“Yes, of course we have heard of shareholder value. But that does notchange the fact that we put customers first, then workers, then business partners, suppliers and dealers, and then shareholders.”

Dr. Wendelin Wiedeking, CEO, Porsche

Porsche Changes Tack

Will Porsche’s new strategy actually create shareholder value?

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• Porsche is a publicly traded family controlled company• Porsche is a relatively simple company by product line, having three existing and

one newly proposed products:• 911 – the only model produced and assembled completely by Porsche• Boxster – licensed manufacturing with Valmet of Finland• Cayenne – co-manufactured with Volkswagen of Germany• Panamera – to be completely Porsche (at least that’s the plan)

• Porsche’s profitability has been extremely impressive over the past decade –particularly for an automaker

• Porsche has followed a strategy with both the Boxster and the Cayenne which uses a combination of licensing, out-sourcing, and in-sourcing to leverage other people’s money

• As a result of its strategy, Porsche has enjoyed an industry leading return on invested capital (ROIC)

• But two major announcements in the summer and fall of 2005 seemingly indicate that Porsche is changing directions:

• The Panamera will be manufactured in-house, with Porsche’s own money• Porsche has invested 3 billion in taking a 20% interest in Volkswagen (Germany), one of the

worst performing automakers in the world

An Overview of Porsche AG, 2005

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1. What strategic decisions made by Porsche over recent years had given rise to its extremely high return on invested capital?

2. Vesi wondered if her position on Porsche might have to distinguish between the company’s abilityto generate results for stockholders versus its willingness to do so. What do you think?

3. Is pursuing the interests of Porsche’s controlling families different from maximizing the returns to its public share owners?

Porsche Changes Tack:Case Questions

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Exhibit 1 Porsche’s Growth in Sales, Profits and Margin

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Porsche’s Expanding Platforms and Growing Sales

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

1994/95 1995/96 1996/97 1997/98 1998/99 1999/00 2000/01 2001/02 2002/03 2003/04

911 Boxster Cayenne

Units

Note: Excludes sales of the discontinued 928 and 944/968 models in 1994-1996. These models totaled 1005 in 1995 and 104 in 1006.

The Cayenne was the single most successful new automobile launch in history.

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• Porsche’s focus is on stakeholder wealth• It has followed what is generically referred to as stakeholder wealth maximization over

its history, rather than the increasingly common focus on stockholder wealth maximization common in the Anglo-American markets

• Stakeholder wealth maximization attempts to balance in theory the needs and returns to the multitude of corporate stakeholders – stockholders, creditors, management, employees, suppliers, customers, community – rather than focus solely on stockholders

• Porsche’s focus may be one of self-interest• Porsche has frequently been accused of operating the company for the primary benefit

of the Porsche and Piëch families, and management, over all other stakeholder groups• Rewards management in the company primarily on the basis of sales, profits, margins,

and other financial measures of corporate performance rather than stock or stock options based on market performance

• Porsche has continued to fight industry standards for reporting and disclosure• It has continued to report according to German accounting standards long after most

other German companies, publicly traded companies, have moved to international standards

• It has continued to report only semi-annually, not quarterly, arguing that it does not see its business quarterly, and does not want to add to the short-term thinking common among equity investors in today’s equity markets

Corporate Governance at Porsche

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Managing to Metrics: ROIC

ROIC = X

Operating ProfitsAfter-tax

Sales

Sales

Invested Capital

Operating Margin Velocity

Return on invested capital is composed of two components calculated from the firm’s incomestatement and balance sheet, termed operating margin and velocity.

In both cases, bigger is better. The larger the operating margin and the greater the velocity, the greater the return on invested capital. Traditionally, most companies focus on the operating margin, often concluding they have little capability to alter their basic velocity value. Velocity itself will change only with changes in corporate strategy – including licensing and out-sourcing at Porsche, or the growing influence of in-sourcing in other industries.

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Exhibit 2 Return on Invested Capital (ROIC) for European Automakers, 2004

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Exhibit 3 Porsche’s Velocity,Margin, and ROIC

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What is Invested Capital?

Assets Liabilities & Net WorthCash € 1,766 Interest bearing debt € 407NWC 996 Other liabilities 3,816 Net fixed assets 3,216 Shareholders' equity 1,755

€ 5,978 € 5,978

Invested capital = Shareholders' equity + Interest bearing debt= 1,755 + 407 = 2,162

If netted for cash = 2,162 - 1,766 = 396

Assets Liabilities & Net WorthCash € 2,791 Interest bearing debt € 2,106NWC 1,259 Other liabilities 3,418 Net fixed assets 3,797 Shareholders' equity 2,323

€ 7,847 € 7,847

Invested capital = Shareholders' equity + Interest bearing debt= 2,323 + 2,106 = 4,429

If netted for cash = 4,429 - 2,781 = 1,683

Porsche's Managerial Balance Sheet, 2003

Porsche's Managerial Balance Sheet, 2004

Porsche’s problem inrecent years is that ithas accumulated a verylarge cash balance.

‘Cash’ is not free; it mustbe funded on the right-hand-side of the balancesheet. If Porsche haddispensed the excess cashrather than retaining it,its invested capital basewould not have grown,undermining its ROIC.

Porsche has one othercomplicating factor: itpossesses a large amountof non-interest bearinglong-term liabilities, afeature of traditionalGerman business practices.

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• Porsche says• The investment of €3 billion in VW is to secure its on-going and future strategic partnership with VW• VW is currently responsible for roughly 30% of Porsche’s automotive manufacturing and assembly

• VW and major VW shareholders• See a significant conflict of interest between Porsche and VW, including prioritization of VW’s and

Porsche’s portfolio evolution, as well as the competitive conflicts between Porsche and Audi of VW • A conflict of interest by Ferdinand Piëch, non-executive chairman of VW, and the grandson of the founder

of Porsche and a major family member of the current owners and leaders of Porsche• VW is one of the two biggest underperformers in the European auto industry at present, and is in need of a

strong wage reduction and cost reduction initiative which is not consistent with Porsche’s track record of accommodation of wage demands by auto industry workers

• Auto Analysts and Critics and Stockholders Argue• That Porsche could have obtained the continuing services of VW and VW’s technical resources in a variety

of much more cost-effective (and shareholder friendly) methods• That the expenditure/investment of more than €3 billion was an enormous use of corporate financial

resources which would have generated better returns by simply being returned to shareholders (which had been the hope of much of the marketplace in recent years)

• That this decision is largely motivated by the personal ambitions and preferences and self-interests of Ferdinand Piëch, rather than indicative of any significant return to German solutions or German cronyism

• In the end may sustain Porsche’s growth and profitability success story at the expense to non-family shareholders

Porsche and Volkswagen

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1. What strategic decisions made by Porsche over recent years had given rise to its extremely high return on invested capital?

• Return on invested capital (ROIC) combines operating margins, found on the income statement, with greater capital utilization, which is derived from the balance sheet.

• All three Porsche product lines – the 911, the Boxster, and most recently the Cayenne – enjoyed high operating margins compared to nearly any other major European automobile manufacturer.

• The two newer product lines, the Boxster and Cayenne, had both been launched with the capital and technology embedded within other companies.

• The Porsche Boxster was manufactured by Valmet of Finland under a licensed manufacturing agreement allowed Porsche to effectively use “other people’s money.” Valmet owns its own factory and tools, and builds the Boxster for Porsche. This reduces the capital Porsche needs to support its own business significantly.

• The Porsche Cayenne was co-manufactured with Volkswagen. The Cayenne chassis was assembled on the same production line as the Volkswagen Touareg in Bratislava in the Slovak Republic, again greatly reducing the required capital to support Porsche’s business.

Porsche Changes Tack:Case Questions

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2. Vesi wondered if her position on Porsche might have to distinguish between the company’s ability to generate results for stockholders versus its willingness to do so. What do you think?

•This is a question which is growing in significance when investors examine the motivations and performance expectations of management in publicly traded companies. Porsche rewards management on business financial performance – the numbers found on the three major financial statements – and not on the market’s opinion of the company’s value (share price).

•This is considered as highly controversial because for the better part of the last 40 years academics have argued that management needs to share the same motivations, rewards, and risks as stockholders do – the share price as core to investor and management returns.

•But Porsche has seemingly focused on executing the business with the highest of regard for the company’s long-term performance and profitability (much like a family owned business), the result of which has been obviously appreciated by the market.

•One key point here is whether the use of 3 billion euros to purchase a growing (and in the end controlling) position in VW was motivated by business needs to family bias? As the real results continue to roll out, it appears to be more and more of both.

Porsche Changes Tack: Case Questions

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3. Is pursuing the interests of Porsche’s controlling families different from maximizing the returns to its public share owners?

• Yes, there is. Although the interests of family ownership and public shareholders are both based in growing and profitable and sustainable business, there is one key difference between families and markets: a focus on growth.

• The returns to a family from its ownership of a business are derived from distributed profits (dividends), salary and compensation (family members employed by the firm), and financial support (family members often enjoy company-owned assets and expenditures).

• The returns to a shareholder in a publicly traded firm are derived from dividends (dividend yield) and share price appreciation (capital gains). Although the dividend yield concept is similar, the capital gains concept of a market driving a share price upwards is much more complex and difficult to “drive” from a leadership perspective than what most family based businesses focus on.

• Clearly, in the end, one of the primary drivers of share prices is a company which promises and delivers profitable growth in both the top-line and bottom-line of the income statement. A family owned and managed business is as interested in sustainability and control as it is in rapid growth.

Porsche Changes Tack:Case Questions

Porsche’s announcementof its investment in VWwas not well-received bythe equity markets.

As illustrated here, thedownward spike justprior to 27.09.05 is themarket’s reaction to theannouncement – a one day loss of approximately10% of its value which was then largely recovered,then lost again, in the following month.

Source: Porsche.com

Porsche’s share priceperformance over the2004-2005 period, however,Recovered and was very good by all comparable measures.

Source: Porsche.com