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Posted : 2013-03-03 10:12
Updated : 2013-03-03 10:12

Do you know your value pattern?

Companies are being forced to question their traditional assumptions and reconsider their priorities for value creation in today's low-growth economic environment. / Korea Times file

By Kim Youl-lee



Kim Youl-lee is a partner and managing director of The Boston Consulting Group.
Like the aftershocks of an earthquake, the consequences of the 2008 financial crisis continue to ripple throughout the global economy. The ongoing fiscal crisis in the euro zone has brought at least some European economies to the brink of renewed recession. Though the U.S. witnessed modest but genuine improvements in growth, it is not entirely clear whether the U.S. recovery will be able to sustain itself. Growth rates in emerging markets continue to outpace significantly those in the developed world and will continue to do so. However there are proliferating signs that these growth rates are slowing in many leading emerging markets such as China, India and Brazil.

Companies, therefore, are being forced to question their traditional assumptions and reconsider their priorities for value creation in today's low-growth economic environment. There are, however, leading companies that deliver superior value creation. Based on The Boston Consulting Group (BCG)'s findings on the analysis of total shareholder return performance at 1,003 global companies, these companies substantially outpaced not only their own industry average but also the total sample average. The top 10 companies in each industry outpaced their industry averages.

Though appropriate pathway and relevant priorities are different for these companies, they all manage to develop successful strategies that create sustainable value over time. How do these companies develop value creation strategies that truly fit the company's starting positions and opportunity sets? The clue is hidden in value patterns.

A value pattern describes how a company's starting position at a given point in time shapes the range and types of strategic moves that are most likely to create value. BCG identified 10 different value patterns through in-depth discussions with professional investors, detailed company vignettes, and a statistical clustering of about 2,700 global companies.

Value patterns share four general characteristics. First, they cut across industry boundaries. Each includes companies from quite different industries. And companies within a single industry may have quite different value patterns. Second, each group's profile is relatively stable over time — although individual companies sometimes move between groups. Third, capital structure, dividend payout, and other financial policies tend to differ by group. So do the tradeoffs between growth and margins, the pattern of "unlocks;" that is, the major value-creating moves, and the key pitfalls; that is, the ways companies in each group tend to destroy value. Finally, each of the patterns has distinct drivers of valuation multiples, and a few of the groups attract particular types of professional investors who specialize in that value pattern and have distinct screening criteria and metrics of interest.

Some value patterns are fairly intuitive and easy to grasp. For example, distressed companies, which take up roughly 4 percent of all public companies, have a specific and easy-to-recognize profile. They have high debt levels and severe constraints on liquidity. They often face external headwinds that result in low or negative returns on capital and negative organic-growth rates. They also trade at low valuations — the enterprise value in the market is lower than book value — reflecting their high risk and poor reinvestment economics.

At the other end of the spectrum, there is a healthy high-growth value pattern that most people recognize immediately. This pattern, which is seen in about 5 percent of all public companies, captures the challenges faced by healthy and successful companies that are still relatively young and growing rapidly. These companies have invented something new and are gaining share in the world as they commercialize their innovation. Their business is expected and also priced by investors to double sales several times over the next five to 10 years.

Some recent examples include companies with a highly scalable digital business model namely Facebook and Twitter, with an advantaged retail format that is still in growth mode such as athletic-apparel maker Lululemon Athletica and restaurant chain Chipotle Mexican Grill, or, more generally, with a proprietary product or service whose strong momentum has not yet grown fully into its visible potential like Intuitive Surgical, makers of a system for minimally invasive robotic surgery, and Cognizant, an IT consulting and outsourcing provider. Investors, seeing the strong prospects of these companies, value them at high multiples, often in the range of four to eight times enterprise book value.

Most companies fall somewhere between these two extremes. About three-fourths of all companies have some starting-position "spikiness" that differentiates them from the average company. These value patterns are distinctive, and to an outside observer — such as a professional investor — they suggest clear pathways to competitive success and value creation. About one in four companies, however, has a starting position that we call average. These companies have characteristics close to the average company in our sample. Instead of being able to focus on two or three clear issues in their investment thesis, they have to take a more balanced approach.

Value patterns do not offer a one-size-fits-all prescription or strategy cookbook. The investment thesis and strategic agenda for any particular company will be highly specific to its particular situation and will reflect critical issues not captured by the outside view of a company's starting position. In particular, there is an inside view, not fully visible to outsiders, that incorporates the management's view of the company's proprietary opportunities to create value.

Nevertheless, by identifying the types of actions that are more likely to create value, a company's value pattern is an essential input that helps inform the strategic agenda. Put another way, knowing your value pattern won't necessarily tell you what to do, but it will tell you where the better odds are — and where experienced outsiders might expect you to focus.

A working understanding of value patterns presents companies with following key imperatives.

Firstly, embrace the outside view. Engage honestly in understanding the realities of your company's starting position. How would a savvy investor describe it — for each major part of the business and for the company overall? Especially when there is bad news — a negative industry outlook, an underperforming business, or investments not performing as planned — it's critical to candidly embrace those facts and their consequences.

Secondly, frame an investment thesis that fits your value pattern. Every company needs an investment thesis — an agenda that outlines the handful of key actions that are required to drive attractive performance over a specific time horizon. This thesis is not a summary of broad aspirations or a catalog of advantages that the company enjoys. Rather, the investment thesis describes the short list of specific actions that, if successful, will create value. Management's ambition is an important input to that agenda, but ambition alone is dangerous. A good thesis guides and shapes ambition by incorporating the specific tradeoffs, risks, and pressure points of the company's starting position.

Thirdly, test every investment thesis for new ways of it being further unlocked. For every value pattern, there is a small set of specific and critical leverage points that have the potential to unlock large amounts of value. Leading category innovation, fixing a troubled business, simplifying the portfolio, paying down debt, returning more cash to investors, improving asset productivity, and other moves might be among the key moves that drive success. But which levers really matter depends on the value pattern.

Lastly, anticipate shifts from one value pattern to another. Over time, businesses change, and their competitive environments shift, sometimes abruptly. These changes trigger different business economics and investor expectations, causing a transition from one value pattern to another.

One of the biggest challenges facing executive teams is being able to recognize the significance of such shifts and respond quickly and appropriately. In many cases, these marketplace shifts require changing deeply held assumptions, which can be especially difficult for a team that is strongly committed to its current strategy. A knowledge of value patterns and their dynamics can provide a rapid "second opinion" on performance priorities as new events unfold.

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