S. David Young
Blue Line Management
B2C Firms
“Customers”
B2B Firms
Cash
Raw Materials
Objective for Firms - Value Creation & Capture
Value =
Happiness
Value =
The expected cash flows,
discounted at the opportunity
cost of capital
S. David Young
INSEAD, April 2011
What is “value”?
S. David Young
INSEAD, April 2011
Value-driven capital investment:
How can we distinguish good ideas from bad?
Value creation occurs when the value of expected cash
inflows is greater than the value of initial and subsequent
cash outflows.
We call this the Net Present Value (NPV) rule.
S. David Young
INSEAD, April 2011
Two key lessons …
•We need to know the cash flow consequences of our
decisions.
•We need to know the opportunity cost of capital.
S. David Young
INSEAD, April 2011
Value creation requires …
•A sustainable competitive advantage
•Tools to identify +NPV projects
•Incentives to identify and implement +NPV projects, and to
reject ‒NPV projects
S. David Young
INSEAD, April 2011
But managers often get in the way ...
•The role of managers
•The “agency cost” problem
S. David Young
INSEAD, April 2011
Value ≠ Price
Blue line management
S. David Young
INSEAD, April 2011
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S. David Young
INSEAD, April 2011
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S. David Young
INSEAD, April 2011
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S. David Young
INSEAD, April 2011
Blue line management—Customers
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What do you sell?
To whom do you sell it?
Why do they buy it?
What are the features/attributes they value?
How much are they willing to pay for them?
The customers who aren’t buying from you, who are they buying from?
Why are they buying from the competition?
What features/attributes/services do they offering that you don’t?
Why aren’t you offering comparable features/qualities/services/price?
If you decided to offer competitive features to win customers back, how much would it cost?
How many customers would come back?
How many more units would you sell?
Would you also be able to increase your price? By how much?
How quickly do your customers pay? What would be the impact of offering them 5 extra days to
pay? Could you improve on the price? Sell additional units?
S. David Young
INSEAD, April 2011
Common examples of red line management
•Referring to share price impact in explaining or
justifying business decisions
•Buying back shares to boost EPS
•Using hidden reserves to manage earnings
•Sale and leaseback transactions to get debt off the
balance sheet and to boost return on invested capital
S. David Young
INSEAD, April 2011
Why is red-line thinking so persistent?
•The red line is seductive.
•Top management is paid to deliver growth, often at the
expense of value.
•The proper role of key performance indicators (KPIs) is not
understood.
S. David Young
INSEAD, April 2011
The red line is seductive
•Toyota
•General Electric
S. David Young
INSEAD, April 2011
Compensation policies also play an
important role
•Directors are often confused about the nature of the
incentives they create for top management.
•Most top managers have stronger incentives to grow
revenues than to create value.
S. David Young
INSEAD, April 2011
Red-Line management isn’t just
a corporate level problem
•Red-line thinking can reach any level of an organization
through the misuse of KPIs.
•The problem is not with KPIs, but rather with the tendency to
manage based on KPI targets.
S. David Young
INSEAD, April 2011
Consider the following example:
You are the managing director of a major operating unit.
Return on Invested Capital (ROIC) features prominently in
your evaluation and bonus scheme. Current ROIC is 15%. The
opportunity cost of capital is 7%. A proposed investment is
expected to yield 12%. Do you accept it?
S. David Young
INSEAD, April 2011
Value drivers vs. Indicators
Value
Creation
Value
Drivers
Attention to customers
Motivating employees
Managing product quality
Strengthening team orientation
Learning from failure
Optimizing inventory
Shortening prod-dev cycle
Indicators
Customer satisfaction
Employee productivity
Defect rate
Return on Invested Capital
Employee turnover
Working capital / revenues
Time from patent to product
S. David Young
INSEAD, April 2011
Value Drivers and KPIs:
Understanding the difference
Identifying Value Drivers
An illustration of how R&D and product
development drives value
How effectively do
new products /
technology
generate revenues
&/or cost savings?
How effective is
organization at
implementing
new technology /
products?
How effective is
organization at
converting new
tech. to actual
application ?
How effective is
organization at
grasping and
developing new
ideas?
How effective is
organization at
identifying and
acting on new
ideas?
Is organization
actively encouraging
idea generation?
# ideas
generated
Survival!
# ideas
introduced
# ideas become
actual technology
# new products
/ applications
Value creation
x
# implemented
products/activities
revenues/ cost
savings per idea
x
x
% ideas acted
upon
x
% conversion to
patent/next step
x
% convert tech.
to application
% launch to
client / activity
Time from idea generation to product launch / technology implementation
S. David Young
INSEAD, April 2011
The dangers of paying managers for KPI
outcomes
•Targets can be reached by creating value or destroying it.
The latter is nearly always easier.
Example: Suppose you are set a 15% target for operating
margin. You expect to earn 12%. What do you do?
•When outcomes are managed, indicators are no longer
“unbiased” measures. If managers get paid or evaluated
based on KPI outcomes, the results will always be biased.
•When KPIs are biased, how can we interpret them?
S. David Young
INSEAD, April 2011
Lessons learned
• Value creation is an imperative.
• Value and price are not the same thing.
• High performance is defined on a single dimension: an
understanding of, and ability to deliver, value.
• Every decision is either positive NPV or negative NPV.
• Value drivers and KPIs are not the same.
• Delivering on KPI targets is not value creation.
S. David Young
INSEAD, April 2011
Some more lessons learned
• Value creation is possible only when managers know their
opportunity cost of capital, and the cash flow consequences of
their decisions.
• Value-driven organizations are learning based, and learning
requires toleration of failure.
• The most important attribute of any performance measurement
system is whether it encourages truth telling.
• Maintaining organizational focus on value creation requires
constant vigilance.
S. David Young
INSEAD, April 2011