McKinsey on Finance

High tech’s coming consolidation 1

Perspectives on
Economic pressures to restructure high tech will eventually become
Corporate Finance
irresistible. More acquisitions loom.
and Strategy
When efficient capital and operations go hand in hand 7
Number 11, Spring
Olli-Pekka Kallasvuo, Nokia’s head of mobile phones and a former
2004
CFO, discusses strategic organization, performance measurement, and
the value of financial transparency.

All P/Es are not created equal 12

High price-to-earnings ratios are about more than just growth.
Understanding the ingredients that go into a strong multiple can help
executives make the most of this strategic tool.

Putting value back in value-based management 16

Value-based management programs focus too much on measurement
and too little on the management activities that create shareholder value.
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High tech’s coming
consolidation
Economic pressures to restructure high tech
will eventually become irresistible. More
acquisitions loom.
Bertil E. Chappuis, For some time, the rules of economics
Kevin A. Frick, and
appeared not to apply to the high-
Paul J. Roche
technology sector. Growth slowed, profits
shrank, and investors eagerly awaited the
billions of dollars in value likely to flow
from mergers, acquisitions, downsizings,
and liquidations. All signs pointed to an
imminent restructuring, yet until recently
little occurred.
Today consolidation pressures are mounting
fast, and some segments have already
succumbed. Where operating systems for
PCs, midrange computers, and mainframes
were once numerous, now only a few
remain. Ditto for database software. Niche
players in segments such as vertical-specific
applications may remain fragmented, thanks
in part to the unique nature of the value
propositions they offer.
To develop a sense of how imminent
consolidation really is, and to pinpoint the
segments within and outside high tech that
might encounter challenges or opportunities
in the trend, we investigated the extent to
which the economic forces driving
consolidation were at play in 21 of the
High tech’s coming consolidation | 1
sector’s leading industries. The indicators
we looked at included each industry’s
fragmentation levels, maturity (as measured
by growth rates), and profitability. We also
considered incentives for consolidation, such
as the need for scale to justify larger capital
expenditures and the importance of scope
to meet the customer’s changing needs.1
Where and how
We found strong signs of impending
restructuring in 11 of the industries we
analyzed (Exhibit 1). These hot spots
account for more than two-thirds of the
sector’s revenues—a fact that speaks
volumes about its ripeness for consolidation.
In IT services, for example, professional and
outsourcing services seem to be poised for
an across-the-board restructuring. Software
is vulnerable in particular areas, such as
enterprise applications, network and systems
management and security, middleware, and
software for application servers. In
hardware, the targets are PCs and notebook
computers, networking gear, and storage
systems; in semiconductors, they are logic,
memory, and semiconductor equipment. Our
research also found many small and midsize
companies that are barely profitable, if at
all, with cost structures more appropriate to
larger businesses (Exhibit 2).
As economic forces take effect, companies
will jockey for increased scale or scope or
for some combination of both (Exhibit 3).
As in any sector, scale-driven mergers,
which aim to streamline fixed costs over
greater volumes and to satisfy the demand
for bigger and more stable suppliers, will
mostly take place between companies
competing in the same industry. Customer
needs will also influence mergers that are
undertaken to achieve advantages of scope.
Indeed, deals of this nature have already
2 | McKinsey on Finance | Spring 2004

exhibit 1

Ripe for restructuring

Key IT industries and segments,1 2002, % of revenues

Ripe for restructuring
Software ($146 billion)

• Enterprise applications • Database

• Operating systems • Desktop applications

Semiconductors ($174 billion) • Vertical applications • Storage

• Logic • Network/systems • Middleware,

management, security application server
• Microcomponents

• Memory

• Analog
17
• Semiconductor equipment
35
• Discrete Hardware ($299 billion)
20
• PCs/notebooks

• Servers
28
• Networking

• Printers

• Storage

IT services ($243 billion) • Smart handhelds

• Professional and
outsourcing services

1 Metricsexamined include market growth rate, 2002–07 (industry maturity); Herfindahl–Hirschman Index (fragmentation levels); number of top 10
companies with negative earnings before interest and taxes in 2002 (industry profitability); qualitative assessment of scale, scope, changes in customer
buying behavior (incentives for consolidation).
Source: McKinsey analysis

taken place: in response to financial fabrication plants. Consolidation has

pressures and to the clamor of capital already taken place in certain pockets, such
markets, companies that manufacture as deposition, diffusion, and lithography,
technology products have been acquiring but the industry as a whole remains
service firms. We expect such mergers to fragmented; only a handful of companies,
proliferate as companies expand their including Applied Materials and Tokyo
breadth of product or service offerings to Electron, have significant positions in more
position themselves as preferred suppliers than one or two areas. The need to
for big customers, to chase new profit consolidate will therefore inspire scale deals
streams, and to hunt for cross-selling and in the few areas that are still fragmented
multichannel synergies. (automation, assembly, and packaging),
while demand for complete process-module
The semiconductor-equipment industry, for solutions means that scope deals are likely
one, is likely to see both scale and scope across industries. Vendors will thus capture
come into play as companies prepare to sales and marketing synergies by selling to
serve fewer and bigger semiconductor the same customer base. Moreover, an
manufacturers, only some of which will be integrated solution across related areas
able to finance next-generation research and (such as deposition and etching) can shorten
 High tech’s coming consolidation | 3

exhibit 2

Unsustainable

Average EBIT1 margin of public IT companies by revenues,2 2002, %

Revenues Software Hardware IT Services Semiconductors

<$50 million –320 –167 –29 –59

$50,000,000–$99,999,999 –1 –1 –3 –13

$100,000,000–$299,999,999 2 –1 4 –9

$300,000,000–$499,999,999 –2 2 5 –15

$500,000,000–$999,999,999 12 4 6 2

$1 billion–$5 billion 11 3 6 –4

>$5 billion 29 5 6 11

1 Earnings before interest and taxes.

2 Includes 2,121 companies worldwide in software (913), hardware (562), IT services (266), semiconductors (380).
Source: Bloomberg; Thomson Financial; McKinsey analysis

development cycles and ramp-up times. The the long view and the need to prepare for
enterprise software market will restructure more hostile deals.
along similar lines.
Leaders and challengers
Restructuring could also be triggered by When industries consolidate, market leaders
companies that exit an industry altogether. and challengers can make acquisitions
This is likely to happen in the PC business if within their industries to create economies
some incumbents decide that the benefits of of scale or across industries to gain
merging are questionable in light of the economies of scope. To know what to do
industry’s deteriorating economics. Finally, and when, companies need to develop a
where mergers and acquisitions don’t make perspective on restructuring trends and the
sense, companies might forge alliances or way these affect their particular industry. To
transform themselves without resorting to envision the likely endgame, they should
alliances or M&A. consider shifts in customer behavior and the
factors required for success. And as they
Shape IT or leave IT make their moves, they must evaluate how
The economic rationale for consolidation competitors will probably respond.
might be similar in all sectors of the
economy, but restructuring unfolds in ways Market leaders. In restructuring sectors,
specific to each of them. In the same vein, market leaders aim to protect their position
our perspective on how to respond to from challengers while seizing opportunities
high-tech consolidation begins at a general to extend their dominance; they therefore
level (Exhibit 4), then tackles specifics. make acquisitions to head off those
We’ll examine the two classic roles— challengers and to increase their scale. In
market leader and challenger—before the high-tech sector as a whole, market
discussing the advantages for M&A of leaders should defend the customer base by
4 | McKinsey on Finance | Spring 2004
exhibit 3
Scale, scope, or skedaddle
Restructuring activity
Scale: peer consolidation
Scope: strategic cross-
segment moves
Exit
1 Selling, general, and administrative.
Source: McKinsey analysis
tightening their control of the value chain
and customer relationships or by creating
scale advantages in R&D and sales. Oracle,
for instance, is pursuing a broader footprint
and new growth in its play for PeopleSoft.
Scale offers efficiencies in large fixed costs—
essential in industries requiring massive
up-front capital investment (like memory
chips) or expensive R&D (like software). It
also extends control over the value chain.
Customers gain confidence in the vendor’s
ability to provide long-term support services
and are more likely to choose it as a
preferred supplier. HP’s merger with
Compaq, for example, gave HP enhanced
control over its value chain, cost synergies,
and access to additional customers, to which
it could now sell more comprehensive
solutions. These factors should help HP
compete with IBM and Dell.
Scope acquisitions can broaden the
footprint of a leader and increase the
dependence of its customers. Cisco Systems’
growth strategy in the 1990s was based on
Drivers Examples
• Improved fixed-cost structures (SG&A,1 R&D, • Logic
depreciation)
• Memory
• Customer preference for bigger suppliers
• Network/systems management, security
• Network, platform effects
• Storage hardware
• Customer preference for broader-reaching suppliers • Database: middleware, application server
• Channel, cross-selling synergies • Hardware: IT services
• Technological synergies (such as those between • Networking hardware: storage
networking and storage) hardware, software
• Value migration from hardware to software, services • Semiconductor equipment
• Maturing core businesses; capital market pressures
for growth
• Desire to limit losses, free up capital • Logic
• Refocusing resources on other businesses • PCs/notebooks
scope acquisitions, and the company swiftly
used its distribution capabilities to stake out
strong positions in access solutions and
security. Microsoft’s purchase of Great
Plains Software and Navision extended its
reach into enterprise applications. EMC’s
acquisition of Legato Systems presaged a
move away from the slower-growth and
rapidly commoditizing storage-disk-
subsystem market and into the system-
management-software market—a core
control point of an enterprise IT
infrastructure. The company’s decision to
buy Documentum shows a similar move
into content management.
For companies in some segments,
such as IT services, scope deals offer
an opportunity to become the prime
integrator for customers’ needs; IBM’s
acquisition of the consulting arm of
PricewaterhouseCoopers is a recent
example. A few words of warning should
be sounded, however: if the acquisition has
a different revenue model (as in the case of
a hardware company acquiring a software

exhibit 4
The big picture
Strategy
Type of company Scale Scope
Market leaders Grow bigger; Cross-sell to
buy or block boost customer
challengers dependence
Challengers Merge with Buy adjacent
peers businesses
Small companies Carve out
sustainable niche
Source: McKinsey analysis
one), the buyer must avoid compromising
the target’s underlying business model.
Challengers. Typically, a challenger in a
restructuring industry confronts industry
leaders by “rolling up” smaller companies
to achieve scale or by merging with another
challenger, thereby driving radical cost-
structure changes through operational
integration and redesigned business
processes. PeopleSoft’s acquisition of
J. D. Edwards in enterprise applications
provides a good example of a challenger
buying a peer to reduce operating costs.
The combined company can use its larger
scale to become a preferred supplier to
key customers.
Alternatively, a challenger can attempt to
extend its scope by acquiring players in
adjacent industries and combining the
offerings into solutions, with the eventual
aim of changing the basis of competition.
BEA Systems, for example, started with a
transaction-processing product and then, by
acquiring companies such as WebLogic,
gained leadership in the application server
and middleware market, where we expect
further consolidation. Second-tier storage
and networking vendors could also benefit
from teaming up in this way, as might
companies in middleware and network
High tech’s coming consolidation | 5
management. In semiconductors, several
companies could combine to form a large
chip maker focused on consumer
Exit electronics. (Beyond high tech, banks such
as Morgan Stanley and UBS Warburg have
used scope combinations to reposition
themselves as financial-services providers.)
Such deals challenge the acquirer to create a
Maximize compelling value proposition and to build a
sale value
sales force that can communicate it
forcefully enough to displace incumbents.
If confronting the market leader directly is
too risky, companies can pair up to carve
out a defendable niche. IT service providers
could take this approach in health care, say,
if they found themselves unable to compete
more broadly. Aspiring niche players must
assess whether they can create sustainable
entry barriers based on proprietary
technology, innovation, industry knowledge,
or locked-up customer ties.
Selling out. Finally, the best way to recoup
value is sometimes to sell part or all of a
company. In this case, it is often wise to
move sooner rather than later to get the
highest value for shares and to position the
company in the most attractive light, which
may mean shedding noncore assets. Such
moves sometimes unlock resources that can
be reinvested to make a company stronger
in more strategic segments.
The long view
Market reactions to merger announcements
tend to favor the target; fewer than half of
high-tech acquirers see their shares rise after
disclosing their plans. No wonder boards
and executives are wary of acquisitions. But
the most successful high-tech companies—
those averaging more than 39 percent
annual growth in returns to shareholders
from 1989 to 2001—were serious deal
6 | McKinsey on Finance | Spring 2004
makers, undertaking almost twice as many
acquisitions as their competitors.2 History
also shows that companies with active
M&A agendas tend to outperform their
peers during and after industry downturns.3
Companies that avoid acquisitions often run
out of steam, whereas enterprising acquirers
renew and refocus themselves.
Companies should be cognizant of, but not
overly concerned with, investors’ short-term
reactions. Instead, they need to ensure that
the long-term returns from their acquisition
plans maximize shareholder value. Take
Intel, which in recent years has acquired
several suppliers of communications chips.
Not all of the deals have been applauded as
successful by observers (for example, the
acquisition of Level One Communications),
but together they helped Intel establish a
new communications growth platform on
which the company has built a multibillion-
dollar business.
High valuations can sometimes make
alliances more enticing than M&A,
especially if synergies wouldn’t justify a full
acquisition. Dell’s recent alliances with
EMC and Lexmark are examples of how
these arrangements can be used as a low-
risk step to broaden a company’s scope into
new segments.
More hostile deals
Most technology mergers have been small,
friendly affairs financed by the acquirer’s
stock, but we expect that picture to change.
Oracle’s attempt to acquire PeopleSoft is an
early example of what could become the
new reality in high-tech restructuring.
Executives and boards should thus prepare
for hostile takeovers, cash deals, and the
greater involvement of private equity
firms—all common in other sectors.
Furthermore, as companies reach for scale
and scope, they will attempt larger deals.
While a hostile takeover is rarely the
preferred approach, these deals are likely to
become more common, especially when the
target’s management has strong incentives
to resist an acquisition that has real
economic logic. For acquirers with deep
pockets, cash offers may be more attractive
in hostile situations, when cash can give
shareholders a low-risk way to take money
out of their investments.
The scale and extent of the coming shifts in
the high-tech sector promise to unlock
tremendous value for companies that
survive the consolidation. However quickly
change comes, those that act wisely can
position themselves as the shapers of high
tech’s next era. MoF
The authors wish to acknowledge the contributions of
Jukka Alanen and Jean-Francois Van Kerckhove,
consultants in McKinsey’s Silicon Valley office.
Bertil Chappuis (Bertil_Chappuis@McKinsey.com)
and Paul Roche (Paul_Roche@McKinsey.com) are
principals in McKinsey’s Silicon Valley office, where
Kevin Frick (Kevin_Frick@McKinsey.com) is an
associate principal. Copyright © 2004 McKinsey &
Company. All rights reserved.
1
To measure the strength of each driver, we used qualitative
and quantitative metrics such as the Herfindahl-Hirschman
Index (a common metric established by the US
Department of Justice and the US Federal Trade
Commission) to assess the current degree of
fragmentation.
2
Kevin A. Frick and Alberto Torres, “Learning from high-tech
deals,” The McKinsey Quarterly, 2002 Number 1,
pp. 112–23.
3
Richard F. Dobbs, Tomas Karakolev, and Francis Malige,
“Learning to love recessions,” The McKinsey Quarterly,
2002 special edition: Risk and resilience, pp. 6–9.
 When efficient capital and operations go hand in hand | 7
When efficient capital
and operations go hand
in hand
Olli-Pekka Kallasvuo, Nokia’s head of mobile
phones and a former CFO, discusses strategic
organization, performance measurement, and
the value of financial transparency.
Fredrik Lind and Nokia’s transformation from a Finnish
Risto Perttunen
conglomerate with its roots in pulp and
paper to the world’s leading mobile-phone
supplier has earned it a reputation as a
model of innovation, brand building, and
operational efficiency. Even during the
severe downturn in the telecommunications
industry the company maintained strong
margins on its sales of mobile phones.
Today Nokia runs 16 manufacturing
facilities in 9 countries, conducts R&D in
11 countries, and has more than 51,000
employees around the world
Nokia is reorganizing itself yet again as it
anticipates increased demand for high-tech
phones and other mobility products.
A base of four business groups—mobile
phones, networks, multimedia, and
enterprise solutions—will exploit scale
advantages across common functions such
as finance, marketing, and operations to
provide maximum flexibility for business
units. The goal: “to go after every market
in this industry and take share.”
So says Olli-Pekka Kallasvuo, who in
January of this year was named head of the
mobile-phones group after serving as chief
financial officer from 1992 to 1996 and
1999 to 2003. A lawyer by training,
Kallasvuo, 50, sees his move from finance
to the leadership of the business group
responsible for most of Nokia’s profits as
perfectly natural. In an interview conducted
at Nokia headquarters outside Helsinki,
Kallasvuo spoke to Fredrik Lind and
Risto Perttunen of McKinsey about Nokia’s
strategy, communicating with markets, and
the CFO’s mind-set when operational and
capital efficiencies go hand in hand.
McKinsey on Finance: What long-term
trends in the handset business do you see,
and how are they affecting Nokia’s strategy?
Kallasvuo: The biggest long-term trend is
our customers’ increasing mobility and, as a
result, their demands for ever more
sophisticated handsets. In one sense, it’s a
kind of convergence of businesses into a
new business domain defined by mobility.
The result is that we’ll continue to see a
very simplistic entry-level phone, with no
bells and whistles, on one hand, and on the
other hand we’ll see a multipurpose device
that has all sorts of capabilities, like mobile
gaming or mobile imaging. This is what we
need to tackle at Nokia, and hence the
reorganization to align our structure to
different segments of this market.
MoF: How do you think about measuring
performance?
Kallasvuo: The thinking over the years
has definitely changed. We’ve learned to
understand that for us, traditional measures
of performance like working capital, for
example, are financial matters, yes, but
more important they’re indicators of how
a company is performing operationally.
8 | McKinsey on Finance | Spring 2004
Olli-Pekka Kallasvuo
Vital statistics
• Born July 13, 1953, in Lavia, in western Finland
Education
• Holds a Master of Laws degree from the University of Helsinki
Career highlights
• Nokia, Inc. (1980 to present)
– Assistant vice president of the legal department (1987)
– Assistant vice president of finance (1988)
– Senior vice president of finance (1990)
– Executive vice president and chief financial officer (1992 to 1996)
– Corporate executive vice president, Nokia Americas (1997 to1998)
– Chief financial officer (1999 to 2003)
– Executive vice president and general manager of mobile phones at
Nokia (2004–present)
Fast facts
• Served as chair and board member of Helsinki Stock Exchange from
1991 to 1996
• Serves on the boards of:
– Sampo, a Finnish full-service financial group
– Nextrom Holding, a Swiss machine manufacturer
– F-Secure, a Finnish company specializing in data security solutions
• In spare time, enjoys golf, tennis, and reading about political history
When I look at working capital, I really
see it first as a reflection of efficiency and
then as a reflection of where our capital is
invested, which is the reverse of the usual
way of thinking.
MoF: So how do you track the company’s
performance over time?
Kallasvuo: A more capital-intensive
business would probably look much more
closely at its returns on investment, but
ROI just is not as useful a measure for a
company that makes its money by investing
in people, in research and development, and
in brand marketing. Measures of efficiency
are much more helpful—operational
efficiencies, production efficiencies, and yes,
financial efficiencies—and they really all go
hand in hand. Production efficiencies and
capital efficiencies are very relevant for
every finance person at Nokia.
And if there were just one single thing to
do to improve performance, it would have
been done already. Improvement is usually
not about making a quantum leap; it’s
about taking small steps, improving a little
bit every day. Nor is this about pushing
responsibility off to individual departments
and saying, “You look at working capital,”
or, “You look at inventory.” These are the
responsibility of everyone at Nokia because
efficiency is the core of the business—
and then working capital becomes a
reflection of how efficient we are, and
that’s why it’s such an important indicator
that remains very high on our agenda even
if financially it’s not critically relevant at
the moment.
MoF: Can the corporate team and the CFO
team contribute to and lead the different
divisions and businesses on the working
capital dimension?
Kallasvuo: No; this is exactly the point.
Efficiency is so intricately entwined in the
system that everyone has a stake in it,
everyone is helping out. So if you were to
start some big push for working capital at
Nokia, with a big headline saying, “Now we
are going to emphasize working capital,” or
announce that suddenly financial concerns
will drive everything, no one would
understand what you’re talking about.
Everyone understands that working capital is
everyone’s job—by taking those little steps
to get logistics working even better. This is
one of our key competitive areas.
MoF: Are there any particular structures
or processes at Nokia to make this
cooperation work?
Kallasvuo: In the end, it really comes down
to a company’s business infrastructure and
 When efficient capital and operations go hand in hand | 9
how it operates in general. As we have
grown from a small, flexible player to such
a large company, we’ve put considerable
effort into combining flexibility and
economies of scale, which has an impact on
how we operate. The emphasis has been on
doing everything we can to take advantage
of economies of scale where we can and
where it makes sense, but not to centralize
anything that is business specific. We’ve
drawn that line very carefully. If something
is business specific, it gets maximum
flexibility, empowerment, decentralization.
If it’s not business specific, then let’s take
the economies of scale. The result has been
an increasing platformization, if you will, of
the business infrastructure. And here the
business infrastructure means other than IT,
so it’s a wider concept.
MoF: What have been the special challenges
of communicating the results of a very fast-
growing company to financial markets?
Kallasvuo: Communicating results is easy.
Giving estimates is more of a challenge,
because in this type of fast-moving business
no one can really know what will happen
over three months—no one. No system in
this world can make that prediction in a
way that is certain. The best you can do is
communicate your best understanding to
the market at the time, which is actually
pretty simple.
At Nokia, we have been simply communi-
cating our best possible understanding to
the market. We have not been playing
games. I was personally criticized by some
investors for not playing games—for not
giving an estimate and then exceeding it by
one penny, which so many companies were
doing. Now, of course, everyone feels this
way. Whatever numbers come out of the
system, in accordance with your accounting
principles, those are your results.
MoF: What is your view of the emergence
of companies over the past year or so that
are minimizing their financial transparency
to the markets?
Kallasvuo: Of course, I can’t speak on
behalf of other companies, but I feel that
our investor base wants quarterly guidance.
It’s very much a matter of providing the
markets with the information they want,
rather than telling them what we think they
should want. This isn’t brain surgery. If the
markets want information, you give them
information.
The question has to be, how can we better
understand what our investors want? The
mind-set really needs to be that we must
listen and communicate in terms of what is
expected. This is very relevant coming from
a small market and growing into one of the
most traded shares in the world. We come
from a context where we really didn’t have
the benefit of the doubt when it came to
our existence and our ability to deliver over
the long-term. It really was an imperative to
listen to what investors expected—if we did
not have that mind-set, we never would
have become one of the most widely held
shares in the United States.
MoF: What is the optimal way to distribute
value back to the shareholders—for example,
through share buybacks or dividends?
Kallasvuo: I don’t think there is a big
difference between dividends and buybacks.
In the end it’s a pragmatic choice, very
much driven by tax questions and the
shareholder base. Otherwise they’re both
pretty equal from the financial perspective.
10 | McKinsey on Finance | Spring 2004
MoF: How important is it for a company to
be listed in the United States?
Kallasvuo: It’s really not possible to
become a major name among US investors
if you’re not represented in the US market
in a major way. Being listed supports the
business, and the business supports the
listing—which Nokia’s experience in the
1990s illustrates very well. Indeed, I
would claim that without its listing in
New York, Nokia would not have become
the market leader in the United States.
Furthermore, if it had not become a
market leader in the United States, the
share story would have been a lot less well-
known. When we first issued our IPO in
the United States, it wasn’t really that we
needed US capital but rather that the listing
would support the business, which is how
it worked out. The result was a positive
spiral, if there is such a thing, each one
supporting the other.
MoF: And how has that transformation
changed your relationship with shareholders—
on both sides of the Atlantic?
Kallasvuo: Sometime in 1995 or 1996,
we became the first company in the world
with a major market cap that had the
majority of its market capitalization coming
from outside its home country, as domestic
Finnish share dipped below 50 percent.
That happened very suddenly and
continued at a rapid pace. Other
companies have since found themselves in
similar positions, but not to the same
extent. So we basically said to ourselves,
“Now we have to see ourselves as a
US company and we have to do things in
the same way a US company would,
because that’s what a majority of our
investors will expect.”
That became a real priority. For example,
instead of having our US investor relations
(IR) staff report to an IR executive in
Helsinki, we located the IR head office for
the entire company in the United States—and
then of course allocated a lot of resources
and everything to make it work. Even the
Helsinki-based IR office reported for many
years to the US office. When it came to
communications, we said to ourselves, we
need to communicate like a US company.
Even today, if some capital-markets-related
legislation or other comes out of the United
States that isn’t necessarily applicable to
non-US companies, we comply anyway, even
if the legislation does not, strictly speaking,
apply. There is no other way for us.
Other companies have chosen exactly the
other way: to be domestic first and
foremost, abiding primarily by their own
government’s practices and legislation and
domestic shareholders. Which one is wrong
or right I can’t say.
MoF: And how comfortable are you with
Nokia’s current level of transparency?
Kallasvuo: I can say that every time we have
had a discussion internally about whether
we should go into this more transparent
reporting, and every time we have made a
decision to report instead of holding back,
the decision to report has been the right
decision, eventually. It’s what I feel. Not
once have I looked back and thought, “Why
did we have to tell this?” But here again,
I would suggest that theories aside, in our
case it’s been a necessity. You are foreign.
You are an ADR.1 You don’t have the option
of not listening to what the market wants.
MoF: Is there any risk, as Nokia begins
reporting separately for multimedia
 When efficient capital and operations go hand in hand | 11
handsets and enterprise solutions? What if
one unit doesn’t achieve very good results?
Kallasvuo: No, definitely not. As I said,
every time we’ve increased our transparency
it was the right decision, so it must be the
right decision here too. And you have to also
remember that external pressure is good for
you. It makes you run even harder. The
people running those operations have even
more reason to perform if external pressure
is there also. That’s been our experience.
MoF: Has the CFO been a part of the
strategic decision-making process in Nokia,
and do you see that role being strengthened
in the future?
Kallasvuo: I don’t really think there is one
and only one role for a CFO. Of course, the
role of a CFO has to be aligned with the way
the company operates, and it also depends
very much on the size of the company. But it
really can’t be the same in every company, in
every business situation, and in every type of
business a company is in.
At Nokia, being CFO has meant being
very much a part of the management
team, looking at matters from a financial
perspective but really not taking the role
of a finance guy who primarily becomes
the voice of that department. Instead of
defining the role in one way and taking
that into the management team, the CFO
at Nokia has a responsibility for the same
decisions as everyone else on the
management team. Yes, of course, you
might look at those decisions from a
certain perspective, but that doesn’t have
to mean that you always take the same
sort of role. You have to be more versatile
than that, which makes the role a very
strategic one.
MoF: In many companies, the role of the
CFO has been expanding on the traditional
role in two directions: the first is a more
strategic-architect or strategic-planning type
of role, even to the point of having M&A
or strategy divisions; the second is moving
toward a more involved operations role,
enhancing some business-controlling
activities or leading corporate-pricing or
working-capital programs. What are your
thoughts on the evolution of the CFO role
in general?
Kallasvuo: If you assume a traditional sort
of controller role as the starting point, then
yes, those are the two natural directions for
the role to evolve. But because it varies
depending on how the company operates,
it’s also possible that both of those roles
might even be combined. The latter role—
the more involved operations role—is
particularly apt for the CFO of a major
business unit, which is very much an
operational role in an operational unit.
The former, more strategic role is more apt
for a corporate, head-office CFO who
operates, supervises, and oversees several
business units. And both are quite relevant
at Nokia, too, because of how we operate
and how the roles of the business units or
even business groups have been defined.
And I would also claim that the role of the
CFO must be aligned to the approach of
the CEO. Without alignment, success is
difficult. MoF
Fredrik Lind (Fredrik_Lind@McKinsey.com) is a
principal in McKinsey’s Stockholm office, and
Risto Perttunen (Risto_Perttunen@McKinsey.com)
is a director in the Helsinki office. Copyright © 2004
McKinsey & Company. All rights reserved.
1
American depository receipt
12 | McKinsey on Finance | Spring 2004
All P/Es are not
created equal
High price-to-earnings ratios are about more
than growth. Understanding the ingredients that
go into a strong multiple can help executives
make the most of this strategic tool.
Nidhi Chadda, When it comes to price-to-earnings ratios,
Robert S. McNish,
most executives understand that a high
and Werner Rehm
multiple enhances a company’s strategic
freedom. Among other benefits, strong
multiples can provide more muscle to
pursue acquisitions or cut the cost of
raising equity capital. Unfortunately, in
their efforts to increase their P/E, many
executives reflexively try to crank up
growth. Too many fail to appreciate the
important role that returns on capital
play in channeling growth into a high or
low multiple.
Simply put, growth rates and multiples don’t
move in lockstep. For instance, the retailer
Williams-Sonoma has a P/E multiple of
about 21, based on earnings growth over
15 percent in the past three to five years
and low returns on capital.1 By contrast,
Coca-Cola has a slightly stronger P/E at 24,
despite its lower growth rate.2 Coke’s
secret? Returns on capital over 45 percent
relative to a 9 percent weighted average cost
of capital.
It’s common sense: growth requires
investment, and if the investment doesn’t
yield an adequate return over the cost of
capital, it won’t create shareholder value.
That means no boost to share price and no
increase in the P/E multiple. Executives who
do not pay attention to both growth and
returns on capital run the risk of achieving
their growth objectives but leaving behind
the benefits of a higher P/E and, more
important, not creating value for
shareholders. They may also discover that
they have confused their portfolio and
investment strategies by treating some high-
P/E businesses as attractive growth
platforms when they are actually high-
returning mature businesses with few
growth prospects.3 Better understanding of
the way growth and returns on capital
combine to shape each business’s multiple
can produce both better growth and better
investment decisions.
Doing the math on multiples
The relationship between P/E multiples and
growth is basic arithmetic:4 high multiples
can result from high returns on capital in
average or low-growth businesses just as
easily as they can result from high growth.
But beware: any amount of growth at low
returns on capital will not lead to a high
P/E, because such growth does not create
shareholder value.
exhibit 1
Companies can have identical P/E multiples
for dramatically different reasons
Expected Expected Implied P/E
ROIC growth multiple1
Growth, Inc 14% 13% 17
Returns, Inc 35% 5% 17
1 Assuming 10% cost of equity, no debt, and 10 year’s excessive growth
followed by 5% growth at historic levels of returns on invested capital.
Source: McKinsey analysis

exhibit 2
Sustaining high growth requires considerably
more reinvestment than sustaining high returns
Growth, Inc1
Year 1 Year 2
Operating profit less taxes 100 113
Reinvestment 93 105
Free cash flow 7 8
Reinvestment rate
93%
1 Assuming 10% cost of equity, no debt, and 10 year’s excessive growth
followed by 5% growth at historic levels of return on invested capital.
Source: McKinsey analysis
To illustrate, consider two companies with
identical P/E multiples of 17 but with
different mechanisms for creating value.
(Exhibit 1). Growth, Inc., is expected to
grow at an average annual rate of
13 percent over the next ten years, while
generating a 14 percent return on invested
capital (ROIC) which is modestly higher
than its 10 percent cost of capital. To
sustain that level of growth, it must
reinvest 93 cents from each dollar of
income (Exhibit 2). The relatively high
reinvestment rate means that Growth, Inc.,
turns only a small amount of earnings
growth into free cash flow growth. Many
companies fit this growth profile, including
some that need to reinvest more than
100 percent of their earnings to support
their growth rate. In contrast,
Returns, Inc., is expected to grow at only
5 percent per year, a rate similar to long-
term nominal GDP growth in the United
States.5 Unlike Growth, Inc., however,
Returns, Inc., invests its capital extremely
efficiently. With a return on capital of 35
percent, it needs to reinvest only 14 cents
of each dollar to sustain its growth. As its
earnings grow, Returns, Inc., methodically
turns them into free cash flow.
All P/Es are not created equal | 13
Because Growth, Inc., and Returns, Inc.,
take very different routes to the same
P/E multiple, it would make sense for a
savvy executive to pursue different growth
Returns, Inc1
Year 1 Year 2
and investment strategies to increase each
100 105 business’s P/E. Obviously, the rare company
14 15 that can combine high growth with high
86 90 returns on capital should enjoy extremely
Reinvestment rate
14%
high multiples.
The hard part: Disaggregating
multiples
Not many executives and analysts work to
discern how much of a company’s current
value can be attributed to expected growth
or to returns on capital. Those who try
often fail. To see why, consider one widely
used model to break down multiples as it
might be applied to a large consumer goods
manufacturer and a fast-growing retailer
with similar P/E ratios (Exhibit 3).
The first step is to estimate the value of
current earnings in perpetuity, assuming no
growth.6 The model then attributes the
remaining value to growth. The
interpretation from this simple two-part
approach would be that the market assumes
that the consumer goods manufacturer
would have better growth prospects than
the retailer.
But this reading misleads because it doesn’t
take into account returns on capital.
Discount retailers fight it out primarily on
price, which translates into lower margins
and relatively low returns on capital—similar
to Growth, Inc. In contrast, consumer goods
companies compete in an environment where
brand equity can generate higher margins
and returns on capital, making them more
like Returns, Inc. In fact, the simple two-part
model is wrong. The discount retailer is
actually expected to grow faster and to
14 | McKinsey on Finance | Spring 2004

exhibit 3

Traditional assessments of enterprise value can lead to a misinterpretation of where value

comes from

100% = operating enterprise value

Traditional decomposition ROIC1-growth decomposition

ROIC: 38%
Consumer goods manufacturer, P/E: 20 48% 52% 48% 50% 2%
Implied growth: 5.1%
Fast-growing retailer, P/E: 20 50% 50% ROIC: 12%
Implied growth: 9.5%2 50% 29% 21%

Value from current Value from future Value from current ROIC premium Value of
earnings in perpetuity earnings performance expected growth
with no growth

1 Return on invested capital.

2 From 2004 to 2018.

Source: Compustat; Zacks; McKinsey analysis

create more value from growth than the on capital and growth in shaping a
consumer goods company, whose high company’s P/E is to expand the simple
valuation would be primarily based on high two-part model and draw out a P/E
returns on capital. premium for high returns on invested
capital. This approach effectively
An executive relying on the faulty analysis disaggregates value into three easily
produced by such a simple model might flirt understood parts:
with trouble. The CEO of the consumer-
goods company Current performance. Current performance
The best way to understand might increase is still estimated in the usual manner, as the
investment or value of current after-tax operating earnings
the respective roles of returns
discount prices to in perpetuity, assuming no growth.
on capital and growth in drive growth, Intuitively, this is the value of simply
potentially maintaining the investments the company
shaping a company’s P/E is
destroying has already made.
to expand the simple two- shareholder value
in the long run. By Return premium. This is the value a
part model to draw out a
digging a little company delivers by earning superior
premium for high returns deeper and returns on its growth capital. In order to
appreciating the assess how a company’s return on
on invested capital.
role of returns on growth capital influences its P/E multiple,
capital, the CEO would more likely focus on we recommend discounting a company’s
protecting high returns and market share. cash flows as if they grew in perpetuity at
some normalized rate, such as nominal
Accounting for the ROIC premium GDP growth.7 Through repeated analyses,
How can we avoid these misinterpretations we have found that the result is a good
and still keep the analysis relatively simple? proxy for the premium a company enjoys
In our experience, the best way to in the capital markets because of its high
understand the respective roles of returns returns on future growth capital. In our

example, the consumer goods manufacturer
would enjoy a large return premium,
consistent with its high historical returns
on capital.
Value from growth. This value represents
how much a company delivers by growing
over and above nominal GDP growth. It can
be calculated as that portion of the
company’s current market value that is not
captured in current performance or the
return premium.8 While more sophisticated
and time-consuming analyses are sometimes
appropriate, in our experience executives
can learn a lot about their P/E multiple with
this simple three-
While more sophisticated part model.
analyses are sometimes
How might an
appropriate, executives can executive change
his or her insights
learn a lot about their P/E
about the consumer
multiple with this simple goods company and
the discount retailer
three-part model.
using this three-part
model? The consumer goods company
would be seen to enjoy a large premium for
its return on capital. In the consumer goods
sector, preserving that return premium must
be paramount, but anything the company
can do to increase its organic growth rate
while preserving its return premium would
translate directly into shareholder value and
the possibility of a very high multiple.
In contrast, the CEO of the discount retailer
would face a tiny premium for return on
capital, since his or her company derives
most of its value from the rapid growth
prospects. Anything this company could do
to increase its ROIC, possibly even reining
in its growth rate, would add value. By
applying the model to calibrate the trade-off
between growth and return, the CEO could
All P/Es are not created equal | 15
even determine that a top management
priority is to redirect some attention from
growth to operations improvement.
High P/E multiples can serve as a powerful
strategic tool. Executives who understand
the complex chemistry of growth, returns,
and P/E multiples will be better positioned
to make strategic and operating decisions
that increase shareholder value. MoF
Nidhi Chadda (Nidhi_Chadda@McKinsey.com)
and Werner Rehm (Werner_Rehm@McKinsey.com)
are consultants in McKinsey’s New York office.
Rob McNish (Rob_McNish@McKinsey.com) is a
principal in the Washington, DC, office.
Copyright © 2004, McKinsey & Company.
All rights reserved.
1
Adjusted for operating leases, Williams-Sonoma’s ROIC
has historically averaged about 10 percent, the same as its
cost of capital.
2
Coke reports earnings around 3 percent over the past
seven years.
3
Likewise, stock market investors can make the same
mistake by thinking they are investing in high P/E “growth
stocks” when in fact some of these stocks are high-
returning “value” investments.
4
For instance, assuming perpetuity growth for a company
without any financial leverage, P/E = (1 – growth/return on
capital)/(cost of capital – growth).
5
Real GDP growth over the past 40 years in the United
States was 3.5 percent.
6
At no growth, we assume that depreciation is equal to
capital expenditure, and therefore net operating profits less
adjusted taxes (NOPLAT) is equal to free cash flow for a
business that does not grow. In effect, the first contributor
is calculated as NOPLAT divided by the company’s cost of
capital.
7
This can be achieved without an explicit discounted cash
flow model by using, for example, the value driver formula
derived by Tom Copeland, Tim Koller, and Jack Murrin,
Valuation: Measuring and Managing the Value of
Companies, third edition, New York: John Wiley & Sons,
2000.
8
For a company that grows more slowly than GDP, this
value will be negative.
16 | McKinsey on Finance | Spring 2004
Putting value back
in value-based
management
Value-based management programs focus
too much on measurement and too little on
the management activities that create
shareholder value.
Richard J. Benson- Value-based management (VBM) burst
Armer, Richard F.
onto the scene a decade ago with a
Dobbs, and
Paul Todd revolutionary promise: a company that
traded in traditional management
approaches in favor of VBM could align its
aspirations, mind-set, and management
processes with everyday decisions that truly
add shareholder value. Name the initiative—
investing in a new project, say, or spinning
off a subsidiary, or implementing new
customer-service guidelines—and
management could not only pinpoint better
projects but also better understand the value
they would create for shareholders. Indeed,
well-implemented VBM programs typically
deliver a 5 to 15 percent increase in
bottom-line results.
Sadly, even as VBM has evolved, most
programs are notable more for their
implementation shortfalls than for their
successes. In our ongoing work and
discussions with executives, we have begun
to identify a few common pitfalls that have
repeatedly plagued underperforming
VBM programs going back years as well as
some newer wrinkles that stanch the benefits
that VBM can deliver. We’ve also developed
an anecdotal view of how the most
successful practitioners push the principles
of VBM to achieve its real promise for
shareholders.
Simply put, ailing VBM programs typically
settle for merely measuring value creation in
business initiatives, while successful
approaches push to link tightly the
measurement to how the business can be
improved. For example, some companies
mechanically measure historical
performance but then fail to apply what
they’ve learned to the strategies from which
value should flow. Most also neglect to
account for future growth and
sustainability. Others make this important
link but then set targets in ways that fail to
mobilize the troops needed to make VBM
pay off. Still others go to great lengths to
implement VBM programs but then relegate
them to the finance department, where they
languish without the commitment of senior-
level management.
Troubled VBM programs do not necessarily
manifest all these symptoms at once. In our
experience, however, the vast majority
suffer from at least one. Moreover, the best
practitioners have learned to overcome them
and can provide guidance about how to
push VBM to better fulfill its potential.
Missing the link between
measurement and value
The original breakthrough of value-based
management was to draw attention to the
failure of traditional accounting measures,
such as net income and earnings per share,
to account for the cost of capital.
Traditional managers focused far more
intently on improving cost and gross
margin and paid little if any attention to
the capital invested in the business. As a

exhibit 1
Metrics designed to measure value have strengths—and weaknesses
Traditional P&L and balance sheet approaches
• Revenues
• EBITDA1
• Net income
• Book value
• ROS1
• EPS1 (diluted or not)
• Relevance for management declining, but still
widely used by companies for communication to
investors (e.g., EPS)
• Economic cost of the capital invested ignored
• Growth, long-term performance, and sustainability
not taken into account
1 EBITDA = earnings before interest, taxes, depreciation, amortization; ROS = return on sales; EPS = earnings per share; ROE = return on equity; ROCE =
return on capital employed; ROIC = return on invested capital; ROA = return on assets; EVA = economic value added; DCF = discounted cash flow; IRR =
internal rate of return; CFROI = cash flow return on investment
Source: McKinsey analysis
result, it was common to find projects in
which much of the capital deployed in
businesses was wasted.
As managers focused on value creation and
the true economic cost of capital deployed
in the business, VBM proponents
introduced metrics to measure a business’s
or program’s value, including return on
invested capital (ROIC), economic profit,
cash flow return on investment (CFROI), or
economic value added (EVA™).1 The
advantages of different measures vary
(Exhibit 1), but they all attempt to
recognize the cost of capital in the
benchmarks managers use to gauge the
value their decisions create.
Yet many companies fall into the trap of
focusing their measurement too much on
historical returns, which are easily
quantified, and too little on more forward-
looking contributors to value: growth and
sustainability. For instance, one consumer
goods company (Exhibit 2) was able to
demonstrate strong economic returns for
Putting value back in value-based management | 17
Value creation: historical metrics Value: forward-looking metrics
• Return ratios • DCF1-value
–ROE1 • Discounted EVA1
–ROCE,1 ROIC1 • IRR1
–ROA1 • CFROI1
• Economic profit or EVA1
• Widely used concepts orientated • Required for active management of
towards taking into account the company’s value
economic cost of the capital in the • Explicit consideration of growth and
business long-term impact of decisions
• Growth, long-term performance, and
• High correlation to market value of
sustainability not taken into account company
• Much harder to measure accurately
and so can be gamed
five years as measured by economic profit.
But because the company delivered its
growth by increasing prices, it ultimately
damaged its customer franchise and could
not sustain its growth rate.
Companies that apply VBM at a more
advanced level move beyond measurement to
help the management team focus on the
levers that can be used to improve the
business. The best programs use value trees2
to identify underlying drivers of operating
value. These have long been at the core of
VBM theory, but we find that they are still
conspicuously missing in many applications.
Savvy VBM practitioners use these trees to
identify areas of improvement, pushing deep
into a business’s operating performance and
comparing it with others to create clear
benchmarks. These benchmarks can also be
pegged to the performance of peers outside
the company, or to the performance of
similar internal businesses. One particularly
informative and credible internal benchmark
comes from analyzing the historical
18 | McKinsey on Finance | Spring 2004
exhibit 2
Financial measures alone are inadequate
Economic profit went up, to a point . . . . . . but proved unsustainable, as market
Year 1 = 100 share steadily declined, %
200 60
50
160
40
120
Profit growth due 30
80 to price increases 20
40 10
0
1 2 3 4 5 6 7
0
1 2 3 4
Year Year
Source: McKinsey analysis
performance of the same business over time.
For example, one processing company’s
analysis found that daily performance alone
varied so widely that the management team
didn’t need to look for outside benchmarks.
Instead, they could improve the overall
performance of the company enough just by
focusing their efforts on the levers that led
to the most severe underperformance on
bad days.
The error in focusing on targets
rather than how they are set
A second common VBM pitfall stems from
the way executives set performance targets
and hand them down to the individuals
responsible for meeting them. These targets
may seem perfectly reasonable to the
managers who set them, but they often
appear arbitrary and unrealistic and convey
little sense of ownership to the teams that
receive them. In our experience, only when
those assigned to meet the targets also
actively help in setting them is a company
likely to generate the understanding and
commitment needed to deliver outstanding
performance (Exhibit 3). Indeed, we find
the process of setting targets to be the
single biggest factor in delivering superior
VBM performance.
Consider the experience of one global
consumer goods company. When the
corporate technical manager ordered that all
the company’s bottling lines should achieve
75 percent operating efficiency, regardless of
their current level, some plant operators
rebelled. Operators at one US plant,
concluding that at 53 percent their plant was
running as well as it had ever run, worked
5 6 7
only to maintain performance at historical
levels. Yet after the plant launched an
inclusive process to permit the operators to
set their own performance goals, they raised
performance levels above the 75 percent
target over a period of only 14 months.
The most effective VBM programs fine-tune
this dynamic even more. As they set targets,
some build in a challenge from peers
running similar businesses. This approach
helps to stretch targets, to highlight
accountability in view of peers, and to
create the sense of commitment and
purpose that comes from collaborating on
tough issues. Because colleagues running
similar businesses will be familiar with all
the opportunities for improvement, they
will be much more effective than line
managers at providing such challenges.
Companies that have excelled at VBM
programs arrange them not only on overall
profitability but also on capital expenditure,
growth, pricing, and costs—as well as
performance during the year. Others create
formal processes that encourage mutual
support among colleagues to improve the
performance of the business. At one of
Canada’s largest privately held companies,
for example, stronger performers are
explicitly assigned to help their colleagues
who are not performing as well.
Or consider how one chemical company
designed a more effective way to review
 Putting value back in value-based management | 19

exhibit 3

Involve managers early in KPI1 definition process to ensure acceptance and accountability

Success factor This Not this

Guided self-discovery
• Managers discover the key value drivers and KPIs for
themselves
• The process, rigor, and insights will be shared between
units
• External team (or a staff team) does
the analysis and develops value drivers
and KPIs

Strong senior management leadership • Management actions and messages emphasize value • Senior managers, publicly or privately,
creation and value-based shaping of the management communicate or act in ways that do not
agenda reflect the value drivers and KPIs

Inclusive and open communication • Relevant staff is involved both in analysis and rollout, • Staff is told what the new value drivers
with a clear understanding of the ultimate objective and KPIs are

Fact-based debate and challenge • Discussions and decisions are based on facts • Discussions and decisions are based on
personal preferences and past actions

Link to ‘real deliverables’ • KPI framework leads to clear assignment of • KPI work is done separately from the
accountabilities for targets and actions budget and targeting processes

1 Key performance indicator.

Source: McKinsey analysis

performance. A year after introducing a
VBM approach to make reported data
more transparent, the company had yet to
see the improvements it expected. Worse,
nearly everyone in the organization
recognized that official discussions about
performance were something of a sham.
Some managers misrepresented reports
of their actual performance in order to
create the appearance of meeting targets;
others built enough slack into future
performance targets to make sure they
would easily be met.
The company’s response: change the review
process. What had been a one-on-one
review involving the division head and unit
leader became a broader discussion between
the division head and all unit leaders
together. And rather than simply reviewing
the data, the meeting focused on the most
important lessons from the previous
reporting period, as well as the greatest
risks and opportunities expected to appear
in the coming reporting period. Emphasis at
the meeting shifted away from individual
successes and failures to a combination of
shared lessons and problem solving on
future risks and opportunities.
Next the company introduced a series of
peer meetings among unit leaders without
the division heads present. These meetings
aimed to review plans and identify risks and
opportunities in order to set priorities for
allocating capital and resources. In the first
year of operating under the new processes,
capital outlays dropped 25 percent and
underlying profits, adjusted for the usual
modulations of the business cycle, rose by
10 percent.
Not ingraining VBM in day-to-day
business processes
Setting targets and committing to meet them
is one thing. It’s another to make sure that
performance targets are acted upon. This
process happens by making certain that
specific individuals are accountable and
responsible for making decisions and by
20 | McKinsey on Finance | Spring 2004
guaranteeing a link between performance
and an individual’s evaluation process.
One energy company, for example,
implemented a VBM program that seemed
to have all the right parts. But management
then failed to carry it over from a discrete
program in the finance department to
engage the
Until a VBM program is an entire company.
This result was
integral part of how a company
despite the fact
manages, it will always be that the
company’s
simply something else to do
finance team
and will inevitably fail. developed a
first-rate
scorecard covering financial performance,
operating drivers, organizational health,
and customer service. Nearly a year later,
there was no discernible impact. Beyond
top-level conversations, few of the
company’s managers used the scorecard—
some didn’t even know what it was. They
had had no involvement in the program’s
development, little understanding of why
the new scorecard was necessary, and no
incentive to use it. The few that did use it
found that targets regularly were missed.
Some companies overcome this pitfall by
using a formal performance contract to
explicitly link the key performance
indicators—such as sales, profit margin,
return on investment, and customer
satisfaction—with roles such as sales
manager, business unit manager, finance
manager, and call-center manager
respectively. This link forces an explicit
conversation to take place about whether
roles and decision rights are correctly lined
up. Other companies link their people-
evaluation system to hitting targets, with
explicit rules about dismissals for
individuals who fail to meet their targets
more than once. By tying performance
evaluation and compensation to individual
objectives, performance can also be aligned
with the objectives of the VBM program.
A rule of thumb: until a VBM program is
an integral part of how a company
manages, it will always be simply
“something else to do” and will inevitably
fail as employees continue to perform as
they always have. Finance department input
is essential, for example, but delegating
VBM to the finance department as a
discrete, isolated program is a surefire way
to snuff its potential.
Too few VBM programs have fulfilled their
early promise. But recognizing common
patterns in programs that have gone awry is
a first step in moving VBM closer to its goal
to help line managers deliver better
performance for shareholders. MoF
Richard Benson-Armer (Richard_Benson-
Armer@McKinsey.com) is a principal in McKinsey’s
Toronto office. Richard Dobbs (Richard_Dobbs
@McKinsey.com) is a principal in the London office,
where Paul Todd (Paul_Todd@McKinsey.com) is an
associate principal. Copyright © 2004 McKinsey &
Company. All rights reserved.
The authors wish to acknowledge the valuable
contributions of Joe Hughes, Tim Koller, and
Carlos Murrieta to the development of this article.
1
EVA is a registered trade mark of Stern, Stewart & Co.,
New York, and is synonymous with the more generic term,
“economic profit.”
2
Tom Copeland, Tim Koller, and Jack Murrin, Valuation:
Measuring and Managing the Value of Companies, third
edition, New York: John Wiley & Sons, 2000.
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