.) However, we will have to pay our agency (or a new one) to create the ad, along with any research they’ll have to do. We’ll handle that as a 2% (one-time) charge to fixed costs.

Factor

Profit
Power

x Range (%)

Profit
= Gain (%)

Average Price

5.0

Sales Volume

2.0

5

10.00

Cost of Goods Sold

3.5

Other Variable Costs

0.6

Fixed Costs

.85

-2

-1.70

Total Profit Gain: More Effective Ads

8.30

The Profit Gain of pursuing such a campaign is the Profit Power of Sales Volume (2.0) times its range (5%) or 10%, less the one-time Fixed Cost of revising the campaign. Should you do it? That depends on the other options you have.

Let’s look at the profit gains that can come from our design initiative. Suppose that such a program would allow you to increase Average Price by 2%, grow Sales Volume by 10% (since design sells), reduce COGS by 4% (easier assembly) and cut Other Variable Costs by 5% (lower field-support expenses). However, it will create another one-time hit to Fixed Costs (for the upfront engineering and retooling) of 3%. The Profit Gain calculations are shown atop the next page:

Factor

Profit
Power

x Range (%)

Profit
= Gain (%)

Average Price

5.0

2

10.00

Sales Volume

2.0

10

20.00

Cost of Goods Sold

3.5

4

14.00

Other Variable Costs

0.6

5

3.00

Fixed Costs

.85

-3

-2.55

Total Profit Gain: Design

44.45

Here the Profit Gain is much higher. So is the effort involved.

The Profit Gains of Management Actions Vary From Business to Business

What about other businesses? Will the “big booster rockets” of one business successfully lift another? Not necessarily, as shown by the pair of charts below. For each business, the profit gains of 60 potential actions are shown as vertical bars. Notice how different actions drive profits in the two businesses.

Remaining Steps

Once you have the Profit Power values for your business, the remaining steps in The Fortune Finder are:

1. Find the revenue gain you’ll get from taking an action.

2. Find the associated profit gain, using the Profit Power figures for your business.

In both steps 1 and 2, coming to appreciate the full potential of an action you’re considering is best done with the help of someone we call a results guide. The guide is an experienced operating executive armed with a book of exploratory questions that can bring you to fruitful new insights. This is actually the most beneficial part of the process; the digging leads to aha’s that become major breakthroughs.

3. Put both gains into a Potentials Table (a live spreadsheet—see the Potentials Table exhibit) that shows the upsides of the action and what it will take to accomplish—its cost, effort etc.

4. Repeat steps 1-3 for the other relevant actions.

5. Enter the Relative Value of Growth you arrived at in answering Question 1 into the bottom of the Potentials Table (or, for a privately held company, enter the equivalent results emphasis).

6. Pick your best shots.

In some cases, your best shots can be found just by eyeballing the Potentials Table, or by checking and unchecking the Do column entries. Two cautions…

- Assess the Economic Margin (next section) of the management actions on your short list that require significant investment.

- You need to account for any overlapping benefits in your chosen best shots, so you won’t mistakenly count the same gain more than once, and mislead yourself about how well you’re going to do.

Although the business benefits (profit/revenue gains) of most actions don’t overlap, some do. If you want to count one or more actions that overlap among your best shots, you should reduce some of the gains you plan on getting.

Here are two actions that overlap: a major revamp of your procurement process, and buying some key components through Internet auctions.

Each of these will reduce some of the same cost elements—namely what’s bought on the Internet. Now if, in maximizing profit, you first decide on the Internet auctions, that will reduce the profit improvement attributable to revamping your procurement process, i.e. the profit gained from the revamp will be lower. Likewise, if you first undertook to revamp procurement, and were then able to buy, say, everything for less, then the incremental benefit of using the Internet auctions would be reduced.

If you’re going to use the “checking Do column boxes” method for finding your best shots, then at least reduce the revenue and profit gains you find by the obvious overlaps. Initially, at least, it’s well to choose best shots with a results guide’s help.

When the best shots are not obvious, there are two more sophisticated techniques for finding them, which we cover as part of The Fortune Finder training.

Finally, there will be situations in which your best shots will constitute a real home run, but they will cause one or more of one of the Reality columns in your Potentials Table to be exceeded. This is a sign that it might make sense to ask for more resources because of the upside uncovered. At least you can have a dialogue about it. It makes the Potentials Table a management tool in the truest sense.

There is not as yet any more detailed published work on The Fortune Finder SM. To discuss how best to use the tool for your business, feel free to contact us. You can also learn more about the tool itself by signing up for one of our free overview teleclasses at www.greatnumbers.com/bestshots.cfm.

3. Is the wealth-creation ability of our businesses better than that of others we can create, or migrate into?

At its core, this question highlights the need to manage with the same wealth-creation-measurement tools your investors use. So you avoid situations where your metrics say you did well and investors’ metrics say otherwise. And your stock tanks.

Moreover, the question is the proper concern of every operating executive, from general manager to CEO. It matters because you might be able to do something even more lucrative with the capital you’re stewarding. Common aspects include:

- Assessment of the investment required by a major new initiative like a best shot.

- The wisdom of acquisitions and divestitures.Looking the wealth-creation ability of each current business straight in the eye, then deciding what to do about it.

Outcomes could include selling business(es) you have, or assuming the risk and uncertainty of making major changes and, with it, overcoming organizational inertia. But addressing the question comes with the territory of maximizing results.

You might ask, “Why this is question three, rather than question one?” In other words, why not address wealth-creation ability at the get-go? You could. But we feel that unless a business can’t be further improved (often unknowable at the outset) it’s better to get it performing its best before making such an assessment. If, at the outset, a business is clearly not worth fixing, so be it. Otherwise, first try to fix it, then sell or shutter it if it’s found to be not fixable or worth fixing. Reasonable people will differ about this.

A Wealth Creation Metric We Can Use for Managing

Some context… Value lies in the beholder’s eye. And in the depth of its pockets, and the value of its currency. As in, “When Google Bought YouTube.” By most common measures, YouTube’s value was some distance below the price it fetched. But to Google, the purchase price was YouTube’s value (at least with the currency being Google’s stock).

Back on Earth, we have managing to do—managing for value. Since we can’t count on “the YouTube miracle” happening to our companies, we’ll just have to pick a good measuring stick.

Of late, many companies have moved to economic rather than accounting approaches to measuring profit. These approaches recognize the cost of the capital the business ties up, which rises, as it should, with the level of risk the investors are taking on. So it’s no longer simply: Does the business make money? Rather, it’s: Does the business make money after we’ve paid the risk-related interest on the debt and we’ve given investors the risk-adjusted return they anticipated (an economic profit)?

It’s also critical that executives manage with accurate measures of wealth creation, instead of trying to steer while blindfolded by distortion-prone or misleading metrics.



What We Need in a Wealth Creation Metric

Executives need a wealth creation metric they can manage with, not necessarily a measure that an investor might use. The executives’ measure must:

  1. speak the truth—accurately gauge wealth creation,
  2. be easy for the “numbers people” in an organization to understand and calculate,
  3. make intuitive sense to executives,
  4. be useful for making comparisons—we need a ratio, not a monetary amount,
  5. be applicable at all levels of a company, and
  6. be suitable for both public and private companies. (To avoid, “Whoops, Herman. We were just acquired by a private-equity firm, so all of our management measures are out the window.”)

After a wide-ranging investigation, the sole measure that met all of the above criteria was Economic Margin ®, the difference between Operating Cash Flow and an appropriate Capital Charge divided by Invested Capital. It was developed by Daniel J. Obrycki and Rafael Resendes of The Applied Finance Group, Ltd.

Economic Margin (EM)

In words, How good is this business (or investment/initiative) at making real money?

The sidebar Why Profits Alone Won’t Move a Stock shows how Economic Margin tracks with share price for Biogen and references a more broad-based analysis.

The tables Popular Wealth Creation Measures and Other Measures We Considered summarize the metrics we reviewed. We list reference sources under Digging Deeper on Wealth Creation, last page.

Popular Wealth Creation Measures

Characteristics

Eco­nom­ic (risk and cost-of-capital based) metrics used to assess public companies as a whole.

Total Shareholder Return or TSR

TSR is the change in share price over a period, plus dividends per share, as a percentage of the start-of-period share price. Used by Fortune and The Wall Street Journal in their public-comp­any performance rankings. TSR paints a clear picture for investors.

As a wealth-creation metric for managers, TSR reflects (through its use of the stock price) what the market thinks the company’s present and future performance will be. Sometimes, that’s correct. Not always.

Rooted in market’s perception of future performance (share price)

Market Value Added or MVA

MVA is a company’s market cap less invested capital. A positive figure shows that management has created value. More telling is a positive value appropriate to the risk of capital. MVA is a dollar amount, not a ratio that can be used to compare companies that differ in size.

Same

Accounting metrics used to assess public companies
as a whole.

Return on Capital or RoC

EBIT over invested capital. Business Week uses it (with distortions removed, averaged over 3 years) in its BW 50 performance rankings. RoC does not look forward.

Based on accounting profit. EBIT is prone to distortion.

Earnings Per Share or EPS

Reported earnings over shares outstanding. The Diluted EPS variant includes stock-option-related, but unissued shares. Can drive share buybacks.

Meaningless for managing—both top & bottom halves.

Price/Earnings Ratio or P/E

Stock price over EPS for the past four quarters. What investors will pay for a company’s earnings.

No relationship to wealth creation.

An economic metric all companies and their businesses can use.

Economic Margin ® or EM

(Operating Cash Flow less an appropriate Capital Charge) over Invested Capital. Economic Margin has been shown to correlate well with changes in stock price. It can also be used to assess major initiatives, acquisitions and divestitures.

An accurate, widely applicable wealth-creation measure.

A hybrid metric usable by all companies & their businesses.

Economic Value Added ® or EVA

After-tax profits (NOPAT) less Cost of Capital. EVA is a monetary amount, not a ratio. We can divide it by Invested Capital to get a ratio we can then use to compare businesses and companies. Note that EVA’s a mixture of accounting (NOPAT) and economic (Capital) terms.

Depreciation of old assets in the NOPAT calcu­lation makes EVA distortion-prone.



Other Measures We Considered

The following measures were considered but can’t be recommended, either because they are not ratios, or could provide misleading results, as detailed below.

Cash Flow ROI ®

CFROI does not measure wealth creation, as it takes no account of the cost of capital. Because it mixes operating and financing decisions, the CFROI value can change depending on whether debt or equity is used for financing, even though there is no change in the business’s underlying operating performance. Finally it is computationally complex. Because of all this, CFROI is not an ideal tool to manage with.

Cash Value Added or CVA

Operating Cash Flow less the Cost of Capital. Since CVA is a monetary amount, to use it to make wealth-creation comparisons, we can divide it by Invested Capital. But when we do that, the formula becomes identical to Economic Margin.

Shareholder Value Added (SVA)

This monetary amount seems to have acquired a number of different definitions. We’ll go with Alfred Rappaport’s—see Digging Deeper on Wealth Creation, last page. SVA is the present value of the capitalized changes in NOPAT over a series of time periods, less the present value of the incremental investments. Here too, we’ll need to divide by Invested Capital to use this measure. Economic Margin seems simpler.

Market to Book Value (or Equity-Spread) Approaches

Market-to-Book-Value approaches, such as Residual Income, are based on the Gordon Model of valuation—see McTaggart, et al. in Digging Deeper on Wealth Creation, last page. That model has issues like over-sensitivity when the cost of equity nears the growth rate and it seems inappropriate for non-dividend-paying stocks.



How the Next Generation of Management Tools Work Together to Increase Results

This table summarizes the tools for answering each of the questions we posed at the outset, along with what each tool reveals, and its implications for companies and executives.

Question

Tool

Insight provided

So that…

1. What are we being scored on?

The Relative Value of Growth ® –RVG

Tells CEOs the importance of profit versus revenue growth to owners.

CEO & Division Heads use RVG to set goals for their businesses.

2. How can we maximize our score?

The Fortune Finder SM

Shows General Managers their best shots–the handful of management actions that will boost their results the most and that they can really take.

The company’s businesses can deliver the best possible RVG-weighted results.

Used together, these two tools can maximize the RVG-weighted profit and revenue growth of a company’s portfolio of businesses—without changing the portfolio itself. But that might help, too… So we ask Question 3.

3. Can changing our portfolio of businesses create more value?

Economic
Margin ®

Shows CEOs & Division Presidents how good the company’s businesses are at creating economic wealth.

Adjustments to the portfolio (start, acquire, shutter or sell) can be made.

Note: Economic Margin can also be used with The Fortune Finder–to judge the merits of management actions that require significant investment.

Using the Tools

The Maximum Results Roadmap exhibit shows how these tools can be used together in mid-size and large companies.

Conclusion

Management tools have now evolved to where executives do in fact have everything they need to deliver maximum results. The exciting part, using these tools and finding the results that might once have gone missing, lies ahead. Plus, leading’s easier when your people and your owners believe you’re on the right track, based on the insights you’ve gained.

About the Author

Drew Morris is Founder and CEO of Great Numbers! LLC. To learn about the management sea change we’re working to create, visit http://www.greatnumbers.com/management.cfm. Your comments and questions are welcome: drew.morris@greatnumbers.com or call
(732) 671-6660. As of this writing, the author has no economic affiliation with any of the other parties this article mentions.

I’m indebted to Nathaniel Mass for his early encouragement, and want to thank Daniel Obrycki and Rafael Resendes for their Economic Margin clarifications and examples.

A Maximum Results Roadmap
What Executives Can Do Now to Maximize Results…

Step

Who

When

Action

Public Companies

1.

CEOs (with help from the CFO)

Now

Find the Relative Value of Growth (RVG) figures that apply to your company, apportion and adjust as need be, and convey the results to your division heads.

Ongoing

Monitor whether the RVG goals you set need changing in view of your businesses’ performance.

2.

Division Heads

Now

Further adjust the RVG figures for your division’s businesses. Get the results to your general managers.

Ongoing

Monitor whether the RVG goals you set need changing in view of your businesses’ performance.

Private Companies

3.

CEOs and Owners

Now

Choose the mix of measures (profits, revenue growth and economic margin) that you’ll use to gauge managers’ performance.

All Companies

4.

CEOs (with help from the CFO)

Now

Begin the implementation of Economic Margin to assess the businesses in your portfolio.

5.

General Managers

Now

Begin the hunt for your best shots. (Once steps 1 & 2, or 3 here are done—and usually before this step 5 is finished—you’ll have the RVG figures or the primary results measure needed to pick those best shots.)

Before choosing, you should also assess the Economic Margin of the management actions on your short list that require significant investment.

6.

CEOs and Division Heads

After step 5

Review the best shots of each general manager. Have the crucial conversations about the actions they chose not to take because of resource limitations.

7.

CEOs and Division Heads (with help from the CFO)

Annually

Monitor the Economic Margins of the company’s businesses. Start, acquire, shutter, sell or keep fixing businesses, as results indicate.

8.

All executives

Always

Keep an eye out for businesses with higher Economic Margins that the company could be in.



Digging Deeper on Wealth Creation

Cash Flow ROI-CFROI

Bartley J. Madden, CFROI Cash Flow Return on Investment Valuation: A Total System Approach to Valuing the Firm.

Earnings Per Share-EPS

Roben Farzad, “Earnings Per Share? Phooey!,” Business Week, June 12, 2006, page 66.

Jeff Heilman, “Time to Rethink Performance Metrics and Valuation Methods,” Chief Executive, October/November 2006, pp 36-43.

Economic Margin-EM

Daniel J. Obrycki and Rafael Resendes, “Economic Margin: The Link Between EVA and CFROI,” Chapter 7 in Value-Based Metrics: Foundations and Practice, edited by Frank J. Fabozzi and James L. Grant.

Kathleen Gallagher, “ ‘Economic Margin’ Factors in Cash Flow, Investment,” The Milwaukee Journal Sentinel, July 5, 1996, available at: http://nl.newsbank.com/sites/mwsb.

For a more extensive analysis of how Economic Margin correlates with stocks’ cumulative returns across a range of economic sectors and company sizes, please request a white paper entitled “Model Portfolio Results” at: http://www.economicmargin.com/moreinfo.htm.

Economic Value Added-EVA

Al Ehrbar, EVA: The Real Key to Creating Wealth.

Market Value Added-MVA

G. Bennett Stewart III, The Quest for Value.

Market-to Book Value Ratios

James M. McTaggart, Peter W. Kontes and Michael C. Mankins, The Value Imperative: Managing for Superior Shareholder Returns, especially
Chapter 5.

Shareholder Value Added- SVA

Alfred Rappaport, Creating Shareholder Value.

Value Based Management-VBM

Anne Ameels, Werner Bruggeman and Geert Scheipers, Value-Based Management: Control Processes to Create Value Through Integration, A Literature Review, Working Paper, Vlerick Leuven Gent Management School, available at
http://www.vlerick.be/en/knowres/publications/working/2898-VLK.html

About drew morris

Drew Morris (drew.morris@greatnumbers.com) is the founder and CEO of Great Numbers! The company helps executives find the various dimensions of the upside in their businesses and mold it into a prosperity design—a blueprint for delivering that upside. He has no stake in any of the companies mentioned.