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Published: March 21, 2011

 
Finance: The Essentials from Booz & Company
 

Total Shareholder Returns

Perhaps the most insidious pitfall, though, is to introduce new measures but then fail to operate differently. The old adage “you manage what you measure” is time-tested, but changing what one measures will not automatically change how one manages, or how well.

The processes that govern strategic planning, resource allocation, performance management, and incentive compensation are the most important factors that determine your company’s ability to maximize long-term value creation. Companies that change the metrics used with these processes, but don’t change any other aspect of them, have seen very little impact on their capacity to deliver superior TSR. Introducing new management metrics — such as free cash flow, economic profit, warranted value, and TSR — does not, in and of itself, change the way a company, management team, planning process, or corporate center operates.

What to Get Right

Only two factors determine the value creation path of any company: the distinctiveness of its strategies and the execution of those strategies. We often hear statements such as, “A great strategy is worth nothing without great execution” or “I’d rather have great execution with a mediocre strategy than the other way around.” The reality is that strategy and execution are two sides of one coin. Is Southwest Airlines or Tesco or Wells Fargo the product of great execution or of great strategies? Yes. Both are needed to produce consistently superior shareholder returns.

What, then, will enable your company to have and sustain distinctive strategies and execution? In our experience, this achievement requires proficiency in both the formal and the informal aspects of a company’s management. On the formal side are corporate strategy, business strategies, strategic planning, resource allocation, performance management, incentive compensation, organizational design, and role of the corporate center. On the informal side are leadership behaviors, peer-to-peer networks, teaming norms and skills, nonfinancial motivators, pride, and a strong sense of the business’s purpose.

Your Company’s Purpose

Many business leaders and their organizations struggle with the idea that their company’s purpose is to maximize shareholder value. This is understandable. Business is a multipurpose human activity. Through the customer’s eyes, the purpose of business is to provide products and services that make their lives better; from an employee’s perspective, it is to provide meaningful work and opportunities. A capitalist might say that the purpose of business is to create wealth; a politician might say it is to create employment. For every Peter Drucker who declares that the primary purpose of business is “to create and keep customers,” there is an Alfred P. Sloan (whom Drucker studied and greatly admired) who says the purpose is “to make money.” In the 1980s, Michael Porter argued that the purpose of business was to maximize profit; today, he writes about “creating shared value.” (See Porter’s article, coauthored by Mark R. Kramer, “The Big Idea: Creating Shared Value,” in the January–February 2011 issue of Harvard Business Review.)

Business leaders need to give purpose to their people, and most employees do not find purpose in maximizing shareholder value. Finding meaning and purpose is a personal quest rooted in one’s daily work and experience, not in statements of purpose from corporate headquarters. Thus, the context is important. Managing for top-tier TSR will not solve the meaning of life or work for your people. But it is a powerful approach that can create and sustain a high-performance, agile company with high-quality growth. Most employees (and other stakeholders) are highly motivated to be associated with such a company.

Author Profiles:

  • Ken Favaro is a senior partner with Booz & Company based in New York. He leads the firm’s work in enterprise strategy and finance.
  • Greg Rotz is a partner in the global health practice of Booz & Company and leads the life sciences team in North America. He focuses on strategy and organization issues for life-science companies.
 
 
 
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