Transcript Slide 1
International Business and
Management
Antonio Majocchi
[email protected]
Associate Professor in international business
Teaching Faculty
Roger Strange, Professor of international
business, Sussex University (18 hours)
David Needle of Professor of management,
King's College London (4 hours)
A business case will be discuss under the
supervision of an external business
consultant (Dr. Ucci from Oliver Wyman)
Attendance even if not compulsory is
highly recommended
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Assessment
The course will be assessed by a final exam
and assignments
The final exam will cover mainly the theoretical
arguments of the course and will count 50% of
the final mark (this year the exam will be
realised in 2 parts)
The assignment is a group projects that count
for 40% of the final mark
The class discussion of the business case
(compulsory) will count for the remaining 10%
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Class assignment
The goal of the class assignment is to
present the international strategy of a
MNCs
Group should be formed by no more then
3 students
A lecture (18 of March?) will be devoted to
discuss and present the main criteria to be
followed in the presentation (sources, aim
of the presentation, methodology etc etc.)
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Assignment
The assignment should be completed for
the end of the course and presented
discussed in the last week of the lecturing
period (exact dates to be defined)
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Reading materials
There is no single recommended text.
Readings will be assigned to students at
every group of thematic lectures
The reference book for Professor Strange's
seminars is:
Bartlett, C.A., Ghoshal, S. and Beamish, P.W.
(2008). Transnational management: text,
cases, and readings in cross-border
management. London: McGraw-Hill (available
in the faculty library)
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Course brief Contents: part I
Market selection and Market Entry
What is “globalisation”: data and trends
The Strategy and Structure of MNCs
Control in MNCs
The balance scorecard
EVA principles and application
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Course brief Contents: part II
Financial management in MNCs
International pricing policy
foreign exchange risk
foreign exchange management
Market forecast
Methodology to forecast market potential
Elasticity and pricing
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
To sum up
Antonio Majocchi
Lectures
Written exam (25%). To be held in the
planned exam dates
Group Assignments
Group presentation (31st May, 1st
June) (40%)
Business case
15 March (tentative date) (10%)
Roger Strange
Written exam (25%). 27th May
Final Mark
if either the Business case or the Group
assignment are missed then the student will
have to sustain the full exam based on the
Bartlett, Ghoshal, and Beamish (2008) book
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Market selection
and market entry
Compulsory Readings:
Ghauri & Cateora, International
marketing, Mc Graw Hill (2° ed), Chapter 7
and Chapter 11 (530 781)
Barriers to international business
1.
2.
Tariffs
Non Tariff Barriers
1. Specific limitations on trade (Quotas, local
content requirements..)
2. Customs and administrative entry procedures
3. Standards
4. Government participation in trade
Risk (political and economic risk)
4. Knowledge (business, market, consumers,
cultural….)
3.
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Political Risk
The likelihood that a government or
society will undergo political changes that
negatively affect local business activity
Political risk arises from a variety of
sources:
Corrupt or poor political leadership
An unstable political system
Conflict between races, religions, or ethnic
groups
Economic problems
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Examples of political risk
Confiscation (take a piece of equipment )
Expropriation (take the whole company )
Nationalization (all the companies in a
business sector)
Political sanctions
Violence
Political reprisals
Corruption…
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Economic Risk
Any economic events that negatively
affect local business activity
As usual economic risk is measured with
the volatility of economic variables
Political and Economic risk define overall
“country risk”
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
ICRG Rating Systemof country risk
AnThe
assesment
Financial
Political
%
default
or unnfavourable loan
Economic expectationsLoan
versus
reality
6%
restructuring
Economic planning failures
6%
Delayed payment of suppliers’ credits
Political leadership
6%
Repudiation of contracts by government
External conflict
5%
Losses from exchange controls
Corruption in government
3%
Expropriation of private investments
Military in politics
3%
Total Financial Points
Organized religion in politics
3%
Law and order tradition
3%
Economic
3%
Racial and nationality
Inflation tensions
Political
terrorism
3%of goods and services
Debt
service
as a % of exports
Civilliquidity
war
International
ratios 3%
Political party
development
3%
Foreign
trade collection experience
Quality
of bureaucracy
3%
Current
account balance as %
of goods and services
Total Political Points
50%
Parallel foreign exchange rate
market indicators
Total Economic Points
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
5%
5%
5%
5%
5%
25%
5%
5%
3%
3%
8%
3%
25
%
Country risk agency
http://www.prsgroup.com/
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
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www.aon.com/
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
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Factors Influencing Market Entry
Strategy
International environment:
• economic • cultural • legal •
Firm’s overall strategy
Global market opportunity assessment:
• country screening • industry potential •
• company sales potential •
Entry strategy choices:
• export • licensing • joint ventures •
• manufactures •
Market entry planning
Positioning
Product
adaptation
Pricing
Channel
selection
Customer
service
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Market selection
The market selection process depends on
the kind of investment
resource seeking
market seeking
efficiency seeking
strategic assets seeking
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Market choice
Economic factors
Resources
Market choice
Firms’ costs
Infrastructure
Cultural factors
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
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Resources (example)
SCHOOL-LEAVING
EXAMINATION
+
GRADUATED
JOB FORCE
HUMAN CAPITAL
STRUCTURES
FOR
INSTRUCTION
PER CAPITAL
INCOME
ROSOURCE ASSETS
MARKET SIZE
GDP GROWTH
TOTAL
POPULATION
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
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Resources (example)
BANKING
PRODUCTION
RESOURCES
BUSINESS COSTS
Agglomeration
of FF
Industrial
districts
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
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Infrastructure
ICT
TELEMATICS
AIR TRANPORT
FREIGHT
INFRASTRUCTURE
BASIC
INFRASTRUCTURE
ELECTRICITY
TRANSMISSION
AND DISTRIBUTION
LOSSES
ROADS NETWORK
RAILWAY FREIGHT
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
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AlternativeMarket
MarketEntry
EntryStrategies
Strategies
Alternative
Exporting
Licensing
Franchising
Joint ventures
Foreign Direct
Investments
Low risk...low
control
High
risk...high
control
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
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Entry Mode
Financial Capital
0%
100%
Control/flexibility
Control
Licensing
Franchising
Minority
holdings
JV
Flexibility
Export
Agreements
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
FDI
FDI
There are 2 different kind of FDI
Greenfield investments
Mergers & Acquisition (M&A)
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Data and trends
FDI general trends
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Source: www.unctad.org
Regional trends
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
M&A activity
Antonio
Majocchi Source:
www.unctad.org
International Business and Management, Academic Year 2009-2010
Newcomers
Source: www.unctad.org
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Strategy and Structure
Compulsory Readings:
Bartlett, Goshal and Beamish, (2008), (510 2368),
• Chapter 1; (pp. 1- 13)
• Chapter 3; (pp. 197 – 209)
• Reading 3-2, G. S. Yip, Global strategy…in a world of
Nations? (pp. 291 – 304)
• Chapter 4; (p. 333- 349) and Case 4- 1 (p.350 – 365)
• Chapter 7 (p. 648 – 660)
Organizational Designs
Types of structures used by companies to
manage foreign activities:
Little/No Formal
Organization
International Division
Global Organizations
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
No formal organisation
Domestic operations assume responsibility
for international activities in the early
stages
The organizational structure reflects the
increased demands from the international
marketplace
The export department structure becomes
obsolete as the firm becomes more
involved in foreign markets
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
International division
Centralizes in one entity all of the
responsibility for international activities
Best serve firms with few products that do
not vary significantly
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Degree of product diversification
The Stopford & Wells Model
Product
Division
Int
division
Grid/Matrix
structure
Improved cost
efficiency is a
major benefit
Follows the
marketing concept
most closely
Area
Divisions
Foreign sales/Total sales
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
The international division
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
International strategies
Local Adaptation
Standardization
low
high
low
Global
high
Transnatio
nal
Multidomestic
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
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Strategy implementation
Multidomestic
(Decentralized) systems have
loose and simple controls. Subsidiary operates
as a profit center
Global (Centralized) systems have tight
controls. Strategic decision making is at
headquarters.
Transnational (Coordinated decentralization)
calls for overall strategy to come from
headquarters
Subsidiaries are free to implement within
agreed upon range
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
A typical area division
Telefónica has a regional structure
The different operations of the
Telefónica Group in 25 countries are
organised into three geographical
regions: Spain, Latin America and
Europe.
The Corporate Centre is in charge of
global strategy and corporate policies,
Telefónica O2 UK,
Argentina, Brazil, Chile, Colombia,
Telefónica O2 Germany,
managementEcuador,
of common
activities
and
El Salvador, United States,
Telefónica
O2
Ireland,
Guatemala, Mexico, Nicaragua,
O2 Czech Republic
coordination of
the
activity
business
Panama,
Peru, Puerto
Rico, Uruguay ofTelefónica
Telefónica
O2 Slovakia
and Venezuela
units.
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
A global company
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Multidomestic
Subsidiaries are managed as a portfolio of
international assets
Coordination is very limited
Control is mainly financial
Subsidiaries have an high level of
autonomy and are focused on localisation
issues
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Global
All value added activities are concentrated
in the MNCs headquarter
There is no adaptation and the world
market is considered as an homogeneous
market
The role of subsidiaries is very very
limited
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
The transnational model
geographic dispersion
economies of scale
interdependence: intense relationships
among units characterised by an high of
cooperation and competition (both
horizontal and vertical)
formal and informal methods of control
diversified role for the subsidiaries
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
The complexity of the model
Source: Bartlett & Goshal, 1987
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
The new role of subisdiaries
Relevance of the local market
Subsidiary
Competences
low
Country organization
a distinctive
CONTRIBUTOR
high with
competence
Most entities hold this
role. It provides
EXECUTOR
low critical mass
high
A competent national
subsidiary that may
STRATEGIC
be serving
as a
partnerLEADER
in developing
and implementing
strategy
The international
company
a low
BLACK has
HOLE
competence country
organization, or none
at all
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
45
The transnational model
The model try to avoid problems of effort
duplication and inefficiency
Subsidiaries are able to make local
business development decisions within the
global framework
Subsidiaries can take a leading role with
regard to specific functions/business or
areas
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Control in transnationals
Control evolves in transational corporation
and became a very complex function
i.e. R&D not only has short-term objectives
(product development) but also medium and
long term ones (patents/research projects)
Even aspects which cannot be expressed
strictly in quantitative terms are considered
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Strategic Control in MNCs
Compulsory Readings:
The balanced scorecard.
Measures that drive Performance,
Kaplan R.S. & Norton D.P. 1992 Harvard Business Review,
Jan/Feb, pp. 71-79
Putting the balanced scorecard to work, Kaplan R.S. & Norton
D.P. 1993 Harvard Business Review, Sept/Oct, p. 71-79
Balanced scorecard for multinationals, S.P. Landry, W. Y.
Canri Chan, T. Jalbert, Journal of Corporate Accounting &
Finance, 2002, 13(6), p. 31-40
Control
Control refers to the general function of
overseeing business unit performance
Typically the corporate development
function oversees strategy and the
controllers (financial function) budget and
measure short-term financial performance
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Control
Different categories of control
Personal/Cultural
Direct/
explicit
Indirect/
implicit
Impersonal/Burocratic
Personal
centralised
control
Burocratic
formalised
control
Control by
Socialisation
and Network
Output
Control
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Socialisation and Network
It combines a lot of relatively diverse
mechanisms.
Socialisation – instrument to ensure that
employees share organisational values and
goals
Informal, lateral exchange of information –
mutual adjustment, informal communication
Formalised cross-departmental relations –
temporarily formalised devices such as task
forces, cross-functional teams…
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Performance measurement
The organisation’s measurement system
strongly affects the behaviours of
managers and employees
However, as the experience of
Multidomestic firms showed, relying only
on financial performance measurements is
a too limited approach
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
The Balanced Scorecard (BSC)
“The BSC is a strategic planning and
management system that is used to align
business activities to the strategy of the
organization, improve internal and external
communications, and monitor organization
performance against strategic goals”*
The BSC includes financial measures but also
operational measures on customer
satisfaction, internal processes and the firm’s
innovation activities
* Kaplan & Norton, 1996
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
BSC and strategy
The BSC is not just a list of performance
indicators but provides executives with a
comprehensive framework that translate
company’s vision and strategy into a
coherent set of performance measures
Therefore, managers should first define
the company’s goal and then define the
measurement and the goals
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
The Strategy process
Given the
firm’s
strategy for
each
perspectives
firm defines
Goals
Measures
Targets
Actions
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
BSC the implementation
BSC Metrics allow the managers to know how
well their business is running
The financial perspective indicates whether or not
the firm’s strategy and implementation is
contributing to bottom-line improvement
In the customer perspective managers define the
segments in which the business units will compete
In the internal perspective executives identify the
internal process in which the firm must excel
The learning and growth process identify the
processes that the organisation must develop to
create long-term growth and improvement
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Mission
Strategy
4 perspectives
The Strategy process
Measures
(KPI)
Goals
Actions
Goals
Actions
Goals
Actions
Measures
Goals
Actions
Measures
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Measures
The Strategy process
“A scorecard makes sense primarily for
business unites and divisions with a well
defined strategy”
A corporate-level scorecard can be defined
only after a BSC has been defined at a
business level
This explain the difficulties in
implementing BSC for MNCs and multibusiness firm
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Goals & measures: examples
The customer perspective goal: time to
market
lead time (existing products)
time to market (new products)
on-time delivery
……
The internal business perspective goal:
cost saving
production time
safety
defect rate
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Goals & measures: examples
Innovation and learning perspective goal:
tech leadership
Employee turnover
Job satisfaction
Training/Learning opportunities
The financial perspective goal: profitability
ROE
Shareholders value
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
How to choose the goals for each
perspective
Building a balanced scorecard should
encourage managers to define the
objectives according to corporate strategy
By this point of view the objectives of the
4 perspectives should be part of a
coherent framework
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Financial perspective
Financial goals could differ considerably at
each stage of a business’s life cycle
Let’s just consider three stages:
Growth
Sustain
Harvest
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Financial perspective
The growth stage is generally a cash burning
phase
Growth rate in sales
Number of new market segments
% of sales from new products introduced within a
specific period
The sustain stage is the most common stage
and typical profitability measure are used
Operating income (Ebit)
Return on capital employed
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Financial perspective
The harvest phase is the mature stage when
firms try to harvest the investments made in
the two previous phases
The goal is typically to maximize cash flow
back to the corporation
Operating cash flow
Reduction in working capital requirements
Cash-to-cash cycle
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Example: Cash-to-cash cycle
It is the sum of days cost-of-sales in inventory
+ days sales in account receivables less days
purchases in accounts payables
Raw materials
from suppliers
Sell
product/services
Days inventories
Days payables
Pay suppliers
Days Receivables
Cash to cash cycle
Collect cash
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Cash-to-cash cycle
The case of a construction company
Cash-to-cash=
89 days
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
The Customer perspective
The customer perspective of the BSC is
aimed at identifying the customer and the
market segment in which they have to
compete
The core measurement group includes
measures of
Satisfaction
Market share
Retention
Acquisition
Profitability…
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
The Customer perspective
Market share
Is the proportion in a given market in terms of sales,
customers, unit volume that a business sells
Acquisition
Measures, in absolute and relative terms, the rate at which a
business unit attracts or win new customers or business
Retention
Tracks, in absolute and relative terms, the rate at which a
business unit retains ongoing relationships with customers
Satisfaction
Assesses the satisfaction level of customers along specific
performance criteria
Profitability
Measures the net profit of a customers after allowing for the
unique expenses required to support the customers
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Customer profitability
In order to have measure of customer
profitability firms should have
implemented an activity-based cost
system
Not all clients’ demand can be satisfied in
ways that are profitable to an organisation
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
The internal business perspective
For the internal business perspective
managers identify the process that are
most critical for achieving customers and
shareholders objectives
Typically firms concentrate on things such
as quality, time, productivity
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
The internal business perspective
The BSC framework identify three main
business processes:
Innovation
Operations
After-sales services
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Innovation
Measures for basic and applied research
% of sales from new products
% of sales from proprietary products
New product introduction vs competitors or vs
plan
Time to develop next generation products
Productivity measure
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Operations
Operations start with receipt of a
customer order and finish with the
delivery
Typical measures are:
Standard costs
Machine efficiency
Operating processes’ quality
Cycle time
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Post sales
Measures:
Cycle times from customers requests to
resolutions of the problems
Costs of after-sales services
Dispute resolution time
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Learning & growth perspective
This perspective develop objectives and
measures to drive organisational learning
and growth
The previous three perspectives identify
where the organisation must excel to
achieve breakthrough performance
Forward looking investments are generally
treated as period expenses so that
cutbacks in these investments are an easy
way to produce incremental short-term
earnings
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Learning & growth
The BSC identify 3 main categories for this
perspective:
Employee capabilities
Information system capabilities
Motivation, empowerment and alignment
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Employee capabilities
Core employee measurement group are:
Employee satisfaction (typically through
survey)
Employee retention (key staff turnover
measurement)
Employee productivity (ranging from simple
measures such as revenue per employee to
value-added per employee
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Information system capabilities
The information system is nowday a
critical resource
It not only interlink all the activities of the
firm worldwide
It supply also rapid, timely and accurate
information and feedback on the product
just made or the services just delivered
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Motivation empowerment
Measures of motivation
Suggestions made and Suggestions implemented
Implementing a reward structure for
implemented suggestions
Measures of improvements
Late deliveries
Number of defects
Scraps
absenteeism
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Alignment
Alignment focus on whether or not units
and individuals have their objectives
aligned with the company goals (as
articulated in the BSC)
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Alignment
In the implementation process a typical
initial measure is the percentage of top
managers exposed to BSC then the same
ratio considering all the staff employees
At a later stage it is considered the degree
of accomplishment of the BSC goals
introducing incentives to achieving these
targets
Incentive can be referred to single
employees (pay raise) or to subunit and
division (resources, autonomy)
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
A tentative strategy map
Objective
Financial
KPI
Customer
share
increase larger
benchmark
positive EVA
premium p on
competition
complaints
> 10% vs
comp price
Retention &
Satisfaction
Premium
price
Internal
< 5% of
clients
workforce
retention
av. Time < 5
days after 1°
contact
> 90%
> 90%
% workforce
stockholders
% trained
Improve service &
contact time
Learning
Sales force
empowerment
Actions
share value
EVA
Saherholder
value
Targets
% workforce
stockholders
standardis.
product program
p
discrimination
Loyalty
program
targeted sales
force
Continuos
learning
program
Contact centre
Stock
ownership plan
training
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
BSC web-service solutions
The BSC is now implemented through web
services applications
At http://www.bscdesigner.com/download
you can find a freeware version (BSC
Designer Light) of one - among the
thousands – available applications
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
A practical example
Tata Tea started building EVA as a key
performance indicator in the balanced
scorecards, so that the performancemanagement system centres around EVA
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Economic value added (EVA®)
Compulsory Readings:
Journal of Applied Corporate Finance
• EVA Momentum: The One Ratio That Tells the Whole Story G.
Bennett Stewart III, 21(2), pp. 74-86, (Spring 2009);
• How To Fix Accounting—measure And Report Economic Profit, G.
Bennett Stewart III, 15 (3), pp. 63-82 (Spring 2003);
• The Eva Revolution, Al Ehrbar, G. Bennett Stewart III, 12 (2), pp
18 – 31, (Summer 1999);
• (SUGGESTED) Specific Knowledge and Divisional Performance
Measurement, M. C. Jensen, W. H. Meckling, pp. 49-57, 21(2),
(Spring 2009)
Shortcomings of accounting
numbers
The classical ratios considered for
businesses control such as EPS, ROI or
ROE have a series of limitation as
standards for measuring business
performance
Standard earning numbers are sensitive to
accounting methods, do not measure
proper cash inflow and ignore the “time
value of money”
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Cash flow estimation
Cash flow from operation (CFFO) may be
calculated as follows:
CFFO = sales-op expenses - tax +
Depreciation (& other noncash items)
– incremental working capital
investments – Capital expenditures
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Incremental Working Cap
Any increments in Net working capital is a
cash absorption activity
NWC increase =
+ increase in receivables
+ increase in inventories
- increase in payables
- increase in deferred taxes
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
EPS
A Subsidiary is planning a new investments
of € 15M which will generate a 10%
increase of sales
Consider that:
Subsidiary has no debt
the cost of equity is 12%
The business is a mature business and the profit
could be consider a perpetuity
Remember that the present value of a
perpetuity is: Perpetuity Annual _ Cash _ Flow
Rate _ of _ Re turn
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
EPS
Even if earnings increase the equity value
of the investment does not change
EPS fails to measure changes in economics
value
Sub A with no debt
Sub A + 10%
Sales
€ 200
€ 220
Op expenses
€ 170
€ 187
Earnings before tax
= € 30
= € 33
Income tax (0.4%)
€ 12
€ 13.20
Earnings
€ 18
€ 19.80
Equity value (CF/CoE)
18/0.12=150
19.8/0.12-15=150
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Roi
Roi & Roe are popular financial performance
indicators. Roi is a frequently used measure
of division’s performance
Roi remains a good indicator of business
profitability but still is an accrual accounting
return and not a full economic measure
This is true even when Roi is compared to an
hurdle rate that generally equals the
business unit cost of capital
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
ROI
Roi is computed by a wide variety of
methods
This is one:
EBIT
Net Book value of FA + Net Working Capital
In this case the “tax shield” effect is not
considered
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
ROI
Moreover,
both the numerator and the
denominator are affected by arbitrary
accounting assumptions
The recent drive towards “fair value”
accounting has mitigated the problem
Nonetheless, operating income (EBIT)
is not the CF generated by the
business
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
ROI
Roi depends on capitalisation and
depreciation policies that are strictly
accounting decisions
For example, R&D expenses are customarily
expensed in the current period and not
considered as an investment (thus
increasing the Roi rate)
Thus, using Roi to compare R&D intensive
and not intensive business can be highly
misleading
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
ROI
Overall Roi has 3 main additional
shortcomings:
It depends on the investments base of the
business unit considered (the larger the
investment base the lower the accounting
return)
Aggressive strategies (R&D spending, new
investments…) typically lower Roi while
harvesting strategies increase Roi
Does not take in account the overall risk (i.e
the cost of capital)
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
ROE
Roe is the ratio of net profit on total
shareholder capital
Roe is seldom used at the divisional level
where debt is rarely allocated but is more
widely used at the corporate level
Roe has all the shortcomings of Roi but in
addition it is sensitive to leverage
Roe increases as more then optimal debt
is issued
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Time value of money
Earning calculations ignore the time value of
money i.e. the risk free rate, the cost of risk
compensation and the expected rate of inflation
This is not the case with NPV calculation (CF=
cash flow; r=interest rate)
NPV
CF 1
(1 r )
1
CF 2
(1 r )
2
......
n
CF n
(1 r )
n
CF t
(1 r )
t 1
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
t
The risk/return relationship
Expected return
Risk free rate
(Rf)
Return
Risk
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
EVA®
EVA (Economic Value added) is a
methodology aimed at measuring
shareholder value creation
EVA is increasingly becoming the global
standard for measuring business
performance
Shareholder value is created only if a
business earns a rate of return on
investments greater than the rate
investors can expect to earn by investing in
alternative, equally risky, securities
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
EVA®
Eva take in account both the real cash
flow generated by the business divisions
and the overall risk of the business
By this point of view Eva is an “economic”
profit measure as opposed to the typical
accounting measures
Eva can be calculated for any entity
including divisions departments, products
lines…
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Eva balance sheet
Regular Balance Sheet
Cash
Short term
Debt
EVA Balance Sheet
Cash
Short term
Debt
NWC
Short term
Receivables
Not Interest+ Inventories
+ Prepayments bearing
liabilities
Long term
Debt
Fixed Assets
SH Equity
Long term
Debt
Fixed Assets
SH Equity
Net Assets Invested Capital
Nopat
Wacc
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
The EVA® approach
Eva = NOPAT – (WACCInvested Capital)
Net
operating
profit after
tax
Weighted
average cost
of capital
Net Fixed
asset + net
working
capital
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
The EVA®
The return on net assets is defined as the
ratio of Nopat on Net Assets (RONA)
Eva will be positive if :
RONA>WACC
Eva can be also be expressed as:
Eva=(RONA-WACC)Invested Capital
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
NOPAT
Nopat is the firm’s profit assuming that the
firm has no debt
The term “net” means that Nopat is net of
amortization (which is a real economic cost)
The idea is that Nopat captures the profit
that accrue to all capital holders (both
lenders and shareholders)
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
NOPAT adjustments
The main adjustment is the reclassification
of some expenses as investments
(typically R&D) and the subtraction of
provision and extraordinary expenses i.e.
all non-monetary costs such as provisions
(except amortization!)
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
NOPAT
Nopat is equal to:
Ebit (adjusted)-corporate taxes (without
debt)=
or more precisely
profit(adjusted)+interest expenditures(1-t)
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Nopat: the formulas
Ebit (+)
100
Option 1
Interest cost (-)
20
Ebit (+)
100
PTP (=)
80
Interest cost (-)
==
Tax rate = 50%
40
Tax rate = 50%
50
Profit
40
Nopat
50
Option 2: Profit + IC(1-t)
Option 3: Ebit (1-t)
Profit (+)
40
Interest cost (1-t) (+)
10
Ebit (+)
100
Nopat
50
(1-t) (-)
50%
Nopat
50
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Income statement (basic)
Sales (+)
100
Costs of Goods and Services (-)
20
Labour Costs (-)
10
Earnings before Interests, Taxes & D&A - EBITDA (=)
70
Depreciation & Amortization - D&A (-)
20
Interest costs (-)
10
Pre-tax profit (t=40%) PTP (=)
16
Profit
40
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Adjusted Profit
In order to estimate the adjusted profit
exceptional costs (i.e. integration costs)
should be deducted and R&D costs should be
amortised according to the amortisation period
considered
Profit
40
Integration costs (+)
5
Research cost capitalised
50
n. of years of capitalisation of R&D costs
10 years
Costs to be added and deducted
+50 and + 5
Adjusted Profit
90
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Nopat
Nopat is not affected by the firm’s capital
structure choices
Unlevered firm
levered firm (1)
levered firm (2)
Invested capital
10,000
10,000
10,000
Equity
10,000
5,000
2,000
Debt
0
5,000
8,000
Sales
16,667
16,667
16,667
Cogs
13,000
13,000
13,000
Depreciation
2,000
2,000
2,000
EBIT
1,667
1,667
1,667
Interests (i=5%)
0
250
400
Pre-tax Profit
1,667
1,417
1,267
Tax (0.4 tax rate)
667
567
507
Net Profit
1,000
850
760
Nopat=NP+Int*(1-t)
1,000
1,000
1,000
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
EVA BS at the divisional level
When Eva is measured at the divisional levels,
cash is typically excluded from invested capital
(cash is typically managed centrally)
EVA Balance Sheet
Cash
Short term
Debt
EVA BS at the
Divisional Level
NWC
NWC
Long term
Debt
Long term
Debt
Fixed Assets
Fixed Assets
ST debt
SH Equity
SH Equity
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
The Cost of capital
The cost of capital is the rate of return a
capital provider would expect to receive if
the capital were invested in a
project/division of comparable risk
Therefore, the cost of capital is an
opportunity cost
Since risk is a crucial element investors
require higher returns from equity capital
than they do from debt
RE>RD
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
WACC
The WACC is calculated as follows:
D
WACC
R d (1 t )
D E
E
D E Re
Where the cost of debt is the pretax rate the
company pays to its lenders (since interest
payments are – as a rule – tax deductible)
The cost of equity should be estimated and
depends on the overall risk of the investment
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
WACC
If the market value of debt is = € 30M; the
market value of equity is = € 50M, the cost
of debt= 9% and the cost of equity is 15%
then, geiven a tax rate of 40% the weighted
cost of capital is equal to…..
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
CAPM
The CAPM (Capital Asset Pricing Model)
offers is one of the methodologies (among
others!) to estimate the cost of equity
Re R f Rm R f
The cost of equity is equal to the return on
riskless assets plus a risk premium which
reflect the price paid by the stock market to
all equity investors, adjusted for beta which
is a specific risk factor
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Beta
Beta is the volatility of a company stock
price with respect to the overall stock
market
Therefore Beta is the company-specific risk
that the asset adds to a market portfolio
Analytically Beta equals:
i
Cov i , M
2
M
or
i i,M
M
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Riskless rate
The only securities that have not default risk
are government securities. Nonetheless they
bear interest rate risk. The most common
rates used are:
T-bill rate
Treasury notes rate
Inflation-indexed Treasury rate
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Equity risk premium
Risk premium should measure what
investors on average demand as extra
return for investing in the market portfolio
relative to a risk free assets
RP is usually estimated looking at the
historical premium earned by stocks over
Treasury bills and bonds
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
US Equity risk premium
Arithm. Av.
Stock
T bill
T bond
1928-2003
11.82%
3.90%
5.28%
1963-2003
12.10%
6.01%
7.40%
1993-2003
12.63%
4.20%
7.76%
Stock
T bill
T bond
1928-2003
9.85%
3.86%
5.02%
1963-2003
10.82%
5.97%
7.00%
1993-2003
10.87%
4.19%
7.30%
Geom. Av.
Source: www.Damodaran.com
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Some Beta Examples
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Some Beta Examples
BETA
AD.BE
TA
MIB30
0,96
0,97
0,13
M
SXXE
1,24
1,16
0,25
31.1.97 - 28.6.02
M
MIB30
0,86
0,92
0,12
FIAT
31.1.97 - 28.6.02
M
SXXE
0,98
0,99
0,15
FIAT
1.1.93 - 26.12.97
W
MIB30
0,90
0,93
0,06
FIAT
1.1.93 - 26.12.97
W
SXXE
1,08
1,05
0,13
FIAT
3.1.97 - 26.7.02
W
MIB30
0,90
0,93
0,07
FIAT
31.1.97 - 28.6.02
W
SXXE
STOCK
PERIODO
RETURN
FIAT
29.1.93 - 28.11.97
M
FIAT
29.1.93 - 28.11.97
FIAT
INDEX
0,96
STDE
0,97
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
0,09
Some Beta Examples
BETA
AD.BE
TA
MIB30
0,76
0,84
0,06
M
SXXE
0,76
0,84
0,16
30.1.98 - 28.6.02
M
MIB30
0,61
0,74
0,11
GENERALI
30.1.98 - 28.6.03
M
SXXE
0,68
0,79
0,13
GENERALI
29.1.93 - 26.12.97
W
MIB30
0,81
0,87
0,04
GENERALI
29.1.93 - 26.12.98
W
SXXE
0,71
0,80
0,10
GENERALI
2.1.98 - 26.7.02
W
MIB30
0,85
0,90
0,05
GENERALI
2.1.98 - 26.7.03
W
SXXE
STOCK
PERIOD
RETURN
GENERALI
29.1.93 - 31.12.97
M
GENERALI
29.1.93 - 29.11.97
GENERALI
INDEX
0,82
0,88
STDE
0,06
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Some Beta Examples
STOCK
PERIOD
RETURN
INDEX
MONDADORI
29.1.93 - 28.11.97
M
MIB30
0,56
0,71
0,15
MONDADORI
31.12.92 - 31.12.97
M
SXXE
0,70
0,80
0,25
MONDADORI
31.12.97 - 31.7.02
M
MIB30
1,55
1,36
0,23
MONDADORI
30.1.98 - 28.6.02
M
SXXE
1,86
1,57
0,23
MONDADORI
1.1.93 - 26.12.97
W
MIB30
0,41
0,61
0,09
MONDADORI
1.1.93 - 26.12.98
W
SXXE
0,56
0,71
0,16
MONDADORI
2.1.98 - 26.7.02
W
MIB30
0,94
0,96
0,09
MONDADORI
2.1.98 - 26.7.02
W
SXXE
BETA
1,04
AD.BETA
1,03
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
STDE
0,11
Beta for divisions
The procedure for estimating betas for
operating divisions within firms depends
largely on whether the divisions are
organized by product line or geography
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Geographical divisions
In this case the cost of equity is set adding
to the company cost of capital a risk
premium equals to
the rate of return on local bonds if the division is
mainly funded in the home currency
A measure of country risk if financing comes
mainly from the parent company
Typical measure of country risk are spread on
local government bond denominated in foreign
currency or DCS
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Product divisions
When division are based on product line
betas can be estimated from comparable
firms in the same or similar industries
This simple approach assumes that the
capital structure of all the firms in the
industry is similar (beta increases when the
D/E ratio increases)
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
The levered Beta
If our capital structure is different from the
industry average structure then we have to
unlevered and then “relevered” the Beta
Since we know that:
L
D
U 1 (1 t )
E
then
U
L
1 (1 t )
D
E
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Estimating business Beta
If the average industry beta is 1.27 and the
average industry D/E ratio is 0.45, assuming
t=0.4, then the unlevered industry beta is:
U
1 . 27
1 (1 0 . 4 ) 0 . 45
U 1 . 00
This means that if the average industry beta
is 1.27, if all the firms had been all-equity
firms, with no debt, their average beta would
be 1.00
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Estimating business Beta
Now to derive the beta for our division we just have
to take the unlevered beta and then lever it back up
again to out capital structure
Let’s assume that our D/E ratio is 0.25, then
D
L U 1 (1 t )
E
L 1 . 0 1 (1 0 . 4 ) 0 . 25 1 . 15
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Eva guidelines
Given that Eva is:
Eva=Nopat-(WACC)Invested Capital
The main indications of EVA methodology to
managers is that they should implement
action either to increase Nopat or the
decrease the invested capital
Wacc depends on overall risk and capital
structure (a financial decision)
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
EVA and time value of money
EVA is much better than conventional
measures in explaining the market value
of a company
The market value of a company depends
directly on the future EVA-values:
The market value of a company
= Book value of equity + present value
of future EVA
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
MV and EVA
If the company produces a return that is
equal to capital costs then the market
value of the company will equal the book
value of equity
I.e. when EVA = 0, then company´s
market value of equity equals its book
value of equity
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
The firm MV
Market value
premium
Market value
of the firm
Book value
of equity
MVP
EVA 1
(1 wacc )
1
EVA 2
(1 wacc )
2
EVA 3
(1 wacc )
3
.....
EVA n
wacc
Firm’s market value=
equity book value + NPV
of future EVA
Positive EVA builds up a
premium to the market
value of equity, since
investors pay for excess
return
Antonio Majocchi - International Business and Management, Academic Year 2009-2010
Marginal EVA and pricing
When EVA is computed at the division level,
the computation requires estimation at the
divisional level
This will involve allocation mechanisms and
allocation of fixed headquarters expenses
becomes an issue
The initial estimates of EVA are likely to reflect
the allocation mechanisms used and the
mistakes made in those allocations
Changes in EVA over time are more useful
measures than the initial EVA estimates
themselves
Antonio Majocchi - International Business and Management, Academic Year 2009-2010