A Refresher on Cost of Capital

Harvard Business Review

You’ve got an idea for a new product line, a way to revamp your inventory management system, or a piece of equipment that will make your work easier. You’ll likely be asked to show that the return on the investment will be better than your company’s cost of capital. To learn more about this commonly used business term, I spoke with Joe Knight, author of the HBR TOOLS: Return on Investment and co-founder and owner of www.business-literacy.com.

Why Sit on All that Cash? Firms Uncertain on Cost of Capital

Harvard Business Review

Many are deeply uncertain about which initiatives they should fund — and one root of this indecision is a general lack of confidence in the cost of capital projections they are using to make the call. This is the key finding of the Current Trends in Estimating and Applying the Cost of Capital research released this week by the Association for Financial Professionals, a trade group of 16,000 corporate treasury and finance practitioners.

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The Challenge Of Achieving Sustained Growth - Take Two

Six Disciplines

As reported in the Harvard Business Review's Daily Stat , the consulting group Bain's updated global database of Sustained Value Creators found only 12% of companies worldwide managed to grow profits and revenues more than 5.5% over the 10 years ending in 2008 and earn back their cost of capital. This study concluded that thirty of these companies were superior, based on growth over this period.

The Complexity of Business Communication

CoachStation

We may well be overcomplicating the language of leadership and business. Poor communication leads to confusion, mixed-messages and a lack of buy-in from our employees. Gabrielle Dolan: The Future of Leadership Conference, Bris, Sept 2015 After attending the Future of Leadership – Workplace Culture conference in Brisbane last week I have been reflecting on the content from some of the speakers. One stops to put on a pair of runners.

20 Quotes From The Daily Drucker

Six Disciplines

There is only one valid definition of business purpose: to create a customer. It is easier to raise the performance of one leader than it is to raise the performance of a whole mass. Listening (the first competence of leadership) is not a skill, it is a discipline. First, put down on a piece of paper a "boss list," everyone to whom you are accountable. The ultimate test of an information system is that there are no surprises. One can only be ahead of it.

How Passion Can Revolutionize Digital Technology, AND Change The.

Terry Starbucker

This once proud company had taken a bunch of body blows, and was staggering – badly. Its CEO at the time was great at cutting costs and preserving capital, but investors weren’t buying it. And change it did, because the new CEO had a vision that went beyond product, and costs, and overhead, and costs of capital.

The Rise of FinTech in Supply Chains

Harvard Business

A new type of services company could transform global supply chains: Financial technology companies that act as intermediaries in facilitating transactions between a company and its suppliers. They enable both the buyer and supplier to improve their working capital by making it possible for the former to extend its payables and at the same time accelerate payment to the latter. the supplier gets $9,959 of the $10,000).

How to Quantify Sustainability’s Impact on Your Bottom Line

Harvard Business

We thus wanted to figure out a way to help executives quantify the financial benefits of reducing their firm’s greenhouse gas (GHG) emissions. We chose Brazil’s beef industry as the location of our case study , both for the size and complexity of the industry and for its impact on the planet. of revenues) and $13 million to $62 million (0.01% to 0.7% of revenues). of the world market, and the second-largest beef producer and consumer.

What You Don’t Know About Sales Can Hurt Your Strategy

Harvard Business Review

The goal of strategy is profitable growth, meaning economic value above the firm’s cost of capital. There are basically four ways to create that value: (1) invest in projects that earn more than their cost of capital; (2) increase profits from existing capital investments; (3) reduce the assets devoted to activities that earn less than their cost of capital; and (4) reduce the cost of capital itself.

What’s Driving Superstar Companies, Industries, and Cities

Harvard Business

The debate about superstar firms and superstar effects has been intensifying, partly in response to the rapid growth of global US tech companies. We define superstar to mean a firm, sector, or city that has a substantially greater share of income than peers and is pulling away from those peers over time. We analyzed nearly 6,000 of the world’s largest public and private firms with annual revenues above $1 billion. counties, which account for 90% of GDP in that sector.

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The Case for Investing More in People

Harvard Business

“A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise output per worker.” ” There is a virtuous cycle between productivity and people: Higher levels of productivity allow society to reinvest in human capital (most obviously, though not exclusively, via higher wages), and smart investments result in higher labor productivity. Steven Moore for HBR.

What U.S. CEOs Should Do with the Money from Corporate Tax Cuts

Harvard Business

The size of this windfall is remarkable, and it comes from several sources. It permits immediate expensing of many capital investments. In a world already awash in investable capital , these changes should further widen the spread between after-tax investment returns and capital costs, driving up multiples. One option, of course, is to drive up the stock price by buying back shares, and some CEOs may choose that course. Emma Innocenti/Getty Images.

The Real Reasons Companies Are So Focused on the Short Term

Harvard Business

Quarterly profits have only increased 5% since 2012 , but investors’ valuations of those profits (as measured by earnings per share) has increased 59% over the same period. Some argue that profits are stagnant because of short-termism—that decades of focusing on current profits over long-run innovativeness has resulted, now, in companies that are hollowed out. Instead of hiring outside CEOs, hire insiders—or at least CEOs with domain expertise.

We Can’t Study Short-Termism Without the Right Metrics

Harvard Business

This can lead to faulty estimations of companies’ myopia. Of these, the last indicator is perhaps the most likely to accurately capture a company’s short-termism. For instance, McKinsey considered a smaller ratio of capital expenditure to depreciation to indicate short-term thinking, because it’s assumed that short-term companies will invest less, and less consistently, than other companies.

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A Refresher on Marketing ROI

Harvard Business

I talked with Jill Avery, a senior lecturer at Harvard Business School and coauthor of HBR’s Go To Market Tools , about this concept and what it tells leaders about their spending on marketing. Marketing ROI is exactly what it sounds like: a way of measuring the return on investment from the amount a company spends on marketing. It can be used to assess the return of a specific marketing program, or the firm’s overall marketing mix. Juan Díaz-Faes for HBR.

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Activist Hedge Funds Aren’t Good for Companies or Investors, So Why Do They Exist?

Harvard Business

Activist hedge funds have become capital market and financial media darlings. The Economist famously called them “capitalism’s unlikely heroes” in a cover story, and the FT published an article saying we “should welcome” them. The most comprehensive study of activist hedge fund performance that I have read is by Yvan Allaire at the Institute for Governance of Private and Public Organizations in Montreal, which studies hedge fund campaigns against U.S.

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The False Premise of the Shareholder Value Debate

Harvard Business

However, it feels to me that all of the argumentation contains an unhelpfully false premise. Proponents of shareholder value maximization got a crucial logical boost in the late 1970s when Mike Jensen, a friend of mine and a great scholar, made the argument that the only way a corporation can make intelligent decisions is if it has a single goal that it seeks to maximize because it is impossible to optimize two (or more) things at once.

Finally, Proof That Managing for the Long Term Pays Off

Harvard Business

Among the firms we identified as focused on the long term, average revenue and earnings growth were 47% and 36% higher, respectively, by 2014, and market capitalization grew faster as well. In recent years we have learned a lot about the causes of short-termism and its intensifying power. We can all see what appear to be the results of excessive short-termism in the form of record levels of stock buybacks in the U.S. and historic lows in new capital investment.

Why Traditional M&A Is Becoming Less Important

Harvard Business

Mr. Rockefeller’s business strategy was to vertically integrate every aspect of the oil business (exploration, development, logistics, marketing) to assure an ongoing competitive advantage. His vehicles were not just mergers and acquisitions, though there were plenty of both along the way. Rather, they were interlocking series of trusts, partnerships and alliances designed for flexibility and control. The new face of deal making will take a variety of forms.

Still Many Ways to Skin a Capital Cost

Harvard Business Review

When executives evaluate a potential investment, whether it's to build a new plant, enter a new market, or acquire a company, they weigh its cost against the future cash flows they expect will spring from it. Estimating the rate at which to discount the cash flows — the cost of equity capital — is an integral part of the exercise, and the choice of rate has a significant effect on estimates of a project's or a company's value.

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4 Ways Leaders Can Get More from Their Company’s Innovation Efforts

Harvard Business

A recent McKinsey report found that while 84% of corporate executives think innovation is key to achieving growth objectives, only 6% are satisfied with the innovation performance of their firm. While the execution of a conventional strategy lends itself to linear progress and clear benchmarks, innovation often proceeds by S-curves , moving at a slow crawl until it explodes at an exponential rate. Other times, however, one of those elements is missing.

ROI 30

6 Digital Strategies, and Why Some Work Better than Others

Harvard Business

As incumbents fight back with their own digital strategies, our research shows that they often trigger a second wave of competition, closer to the notion of Schumpeterian imitation where incumbents start themselves to innovate, sometimes aggressively, against the threat of entrants slashing yet more revenue and profit growth. The six types of digital strategy.

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How Blockchain Is Changing Finance

Harvard Business

Our global financial system moves trillions of dollars a day and serves billions of people. But the system is rife with problems, adding cost through fees and delays, creating friction through redundant and onerous paperwork, and opening up opportunities for fraud and crime. It’s no small wonder that regulatory costs continue to climb and remain a top concern for bankers. This all adds cost, with consumers ultimately bearing the burden.

How Banks Can Compete Against an Army of Fintech Startups

Harvard Business

Banking for small and medium-sized enterprises (SMEs) has been astonishingly unaffected by the rise of the Internet. The marketing, underwriting, and servicing of SME loans have largely taken a backseat. Other sectors of retail lending have not fared much better. Recent analysis by Bain and SAP found that only 7% of bank credit products could be handled digitally from end to end. The problem is that about 60% of small businesses want loans below $100,000.

CEOs Don’t Care Enough About Capital Allocation

Harvard Business Review

In his 1987 letter to investors, Warren Buffet made the following observation: “the heads of many companies are not skilled in capital allocation, and … it is not surprising because most bosses rise to the top because they have excelled in an area such as marketing, production, engineering, administration or, sometimes, institutional politics.” This failure to even mention return on capital seems perverse.

The Basic Principles of Strategy Haven’t Changed in 30 Years

Harvard Business Review

Almost every time I teach the basic concepts of strategy — the five forces framework or the principles of competitive advantage — I get the same question. ” Unfortunately, this question demonstrates a lack of understanding of the nature of knowledge. It the same as saying to a maths professor who is explaining the principles of calculus, “These ideas are more than 100 years old.

Strong Dollar, Weak Thinking

Harvard Business Review

The US dollar has appreciated dramatically over the past fifteen months — from a trade-weighted level of 102 in July 2014 to 120 recently. Americans can buy all sorts of foreign goods at an almost 20% discount from a year ago. The standard concern is that the high US dollar hurts America’s manufacturing cost position because US production costs are inflated by the dollar’s appreciation. Babo Schokker.

EPS 8

Shutting Down Stores Doesn’t Have to Be Bad for Business

Harvard Business Review

When The Gap recently announced its plans to close 175 of its 675 stores in North America, it joined a number of other retail chains — including Staples, Office Depot, Target, and Radio Shack — that have been or soon will be shuttering a slew of outlets for one reason or another. In retailing, most products, stores, business units, and even firms go through a life cycle of birth, midlife, and death.

Should Companies Retain "Strategic" Cash?

Harvard Business Review

To enhance financial flexibility, companies have been retaining unprecedented amounts of cash on their balance sheets, calling it "strategic" cash to distinguish it from the "operating" cash that is needed to run the business. This raises the question of whether retaining strategic cash makes economic sense and should be viewed as a legitimate corporate finance tool in today's environment. Much of the strategic cash is typically held outside the United States.

The Key to a Jobs Plan that Works

Harvard Business Review

There is no shortage of ideas on how to fix the economy. Open any newspaper and the ideas proliferate with an air of desperation: cut corporate taxes, increase personal taxes, decrease government spending, increase government spending, deregulate, re-regulate, ad nauseum. While I don't have the credentials of many of the experts (nor do I anticipate being a father-in-law for another 20 years), I do know a few things about making decisions.

The Comprehensive Business Case for Sustainability

Harvard Business

Today’s executives are dealing with a complex and unprecedented brew of social, environmental, market, and technological trends. Yet executives are often reluctant to place sustainability core to their company’s business strategy in the mistaken belief that the costs outweigh the benefits. Hoping to alleviate their concerns, this article also provides concrete examples of how sustainability benefits the bottom line.

The Three Decisions You Need to Own

Harvard Business Review

When resources are allocated from the bottom up instead of from the top down, they get out of sync with what the senior team is trying to accomplish. At many companies the total cash investment in acquisitions, R&D, and fixed assets has not earned back its cost of capital after adjusting for the time lag in realizing incremental benefits. We are shifting our center of gravity.” CEOs face countless decisions.

The Most Common Mistake People Make In Calculating ROI

Harvard Business Review

Your company is ready to make a big purchase — a fleet of cars, a piece of manufacturing equipment, a new computer system. But before anyone writes a check, you need to calculate the return on investment (ROI) by comparing the expected benefits with the costs. If a company earns a $500,000 profit in a calendar year, shouldn’t it have $500,000 more in the bank on December 31 than it did on January 1 of that year? Most of your time will be spent on this step.

Even for Companies, the U.S. Is Split Between Haves and Have-Nots

Harvard Business Review

The worldwide trend of rising economic inequality applies not only to individuals. Companies in the top one-fifth of profitability earn, in aggregate, about 70 times more economic profit (accounting profit less cost of capital) than those in the middle three-fifths combined, according to McKinsey’s database of 3,000 large, publicly listed, nonfinancial U.S. The comparison is imprecise, of course, but nevertheless suggestive.

What Your Stock Price Is Really Means

Harvard Business Review

There is a fascinating relationship between executives and the stock prices of the companies they manage. On the one hand, executives generally want their stocks to rise, affirming the perceived health of the enterprise they run and padding their remuneration. The vast majority of executives think that their price is too low, but few can articulate an analytical case that backs that intuition. Next, compare the expectations of the market with those of management.

When "Creative Destruction" Destroys More than It Creates

Harvard Business Review

When changes in the natural environment accelerate, so do the extinction rates of the Earth's creatures. The same happens in business, and we are clearly entering a period where the extinction of the slow, the inflexible, and the bureaucratic is about to happen in record numbers. A list of the top 20 banks today contains only seven that were on the list a decade ago. Consider these three statistics from our ongoing analysis: Nearly two-thirds of companies now destroy value.

Providing Earnings Guidance? Think Again

Harvard Business Review

As we conclude another earnings season, then, it's a good time to consider the advisability of providing earnings guidance. It's a question that has defied consensus, with valid arguments on both sides of the issue. The arguments center on the value of establishing increased transparency with investors, and include: Higher Stock Price: The advocates for guidance argue that it can result in a higher stock price.

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Desperately Seeking Simplicity

Harvard Business Review

The softly drifting snowflakes that greeted me every morning at the World Economic Forum in Davos this year were an inadequate warm-up for the cold blast of reality I felt in session after session during this five day Congress on the "state of the world.". I heard it in the opening remarks of WEF founder Klaus Schwab who talked about a growing phenomenon of "burn-out" among world leaders with finite energy and time to put against seemingly bottomless complexity.

Divestment Alone Won’t Beat Climate Change

Harvard Business Review

The fossil fuel divestment movement — an increasingly popular approach with environmentalists — primarily tries to convince pension funds, university endowments, and other asset holders that their investments in oil and coal are unethical because of impact of fossil fuel emissions on the world’s climate. Both of us have done work on sustainable development and are keen to see a transition away from fossil fuels in order to limit climate change.

Divestment Alone Won’t Beat Climate Change

Harvard Business Review

The fossil fuel divestment movement – an increasingly popular approach with environmentalists — primarily tries to convince pension funds, university endowments, and other asset holders that their investments in oil and coal are unethical because of impact of fossil fuel emissions on the world’s climate. Both of us have done work on sustainable development and are keen to see a transition away from fossil fuels in order to limit climate change.

Why the 21st Century Will Belong to Family Businesses

Harvard Business Review

An oft-cited statistic is that only 30% of family businesses make it through the second generation, 10-15% through the third, and 3-5% through the fourth. How many companies of any kind are still around after the equivalent of three or four generations? A study of 25,000 publicly traded companies from 1950 to 2009 found that, on average, they lasted around 15 years, or not even through one generation. Investment: From Other People’s Money to Captive Capital.

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Why Data Breaches Don’t Hurt Stock Prices

Harvard Business Review

Recent high-profile data breaches like those at Target and Home Depot have exposed the private sensitive information of millions of employees and consumers. While consumers are rightfully worried that their personal information may be compromised, shareholders and companies’ management have a wider set of concerns, including loss of intellectual property, operational disruption, decreased customer trust, tarnished brand, and loss of investor commitment.

Get the Strategy You Need — Now

Harvard Business Review

Two uncomfortable strategic truths face the vast majority of executives and companies – and probably you, too. Though both statements may sound extreme, they are the clear implication of new McKinsey research on how companies create value and allocate resources. The widespread absence of a powerful strategy is clear from our recent study of 3,000 of the world’s largest companies, which finds that just 20 percent in that group create 90 percent of its total economic profit.