Modern businesses in the context of globalization, competition and decreasing margins have to focus on ways to drive business performance. Businesses rely on timely and relevant quantitative data to arrive at strategic decisions. It has become increasingly important to focus on value innovation which advocates on maintaining core business strengths while continuously developing new value additive ideas and strategies. Enhanced understanding of risk factors, updated competitive analysis tools, improved valuation, and projection models are all relevant in modern environment.
Modern financial managers must have understanding of control systems and operational risks. Cash management, capital budgeting, earnings volatility, and forecasting demand are the significant challenges faced by managers. The context of increased contagion in the global financial markets creates challenges of managing interrelated employment, debt reduction, monetary policy, and exchange rate policies when companies plan expansion, treasury hedging and capital management, and acquisition strategies.
1.3.1 Strategic value drivers
Mills [2] identify seven value drivers—sales growth rate, operating profit margin, cash tax rate, fixed capital needs, working capital needs, planning period, and cost of capital. The selection of an appropriate planning period is vital for generating future cash flows based on short term and long term perspective. The estimation of the planning period can be explained in terms of five forces identified by Michael Porter. The planning period needs to be explained in the context of potential entrants, possibility of substitute products, relative power of suppliers and buyers and by the degree of competitive rivalry within the industry in which it exists. For example, in the context of planning period, the company may incorporate the threat of new entrant in the market within a five-year period as the present barriers to entry act as a competitive advantage for the company. Organizations which focus on relative performance creates the most value. The strategic value analysis approach must have a long planning period aimed at creating good sales potential and free cash flow.
Competitive advantage is the result of the core competences nurtured by an organization. It results from the collective learning of the company in terms of diverse production skills, integration of different streams of technology, patterns of communication and managerial rewards. Strategic value creation results from the creation of a strategic architecture. Strategic architecture involves identification and development of technical and production linkages across business units which in turn leads to development of distinct skills and capabilities which cannot be replicated easily by other organizations.
John Kay have identified four aspects of core capabilities—reputation, architecture, innovation, and strategic assets. Reputation facilitates companies to follow price differential strategy whereby they could charge premium price for products or gain larger market share at a competitive price. The unique structure of relational contracts that may exist within or around firms is referred to as architecture. Airline industry develops networks through strategic alliances which in turn provides cost effective ways of providing international services to customers. Marks and Spencer’s strategy of growth is based on the development of its supplier architecture. Innovation is also a major source of competitive advantage. Companies like Apple creates value through successful product innovations. Strategic assets are sources of competitive advantage based on the market position.
Fundamental value is based on the present value of expected free cash flows. Shareholder value is firm value minus the value of outstanding debt. Firm value can be based on book value or market value. Market value is based on the stock market performance of a company. The most widely used practical measure of shareholder value is Total Shareholder Return (TSR) which is based on stock price appreciation plus dividends. Companies create value by means of investing capital at a higher rate of return when compared to its cost of capital. Companies with higher returns and higher growth are valued more highly in the stock market.
Knowledge assets are organizational resources which are integral for company’s value creation. The strategic relevance of knowledge assets has led to the generation of new concepts and models for managing a company’s knowledge assets. Intellectual Capital has emerged as a key concept to evaluate the intangible dimension of an organization. The modern economic world is based on the foundation of new technologies, globalization, and increased relevance of intangible assets. Value creation is often perceived as the future value captured in the form of increased market capitalization. The new global economy has led to the emergence of new business models where companies are combining both old and new economy assets. New processes and tools are required to manage the risks on account of new business models. The greatest challenge a company’s face today is identification of the combination of tangible and intangible assets which create the greatest amount of economic value (EV).
Every asset, financial as well as real has value. The key to fundamental aspect of investing and managing assets lies in understanding of not only what value is, but also the sources of value. A value driver is a performance variable which impacts the results of a business such as production effectiveness or customer satisfaction. The metrics associated with value drivers are called key performance indicators (KPIs). Value drivers should be directly linked to shareholder value creation and measured by both financial and operational KPIs which must cover long term growth and operating performance.
The three commonly cited financial drivers of value creation are sales, costs and investments. Earnings growth, cash flow growth and return on invested capital are specific financial drivers. Profitability, growth, and capital intensity are considered as important drivers of free cash flow and value of a firm. The KPIs also include financial measures such as sales growth and earnings per share (EPS) as well as nonfinancial measures. The nonfinancial performance me...