Author: Patrick Cote,Contributors: Kate McGreevy Julian Critchlow,bc,Corporate Performance Measurement,April 1999,Copyright 1999 Bain & Company, Inc.,2,CorporatePerformanceMeasurement,Executive Summary Objectives Background Performance Measurement Framework Market Value Added (MVA) Economic Profit (EP) Cash Flow Return on Investment (CFROI) Exercises MVA Economic Profit Case Study - Diageo,Agenda,3,CorporatePerformanceMeasurement,Corporate performance evaluation has evolved from the 1960s focus on ROE to the current variations of economic profit that measure impact on shareholder value many firms have devised their own variations of economic profit Stern Stewarts Economic Value Added (EVA)TM is best known of these measures Holt/BCGs Cash Flow Return on Investment (CFROI) is a similar concept presented in % return format Both ROE and EP are business metrics, tools used to measure the performance of the business separate from fundamental business drivers, the actual factors that influence shareholder value, and output measures the backward-looking records of overall company performance Focusing on EP instead of ROE decreases the likelihood of destructive behavior by managers By evaluating managers based on EP, manager behavior can be altered such that only projects that add value (with NPV0) are undertaken, which does not always occur with ROE,Executive Summary (1 of 2),4,CorporatePerformanceMeasurement,Executive Summary (2 of 2),End goal of EP exercises is consistent with traditional Bain focus of maximising shareholder value Bain has measured historical performance with Total Shareholder Return Stern Stewart devised Market Value Added (MVA)TM as means of measuring market expectations of EP that managers will add in the future managers objective should be to maximise MVA All economic profit measures deduct charge for use of equity capital from accountings typical net income or profit after tax to reflect the opportunity cost associated with equity investments Stern Stewart has trademarked EVATM by specifying adjustments to make to EP,5,CorporatePerformanceMeasurement,Agenda,Executive Summary Objectives Background Performance Measurement Framework Market Value Added (MVA) Economic Profit (EP) Cash Flow Return on Investment (CFROI) Exercises MVA Economic Profit Case Study - Diageo,6,CorporatePerformanceMeasurement,Objectives,There are three objectives of the Corporate Performance Measures Module:,To define the most popular measures of corporate performance To explain the significance of these measures in the corporate environment and potential applications in Bains strategy work To outline calculations of each performance measure,7,CorporatePerformanceMeasurement,Agenda,Executive Summary Objectives Background Performance Measurement Framework Market Value Added (MVA) Economic Profit (EP) Cash Flow Return on Investment (CFROI) Exercises MVA Economic Profit Case Study - Diageo,8,CorporatePerformanceMeasurement,With the rise of conglomerates, most companies focused on Return on Equity, or ROE, as their primary measure of performance led most managers to undertake acquisitions solely to manipulate accounting figures,1960s/70s,1980s/90s,With the increased focus on delivering shareholder value, managers have accepted systems that measure the change in value managers realised equity is not free economic profit (EP) meets these needs by telling managers where value has been created and where it has been destroyed As aligning interests between owners and managers has become more important, tying management compensation to EP provided a popular solution,Corporate performance evaluation has evolved from the 1960s focus on ROE to the current variations of economic profit (EP) that measure impact on shareholder value,Background,Corporate Performance Evaluation,9,CorporatePerformanceMeasurement,Bain was the first of major consulting firms to focus on creating shareholder value To achieve this, Bain has used the output measure of Total Shareholder Return and the accounting measures of ROE and ROI Modified accounting measures, such as EP, provide an alternative means of measuring the creation of shareholder value,Background,Relevance to Bain,10,CorporatePerformanceMeasurement,To illustrate the role of corporate performance measures and resource allocation to strategy work, an examination of Marakons “program” is useful Marakon applies the following program, which can take several years to complete, to all of its clients: assess the economic profit of all customer segments and product lines compare company performance to industry performance investigate three or more strategies for each business every planning cycle shift resource allocation from economically unprofitable products/customers to economically profitable leads to yield loss for Marakon and clients since additional scenarios frequently evaluated,Marakon has made economic profit (EP) the central focus of the program they apply to ev