Firms that invest in acquisitions, such as private equity firms and investment bankers, only achieve their end-goal by raising the market value of the acquired companies. Acquiring organizations are called capital market firms. Their ultimate financial gain is realized from the buy-sell spread when they divest each investment. But research studies reveal that only a minority achieve their targeted ROI. One study reported that less than half of mergers achieve their goal.1 Why such poor results? Do they over plan but under execute their economic value creation activities?

 

Five Value-Capture Categories to Realize Results

 

Realizing actual economic value from mergers and acquisitions (M&A) is a high stakes juggling act.2 So many things must be correctly executed to maximize the potential economic value. Problems arise such, however, as the disruptions from executive and employee turnover and poor strategy execution - both the modified business strategy and the M&A integration strategy.

 

Figure 1 displays five value-capture categories that contribute to lifting shareholder value from an enterprise’s initial conditions. Although this figure describes opportunities for an M&A deal, it can be applied to any existing commercial organization.

 

 

Employees fear that the majority of the value lift will come from the third arrow - operating expense savings - which is perceived as code for employee layoffs. How can all five of the arrows generate the lift?

 

How Can Performance Management Methodologies Unlock Potential Value?

 

There is confusion about what performance management (PM) at the enterprise level is; and PM is too often narrowly described as just visual dashboard measures and better financial reporting. It is much broader. PM is the integration of multiple managerial methodologies (e.g., customer relationship management, a balanced scorecard, Six Sigma) with an emphasis on analytics of all flavors, particularly risk management and predictive analytics. PM’s methodologies themselves are not new, but organizations tend to independently implement each of them sequentially, often using disconnected spreadsheet tools rather than formal and proven information technologies. PM deploys the power of business intelligence (BI) to enable decision-making.3

 

Although there are interdependencies of PM across all five value-capture categories, different PM methodologies play a prominent role in each category:

  • Integration strategy and management - The heavy lifting is done in the next four categories to the right in Figure 1. In the first category the main PM methodology is human capital management (HCM). Employees, like information, can be a powerful asset to lift ROI. A robust HCM system is not just an automated personnel database, but is much more powerful in aiding employee selection and retention. For example, an analytics-powered HCM system can quantify historical employee turnover and apply statistical correlations from that history to the existing work force to rank-order predict the most or least likely employee to resign and therefore enable management interventions. Both the employer and employee benefit. With an aging work force approaching retirement at many companies, an HCM system becomes essential.

  • Revenue growth - Several PM methodologies are engaged here:

    • Enterprise risk management (ERM). ERM goes beyond monitoring the traditional three pillars of market risk, credit risk and operational risk. ERM formally manages an organization’s risk appetite with its risk exposure.
    • Business strategy management and execution. David Norton, coauthor of The Balanced Scorecard book series, has stated that nine out of 10 companies fail to successfully implement their business strategy.4 PM addresses this with the integration of:
      1. Strategy maps;
      2. Scorecards (for strategic objectives and their associated key performance indicators (KPIs) with targets);
      3. Dashboards (to cascade downward all measurements for operational actions;
      4. Incentives; and
      5. Analytics (to drill down to examine problem areas plus predict future outcomes).5
    • Price optimization. Pricing is too critical to be a “thumb-in-the-air” intuitive feel for what price the market will bear. PM tools that optimize pricing include price elasticity analysis of consumer demand. This is incorporated into scalable forecasting and optimization routines that determine profit and volume maximizing price-point - for example, for each retail stock keeping unit (SKU) at a store specific level.
    • Product, service-line, channel and customer profitability. Profit is calculated as sales minus costs, but few managerial accounting systems properly trace and assign consumed resource expenses into costs; they rely on antiquated broadly averaged cost allocations that distort true costs and profits. Traditional costing practices mask and hide costs of a product or service as a lump sum. PM’s inclusion of activity-based cost (ABC) principles resolves these deficiencies. It is critical to have visibility and transparency of the contributing elements of costs - with accuracy - and to understand the many layers of profit margins.
    • Customer value management - To determine the value of a customer, marketing staffs have traditionally relied on basic customer recency, frequency and monetary spend data. That data is not enough. Today there is a much greater need for customer intelligence that measures psychodemographic information of customers as well as apply customer lifetime value metrics to answer the key questions. Some examples of key questions are: What types of customer microsegments should we retain, grow, acquire and win back? Which types should we not? How much should we spend with differentiated deals or offers on each microsegment so we don’t risk over-spending on loyal customers or under-spending on marginally loyal customers who may defect to a competitor? The more powerful and scalable PM technologies answer these questions and enable the ultimate microsegmentation - to the individual customer or consumer. Maximizing ROI is not accomplished by just growing sales, but rather by growing sales profitably. That is, smart revenue growth rather than growth at any cost.

  • Operating expense savings - The recent popular improvement initiatives of Six Sigma and lean management help the work force learn how to think (and PM provides more reliable and useful data for them, such as ABC information). But PM provides information for where to think. PM brings focus. Improved productivity from business process improvements will reduce expenses but there are diminishing limits, and breakthrough innovations stimulated by PM information will inevitably be required. Warranty and service parts expenses are often loosely managed, and PM addresses these with analytics that quickly detect minor problems before they escalate into major ones. PM also facilitates sourcing with supplier management and consolidation tools.

  • Asset efficiency - For product-based companies, a large portion of their working capital is inventory. PM’s solution to reduce inventories leverages statistically-based forecasts (updated periodically with demand history and potential influencing factors) to reduce uncertainty so a company can more confidently match its supply with demand. The objective is to minimize stockouts, shortages and surplus unsold items. The resulting right-time and right-amount inventories increase inventory turnover rates that in turn improve the financial gross margin return on investment (GMROI).

    For fixed assets, a growing portion of an organization’s expense structure is its information technology expenses, and PM supports managing these infrastructure expenses with IT value management reporting and planning systems of technology capacity and usage as well as their associated workforce requirements.

  • Cost of capital reduction - The cost of capital has two components: the amount required and its composite rate. PM methodologies contribute to reducing both.

    PM’s “more with less” productivity actions optimize the amount of assets and resources required to fulfill customer orders and meet strategic initiatives. For banks this means better control of their capital reserves. PM provides risk mitigation and reduced earnings volatility through powerful predictive analytics to reduce the cost of capital rate.

Performance Management’s Bonus Methodology - Rolling Financial Forecasts

 

Capital market organizations hate surprises. PM can not prevent surprises from fraud, ethics violations or unexpected financial restatements, but PM’s analytics can provide earlier warnings. A surprise that PM can reduce for capital market firms is an earlier alert that their acquired company will “miss their numbers.” Today the annual budget is arguably outdated as a financial control instrument in part because it is obsolete soon after being published. But worse, the annual budget is criticized for not effectively allocating resources to their highest returns. PM addresses these shortcomings by shifting the accountants’ mentality from negotiating the next fiscal year’s incremental percent spending changes with managers to a more logical approach. This approach models resource capacity planning, staffing levels and supplier spending.

 

Imagine producing a budget twelve times a year. That is a nightmare for the accountants. Budgets are financial translations of nonfinancial operations. PM tools combine future volume-based demand drivers (e.g., sales projections) with funding for strategic initiatives. Since sales forecasts are constantly updated and because a strategy is dynamic, not static, then with constant adjustments various PM methodologies automate the translation of operations into rolling financial forecasts.6

 

What Leads to the Unfulfilled Promises Of ROI for Capital Market Firms?

 

Capital market firms place high importance on executive leadership - and they should. From reading this article you may conclude that the PM methodologies are like cog gears, and executives, with the best-in-class technologies that support PM’s methodologies, can just push or pull the levers and pulleys and watch the dials. To achieve superior results, executive leaders must exhibit vision and inspiration. That is what a workforce responds to.

 

However, to fully achieve the highest potential in the right side of Figure 1 an enterprise can not rely on a rudder-and-stick to get there. The executive team and their work force need integrated business intelligence and PM software for those gears to mesh and revolve at faster speeds. The premier software technology not only integrates PM’s suite of methodologies, but its underlying architecture is on a common data platform and its compute power is optimized for analytics - particularly predictive analytics. The result and benefit is better, faster, cheaper and smarter.

 

Enterprise resource planning (ERP) software is helping companies get operational control, but ERP software is not designed to transform transactional data into information needed for decision support. As the capital market firms influence (or demand) their acquired companies to adopt and integrate PM methodologies with their supporting technology, their desired ROI targets will be achieved and possibly surpassed.

 

References:

 

  1. Dwight Allen. “Strategic Acquisitions Amid Business Uncertainty: Charting a Course for your Company’s M&A.” Deloitte Research, 2007.
  2. Carol Bailey and Trevear Thomas. “Mergers and Acquisitions: What CFOs Should Consider Asking Before the Deal is Done.” Deloitte Consulting, March 2008.
  3. Gary Cokins. “How does Performance Management and Business Intelligence Fit Together?” DM Review, April 2006.
  4. David Norton. “The Balanced Scorecard: Translating Strategy into Action.” Harvard Business Publishing, November 2006.
  5. Gary Cokins. “How are Balanced Scorecards and Dashboards Different?” DM Review, April 2008.
  6. Gary Cokins. “Put Your Money Where Your Strategy Is.” DM Review, January 2007.