If your company has determined that it needs to transform its value-creation strategy, you can do a number of things to make it happen.
So senior executives will need to be prepared to test their stretch goals against the realities of their companies’ competitive positions and organizational capabilities, as well as against the expectations of investors.
The good news is that if a company succeeds in delivering TSR that is just 2 to 3 percentage points above average year after year, such a performance can add up to top-quartile TSR over the long term.
Different ways of achieving cash flow are valued differently by investors, with varying impacts on TSR. Optimizing a company’s value-creation strategy is a matter of managing trade-offs-for example, between investing in growth and investing in margin improvement, between growing organically and growing through acquisition, between maintaining gross margins and reducing operating expenditures. It’s critical to put in place the right metrics that make the key trade-offs in a company’s value creation visible so that senior management can navigate them effectively.
A key step in two client examples were that both their transformations were to start measuring company and unit performance using value-based metrics, such as TSR. These metrics are important not only for tracking a company’s past performance but also for identifying future initiatives that will fund the company’s transformation journey. By translating its business and financial plans into estimates of future contribution to overall company TSR, a company can assess its future value creation potential at the level of individual businesses and strategic initiatives.
With a clear view of future TSR potential by product, business, region, and initiative, companies are in a better position to identify which initiatives will really move the TSR needle, debate alternative pathways to superior value creation, and target improvements in their business plans. A trans-formative value creation strategy also depends on a clear portfolio strategy and active portfolio management.
Both are critical to determining how the company will win in the medium and long terms. What’s more, capital and other resources-such as managerial talent-need to be allocated differently across the corporate portfolio on the basis of each unit’s current performance, future potential, and role in the value creation strategy?
The company had to make sure that capital allocation favored markets that were not already overbuilt and in which our client had a strong share relative to its competitors. Nearly every company has a portfolio be it geographic markets, products, R&D pipelines, or business units-which it needs to actively manage to optimize value creation.
One client used divestiture to bring more focus to its portfolio, then reorganized to create five focused business units with clear roles and accountability for different aspects of the company’s business.
Most transformation efforts at large companies focus on business strategy, operations, and technology. It’s equally important for a company’s financial strategy to be aligned with the company’s long-term objectives. Because financially healthy companies generate cash well in excess of their reinvestment needs, they need to have a plan for what to do with the excess cash.
That involves striking the right balance between cash kept on the balance sheet, share buybacks, and dividends returned to investors while also considering the optimal capital structure and credit rating. Getting that balance right is a powerful way for companies to create alignment with their investors.
What’s more, these alternative uses of capital have a direct impact on TSR and an indirect impact on a company’s valuation multiple.
Decisions about a company’s financial policies need to be an explicit part of the company’s value-creation strategy. At one client, for example, a key part of the new value-creation strategy was to substantially increase the company’s dividend.
The increase was a signal to investors that our client had shifted its investment approach from the traditional focus on pure growth to one that emphasized balanced growth at a reasonable price. A successful value creation strategy also needs to reflect the priorities and expectations of a company’s most important investors. Sometimes that means listening carefully to what your current investors want.
Other times it means migrating the investor base to new types of investor’s who are more likely to be in sync with management’s business and financial strategies. In either case, it is important to start thinking of investors the way a company thinks of customers.
That is, segment investors into categories based on investment style and priorities, and identify the “Natural” investor type for the company.
Who are our dominant investors right now? Are they the ones who are likely to support our value-creation strategy in the medium and long terms? Do current or desired investors find the company’s strategy credible? What can we do tocreate better alignment among our business, financial, and investor strategies?
At one client, the natural investor segment for the company’s stock consisted of funds that pursued a strategy of growth at a reasonable price. To appeal to the priorities of this type of investor, the company had to make moves such as developing the more value-focused capital-allocation policy and generating large dividend increases. A company’s value-creation strategy is only as strong as its value-management capability, which drives a company’s processes and organizational culture.
The final step in a TSR-driven transformation is to focus key management processes-such as target setting, planning, resource allocation, and incentive compensation-on TSR and to create strong links to value creation at the level of the individual business unit. By following these six steps, any company can use a focus on value creation to drive a broad-based business transformation.
The result: better financial performance, above-average TSR relative to the company’s peer group, and improved positioning for success in the future, regardless of economic conditions or market environment.