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Volume I

L.E.K. Consulting
Shareholder
Va l u e A d d e d
Identifying and Managing Key
Value Drivers
Auckland

Over the years,L.E.K.Consulting Future issues will address


Bangkok
has worked with a wide variety of topics such as:
companies to help them implement
Beijing How Different are Share-
shareholder value techniques.In doing
holderValue Companies
so,we have found that a number of
MeasuringValue and
Boston fundamental questions are raised.We
Value Creation
have created this series to address these
Utilizing SVA to conduct
Chicago specific questions and others of interest
Acquisition Strategies
to our readers.Our hope is that each
issue of our Shareholder Value Added We hope that you will find
London
newsletter will spark a useful dialogue this series thought-provoking and
within your company. useful.Many of you will want others
Los Angeles in your organization to receive this
This issue presents an approach to
newsletter or have ideas on future
increasing performance which will
Melbourne topics.Please feel free to contact Leon
forge stronger links between operating
Schor at 1-800-929-4535 ext.9565 or
performance measures and shareholder
by e-mail at L_Schor@lek.com with
Milan
value creation.Our work has confirmed
your ideas or requests.
that many companies unintentionally
Munich reward managers for attaining perfor-
mance measures which have little
Pa r i s impact on value.This issue describes
how companies can identify key
drivers of value creation and structure
S a n Fr a n c i s c o
a performance measurement approach
around these value drivers.
Shanghai

Singapore

Sydney

B u s i n e s s S t r at e g y S h a r e h o l d e r Va l u e Mergers and Acquisitions


How Value Drivers Link to Value Creation Managing Value Drivers

Paths to Value Creation Value Drivers Corporate management has an on-


going mandate to maximize shareholder
Invest in Value Creating returns.But while maximizing share-
Growth Drivers
Growth Opportunities
holder value is an important corporate
objective,it is not specific and account-
Invest in Operating able enough for operating manage-
Efficiency
Value Creation ment,who must also know which
Efficiency Drivers
(SVA) factors most influence value,and which
Divest in Value
factors can be most easily effected.
Destroying Activities
We call these factors value drivers
and they are the primary focus of
Reduce Capital
Financial Drivers companies that succeed in maximizing
Cost
shareholder value.

Prioritizing Value Creating


ActivitiesThe Role of
Value Drivers

Identifying and managing value drivers


helps management focus their attention
on activities which will have the great-
Aligning Management Responsibility for Value Drivers est impact on value.This focus enables
management to translate the broad
Management Value goal of value creation into the specific
Level/Function Measurement Focus
actions most likely to deliver that value.
Executive & Shareholder Value There are three categories of
Senior Operating
value drivers:growth drivers,efficiency
drivers,and financial drivers. As shown
Marketing, Sales in the top figure, companies tend to
Growth Drivers
Business Development
manage these value drivers in four
ways. By focusing on value drivers,
Operations Efficiency Drivers management can prioritize the specific
activities which will affect performance
in each area.
Treasury, Finance Financial Drivers
Examining and defining paths
to value creation enables companies to
identify and understand responsibilities
by function and level within the
organization.This in turn helps
managers to focus their attention on
factors that really matter as shown in
the bottom figure.

L.E.K. Consulting llc

2
What is a Value Driver? Value Driver Matrix
We find that most companies manage
High
their business as if every operating
I IV
factor were equally important.Most
Manage Actively
operating managers have a solid
Monitor
knowledge of the variables which
impact business performance and
they manage that list aggressively. Key Performance
Indicators
The problem is that the list of
Management
variables is often too long,and may Influence
II III
be prioritized against goals other than
value creation.Valuable resources are
marshalled to increase market share,
Low Priority Hedge downside,
maintain pricing,increase distribution,
or reconfigure by
introduce new products,increase oper- changing strategy
ating efficiency,etc.,without a clear
sense of what truevalue drivers are.
Low High
There are two easy ways to identify Value
Impact
value drivers:

Value drivers have a significant


value impact,and What is Value Driver Step I: Develop a Value Driver
They are controllable.(For example, Analysis? Map of Your Business
commodity inputs may be important Value driver analysis is an important To understand where your companys
to your business,but since they are not foundation for strategic planning,help- value drivers lie,you must first break
easily controlled,they may not deserve ing management sort through their down the broad operating parameters
significant management attention.) operations to define critical strategic of the business into progressively smaller
TheValue Driver Matrix above levers.If,for example,growth drivers components until you reach the level
illustrates a framework for prioritizing are important to a particular firm, where daily operating management
value drivers.The task is to identify management can direct strategic plan- decisions reside.You then document
variables which reside in quadrant IV ning to focus on growth strategies.In which specific factors influence broad
and manage the resources directed at short,value drivers ensure that strategy measures such as sales growth,operating
influencing variables in quadrants is grounded in the reality of operating profit,etc.
I through III. performance.

Identifying value drivers is a


three-step process:

Develop a Value Driver


Map of your Business

Test for Value Driver


Sensitivities

Test for Controllability

L.E.K. Consulting llc

3
Value Driver Map for Petroleum Marketing

Retail Operating Costs


Linkages Controllable Factors Key Value Drivers Component Breakdown
Sales volume/mix Product losses/gains Refinery production
Capital Expenditures Refinery, imports at
Price (lubes) Gate price (no control) Product import Product cost
-run times,
Labor productivity Lube costs
Packaging Cost, etc.
Capital Expenditures Product losses/gains Depot cost
Working capital Depot automation Rail cost Distribution
Volume Headcount
Contractor deals Trucking cost Operating
Truck utilization Margin
Volume Automated sales Sales reps/mgr
Regional offices
Working capital systems Direct selling cost
Compensation policy
Wages Admin/mktg OH
Bonus/overtime Advertising

Volume Material cost Distribution


Capital Expenditures Repair contracts repair & maintenance
Working capital Maintenance programs Repair & Maintenance
Site
repair & maintenance Other

In theValue Driver Map for customers and managing trucking


Petroleum Marketing example,we costs.However,as theValue Driver
disaggregate operating profit first into Sensitivities example shows,these
the main components of cost and then factors have a relatively minor impact
into the key drivers of cost,such as on value relative to other factors.
trucking,rail and depot costs.In order
to develop the value driver map,the
physical flows and processes within the
business were examined to capture
critical linkages between value drivers. Value Driver SensitivitiesPetroleum Marketing

Industrial Retail
NPV impact of changes ($ Millions) NPV impact of changes ($ Millions)
Step II: Test for Value Driver
Sensitivities 0 200 400 600 800 1,000 0 200 400 600 800

Consumer Total Retail


After assembling base levels for each Margin and +10% 548 Margins and +10% 681
Recoveries Recoveries
operating factor,you must examine how
Volume +10% 14 Volume +10% 321
changes in each factor impact the over-
all value of the business.This usually Discounts -1% 221 Rentals +10% 6
leads to interesting insights which can
change management priorities. Truck cost -10% 26 Truck cost -10% 33

For example, the petroleum


Rail cost -10% 109 Rail cost -10% 281
marketing business was very focused
on increasing volume to industrial Investment -10% 92 Investment -10% 385

L.E.K. Consulting llc

4
Step III: Test for Controllability Key Value Driver MatrixPetroleum Marketing
Each variable must then be examined High
to discover those which management Working Retail Investment
can control.For example,within petro- Capital
leum marketing,the key value drivers
Consumer
Consumer Actively Manage
were discounting,retail volume,invest- Volume Strategic Priorities
Discounts
ment,and rail costs.This particular Retail
Truck Costs
market is heavily regulated,so pricing Volume
Storage
was not a controllable variable. Costs
Management
Influence
Value driver analysis requires Rail Costs

investing significant time and energy Consumer


Margins Can the company
on the part of management.It may enhance its
require information which is difficult influence over
less controllable
to access.It also involves developing Retail factors?
Margins
information about interrelationships
between variables within your business.
Low High
However,companies which have Impact of
Value
made this investment have found that
this analysis helps to focus management
attention on a manageable number
of value drivers.It can also provide
Summary
the foundation for determining
which strategies will optimize value One way to highlight value KeyValue Driver analysis can be a
driver performance and maximize driver performance is to build measures powerful way to focus management
value creation. of this performance into the regular attention on activities which will have
performance measurement systems the greatest impact on value. However,
and reward structures of the business. it does involve a significant commit-
How Do Companies Manage
Management must agree on which ment from management and should
Value Driver Performance?
value driver measures they want to be given high priority within the
Once management has built a track and then develop a regular organization if it is to succeed.
consensus around key value drivers, reporting structure which includes
Once completed,this analysis can
they can focus on the logistics of these measures.
help to ensure that strategies and deci-
increasing value driver performance.
Management incentives can also sion making are all aligned within the
If, for example, inventory management
be an effective way to highlight value true drivers of value for the business.
is a key value driver, management
driver performance.Value drivers can
can focus on the system and process
be substituted for other objectives in
improvements which will result in
annual incentive plans.These can be
increased inventory turns.
tailored by function to ensure that
managers are tied to value drivers which
they are responsible for managing.

L.E.K. Consulting llc

5
L.E.K. Consulting llc
For further information contact:

Boston Los Angeles


28 State Street 1100 Glendon Avenue
16th Floor 21st Floor
Boston,MA 02109 Los Angeles,CA 90024
Telephone: 617.951.9500 Telephone: 310.209.9800
Facsimile: 617.951.9392 Facsimile: 310.209.9125
Toll Free: 800.929.4535

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51st Floor 11th Floor
Chicago,IL 60606 San Francisco,CA 94111
Telephone: 312.913.6400 Telephone: 415.887.3207
Facsimile: 312.913.6401 Facsimile: 415.887.3061

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