NPV and Strategic ValueNPV and Strategic Value

Presented by Presented by

Mark HeathMark Heath

OverviewOverview

Who is MBH Management?Who is MBH Management?Managing by ProjectManaging by ProjectNPV as a black boxNPV as a black boxMeasuring strategic valueMeasuring strategic valueNegative NPVsNegative NPVsPayback and investment time Payback and investment time horizonshorizonsUsing IRRUsing IRR

MBH Management Pty LtdMBH Management Pty Ltd

Founded in November 1999Founded in November 1999

Frustrations of modern consulting Frustrations of modern consulting practicespractices

Strong growth potential in project Strong growth potential in project management consulting industrymanagement consulting industry

MBH VisionMBH Vision

To be an Australian leader in business, To be an Australian leader in business, environmental and socio-political environmental and socio-political change management change management following a following a Managing by Project approach.Managing by Project approach.

MBH MissionMBH Mission

To position the MBH brand as the To position the MBH brand as the leader in facilitating business growth leader in facilitating business growth and change and change

What is Managing by Project?What is Managing by Project?

Vision – How a company should Vision – How a company should look in the long termlook in the long termStrategy – Approach to achieve the Strategy – Approach to achieve the visionvisionProject selection – Based on the Project selection – Based on the strategic alignment and value strategic alignment and value created by a projectcreated by a projectProject Management – The delivery Project Management – The delivery mechanism for each project mechanism for each project selectedselected

MbP – How does it work?MbP – How does it work?

Selection processSelection process

Prioritisation process Prioritisation process

Directly involves the customerDirectly involves the customer

Use of cross functional teamsUse of cross functional teams

Utilises a facilitated workshop Utilises a facilitated workshop approachapproach

P ro jec t P ro jec t

S tra teg y

Task Task Task

M ajo r Task M ajo r Task

S u b P ro jec t S u b P ro jec t

P ro jec t

S tra teg y

P ro jec t P ro jec t

S tra teg y

M iss ion

V is ion

MbP & project selection - WBSMbP & project selection - WBS

MbP – Why use this approach?MbP – Why use this approach?

Fewer resources (time, money, Fewer resources (time, money, people)people)

Fluid structureFluid structure

Short lifeShort life

Integrates multiple functionsIntegrates multiple functions

Minimises non value-addMinimises non value-addinging work work

Delivers visionDelivers vision

PLAN ACCOMPLISH

SOFT HARD

LEV

EL

OF

EF

FO

RT

TIME

PHASE 1

CONCEPTPHASE 2

DEVELOPMENTPHASE 3

IMPLEMENTATIONPHASE 4

TERMINATION

Project Life CycleProject Life Cycle

Removing the black boxRemoving the black box

Understand where +ve NPV comes Understand where +ve NPV comes fromfrom

Articulate benefit drivers (EVA)Articulate benefit drivers (EVA)

Align project to business strategyAlign project to business strategy

Only NPV is relevantOnly NPV is relevant

Not a black box Not a black box

Measures strategic valueMeasures strategic value

Incorporates riskIncorporates risk

Creates instant priority processCreates instant priority process

Calculating NPVCalculating NPV

Benefit driversBenefit drivers

Cost of the projectCost of the project

Ongoing costsOngoing costs

WACCWACC

DCF = NPVDCF = NPV

What is strategic value?What is strategic value?

Project must be more than Project must be more than “Strategic”“Strategic”

Must add strategic Must add strategic valuevalue

Results in competitive advantageResults in competitive advantage

Competitive advantage = +ve NPVCompetitive advantage = +ve NPV

Competitive advantage = strategic Competitive advantage = strategic valuevalue

How is strategic value achieved?How is strategic value achieved?

Build on existing strengthsBuild on existing strengths

Reduce weaknessesReduce weaknesses

Create new businessesCreate new businesses

Create new options/opportunitiesCreate new options/opportunities

Reduce riskReduce risk

Negative NPV projectNegative NPV project

Gut feel says yesGut feel says yes

Appears to have competitive Appears to have competitive advantageadvantage

Time horizon is longTime horizon is long

Possibilities of follow-on Possibilities of follow-on investmentsinvestments

Need to value optionsNeed to value options

Option pricing and NPVOption pricing and NPV

Value option of follow-on investmentValue option of follow-on investment

Estimate volatility of forecastsEstimate volatility of forecasts

Estimate time to investment decisionEstimate time to investment decision

Plug into Black-Scholes formulaPlug into Black-Scholes formula

Add option value to NPV valueAdd option value to NPV value

Positive number means project has Positive number means project has valuevalue

The danger of paybackThe danger of payback

Short term investment horizonsShort term investment horizons

The need for EPS growth nowThe need for EPS growth now

Forced by investment analysts time Forced by investment analysts time horizonshorizons

Investment horizons need to changeInvestment horizons need to change

Focus on 10 - 15 years rather than 1 - 3.Focus on 10 - 15 years rather than 1 - 3.

Remove going concern assumption!Remove going concern assumption!

Other assessment tools usedOther assessment tools used

IRRIRR

ROIROI

PaybackPayback

Gut feelGut feel

Political decisionPolitical decision

CEO says soCEO says so

Why not IRRWhy not IRR

Negative IRR for positive NPV Negative IRR for positive NPV projectsprojects

Multiple rates of return possibleMultiple rates of return possible

Excluding the wrong mutually Excluding the wrong mutually exclusive projectexclusive project

IRR means NPV = 0IRR means NPV = 0

Prefer NPV > 0!Prefer NPV > 0!

ConclusionConclusion

Utilise MbP approach to business Utilise MbP approach to business managementmanagement

NPV & option pricing only for NPV & option pricing only for project selectionproject selection

Understand where the value comes Understand where the value comes fromfrom