-> DEF: indicators which provide managers with earlier signals (drivers) of value creation:

• Are endless & company specific.

Introduction:

-> Untill now we analysed:

• ACCOUNTING-BASED INDICATORS: measure mainly profitability and liquidity of the company.
  • Look only at the next 12 months;
  • Doesn’t consider the medium-long term perspective.
• VALUE-BASED INDICATORS: measure the EV (enterprise value) and E (equity value).
  • Look at the medium-long term perspective.

-> PROBLEMS:

• TIMELINESS: it’s needed to decide very fast in a company (these indicators require time to be computed);
• OVERALL VISION: don’t give a detailed vision of the single function of the company;
• CONNECTIONS: it’s difficult to connect the everydaty action to the FS & the capability of generating enterprise value.

=> We need another type of indicators: the VALUE DRIVERS.

The “Value” Tree:

-> DEF: tools to understand how increase the equity or enterprise value.

• Create a cause-effect relationship.

-> CHAR:

• We can use it to show what are the Competitive Advantages of the company.
• The value drivers are non-financial indicators.
• Was invented by Pirelli.

EBITDA = REVENUES – CASH COST

CASH COST: cost that will generate a cash outflow (installments).

• ⚠️Depreciation is not a cash cost;
• Are all the cost in the IS without Depreciation.

How companies use the data:

(in italy, source: Politecnico di Milano internal resource)

1. The usage of traditional financial indicators is 85,7% (14% of large companies are not using traditional financial indicators);
2. DCF: Discounted Cash Flow, is an important value based indicators, and it’s used only by 47,6% of companies!!!

-> The percentage of its use is very low: organization don’t use this indicator, because is very difficult to compute.

Building Value Drivers:

-> Tipically we study the Enterprise Value because is directly connected to the Business Unit inside the company.

-> Value-Based Indicators (EV, FCFF, Cost of Capital, TV) are connecetd to the Accounting-Based Indicators (EBITDA, revenues, cash cost, receivables, inventories, payables).

-> We can divide the REVENUES as…

• SALES: revenues from existing products;
• MARKETING: revenues from new products.

-> Looking at the last line we can define clear objectives (reducing TTM, improving customer satisfaction, establish more relationship) and actions: we are closer to the functions.

• The value tree is directly connected to the Competitive Advantages (DEF: everything that we can connect logically to the EBIT).

TTM, Time to Market: is the time from the idea generation of the product (all the analysis, assessment) to the first unit sold in the market (tipically, could be different).

NPPY: are ne number of product that are thinked every year.

Too many indicators:

-> We don’t want too much indicators, because:

• Managers get stressed:
  • They have to decide with too much data (more than 20 numbers) because we don’t know the inner connections of this data, or;
  • They have to decide without information;

-> It’s a Pareto approach: the 20% of the data explain the 80% of variation.

• Conflicts and contradictions. Indicators shouldn’t be isolated: the real value is in their connections.

-> Use the value tree to choose the best indicators.

The Value Drivers non-financial Indicators:

-> DEF: are all the indicators which provide managers with EARLY SIGNALS (drivers) of value creation.

-> CHAR:

• Are endless & company-specific (because strategy is different company by company);
• Since they are fast we assume that are 100% NON FINANCIAL (but they could be not);
• 🔼TIMELINESS: is the main advantage;
• 🔼LONG-TERM ORIENTATION: shall select the right indicators.
• 🔽MEASURABILITY: it might be ambiguous. Solved by implementing a protocol for each indicator where the following information is clarified.
  • Measure: title of the measure;
  • Purpose: whiy does the company want to measure this?
  • Formula: how this measure must be measured?
  • Unit of analysis: which is the object of measure this=
  • Sources of data:
• 🔽COMPLETENESS: each indicator refers to a specific factor (no synthetic measure);
• 🔼SPECIFIC RESPONSIBILITIES: measure related to day-by-day.

-> TYPOLOGIES:

• PERFORMANCES DRIVERS: mainly non-financial of the present performance of the company (time, quality, productivity, flexibility, engironment & society)
• RESOURCE DRIVERS: mainly non-financial, reflect the main resources of the company that will be able to generate value in the future (money, technology, human resources, image & reputation).
• KEY RISK INDICATORS: provide easly signals about what might happen in the next future and allow managers to ancitipate potential risks & implement corrective actions.

Comparisons

❓What is the difference between Non-Financial Indicators & Value Drivers?

• They are overlapped in most o fthe cases

NON-FINANCIAL INDICATORS: all indicators that are not measured in currencies.

VALUE DRIVERS: all indicators that are connected to EBIT.

-> EX:

• Nationality of the board member;
• Female & male composition of the board: plenty of studies that demostrate that it drive to a better value;
• It’s not the color of their eyes.

-> COMPARISON:

=> We should combine them, with the value tree, during the decision making.

Performance Drivers:

-> We have 5 main domains in accounting and 2 different focusses:

• EXTERNAL FOCUS –> REVENUE DRIVERS: capability of the company to generate superior revenues;
  • Increase revenues (EBITDA, Cash Flow, Enterprise Value) in the value tree.
  • Incrasing the average price without modifing the volume or keeping the price as it is and incrasing the market shares (Porter division).
• INTERNAL FOCUS –> COST DRIVERS: capability of the company to minimize the full product cots (COGS).
  • Producing with lower costs;
  • Relative to the operation functions NOT the period cost.

REVENUES DRIVERS:	COST DRIVERS:
-> 🔼 revenues => 🔼  EBITDA that is connected to cash flow connected to EV.	-> 🔽 cost => 🔼 gross profit that is  connected to cash generation, connected to EV. We can also reduce price and keep same contribution margin (🔽 price => 🔼 market share).
TIME
TTO: higher price for faster delivery & more customer for faster selling increase the revenues. TTM: beeing the leader in product creation, company can create a monopoly, can collect data, test the market & will remain market leader.	Cycle Time: improving cycle time (throughput time) company can reduce COGS.
QUALITY
Customer Satisfaction is difficult to gather information about it; Claims: are objective.	-> Improving spoilage % leads to reduce COGS;
FLEXIBILITY
-> DEF: capability to change fast and cheap, so without using too many resources. Product Range: capability to of the company at customizing the product as the customer requires; Delayed Choices: is the capability to postpone allowing changes.	-> CHAR: Relative CA only in market that are turbolent. In stable market flexibility is inefficient. Postpone the features/ personalization of the product (for customer), less is the freezing period, more you are competitive;   -> Assest the efficiency & labor productivity
ENVIRONMENTAL & SOCIAL RESPONSABILITY
-> Emission Level Product Compliance: customers are more conscious & buy more from companies that are green.	-> Energy Savings.

Relevance vs Performance Matrix:

-> Since we have many divers we can create the following matrix:

• RELEVANCE is the importance (different for each company)
• PERFORMANCE.

-> Not all the performances are relevant. We must know what is the performance for the customer.

-> EXAMPLES: students asking for the services delivered by the office from PoliMi

❓When an indicator is important?

-> When it’s able to generate value.

Resource Drivers:

-> DEF: indicators of Resouce State.

-> AIM: caputring potentialities for enterprises to innovate & grow in the medium-long term.

• Oriented to the capability of the organization to generate value the whole time.

-> Four types of resources: Financial, Technological, Human & Organizational, Image & Reputation.

-> The state of each resource should be assessed against 3 types of measures:

• Quantity: how much we have of a resource;
• Quality;
• Accessibility: capability to increase this resouces overtime.

-> EXAMPLES:

RESOURCES	FINANCIAL	TEHCNOLOGICAL	HUMAN & ORGANIZATIONAL	IMAGE & REPUTATION -> CA not sustainable over time: difficult to generate & maintain & estimate a return. -> Not so tangible.
QUANTITY	Bank Debts: we can measure it as bank debts, as cash from operating activities, etc. (cash: not correct because there is the assumption that cash should be low because it is an opportunity to invest).	Total Patents awarded or pending	# FTE Employees by Role: Written in the financial report	# of Social Initiatives
QUALITY	Average Cost of Debts (Kd)	Incidence of New Product Sales: Capability of the patents to generate enough value (generally revenues come from 10-15 patents).	# FTE Employees with PHD/ MBA: Percentage of female; Internaizonalization of the employee;	Brand Equity: There are different rakings & definitions about brand equity. -> BE: is a measure of the capability to generate additional revenues (or additional perormances) becouse of the brand.
ACCESSIBILITY	Financial Leverage (D/E): capability to increase the resources in terms of quality and quantity, for example financial leverage.	Relationship With Research Centres or universities	Education Level in the Neighboroughts: What the environment can offer to organization & human  resources.	Number of Followers: Since you have a large quantity of follower companies can generate additional value, thanks to support, connections and others.

-> They are not important per se, but because they are connected to the enterpise value.

Intellectual Capital:

-> In the last years these drivers were aggregated. The last example is the INTELLECTUAL CAPITAL…

-> DEF: idea that the I.C. is the most important Competitive Advantage in a company.

• Because the data and the knowledge are the most important resources.
• It joins differet types of intangible assets and it has three main dimensions:
  • HUMAN CAPITAL: refers to the skills, training, education, experience, quantity & quality of employees.

-> Measurable in terms of degrees (simple & limited) or # of exams.

• STRUCTURAL CAPITAL (internal): intanbible assets & knowledge embedded in organizational structures and processes.

-> This dimension comprises patens, research and developtment, technology usually storaged in computers.

-> Intenal: the knowledge is where the people (employee) are, internally.

• RELATIONAL CAPITAL: encompasss relationship with customers and suppliers, brand names, trademarks and reputation.
  • Not only the number of connections but even the quality of them.

-> It’s use to describe the difference between the book value (past) and the market capitalization (the future).

• In the BV you don’t account the intellectual capital.

-> How measure them? It’s difficult.

-> We have to aggregate, in different ways, these indicators.

Key Risk Drivers, KRIs:

-> DEF: metrics that allow managers to monitor & anticipate the impact of one or more adverse events (risk).

• They migh influence negatively the capability of an enterprise to reach its goals.

-> TYPOLOGIES: the arena is enlarging every voice…

• MICRO-ENVIRONMENT: drivers that refer to the company’s internal environment;

(e.g., employees’ satisfaction; absenteeism (we prefer this indicator than customer satisfaction because is yet there); machine failures etc.)

• MESO-ENVIRONMENT: rivers that cover the company’s perimeter, such as suppliers, distributors, customers;

(e.g., potential for vertical integration)

• MACRO-ENVIRONMENT:  drivers that refer to the macro-economic context and the global market;

(e.g., PEST analysis)

📌Asians have a different meaning for risk. While, for european, risk has only a dark side, for asians it has a good side: risk can be opportunities.

-> Compay must be able to catch this indicators while they are growing.

Balanced Scorecards:

-> DEF: framework to provide all indicators to managers in an informative way.

• Alternative approach to value tree;
• Has different generations;
• Balance: balance the information in the four mean domain.

-> OBJ: Connect the three families of indicators;

• Allign the different perspecitves of the people: different people make different maps => identify the most relevant indicators & strongest connection.

Kaplan (Boston full professore) & Norton (Consultant) Model:

-> The first model was invented by Kaplan and Norton (Harvard, 1992).

-> IDEA: connect strategy with indicators.

The Domains:

-> The four quadrants (scorecards) should be balanced.

• Pareto’s approach: 20% explain 80%.

Financial Perspective:

-> DEF: analyses the company trend towards shareholders with reference to:

• Long-term Value (EV, E)
• Profitability (ROE, ROI, EBIT)
• Cash Generation (Cash Flow)

Customer Perspecitve:

-> DEF: highlights performance about the relation with the market:

• How good we are to meeting the customers satisfactions.

-> In terms of…

• Size (market share, sales, revenues (can be either in financial/ customer perspective);
• Delivery time;
• Customer satisfaction.

Internal Process Perspective:

-> DEF: includes measures oriented to the control of internal efficiency:

• Average cost per unit;
• Productivity;
• Cycle Time.

Learning & Growth Perspective:

-> DEF: shows the innovative capability of the company:

• Time to Market;
• Learning curve;
• Competencies.

-> View tailored company by company.

-> The positioning of the vioces in the quadrant (for revenues) can be repeated. The importance is that there are.

-> The output was something like:

=> We don’t have any idea if the company is going well or not. I don’t have numbers & the indicators are not connected to the companies functions.

-> The first BS was not working => We have to change the story…

=> Balance is irrilevant, the CAUSALITY matters!!!

• It’s a logical chain.

-> EXAMPLE:

-> Jaguar value is the custumization => The value driver is the employee skills in installing options.

• Arrow: point is affecting the arrival;
  • Larger the arrow more the relevance/ the impact.
  • Everything could be connected to everything, but we connect only those things that are very relevant.
• Relations: by increasing (+)/ decreasing (-) the point you are increasing (+)/ decreasing (-) the arrival.

-> Jaguar use the congnitive map…

COGNITIVE MAP: map that shows the logical connections among the different factors.

• We can use different sized arrows to highlight the importance of the connections.

⚠️ATTENTION⚠️

CONTRIBUTION MARGIN: difference between price per unit – variable cost per unit.

GROSS MARGIN: Revenues – Product Costs

• Contribution margin * Volumes = Contribution margin total.
• Not include the Period Cost!

-> Single elements:

GREEN = financial

ORGANGE = customers

BLUE = internal processes

-> There are many variations of Balanced Scorecards (E.g. Luxottica has implemented sustainability indicators).

Discussion:

1. Pay attention to the usage of these data + understand the real chain that generate value:

-> Example: British Airway impelemented the balance scorecard. They found, with statistical evidance, that more the flight was late, more the customers was happy. The problem was connected to how they collected the data. This was before that there was low cost flight (20 years ago, Milano-London 600€). Missing part of the story was the stuart and hostess: most the flight was in late most the stuard & hostess were kind. The questionaries were runned after that customers were sit and cured by hostess. They were measuring the capability of the stuart/ hostess to do a service. => Pay attention on the causality.

-> AI find corrleation, but don’t explain causality. We need it.

-> We need logically connections between the causes.

1. TIME OF IMPACT: what is the time-lenght in which a logical connections materialize?

-> Example: everyone agree that the climate change is important. What change is in which periods we have to act and have results.

Summary Balanced Scorecards:

-> They are earlier predictors => They provide managers with timely relevant information.

-> The average time needed to have a balance scorecard working is 18-24 months, because managers don’t agree the strategy. It’s difficult design the flowchart and measure it.