usb barcode scanner java api 4: How Conquering Complexity Drives Shareholder Value in Software

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4: How Conquering Complexity Drives Shareholder Value
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EP and stock prices We ve plotted some empirical stock market data in Figure 42 to show how shareholder value is correlated with: Return on Invested Capital (ROIC) minus the Weighted Average Cost of Capital (WACC), which is the return that could have been earned from alternative investments the opportunity cost for investors Good growth, that is, growth that fuels the proliferation of value-add products and services that are generating positive Economic Profit (the x-axis in Figure 42) Figure 42: Stock Price Performance and Complexity EP% is graphed along the axis going back into the page, while revenue 8 growth % is along 7 the front axis The Unilever 6 vertical axis repre5 sents the market view (Market to 4 Toyota Book ratio) You ll 3 Southwest notice that compa2 nies like Ford whose 1 Ford ROIC% is less than 0 American >10% its cost of capital, 0-3% 6-10% 3-9% 2-6% 9-13% trade at around (2)-2% 13-25% Revenue Growth EP% = ROI C - W ACC book value (lower left corner) Conversely, companies like Colgate Palmolive (with an ROIC of 27%) are off the scale and receive high price premiums
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Data 1994 to 1998, Copeland s Valuation, ex 52, 2000 Edition Colgate
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As you can see in the chart: Values rise most steeply along the EP% axis, meaning that EP% (or equivalently, Discounted Cash Flow) is the most powerful driver of share price Revenue Growth, the darling of the internet bubble, is only of sustained value when EP is greater than 2%
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Because Economic Profit accounts for costs as well as returns, it holds a critical lesson for us that other metrics overlook: Most of us have been trained to think of growth as a good thing, but growth will actually accelerate the destruction of shareholder value if Economic Profit is negative Understand that for every shareholder dollar invested by the corporation in projects that yield below the cost of capital, the investor has suffered economic losses; growth simply magnifies this shareholder loss10 Figure 43 shows an example of how this happens The chart shows the stock performance of Value City (VCD now owned by parent company Retail Ventures, Inc, which also owns DSW Shoe Warehouse and Filene s Basement stores), Kohl s (KSS), and May Department Stores Co (MAY), all department store chains, versus the S&P 500 Index Both Value City and Kohl s saw revenue growth rates of about 20% But from 1999 to 2004, Value City saw negative ROIC, while Kohl s remained at a solid 13% This is reflected in the value of the shares Value City was thus valued at less than book value May Co, on the other hand, while maintaining a relatively robust ROIC of 97%, had an anemic growth rate of 083% Its market-to-book ratio, while better than Value City s, is only 188 The market performer had strong growth rates working to leverage its strong return on capital For Value City, growth served only to magnify the value destruction In short, growth can be an accelerant to value destruction, a conclusion not too surprising to people who are attuned to the true impact of complexity on costs and speed
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The call to action is made imperative by the ferocity of global competition We are now operating in fast, vast markets ABN-AMRO, a Netherlands-based multinational commercial and investment bank with roots back to Dutch colonial times, lost ground to competitors in the late
4: How Conquering Complexity Drives Shareholder Value
Figure 43: Stock Performance of Kohl s, May s, and Value City Department Stores
Share Price Change (%)
250% 200% 150% 100% 50% 0% -50% -100% Jan 99 Jan 00 Jan 01 Jan 02 Jan 03
S&P500 MAY VCD
Jan 04
Kohl's Corp (KSS) Value City Department Store (VCD) May Department Stores Co (MAY)
Over the last five years, an investment in Kohl s would have yielded a doubling of shareholder value, due to its strong Economic Profit and growth records An investment in May s would have barely broken even this is consistent with an Economic Profit of approximately zero Value City, despite a growth bonanza (or rather because of it) has yielded negative returns for investors in that time period
nineties as the financial markets transformed around it into a global marketplace, while ABN-AMRO remained true to its tradition of being a universal bank offering all investment as well as savings and loans services The bank s focus on earnings and growth, rather than value, led to its complex offering portfolio with many services generating negative Economic Profit When a new chairman, Rijkman Groenink, was appointed in mid-2000, one of his first actions was to redefine the set of competitors that formed its frames of reference, emphasizing the point that while the consensusdriven management of the bank remained very Dutch in style, the pressures it was facing were global and unrelenting, coming from competitors such as Citigroup, Bank One, Barclays and Wells Fargo It had to change from its universal approach to being selective in which
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