Author: Patrick CoteContributors: Kate McGreevy Julian Critchlow bcCorporate Performance MeasurementApril 1999Copyright 1999 Bain & Company, Inc. CorporatePerformanceMeasurementbcCorporate Performance MeasurementLON Executive SummaryObjectivesBackgroundPerformance Measurement FrameworkMarket Value Added (MVA)Economic Profit (EP)Cash Flow Return on Investment (CFROI)Exercises MVAEconomic ProfitCase Study - DiageoAgenda2CorporatePerformanceMeasurementbcCorporate Performance MeasurementLON Corporate performance evaluation has evolved from the 1960s focus on ROE to the current variations of economic profit that measure impact on shareholder valuemany firms have devised their own variations of economic profitStern 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 formatBoth ROE and EP are business metrics, tools used to measure the performance of the businessseparate from fundamental business drivers, the actual factors that influence shareholder value, and output measures the backward-looking records of overall company performanceFocusing on EP instead of ROE decreases the likelihood of destructive behavior by managersBy 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)3CorporatePerformanceMeasurementbcCorporate Performance MeasurementLON Executive Summary (2 of 2) End goal of EP exercises is consistent with traditional Bain focus of maximising shareholder valueBain has measured historical performance with Total Shareholder ReturnStern Stewart devised Market Value Added (MVA)TM as means of measuring market expectations of EP that managers will add in the futuremanagers objective should be to maximise MVAAll 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 investmentsStern Stewart has trademarked EVATM by specifying adjustments to make to EP 4CorporatePerformanceMeasurementbcCorporate Performance MeasurementLON AgendaExecutive SummaryObjectivesBackgroundPerformance Measurement FrameworkMarket Value Added (MVA)Economic Profit (EP)Cash Flow Return on Investment (CFROI)Exercises MVAEconomic ProfitCase Study - Diageo5CorporatePerformanceMeasurementbcCorporate Performance MeasurementLON Objectives There are three objectives of the Corporate Performance Measures Module:To define the most popular measures of corporate performanceTo explain the significance of these measures in the corporate environment and potential applications in Bains strategy workTo outline calculations of each performance measure6CorporatePerformanceMeasurementbcCorporate Performance MeasurementLON AgendaExecutive SummaryObjectivesBackgroundPerformance Measurement FrameworkMarket Value Added (MVA)Economic Profit (EP)Cash Flow Return on Investment (CFROI)Exercises MVAEconomic ProfitCase Study - Diageo7CorporatePerformanceMeasurementbcCorporate Performance MeasurementLON 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 figures1960s/70s1980s/90sWith the increased focus on delivering shareholder value, managers have accepted systems that measure the change in value managers realised equity is not freeeconomic profit (EP) meets these needs by telling managers where value has been created and where it has been destroyedAs aligning interests between owners and managers has become more important, tying management compensation to EP provided a popular solutionCorporate performance evaluation has evolved from the 1960s focus on ROE to the current variations of economic profit (EP) that measure impact on shareholder valueBackgroundCorporate Performance Evaluation8CorporatePerformanceMeasurementbcCorporate Performance MeasurementLON Bain was the first of major consulting firms to focus on creating shareholder valueTo achieve this, Bain has used the output measure of Total Shareholder Return and the accounting measures of ROE and ROIModified accounting measures, such as EP, provide an alternative means of measuring the creation of shareholder valueBackgroundRelevance to Bain9CorporatePerformanceMeasurementbcCorporate Performance MeasurementLON To illustrate the role of corporate performance measures and resource allocation to strategy work, an examination of Marakons “program” is usefulMarakon 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 linescompare company performance to industry performanceinvestigate three or more strategies for each business every planning cycleshift resource allocation from economically unprofitable