Session 9 Final MB

7/25/2019 Session 9 Final MB

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Managing for Value CreationSession 9

Measuring (Financial) Value

Using Research & Market Indicators


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Lecture Schedule

2


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Measuring financial value

The strategic aim of a business is to earn a return

on capital, and if in any particular case the return in

the long run is not satisfactory, then the deficiency

should be corrected or the activity abandoned for a

more favorable one.

Alfred P. Sloan

My Years with General Motors


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Topics for today

Economic value added The balanced scorecard

Marketing metrics

Measuring returns on marketing

Customer lifetime value

Return on marketing investments

Issues with performance measurement


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EVA: an introduction


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What is Economic Value Added?

Specific measure developed by Stern Stewart andCompany in late 1980s.

Is a way of measuring that firms are earning returns on

capital exceedingtheir cost of capital.

EVA = economic profit

Not the same as accountingprofit:

in EVA, costs include expenses andcost of capital.

represents a minimum acceptable return

Economic Value Added =

after-tax operating income - investment charge


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What is Economic Value Added?

EVA = NOPAT (Cost of Capital x CapitalEmployed)

Since a cost is charged for equity capital, a positive

EVA generally indicates shareholder value is beingcreated.

Based on Economic NOT Accounting Profit.

NOPAT net operating profit after tax is a companys

potential after-tax profit if it was all-equity-financed (orunlevered)


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Components of EVA

NOPAT

Net operating profit after tax

Cost of capital

Weighted average cost of capital %

Capital employed

Net operating working capital, goodwill, other operating assets

NOPBT*)

Capital cost

before tax*)

EVA

time

Yr 1 Yr 2 Yr 3


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What is NOPAT?

Net sales (+) 150,000Cost of sales (-) 135,000

Depreciation (-) 2,000

Selling, General & Admin Expenses (-) 7,000

Net Operating profit (result from above) 6,000Taxes @ 40% 2,400

NOPAT 3,600


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What is Operating Capital?

Capital = Net operatingassets

Net operating assets: Cash, receivables, inventory, prepayments

Trade payable, accruals (adjustments to bemade), deferred tax assets

Net property, plant, and equipment

Exclude non-operating assets:

Marketable securities, investments,...


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What is the Capital Charge?

Represents a rental charge for the use of the operating

capital

Minimum rate of return operating capital should earn

Calculated as the:

firms weighted average cost of capital (%)

multiplied by invested capital.

typical WACC figures are 8-12%

Note: capital charges differ between projects and countries


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Drivers of Long-term EVA

Sales growth without incremental investment costs

(usually new channels OR new markets, not both)

Higher prices (develop strong brands, identify pricesensitivity by segment, effectively communicate

customer value, create exit barriers, innovation,pricing strategy matched to cost structure)

Cost decreases (more effective use of marketing

resources, balance between fixed and variable costs,scale and learning effects)

a more detailed view.........


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Improving EVA

Manufacturing EVA Drivers

Reduce inventory

Reduce cycle time

Improve yieldsReduce scrap/waste

Maximize labor efficiencies

Improve vendor efficiencies

Process improvements

Staff EVA Drivers

Work group/process simplification

Consistency monitors audit

Centralizing resources/synergies

Best practices benchmarking

Insourcing/outsourcing decisions

Simplify EVA measurements/reporting

Ensure compliance with legislation

Research & Development EVA Drivers

Improve to-marketprocess

Reduce R&D expenses as % of new product salesStrategic partners for R&D

Stronger links to product marketing

New products via:

!Research

!Formulation!Development

!Acquisition

Marketing EVA Drivers

Increase market share / revenue

New markets

More focused channel programs

Voice of customer / consumer

Leverage advertising / promotionBuild brand awareness

Customer Satisfaction New Products

Volume Marketing

Product Pricing Growth

Sales

Overhead Compensation

Account Management Training & Development

Manufacturing Costs

Operating Expenses

Acquisitions & Divestitures Working Capital Management

Alliances Accounts Receivable

R&D Decisions Inventory Management

Capital Charge

Improvement in EVA


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The balanced scorecard: an introduction


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Firms need to carefully make choices

Copyright ! 1998 by Houghton Mifflin Company. All rights reserved.

2-20

Tradeoff Between ProfitabilityTradeoff Between Profitabilityand Growth Rateand Growth Rate

G0

P1

P2

PMAX

G1 G2Growth Rate

Profitability


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The balanced scorecard

Firms need to tradeoff choices and activities:

Long-term versus short-term goals

Financial versus non-financial measures

Tangible versus intangible assets

Internal versus external perspective

Performance drivers versus outcomes


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Vision andStrategy

Objectives Measures Targets Initiatives

FINANCIALTo succeedfinancially,

how shouldwe appear to

our

shareholders?

Objectives Measures Targets InitiativesLEARNING AND GROWTHTo achieveour vision,

how will wesustain our

ability to

change andimprove?


CUSTOMERTo achieveour vision,

how shouldwe appear to

our

customers?


INTERNAL BUSINESS PROCESSTo satisfy ourshareholders

andcustomers,

what business

processesmust we excel

at?


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Financial Perspective

How do we look to shareholders?

Sample Measures:

Sales revenue growth

Gross margin growth

Return on investment


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Customer Perspective

How do customers see us?

Top priority for long-term success

Customer satisfaction critical to achieving the companys

financial goals

Sample Measures:

Market share

Increasing number of customers

Customer satisfaction

Repeat customers / retention rates

Rate of on-time deliveries


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Internal Business Perspective

What business processes must we excel in to satisfycustomer and financial objectives?

Sample Measures:

The number of new products developed or

new-product development time (time-to-market)

The number of units produced per hour and defect rate

The number of warranty claims received, average repair

time, and average wait time


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Learning and Growth Perspective

How can we continue to improve and create value?

Sample Measures:

Hours of employee training

Employee engagement levels

Employee retention / turnover rates

Employee input / suggestions implemented.

Percentage of employees with access to customer data and

percentage of processes with real-time feedback.


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Traditional financial reports look backward and do notmeasure value creation moving forward.

The Balanced Scorecard sets objectives, measures,targets and initiatives that create long-term value.


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Marketing metrics


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The need for marketing metrics

For years, corporate marketers have walked intobudget meetings like neighbourhood junkies.

They couldnt always justify how well they spent past

handouts or what difference it all made.

They just wanted more money for flashy TV ads, for

bigticket events, for, you know, getting out the

message and building up the brand.

But those heady days of blind budget increases are fastbeing replaced with a new mantra:

measurement and accountability.

Diane Brady, with David Kiley & Bureau Reports

Business Week, 13 December 2004


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Marketing Metrics - Examples

Financial value is largely the result of creating customervalue. How can we measure customer value?

Assessing marketings impact on the bottom linemeasures may include:

Customer Lifetime Value (CLV)

Return on Marketing Investment (ROMI)

Retail metrics

Media metrics


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Sequence of activities

Market results

Marketing

Investments Purchase behavior

!Market share

!Unit sales

!Price premium

!Penetration of key

segments

!Etc.

Relationshipmarketing

Advertising

Promotions

Etc.!which in turn

affects!

$ Spend

affects!

SOM

Consideration

Brand and ProductAwareness

Intent

Purchase

Loyal--ty

!Allocation of funds across marketing activities

!Optimization of spending within each lever

Financial

results

!ROI

!Shareholder value

!EVA

!Etc.

!which in turn

affects!

$ Profit

SOM


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Consumer Purchase Funnel

!Internet / mass media

!Word-of-mouth (WOM)

!Referrals

Marketing Tools

Marketing Tool Mix and Purpose

Retention

!Search tools (Google / mobile++)

!Outdoor advertising

!Promotions

!Sampling

!Pricing offers

!Promotions

!

Pricing!Loyalty programs

!Increasing share of wallet /

upselling

Awareness

Consideration

Trial

Occasional

BuyerRegularBuyer

Pene-tration


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Measuring returns on marketing


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Financial and marketing metrics

Consider some of the previously discussedmeasures: EVA, Balanced Scorecard

Marketing-type measures can add to this as they are

distinctly different:

(Seggie et al, 2007)

M t i f C t C t i it


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Metrics of Customer-Centricity

(Source: Rust et al. 2010)

lifetime discounted value ofcurrent / future customers


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Customer lifetime value


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Customer Lifetime Value (CLV)

CLV considers the value of an individual customer.

The present value of the future cash flows attributed to thecustomer during his/her entire relationship with the company

Considers the cost of:

acquiring customers: money needed to advertise and

promote for future customers

discount rate: time value of money, typically 8-12%

retention rate: the % of customers that buy from one

purchase to the next purchase

the cash flows generated by customers,

CLV =(margin)(retention) t

1+discount%( )t

t=1

T

!


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CLV scenarios

Assume iPhone 600AUD, 1 purchase/year, 10AUD direct marketing

costs, 40% gross margin, 85% retention rate, 10% discount rate


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CLV scenario 1: increasing the price only

Assume iPhone 900AUD, 1 purchase/year, 10AUD direct marketingcosts, 40%gross margin, 85% retention rate, 10% discount rate

CLV scenario 2: increasing marketing spend


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CLV scenario 2: increasing marketing spendwithout benefits

Assume iPhone 600AUD, 1 purchase/year, 15AUD directmarketing costs, 40%gross margin, 85% retention rate, 10%

discount rate

CLV scenario 3: increasing marketing spend


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CLV scenario 3: increasing marketing spendwith benefits (retention rate)

Assume iPhone 600AUD, 1 purchase/year, 15AUD directmarketing costs, 40%gross margin, 95% retention rate, 10%

discount rate


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Making CLV scenarios

Consider the costs of acquiring and retaining customers (marketing

costs).

Management of ongoing customer relationships becomescritical, not the individual sale

Focus moves away from acquiring customers regardless (think

of supermarket discounting) to reducing churn.

Helps optimize allocation of marketing resources in order to

achieve a better returns

Problems: the retention rates are not similar and vary for customer

segments

Use http://hbsp.harvard.edu/multimedia/flashtools/cltv/index.htmlas a

calculator for the CLV and for making alternative marketing scenarios.


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Assessing Investments vs Returns: CLV

How can CLV help? How can CLV help make decisionson what compensation to offer?

- What measures should we use?

(Source: Rust et al. 2004)


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The idea behind CLV

Rust, Lemon, Zeithaml. JOM 2004

R M k i I (ROMI)


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How can we measure the returns on these marketinginvestments?"ROMI!

ROMI=

An important consideration in calculating ROMI is the

estimation of short- and long-run effects

(Incremental revenue due to marketing

spending*contribution margin) - marketing spending

marketing spending

(R t t l 2004)


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ROMI: model (Rust et al. 2004)

Improve valueequity drivers

Improveswitching matrix

Improverelationship equity

Improve brandequity drivers

Improve relationequity drivers

Improve brandequity

Improve valueequity

Improvecustomer

lifetime value

Improvecustomer equity

Firm value

I l it


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Improve value equity

Value Equity:

the customers objective assessment of the utility of a brand, basedon perceptions of what is given up for what is received

Quality, price, convenience

I b d it


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Improve brand equity

Brand Equity:

the customers subjective and intangible assessment of the brand,above and beyond its objectively perceived value

brand awareness, attitude toward the brand, perceptions of

ethics/corporate citizenship

I l ti it


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Improve relation equity

Relation equity:

the incremental tendency of the customer to stick with the brand,above and beyond the customers objective and subjective

assessment of the brand, arising from relationship management

Loyalty programs, special recognition and treatment, affinity,

community building, knowledge building


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www.interbrand.com

Brand Value 2015 Interbrand Valuations


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Brand Value 2015 Interbrand Valuations

Sept 2015 trust in VW andimpact on brand value

Source: www.interbrand.com

Practical use of Valuing a Brand


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Practical use of Valuing a Brand

Source: Interbrand, Feb 2016


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Assessing Marketings impact on the bottom line

Marketing metrics


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Marketing metrics

Marketing metrics are useful if

they impact financial measures.

If they are early indicators

If they relate imperfectlytofinancial measures

If they are causally linked

If they are valid / can bemeasured reliably

Metrics and firm performance:


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Metrics and firm performance:

Value capture

Value creation

Source: Gupta & Zeithaml (2006), Kumar & Shah (2009)


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Example

Measure Customer satisfaction

Purpose Understand why customers are (dis)satisfied

Relates to Need to satisfy customers

Target 75%

Formula % customers rating high / very high (top 2 box

Source of data Customer surveys; issued consistently

Frequency Quarterly

Who measures? Marketing department

Who acts on the data? CEO, with marketing with salesWhat do they do? Analyze very low scores, find source of (dis)

satisfaction and influence these drivers to increase

results

Summary


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Summary

Ability to measure marketing performance has a significant

impact on firm performance, profitability, stock returns, andmarketings stature within the firm

Customer Lifetime Value (CLV) and Customer Equity (CE) arelong-term oriented metrics; measurement is often challenging.

Value, brand, and relationship equity are reflected in customer

equity

Customer Equity can be a proxy for firm value


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Issues with performance measurement


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Managers who complain about lack of motivation oftheir workers might do well to consider the possibility

that the reward systems they have installed, are paying

off for behavior other than what they are seeking

Steven Kerr

Academy of Management

Executive, 9(I), 1995

Issues with measurement


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On the folly of rewarding A, while hoping for B

What does the US military want:

to win

What does the average soldier want:

to survive / to go home Hoping to win, rewarding survival behavior

Result of the Vietnam war:

Seek and evade becomes military jargon

Many business examples

What is the issue?


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What is the issue?

Goal displacement:

Goal displacement results when the means become

ends-in-themselves that displace the original goals



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On the folly of rewarding A, while hoping for B.

Hoping for: While rewarding:

Team work and collaboration,(all-for-one spirit)

the best team members (advertisingendorsements)

Innovative thinking and risk taking Proven methods and not making

mistakesDevelopment of people skills Technical achievements and

accomplishments

Employee involvement andempowerment

Tight control over operations andresources

High achievement Another years effort

Long-term growth Short-term sales cycle targets

Causes


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Causes

Causes:

Fascination with an objective criterion

Overemphasis of visible behaviors

Emphasis on morality or equity rather than efficiency

Other problems with performancet


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management

Other problems with measurement systems


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Amassing too much data (and not using it)

Focusing on the short-term only

Dumbing-down the data Establishing unrealistic and/or unreasonable

measures



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Ot e p ob e s t easu e e t syste s

Driving the wrong performance

Encouraging competition and discouraging team work

Measuring progress too often or not often enough

Conclusion: Designing control systems


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g g y

Nature ofperformance

measure?

Subjective

Objective

Motivating only iftrust is high!

Is measurecomplete?

Can individualinfluencemeasure?

Can individualinfluencemeasure?

Complete

Incomplete

Yes

Yes

No

No

Ideal, but difficult to design

for non-routine work

Limited control (e.g. firmvalue, profit, EPS)

Dysfunctional behavior

Ignore

Characteristics ofdiagnostic control

systems measures

Source: R. Simons, 1995, Levers of Control, HBS


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Any remaining questions or issues?

Lecture Schedule


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