BELIEFS, BEHAVIORS, & RESULTS
THE CHIEF EXECUTIVE'S GUIDE TO DELIVERING SUPERIOR SHAREHOLDER VALUE
By SCOTT GILLIS LEE MERGY JOE SHALLECK
Greenleaf Book Group Press
Copyright © 2013 MS Galt & Company, LLC
All right reserved.
Chapter One Explaining Our Central Theme: How Beliefs Impact Behaviors and Results
"Leadership is about instilling the beliefs and behaviors that produce desired results."
John Allison, former Chairman and Chief Executive, BB&T
Although external competitive forces are constantly working against a company's growth in shareholder value, it is the internal misconceptions that exist within management that place the greatest limitations on corporate performance.
Improving shareholder value is about overcoming these misconceptions and establishing the beliefs and behaviors that lead to superior results in both the customer and capital markets.
Ensuring that employees truly know what leads to superior performance and how to put those principles into practice is one of the most important roles of the chief executive and their management teams.
WHAT IS SUPERIOR PERFORMANCE?
If asked, the senior management teams of virtually every publicly traded company will say that they are focused on delivering superior shareholder returns. Yet very few companies have been able to outperform their peers consistently over extended periods of time.
Over the past twenty years, the average company in the S&P 500 delivered total shareholder returns (TSRs, or stock price appreciation plus dividend yield) of about 10 percent annually. In other words, $100 invested in the average S&P 500 company today would be worth $110 a year later. At that rate of return, it would take approximately 7 to 8 years for a company to double its shareholder value.
If we group companies within an industry into quartiles, however, as we do in Figure 1.1, those firms in the top 25 percent did significantly better, with most generating TSRs of 16 percent to 20 percent. In effect, companies in the top quartile have doubled their shareholder value in 4 to 5 years.
Why is this gap so large? What distinguishes chief executives and companies that have been able to consistently deliver shareholder returns in the top quartile of their peer group from those that have not? Is it product innovation? The assets the company controls? The market share position it has built? Or is superior performance just a statistical phenomenon that is difficult, if not impossible, to either predict or replicate?
Based on nearly twenty-five years of working with some of the world's best-run companies, we have learned that superior performance is not random; it can be managed. More specifically, what we have observed is that superior performance is the result of a disciplined approach to management and the resulting culture that this discipline creates. Underpinning this discipline is a set of beliefs that the CEOs, along with the senior management teams, have instilled in their organizations. Those beliefs drive behaviors, which in turn drive the outstanding results these companies have been able to achieve.
CHECK YOUR PREMISE
"I know what increases shareholder value," many managers say. "I hire good people who make good products and deliver outstanding service, which leads to satisfied customers. That in turn generates healthy earnings growth and solid increases in our stock price."
As a general rule of thumb, that is correct. But not all customers and investments are profitable. So, yes, you want to hire good people and you want those good people to make good products that satisfy customers. But you also want your people to understand fully how their decisions and actions link to and drive profitability and cash flow. You don't want your advertising manager spending all their time thinking about boosting shareholder value. But you do want to make sure that the majority of advertising investment is driving profitable growth.
The idea of hiring good people who make good products leads us in the right direction, but it is not specific enough. As we will see in a moment, there is a single path that will lead to maximum shareholder value. But as you move down it, there may be scores of different decisions that a wide range of employees will have to make. The odds are very small that they will make all those decisions correctly without a specific set of principles that they can follow.
It makes much more sense for senior management to explain to employees:
What drives shareholder value.
How to determine where and why shareholder value is being created and consumed.
How to use this information to make better strategic and resource allocation decisions and deliver higher levels of profit growth and cash flow.
WHERE COMPANIES GO WRONG: COMMON MISCONCEPTIONS
Correcting management misconceptions about what drives shareholder value and how to effectively grow it is the first step toward producing superior shareholder returns. What are some of those misconceptions? Let's highlight a couple of the more chronic ones.
Believing All Growth Is Good
Markets are not homogeneous, yet most managers consider all share points to be valuable and believe that all revenue growth is good. Few management teams appreciate just how much profit margins and cash flow vary by product category, customer segment, channel, geographic region and activity across the value chain.
While most management teams segment their markets by consumer, product, or channel to better understand customers' needs, few managers go through the effort of measuring the profitability those market segments generate today or can generate in the future.
As a result, most management teams are reduced to managing a business profitability by aggregated financial line item. When viewing the averages, all revenues look good, all costs look bad, and the opportunities to better manage the business mix are not seen, let alone acted upon.
From an aggregate line-item perspective, there is a strong bias to achieve revenue share leadership. After all, doesn't market share leadership generate significant competitive advantages such as economies of scale, being top of mind with consumers, and gaining leverage with the trade? And don't these advantages naturally lead to superior financial results?
The answer to both questions is: not necessarily. Blind pursuit of market share makes a critical and often painfully incorrect assumption that all points of market share contribute to shareholder value.
You have to overcome what Sir Brian Pitman, former Chairman and CEO of Lloyds TSB, calls with a great degree of irony, "the Institutional Imperative."
"There is a propensity to grow, regardless of the consequences to the shareholder. It is present in all companies, even the best managed. It is an extremely tenacious force that works incessantly against achieving superior shareholder returns. Not all growth is good. Your focus must be on the things that increase shareholder value," said Pitman.
It is not the case that Pitman was antigrowth. He was just much more clear than most about what his company was focused on growing: shareholder value.
You may be surprised to learn that in many Fortune 200 companies, less than 40 percent of the company's employed capital is generating over 100 percent of its shareholder value, while 25 percent to 35 percent of its employed capital is actually destroying shareholder value!
When you think about that statement, you can begin to appreciate the enormous leverage that exists to improve the shareholder value of most corporations. Companies can often double shareholder value by redirecting resources (both capital and people) to more aggressively grow those parts of the company that are contributing to shareholder value while reducing investment in those areas that are not.
Believing That EPS Growth Alone Drives Shareholder Value
Most management teams are convinced that growth in earnings per share drives their companies' stock prices. (After all, this seems to be the only thing sell-side analysts talk about.) The reasoning goes something like this: "I have a price-to-earnings multiple of 15; the market values companies like ours with P/E ratios between 14 and 16. So improving shareholder value isn't that complicated: we'll grow our earnings, multiply those earnings per share by our P/E multiple, and that will determine our stock price. The analysts rarely ask about the balance sheet if we don't carry too much debt and don't make any acquisitions that would dilute earnings."
Appealing as that logic may seem, it is wrong. Most managers are surprised to learn that not all EPS growth improves shareholder value. Actions that increase earnings can actually consume shareholder value if those actions compromise the company's future cash flow potential. How often have you seen shortsighted managers chase EPS growth by cutting back on necessary reinvestment or reducing marketing and R&D spending in order to make next quarter's earnings target? How often have you seen acquisitions that are accretive to earnings but do not generate an adequate return on the capital invested to make the acquisition? And how often have you seen managers "invest for the long term" by pouring capital into declining businesses only to see future cash flows continue to deteriorate?
Cash flow, not earnings, drives shareholder value. And the capital requirements of a company (or business) have a direct impact on the percentage of earnings that is translated into cash flow.
A more accurate measure of profitability, from the shareholder's perspective, is called economic profit. Economic profit is the earnings generated by a company (or business) minus a charge for the capital employed to generate those earnings. As we will discuss further in Chapter 2, cash flow drives shareholder value, and economic profits drive the shareholder value that is created in excess of the capital invested in a company (or business).
WHAT'S REQUIRED TO EFFECTIVELY MANAGE SHAREHOLDER VALUE?
When you chip away all the stuff that doesn't work and lay to rest all the misconceptions, you are left with five core principles shared by the CEOs who have been able to sustain superior total shareholder returns over time:
1. Establish the right definition of winning and measure of success.
The executives at shareholder-value-managed companies believe that their ultimate objective is to deliver superior returns for their stockholders over time. They define winning as (a) delivering higher returns for their shareholders relative to their industry peers by (b) delivering consistently greater cash flow and economic profit growth than their peers. While these executives acknowledge the importance of revenue growth, market share, earnings per share, and return on capital, they understand that focusing on any of these measures in isolation can lead to sub-optimal shareholder value creation.
2. Capitalize on the fact that shareholder value is always highly concentrated.
The executives at shareholder-value-managed companies know that economic profits and shareholder value contribution are always highly concentrated in every market and market segment. These executives capitalize on the tremendous performance leverage that this concentration offers. They make sure their managers are developing strategies and allocating resources in ways that increase their share of economic profits in each market where they participate, while letting their less informed competition pursue growth in the economically unprofitable segments of these markets.
These CEOs constantly remind their management teams to eliminate economic losses and redirect investment to accelerate the growth of economically profitable business segments. Through this redirection and a renewed focus, these companies succeed in establishing and sustaining a reinvestment advantage that is difficult for competitors to match.
3. Actively pursue the highest value-at-stake opportunities.
These chief executives behave like activist investors, continuously seeking out and then concentrating on the issues and opportunities that will have the greatest impact on their company's economic profit growth and shareholder value. They recognize that only a handful of strategic decisions will ultimately determine whether their company outperforms or underperforms its peers. These executives do not become overwhelmed by an endless list of tactical initiatives that diffuse their focus and spread resources so thin that they don't have much impact.
4. Deploy differentiated strategies, and differentially allocate resources against those strategies.
Executives at value-managed companies understand that economically profitable growth and superior shareholder returns are the result of economically differentiated strategies and the differential allocation of resources. As a result, they do not attempt to copy "best-demonstrated practices." Rather, they develop and deploy business models that uniquely satisfy the needs of profitable customers more effectively than their competitors, thereby capturing a disproportionate share of the available profits in the markets they serve. They ask the uncomfortable questions, challenge historical assumptions, and accepteven embracethe fact that creative destruction is constantly at work in every market and that shareholder resources must continually flow toward value-creating opportunities and away from value-consuming ones. They know that they must proactively manage this reallocation of resourcesor the capital markets will do it for them.
5. Build the organizational conditions and capabilities to manage shareholder value.
These executives appreciate that one of their primary responsibilities is to instill throughout the company a set of beliefs and behaviors that are aligned with the long-term interests of the company's shareholders. These CEOs recognize that superior performance is ultimately the result of an organizational advantage. They create this advantage by building the organizational conditions and capabilities that encourage their managers to think and act like owners.
Figure 1.2 summarizes the contrasting characteristics of typical companies and value-managed companies. The table both serves as a quick review of the five principles discussed in the preceding pages and gives you a chance to consider how your organization compares.
YOU ALREADY KNOW THIS ... BUT DOES EVERYONE ELSE IN YOUR ORGANIZATION BEHAVE ACCORDINGLY?
Often, when we describe what we have learned from working with CEOs who have consistently delivered superior shareholder value and go on to sketch out the five principles underlying their success, our clients say something like, "I knew all this. I may not have put it in exactly those words, but those are exactly my views."
That doesn't surprise us. As we've said, we have only met a few CEOs who do not believe their ultimate goal is to increase shareholder value. So we agree with you: you do get it. And if you were making every decision in your organization, you would make just about all of them correctly.
But you have hundreds if not thousands of managers in your organization who are making decisions that have at least some impact on shareholder value, and they don't get it as well as you do.
Travis Engen, who ran ITT Industries and later Alcan, explains the challenge well: "In my life, the difficult problem hasn't been figuring out what to do; it has always been getting other people to reach similar, or at least congruent, conclusions. As I've matured through my business career, I've gone from basically being an engineer to being a people engineer, figuring out how to get people interested, motivated, excited, and passionate about working collaboratively on things that are important, on improving total shareholder returns."
This book is intended to be a resource for doing just thatgetting all your managers to think and act like owners.
SUMMARY AND KEY TAKEAWAYS
* Internal management misconceptions (about what drives shareholder value and how to manage its growth), not external competition, are the most significant impediment to improving shareholder returns.
* Overcoming these misconceptions, and instilling the organizational beliefs and conditions that encourage the right behaviors, distinguishes CEOs who have been able to effectively manage shareholder value growth from those who have not.
* While every organization is different, and CEOs need to tailor their approach and their leadership to the specific needs of their companies, we have found that the following five core beliefs distinguish the successful efforts from the less successful ones:
1. Winning is ultimately defined by delivering higher sustainable shareholder returns than your competition. In order to win, you must do a better job of creating and capturing customer value for your shareholders. If you do, you will realize higher levels of cash flow and economic profit growth than your competition.
2. Shareholder value contribution and growth are always highly concentrated. This concentration offers a tremendous opportunity to better focus your strategies and resources on capturing a disproportionate share of economic profits in every served market, thereby achieving a reinvestment advantage that is difficult for competitors to replicate.
3. There are only a handful of opportunities to significantly impact the economic profit growth of an entire corporation; keeping time and resources focused on those opportunities is the way to run a company.
4. Good performance is the result of doing things better. Superior performance is the result of doing things differently. In order to maximize shareholder value, businesses must develop differentiated strategies and differentially allocate resources.
5. Shareholder value is impacted by the daily decisions and actions of hundreds of managers. Adopting the beliefs and organizational conditions that align these decisions and actions with shareholder interests is the only way to sustain superior performance.
Excerpted from BELIEFS, BEHAVIORS, & RESULTS by SCOTT GILLIS LEE MERGY JOE SHALLECK Copyright © 2013 by MS Galt & Company, LLC. Excerpted by permission of Greenleaf Book Group Press. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.