Succeed in uncertain times - Boston Consulting Group · E-Mail: [email protected] ... Hope for the best, plan for the worst – and profit whatever happens 31 Appendix • Study

BCG R E P O R T

Succeedin uncertain times

Value Creators Report 2002

A global study of how today’s top corporations

can generate value tomorrow

2 BCG

© 2002 The Boston Consulting Group, Inc. All rights reserved.For information and reprint authorisation please contact BCG at the following address:

The Boston Consulting GroupMarketing & Communications/LegalLudwigstraße 2180539 MunichGermanyFax: +49 (0)89-2317 4718E-Mail: [email protected]

The Boston Consulting Group is an international strategy

and general management consulting firm whose mission

is to help leading corporations create and sustain

competitive advantage. As a truly international firm,

our strong global presence offers clients and employees

a wealth of cross-cultural experience.

3

Succeed in uncertain times

Acknowledgements 4

Overview 5

A perilous situation? 11

An agenda for improved, sustainable value creation 15

I. Set a realistic, long-term value creation goal 16

II. Control your company with fundamental measures that

strongly influence long-term TSR 19

III. Manage your business units as a portfolio of value

creators and destroyers 21

IV. Concentrate on organic growth, but seize opportunities

for acquisition growth during downturns 23

V. Manage your relative expectation premium 25

VI. Make your strategy appealing to your dominant

investor segment 29

Hope for the best, plan for the worst – and profit whatever happens 31

Appendix

• Study background 35

• Regional and industry rankings 37

• Technical notes 75

Global contacts 78

Contents

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Dr Daniel Stelter, a Vice President based in Berlin, who leads BCG’s Corporate Development practice in Europe andis co-leader of BCG’s corporate finance expertise worldwide. Daniel Stelter initiated this report and the analysis thereport is based on (email address: [email protected]).

Dr Pascal Xhonneux, a Vice President based at Dusseldorf, who leads BCG’s Corporate Development Practice inGermany. He was responsible for the project team conducting the analysis and for the preparation of the report (emailaddress: [email protected]).

Their co-authors were:

Mark Joiner, a Senior Vice President based in New York, who leads BCG’s Corporate Development practice worldwide(email address: [email protected]).

Eric Olsen, a Senior Vice President based in Chicago, who leads BCG’s Value Management expertise worldwide(email address: [email protected]).

Gerry Hansell, a Vice President based in Chicago, who co-leads BCG’s Corporate Finance expertise worldwide (emailaddress: [email protected]).

Brad Banducci, a Vice President based at Sydney, who leads BCG’s Corporate Development Practice in Asia Pacific(email address: [email protected]).

Acknowledgements

For more information on The Boston Consulting Group’s capabilities in value management and corporate development,contact the individuals listed below:

AMERICASAlan Wise AtlantaStuart Grief BostonGerry Hansell ChicagoJ Puckett DallasThomas Wenrich MexicoJeff Kotzen New YorkRohit Bhagat San FranciscoWalter Piacsek Sao PauloPeter Stanger TorontoRobert Hutchinson Washington

ASIA PACIFICJean Lebreton BangkokNicholas Glenning MelbourneJanmejaya Sinha MumbaiByung Nam Rhee SeoulRoman Scott SingaporeBrad Banducci SydneyNaoki Shigetake Tokyo

EUROPEKees Cools AmsterdamDaniel Stelter BerlinYvan Jansen BrusselsPascal Xhonneux DusseldorfPer Hallius StockholmDavid Rhodes LondonFelix Rivera MadridTommaso Barracco MilanImmo Rupf ParisMatthias Hug Zurich

The authors express special thanks to the people above for their input in the preparation and editing of this report. They would also liketo thank the project team: Kerstin Biernath, Susanne Gehweiler, Dr Jens Kengelbach, Martin Link, Elke Schall, Dr Karsten Wildberger.

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These are difficult times. After the longest-running bull market in history,corporations are not only having to contend with a record drop in stock pricesbut also a highly fragile global economy. In the US alone around $7 trillion hasbeen wiped off the value of stocks since early 2000, equivalent to two-thirds ofthe nation’s GDP. Add in lingering doubts about management credibility in thewake of recent scandals, not to mention current geo-political uncertainties, andit’s not surprising many investors are feeling distinctly uneasy.

There’s no doubt a stock market correction was long overdue. As we pointed out2000 and 2001 in our previous two annual Value Creators reports, expectationpremiums – the difference between market and fundamental values – hadreached unsustainably high levels. Between 1993 and 2000 they soared to anunprecedented 80 percent on average, or more than forty percent of the valueof the average stock price. By 2001 they had declined to a more ‘modest’ 27percent and at the time of going to press they stood at 21 percent.

Threat of a deeper drop

Which way will the markets go now? No one knows. However, historicalprecedents are not encouraging. Periods of high expectation premiums havepreviously been followed by prolonged periods of low expectation premiums: themarkets tend to over-correct. More disturbingly, in view of the unprecedentedscale of recent premiums, research has shown that the bigger the bubble, thelarger the drop in total shareholder returns (TSR).

In fact, nearly half of the sectors analysed in this year’s report already havenegative expectation premiums. Several market indices, including the GermanDAX Index, have also slipped into the red. The larger US indices, notably theDow Jones Industrial Index and S&P 400, however, still have positive premiums.Will these buck the historic long-term trend? We hope so. But it’s worth notingthat to justify its current expectation premium of 21 percent, the S&P 400 wouldhave to increase its earnings before interest and tax (EBIT) by 4.8 percent ayear for the next five years simply to sustain its value. But investors expectabove-average TSR year on year. To achieve a 12 percent annual rise in TSR –the long-term market average – a 17.3 percent increase in EBIT would be

Overview

After last year’s market correction, stock prices plunged heavily again in 2002 and, if

you believe some commentators, deeper drops – and a deep recession – are possible.

What went wrong? More crucially, what can your company do to succeed in such a

challenging and uncertain environment?

This report addresses these issues, based on a study of over 4,000 of the world’s top

corporations. Ii is the fourth annual report of a series started in 1999 when the first

BCG Value Creators Report was published.

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1. See John Percival (The Wharton School, University of Pennsylvania, Finance & Investment Faculty), 2002: “Is it time to get rid of EBITDA?”

needed.

Underlying economic indicators don’t provide much ground for optimism either.Economic growth is faltering and severe corporate, consumer, and federaldebts, coupled with interest rates that leave little room for further reductions,suggest the situation might get worse before it gets better. And what would bethe impact on the global economy of a war with Iraq? Or another major terroristincident?

Misguided ‘bubble’ practices have to change

What should management do in such a challenging and uncertain environment?Two major steps must be taken: First, many businesses need to radically re-thinkhow they create and sustain shareholder value, including setting reasonabletargets, the fundamental levers they need to pull to generate long-term value andhow they deal with investors. Over the last decade, the bubble has engendered anumber of highly corrosive ‘norms’ that have undermined long-term fundamentalperformances.This is evident from this year’s study. Between 1995 and 2000, whenstock prices were marching relentlessly upwards, the trend for the averagefundamental performance for each TBR quartile was down. Today, it is steeplydown, as is TSR. In the long run, fundamentals drive shareholder returns, notexpectation premiums. The second key step is to prepare for a more severeeconomic downturn, which we discuss at the end of this overview.

Setting aside corporate governance for the moment, some of the misguidedpractices that have seeped into the corporate ‘ecosystem’ include:

● Inappropriate shareholder return targets: Many CEOs target double-digitannual earnings per share growth (EPS), sometimes as high as 15 percent,but the long-term actual average growth is nearer 7 to 8 percent. That’s a biggap to sustain. In fact, only a small percentage of companies are able to beattheir local market average for more than a few years running. More realisticgoals stretched over longer periods, not year-on-year, are required. Inaddition, these targets need to be set relative to industry averages, not as‘limitless’ absolute goals. Unfortunately, as EPS is shaped by factors uniqueto each firm, valid intercompany comparisons are not possible. This, togetherwith the potential to manipulate EPS, for example by postponing long-termvalue creating investments to lift short-term earnings, casts doubt on its valueas a shareholder return metric. Relative TSR is a more robust alternative.

● Unsuitable measures for controlling fundamental value: The earningsmeasure, EBITDA, is now commonly used by corporations to gauge anddirect fundamental performance. But due to its omission of cash-consumingexpenditures, such as interest and taxes, as well as cash required forreinvestment (not to mention its susceptibility to accounting distortions), itcan lead to inefficient decisions that produce short-term gains at the expenseof long-term fundamentals. A rising chorus of respected voices is now callingfor it to be abandoned or used cautiously in limited situations1. A more

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suitable approach is to employ the ‘cash value added’ principles and, inparticular, its two main components: cash flow return on investment (CFROI)and gross investment growth. Both of these measures have strongrelationships with long-term shareholder returns, unlike EBITDA.

● Tolerance of unprofitable business units: Impressive lifts in profitability havebeen achieved recently. In the US, for example, profitability (measured byCFROI) has been around 11 percent over the last five years for the largestcorporations, compared to the previous long-term average of around 7percent, although cracks are appearing. High profitability is important,especially in downturns; as we show in this report – firms with the highestCFROI withstand these shocks more effectively. However, high corporateprofitability coupled with inflated stock prices, encouraged many firms totolerate low-CFROI business units. Without the protective cushion ofexpectation premiums, this complacency cannot continue. Strongfundamentals are more important than ever and all units will have to pull theirweight to achieve reasonable shareholder returns. Those that cannot beturned around quickly should be divested and capital allocated to the othersbased on their value creation potential, not democratically.

● Pursuing the wrong type of growth at the wrong time: Partly fuelled by the useof inflated stock prices as an acquisition currency, the M&A bonanza of the1990s was at this time a key contributor to excessive expectation premiums.However, new research from BCG’s ValueScience Center shows that organicgrowth is the overwhelming driver of long-term shareholder returns,underlining the importance of innovation and asset productivity. This doesn’tmean M&As should be ignored, but rather timed more carefully: a soon-to-bepublished BCG study demonstrates that M&As executed in downturns aresubstantially more likely to produce higher long-term value than thoseconducted in booms.

● Failure to monitor and manage relative expectation premiums: Left un-addressed, unrealistic expectation premiums are damaging, as many firmsare now discovering. In downturns, high premiums can be punished withdisproportionate drops in shareholder returns, while negative premiums canlead to all the problems associated with undervaluation, including difficultiesraising capital. Although you cannot control absolute premiums, which arelargely determined by macro-economic forces, you can quantify and manageyour relative premium. This is fuelled by transparency, share liquidity, marketleadership and other factors discussed in this report. New techniques formanaging premiums for sustainable competitive advantage are emergingand should be applied. One approach is to use scenario-based forecasts ofa company’s results for the next three to five years, then compare this to theimplied growth rate in today’s stock price, and work steadily to resolve thesedisconnects.

● A disconnect between corporations and their dominant investor segments:Most corporations have little knowledge of the diverse aspirations of their

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investor base. Some shareholders, for example, may focus on free cash flowand intrinsic value, while others will seek aggressive growth or shades inbetween. Failure to align your strategy with your dominant investor segment’srequirements is likely to have a detrimental impact on your stock price. Amajor expansion into a risky market, for instance, will produce a stock pricediscount if your dominant segment wants stable ‘growth at a reasonableprice’. In fact, BCG research, conducted jointly with Thomson Financial, hasfound that this mismatch between supply and demand can lead to substantialgaps between market and fundamental values, typically in the order of 30 to50 percent and typically undervalued. To avoid this, corporations mustdevelop a deeper understanding of their investor segments, supported by amore regular, direct dialogue with them.

Not all companies have stepped into these pitfalls. Many of the 4,000-plusbusinesses we studied for this year’s Value Creators Report generated bothimpressive fundamental performances and admirable TSR, given today’senvironment. The details of these top performers and others can be found in thisreport’s appendix at the back of this report. But the reality is that mostcorporations have fallen into at least one – and usually several – of these trapsand their resultant low fundamental performance is now being felt in seriouslydepressed – and sometimes undervalued – stock prices. As Warren Buffet oncesaid, “It’s only when the tide goes out that you can see who’s swimming naked.”

This report provides a ‘manifesto’ for change to improve and sustain valuecreation – a set of recommendations that need to be implemented to shake offthe excesses and damaging misconceptions that were cultivated during theboom.

Dangers of the ‘quarterly earnings game’

Why did so many corporations adopt such counter-productive practices over thelast decade? Why were short-term shareholder return priorities allowed topreside over long-term fundamentals and long-term TSR?

There were various reasons. Stock options, the herd instinct, the notion that ‘thistime it is different’, and many other factors all enter the frame. But the power andinfluence of investment analysts also played an important role. Our argumentdoesn’t rest on the conflict of interest issue, although this has undoubtedly beendamaging to both the capital markets and to corporations. It hinges rather on themind-set and practices investment analysts have encouraged companies toadopt.

There are two main problems. First, many corporations now use analysts’ ‘goldstandard’ of value creation, EPS, and very simple accounting-based figuressuch as EBITDA. As we have briefly discussed, these measures have littlerelationship with long-term TSR and can be distorted – inadvertently,deliberately and even fraudulently. The absolute nature of EPS growth alsoraises the question, ‘How far do you have to push it?’ Without a relativebenchmark, the answer has sometimes been ‘as far as you can’, leading tounsustainable goals and some questionable solutions.

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Second, analysts’ pressure on corporations to hit quarterly earnings forecastshas not only established a norm that it is short-term results that matter but alsothat consecutive quarter-on-quarter and year-on-year improvements infundamentals and shareholder returns are sustainable. They rarely are.

Not all firms have agreed to play the earnings game. Porsche, for example,successfully refused to publish quarterly earnings, arguing that they increasedstock price volatility and gave no insights into fundamental performance for sucha mature industry as automotive. Such an extreme measure won’t suit manycompanies. It’s also important that steps like these do not compromisetransparency. However, it does show that it is possible to refuse to play theanalysts’ game. A more generally valuable approach is to build a closer, direct,nondefensive relationship with investors in order to win trust and support foryour long-term goals and value creation strategy. Truly independent analystshave an important role to play – and some ‘boutique’ research firms areemerging – but their role should be to analyse objectively, not to set the heightof the value creation bar or direct managers how to manage.

Prepare contingency plans for a possible downturn

Earlier we said there were two steps corporations had to take to succeed bothtoday and in the future. The first, already covered, is to sweep out valuedestroying and limiting practices.The second is to prepare contingency plans fora possible economic downturn.

During economic downturns two critical things happen: cash flow diminishesprecipitously and decision-making times shrink dramatically. In the absence ofa contingency plan, incorrect decisions often go unchallenged and becomeintegrated into strategies, leading to their magnification over time. Like theproverbial butterfly that flaps its wings in one part of the world and creates astorm in another, this can have a devastating impact on already dwindling cashflow and a company’s survival prospects.

The key to success is to have a plan that bullet-proofs your cash flow andenables you to use your superior cash flow to ‘invest against the tide’ and profitfrom your competitors’ weaknesses. This will allow you to emerge in a strongerposition after the ‘storm’. Indeed the process of preparing a plan – includinganalysing and correcting the relative vulnerabilities of your business units’ cashflows to different market scenarios – will benefit your business in a number ofways regardless of whether there is a downturn or not. It will identifyfundamental weaknesses, foster a more risk-aware culture and focus managers’minds on operating in extreme conditions, often stimulating creative new ideas.

At the end of this report we explain how to prepare a ‘crisis management’ plan.This needs to be started now. Or, as a former US president said, “Yesterday isnot ours to recover, but tomorrow is ours to win or lose.”

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The story so far – a steep fall in investorconfidence

Expectation premiums – the difference betweenmarket and fundamental values – rose to historicalhighs over the last decade (Fig. 1). Thesepremiums are essentially a measure of investorconfidence. And since 2000, when expectationpremiums accounted for two-thirds of the averagecompany value of the S&P 400, this confidencehas fallen dramatically.

The fall in premiums for the world’s top 100corporations as measured by total shareholderreturns (TSR), has been equally steep (Fig. 2). In2001 expectation premiums had dropped to 52percent on average and, by 31 October 2002, theyhad declined to 40 percent. In fact, expectationpremiums have decreased in all industries, apartfrom utilities (Fig. 3). (Further details are available inthe appendix.)

The decline in expectation premiums waspredictable, although not necessarily the scale andspeed of it. On average, market valuations wereunjustified by fundamental performance. Simply tosustain the S&P’s average market value in 2000would have required 10 percent year-on-yeargrowth in earnings before interest and tax. Butinvestors expect growth in stock value (TSR). Justto achieve the long-term average market growthrate of 12 percent in TSR would have required aHerculean improvement in fundamentals. Today’saverage premiums for the S&P also seem on theambitious side (see Overview).

A perilous situation?

In periods of uncertainty, it pays to plan for both positive and negative outcomes. And these are undoubtedly

precarious times, both economically and geopolitically. This section takes an unashamedly downbeat view of

what might happen to the global economy and capital markets, based on historical precedents.

The past, of course, isn’t always a reliable indicator of the future. Our aim here is simply to underline the

urgency for corporations to rethink how they create value and to plan for a downturn – just in case the glass

turns out to be half empty, not half full.

Long-term Analysis of the S&P 400 between 1926 and 24 October 2002

0

20

40

60

80

100

120

140

160

180

200Market value

Fundamentalvalue

Expectation premium > 0

Market High

Market Low

Market Avg.

1926 1935 1945 1950 1965 1970 1975 1980 1985 1995 2000199019401930 1955 1960 10/02(2)

268 %

210 %

( 1 ) 1926 to 1949: 40 companies; 1950 to 2000: 376 companies excluding financial institutions and P/E Corp Bio Systems( 2 ) Assuming a reduction in 2002 of 2001 EBIT by 10 %. MV/FV as of end of October 2002: 126 %Source: Moody's Manual of Investments; Value Management Research Engine

Fig. 1 Expectation premiums show strong oscillations over time

Expectation premium for the top100 companies worldwide(1)

0

100

200

300

400

500

2001 2002 (2)

Total valueindex

508

422(2)

21%

79%

27%

73%

-17%

0

100

200

300

400

500

2001 2002 (1)

48%

52%

307

60%

40%

246

-20%

Expectation premiumFundamental value

( 1 ) Top 100 according to TSR ranking( 2 ) As of end of October 2002Source: T.F. Datastream; BCG analysis

Expectation premium for the S&P 400 (Midcap)

Total valueindex

Fig. 2 Although the market has declined in 2001 and 2002expectation premiums remain very high

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Historically, the markets have over-correctedhigh expectation premiums leading to periodsof undervaluation

In the long term, expectation premiums tendtowards zero, underlining the efficiency of capitalmarkets. However, an analysis of expectationpremiums between 1926 and 2002 revealsmarkets over-corrected unrealistically highpremiums, producing periods of prolonged lowexpectation premiums, notably between 1932 and1949 and between 1974 and 1990 (Fig. 1).

Moreover, a study of the sensitivity of premiums tomarket corrections shows that the highestpremiums – and we have just had recordpremiums – tend to be punished withdisproportionately large drops in TSR. Figure 4,based on 2001 data, shows how expectationpremiums suffered their first major correction afterthe peak of 2000.

Does this mean the recent decline in expectationpremiums is just the start of a deeper drop intonegative premiums? Again, we don’t know. Andthe capital markets appear equally uncertain,reflected in rising stock price volatility. But it isworth noting that six of the fourteen industries westudied already have negative premiums (Fig. 3).One of these recently moved into negative territory(industrial goods) and the position of three of theother six has deteriorated further this year.

Several market indices have also slipped into thered, including the German DAX (Fig. 5). The S&P400 and the Dow Jones Industrial Index, however,still have positive expectation premiums.

Possibilities that could push stock prices andpremiums down further include a war with Iraq,another major terrorist incident, a debt-deflationaryrecession or revelations of more corporateaccounting scandals. Looking further ahead, ifstock markets generally have negative expectationpremiums, one must consider the potential impactof the generation of 1950s ‘baby boomers’withdrawing equity to fund retirement.

Will the capital markets buck the historical long-term trend? No one can say. But the current trendis similar to those experienced prior to the GreatDepression and Japan’s current deflationary period(Fig. 6).

2000 2001 31 October 2002(1)Industry

69%

55%

42%

43%

46%

42%

24%

28%

31%

45%

58%

57%

54%

58%

76%

72%

94%

115%

100%

124%

119%

129%

-19%

-24%

0%

6%

-15%

-29%

Pharmaceuticals

Insurance

Banks

Retail

Multibusiness

Media

Technology

Industrial Goods

Pulp & Paper

Chemicals

Consumer Goods

Automotive

Travel & Tourism

69%

61%

47%

43%

39%

34%

30%

24%

31%

39%

53%

57%

61%

66%

70%

76%

100%

112%

111%

115%

121%

142%

0%

-11%

-15%

-21%

-12%

-42%

51%

42%

33%

32%

28%

49%

58%

67%

68%

78%

72%

92%

92%

119%

120%

112%

132%

128%

138%

22%

-19%

8%

8%

-12%

-32%

-28%

-20%

-38%

Expectationpremium

Fundamentalvalue

Utilities

( 1 ) Expectation premium calculated using an estimated fundamental value and market value as of31 October 2002

Source: T.F. Datastream; BCG analysis

Fig. 3 Expectation premiums by industry

83% 71% 62% 54% 47% 41% 35% 28% 22% 16% 10% 5% 0% -6%

-13% -21% -30% -39% -53% -73%-200%

-100%

0%

100%

200%Averageexpectationpremium 2000

-21%

-8%

-11%

3% 4% 4% 4%

9% 9% 8%

12%

9%

14% 14%

18%

3%3%

13%

5%

-1%

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%AverageTSR 2001(YTD)(2)

Companies(1) withhighest

expectations suffermost

Companies(1) with lowor negative

expectations gain value

( 1 ) Sample: The largest 1,700 companies, listed since 1996, without market capitalization hurdle; simple average; 84 companies per cluster( 2 ) TSR calculated from 1/1/2001 – 31/08/2001Source: T.F. Datastream; BCG analysis

Fig. 4 Relationship between size of expectation premium and TSR development

Average expectation premium DAX companies (1)

-50

0

50

100

150

200

250

1996 1997 1998 1999 2000 2001 2002

Total valueindex(2)

95% 90% 93% 68% 81% 84% 111%

100124

145

197186 184

155

5%10%

7% 32% 19% 16%

-11%

(3)

Fundamentalvalue

Expectationpremium

( 1 ) Weighted average of total sample, 20 companies( 2 ) Total company value (market value of equity + interest-bearing liabilities), 1996 = 100( 3 ) Based on an estimated fundamental value; market value as of 31 October 2001Source: T.F. Datastream; BCG analysis

Fig. 5 German DAX index has slipped into the red

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The economic foundations for an imminentrebound look shaky. In fact, some of thetrends show disturbing parallels with a lesshappy deflationary period of the past.

● Economic growth is slowing. Since 2001 therehas been a steep decline in investments andGDP growth (Fig. 7).

● Deflationary tendencies exist. In the thirdquarter of 2002, the GDP price index for theUS – a closely watched measure of inflation –grew by just 0.8 percent year-on-year, thelowest rate since 1950.

● Interest rates can’t fall much lower. Overthe last five years interest rates have followeda similar trajectory to those that preceded theGreat Depression (Fig. 8). What else canCentral Banks and governments do to re-boot the global economy?

● Consumer consumption has reached recordlevels. Today, US consumer consumptionaccounts for around 70 percent of GDP (Fig. 9).

● Declining credit ratings are limitingfinancing options. The number of creditrating downgrades has been rising in both theUS and Europe, while upgrades have beendeclining (Fig. 10).

● The world’s largest economy has amassive current account trade deficit.Since 1991 the US current account tradebalance has plummeted from a small surplusto a US$400 billion deficit (Fig. 9).

Is a major recession – and possibly evendeflation – on the cards?

We’ll have to wait and see. What we can say withcertainty is that two major steps need to be taken.First, a new agenda for corporate value creation isrequired to shake off the misguided practices thathave shaped many businesses’ decisions andundermined long-term sustainable shareholderreturns. Second, all corporations must prepare acontingency plan for a downturn. Both of theseinitiatives will improve your long-term fundamentalperformance regardless of how events unfold. Therest of this report deals with these two issues.

0

50

100

150

200

250

300

350

400

1994 1995 1996 1997 1998 1999 2000 2001 20021984 1985 1986 1987 1988 1989 1990 1991 19921924 1925 1926 1927 1928 1929 1930 1931 1932

USA 1924 to 1932 (Dow Jones)

Japan 1984 to 1992 (Nikkei)

USA 1994 to date (S&P 400 ind.)

Source: T.F. DatastreamSource: T.F. Datastream

Fig. 6 Stock Price Index development in the Great Depression, the Japan Crisis and today

-4

-2

0

2

4

6

1996 1997 1998 1999 2000 2001 2002

US GDP growth (1) European GDP growth

US investment growth European investment growth

-4

-2

0

2

4

6

1996 1997 1998 1999 2000 2001 2002

-15-10

-50

51015

1996 1997 1998 1999 2000 2001 2002-15-10

-50

51015

1996 1997 1998 1999 2000 2001 2002( 1 ) Adjusted for seasonal effectsSource: Bureau of Statistics, Germany

(1)

(1)

(1)

Fig. 7 Economic growth is slowing down

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Whereas in contrast the US money supply has been increased

U.S. prime rate%

80

100

120

0

2

4

6

8

US money supply

Index

1928 19311929 19301999 20022000 2001

1928 to 19311999 to 2002

Source: T.F. Datastream; Federal Reserve Bank of Minneapolis; BCG analysis

Fig. 8 US Prime Rate shows parallels to the Great Depression

Key figures of the US economy show a downward trend

65666768697071

1995 1996 1997 1998 1999 2000 200112

14

16

18

-500-400-300-200-100

0100

1991 1993 1995 1997 1999 2001

Consumption and debt of U.S.households at an all-time high

Slow reduction in surplus capacities andhigh current account deficit

Long-term avg.

US consumer spending in % of GDP

800

1200

1600

2000

1995 1996 1997 1998 1999 2000 2001

US consumer credit in million $

US investments in % of GDP

Long-term avg.

1991 1993 1995 1997 1999 2001

US current account deficit in billion $

Source: T.F. Datastream

Fig. 9 The foundation for the next boom is shaky

Downgrades overhauled upgrades after the hype was over

Rating Development US

US

0

400

800

1990 1992 1994 1996 1998 2000

EU

Downgrades

Upgrades

Downgrades

Upgrades0

100

200

1990 1992 1994 1996 1998 2000

Rating Development EU

Source: The Economist

Fig. 10 Is a credit crunch looming?

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An agenda for improved, sustainablevalue creation

Over the last decade many corporations adopted a number of counter-productive norms

and practices, undermining their ability to create and sustain long-term value. Here

we present an agenda for change. In the following we elaborate on these

recommendations, supported by new research and case studies.

I. Set a realistic, long-term value creation goal

II. Control your company with fundamental measures that strongly

influence long-term TSR

III. Manage your business units as a portfolio of value creators

and destroyers

IV. Concentrate on organic growth but seize opportunities for

acquisition growth during downturns

V. Manage your relative expectation premium

VI. Make your strategy appealing to your dominant investor segment

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An agenda for improved, sustainable value creation


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How corporations set their ‘external’ value creationgoals – shareholder returns – is one of the mostimportant decisions they will make. Everything elsestems form it, including internal fundamentalperformance targets and business plans.

The importance of relative industryshareholder returns

The single-minded focus on absolute shareholderreturns – such as ten percent earnings per share(EPS) growth – is both illogical and counter-productive. It is relative returns that count and thatshould shape your shareholder return target fortwo key reasons:

● Although absolute shareholder returnsmeasure the total gain to shareholders, it isyour relative industry return that primarilydetermines whether investors drawn to yourindustry place their money in your companyor a competitor. To attract and retain theseinvestors, you need to set a target relative tothe industry performance that satisfiesinvestors’ aspirations.

● Without a relative benchmark how do youknow how high to set your target? This was aquestion many corporations seemed unableto answer during the bull market, leadingmany to take their cues from analysts and topush for unsustainably high earnings goals.Often the only way to do this was to milklong-term fundamental performance forshort-term gain. Or, in extreme cases, toresort to fraudulent practices.

Use a robust measure of shareholder returns – TSR

Total shareholder returns (TSR) – the change in

share price plus dividends – is a more objectivemeasure of shareholder returns than EPS, themost commonly applied yardstick.

The advantages of TSR

● TSR is a true measure of what shareholdersmaterially gain – the increase in share priceplus dividends.

● It is an objective measure of a firm’s ‘external’value creation – it is not affected by acompany’s internal accounting methods.

● Like-for-like comparisons betweencompanies’ TSRs can be easily made (takinginto account any currency differences in international stock comparisons) – itsatisfies the need for a relative shareholderreturn measure.

The pitfalls of EPS

● EPS does not measure what shareholdersmaterially receive, only the ‘internal’fundamental value valuation (earnings) pershare that a firm’s accounting proceduresclaim the company has generated.

● EPS can be manipulated, painting amisleading picture of a firm’s true fundamentalpotential in investors’ eyes, a move that canrebound on a firm’s stock price when the truestory emerges. The exclusion of stock optionexpenses, which lift earnings, is one way thisis frequently done. Postponing investments –in essence, sacrificing long-term fundamentalperformance for a short-term rise in earnings– is another. In extreme cases, earnings canalso be distorted via unethical practices:Enron’s use of off-balance sheet techniqueswas one of the most high-profile examples.

I. Set a realistic, long-term value creation goal

It is relative industry long-term shareholder returns that determine your target

investors’ allegiance to your stock. But very few businesses have been able to sustain

superior returns for more than a few years in a row. Aspirations need to be revised

downwards and reconfigured over longer time horizons.

17



BCG

● Equally significantly, it is not possible to makevalid intercompany comparisons betweenfirms’ EPS growth rates due to the fact each company’s EPS is shaped by factorsunique to that business, such as its size, riskprofile, number of shares, share buy-backsand leverage.

Setting a realistic long-term RTSR target

The pressure to hit analysts’ quarterly forecastshas fostered the notion that relentlessimprovements in shareholder returns are feasible (see box, ‘Beating the quarterly blues’).They are not, however – at least not on a year-on-year basis.

Over the last decade the majority of companieswere only able to sustain above-average TSRrelative to their local market indices for no longerthan five years in a row. None of the 1,665 largestcompanies that BCG studied for this analysismanaged this for ten consecutive years (Fig. 11).To achieve a year-on-year top quartile performanceis even tougher. In the S&P 500 Index, wheremedian TSR has hovered around 10 percent overthe last thirty years, this would have required 21percent annual TSR.

A more realistic approach is to aim for a long-termaverage TSR target relative to an appropriate indexover a period of years. This not only acknowledgesthe fact that long-term fundamentals fuelshareholder returns (and the reality that allbusinesses are susceptible to occasional, short-term performance dips), it also lowers the TSR bar.To reach the top quartile in the S&P over a five-yearperiod, for example, the compound TSR needed is16 percent, compared to 21 percent year-on-year.To do this over ten years, it is 14 percent.

Equally crucially, companies need to revise theirtargets downwards. Many of the shareholderreturn goals set by corporations in the recent past– and today – are untenable. For example, CEOsstill typically target double-digit year-on-year EPSgrowth in today’s environment. Putting aside forthe moment the downside of EPS and year-on-year growth, the long-term average for EPS growthis in the order of 7 to 8 percent.

Inevitably there isn’t a ‘universally’ realisticshareholder return target. Relative TSR targets willvary between different types of corporations,depending on their industry, geographic reach and– above all – your target or ‘dominant investorsegment’s expectations, reflected in anappropriate index. Understanding this investorsegment is an essential step, as we explain in thesection ‘Make your strategy appealing to yourdominant investor segment’.

A word on executive incentives to hit RTSRtargets

Stock options undoubtedly encouraged seniorexecutives in certain companies to take measuresthat generated short-term gains at the expense oftheir firms’ long-term fundamental performance –either wittingly or, due to lack of understanding of thedrivers of long-term value creation, unintentionally.These types of incentives, which are based on short-term absolute changes in stock prices, need to bereconsidered.

To ensure management’s actions are aligned withshareholders’ long-term interests, incentives shouldbe linked to sustainable, long-term improvements invalue creation. The ‘relative’ component is again key– this will mean that executives are compensatedappropriately for their contribution to value creation,not for market- or industry-wide rises in stock prices.

0 4

56

137

304

458

387

192

112

15 00

50

100

150

200

250

300

350

400

450

500

0 1 2 3 4 5 6 7 8 9 10

Number of companies

(1)Number of years in which they beat the local market

( 1 ) Between 1992 and 2001Note: Analysis includes all 1,665 companies that had a minimum market capitalisation above $1Billion as of 31 December 2001 and were listed for more than ten yearsSource: T.F. Datastream; BCG analysis

Fig. 11 Creating value year after year is a difficult task

18



BCG

CASE STUDY: Beating the quarterly blues

0

200

400

600

800

1,000

1,200

1,400

1,600

Performance index(1)

1996 2002

Value creation from an outside perspective, 1996–2002

World auto and partsindex (1) Performance including share price and dividends, 1996 = 100

Source: T.F. Datastream, BCG Analysis

MDAX removal

Fig. 12 Porsche outperformed the automotive indexNot all companies have bowed to the demands

to play the quarterly earnings game. Porsche

refused to publish quarterly earnings on the

basis that these short-term snapshots added to

stock price volatility in a mature industry like

automotive and gave no true insights into long-

term fundamentals. This decision led to its

removal from the MDAX Index. Despite a short-

term drop in its stock price, the long-term

impact has been negligible. Its stock price has

continued to rise, built on strong fundamentals.

Although we wouldn’t recommend companies

use Porsche’s particular strategy, it does show it

is possible to break away constructively from

the short-term earnings fixation. As we discuss

later (see ‘Make your strategy appealing to your

dominant investor segment’), a more suitable

alternative is to develop a deeper, direct

relationship with your core investors.

19



BCG

As Figure 13 illustrates, long-term TSR is driven byfundamentals, measured by total business returns(TBR) – the percentage change in fundamentalvalue and cash flow. Although TBR’s closecorrelation with TSR makes it a valuable tool forunderstanding the stretch in fundamentalperformance needed to hit current TSR (and, inreverse, for setting shareholder return targets), itscomputational complexity makes it impractical forday-to-day control of a business. The questions topose are, ‘Which measures are suitable, practicalproxies? Which levers do you need to pull toensure your fundamental improvements translateinto higher TSR?’

The least useful solution in many cases, is to useEarnings Before Interest, Tax and Depreciation(EBITDA), as many companies now do.

Dangers of EBITDA

EBITDA originally came into vogue in the 1980s asa tool to identify leveraged buy-out candidates(LBOs): it was considered a good measure of acompany’s ability to service its debts. Soonanalysts and others became enamoured with thissimple metric because its removal of ‘non-operating’ costs such as interest and depreciationwould enable them to analyse and compare firms’core operations more accurately. And as theinfluence of analysts grew. many companies fellinto line and controlled their businesses withEBITDA.

However, this was often a misguided step, a viewendorsed by a growing army of leading authorities

on accounting and value creation, includingacademics at Wharton, one of the leading US topbusiness schools2. Some accounting standardsetters are also now cautioning against usingEBITDA as a performance measure.

The problem is that EBITDA excludes cash-consuming expenditures, notably interest and tax,as well as cash required for reinvestment. Itgauges neither a firm’s net income, nor – due to itsnet income failings – free cash flow. It is especiallyshort-sighted as a tool for capital-intensiveindustries, such as utilities, IT andtelecommunications, to name just three, as it omitsthe reinvestment costs needed to sustain long-

II. Control your company with fundamental measures that strongly influence long-term TSR

The combination of cash flow return on investment (CFROI) and gross investment,

producing cash value added (CVA), satisfies this criterion. EBITDA – a widely used

control metric and analysts’ preferred measure for tracking business performance – has

a weaker relationship with TSR, which can lead to inappropriate decisions that

undermine long-term fundamental performance.

TBR-Quartiles Selective, Stable And in Line With TSR Quartiles

Note: Top 565 companies of BCG Succeed in Uncertain times study 2002, Quartile made according to 5-yr. Avg. TBR (Total Business Return)Source: T.F Database; BCG-Analysis

On which performance indicators should executives focus in order to create good TBR and therebygood TSR performance?

On which performance indicators should executives focus in order to create good TBR and therebygood TSR performance?

Median-TBR per Quartile Median-TSR per Quartile

-5%

0%

5%

10%

15%

20%

25%

30%

35%

40%

1993 1994 1995 1996 1997 1998 1999 2000 2001 1993 1994 1995 1996 1997 1998 1999 2000 2001

1. quartile 2. quartile 3. quartile 4. quartile 1. quartile 2. quartile 3. quartile 4. quartile

-10%

0%

10%

20%

30%

40%

50%

Fig. 13 BCG’s fundamental value (TBR) is a very good proxy for shareholder return (TSR)

2. See John Percival (The Wharton School, University of Pennsylvania, Finance & Investment Faculty), 2002: “Is it time to get rid of EBITDA?”

20



BCG

term value creation. In addition, these costs areliable to different accounting treatments – in somecases even ‘questionable’ practices.

Not surprisingly EBITDA has little relationship withlong-term shareholder returns. This can be seen inFigure 14. In 1997, for example, top quartileEBITDA companies had the highest shareholderreturns. By 2001, however, these firms haddestroyed more value in four years than all theother quartiles.

A more robust approach: CFROI and grossinvestment

A more reliable solution for sustaining valuecreation is to concentrate on two main levers –CFROI and gross investment. Together,improvements in CFROI and gross investmentgenerate ‘internal’ fundamental value expressed bythe change in cash value added (delta CVA)3. Thiscan be seen in Figure 15. More crucially, as Figure16 demonstrates, both levers have a strongrelationship with long-term shareholder returns(TSR). However, you have to pull these in the rightorder. CFROI has to be above the weightedaverage cost of capital first. Only then will grossinvestment create value; unprofitable growth willdestroy value and shareholder return.

TSR-Quartiles Are Not Selective At All

EBITDA margins should not be used to predict good shareholder value performance.EBITDA margins should not be used to predict good shareholder value performance

Median EBITDA-Margin per quartile Median TSR per quartile

0%

5%

10%

15%

20%

25%

30%

35%

40%

1993 1994 1995 1996 1997 1998 1999 2000 2001-10%

0%

10%

20%

30%

1993 1994 1995 1996 1997 1998 1999 2000 2001

1st quartile 2nd quartile 3rd quartile 4th quartile

Note: Analysis based on all top 565 companies of total sample, quartiles made according to 5-year avg. EBITDASource: T.F. Datastream; BCG analysis

Fig. 14 High EBITDA margins not sufficient for good shareholder performance

BothRise in profitability

CFROI1

Cost ofcapital

CFROI2

GI1, 2

Profitable growth

Cost ofcapital

CFROI1, 2 CFROI1

Cost ofcapital

CFROI2

GI2 GI1 GI2GI1

It is the dynamic view that countsIt is the dynamic view that counts

CVA(1)

CVA

(1)

CVA(1)

∆

∆∆

( 1 ) Same principle for banks and insurance companies on an equity basis: CFROI = ROE, GI = equity, delta CVA = delta AVENote: CVA = cash value added; AVE = added value to equity; CFROI = cash flow return on investment; ROE = return on equity; GI = gross investment

Fig. 15 How CVA is calculated and influenced by different levers

... and Thereby Highest Shareholder-Return

Median TBR per Quartile Median CFROI per Quartile

-5%

0%

5%

10%

15%

20%

25%

30%

35%

40%

1993 1994 1995 1996 1997 1998 1999 2000 20014%

6%

8%

10%

12%

14%

16%

18%

1993 1994 1995 1996 1997 1998 1999 2000 2001


CFROI performance in line with TBR Quartiles.CFROI performance in line with TBR Quartile

Note: Analysis based on all top 565 companies of total sample, quartiles made according to 5-year avg. TBR (Total Business Return)CFROI and gross investment growth are not auto-correlated to TBR quartiles, looking at the small adjusted R2 values of the

adj. R2 = 0,2/ 0,24/ 0,42/ 0,05/ 0,39/ 0,2/ 0,1/ 0,36/ 0,24Source: T.F. Datastream; BCG analysis 2001

regression analysis 1993-2.

Fig. 16 Top CFROI preformers generate highest fundamental value

3. This produces a similar result to the Free Cash Flow (FCF) methodology now advocated by several people, including Warren Buffet. The difference and, inour view, the advantage of delta CVA over FCF is that it takes into account the gross investment required for long-term value creation.

21



BCG

During the bull market, companies with weakfundamental performances were able to enjoyreasonable stock price growth – rising expectationpremiums did most of the work for them. At onepoint you didn’t even need a fundamentalperformance, just a dot-com suffix to yourcompany’s name. Today, the protective cushion ofexpectation premiums has largely been removedand a stronger fundamental performance will berequired to generate shareholder value (TSR) –particularly if the economic climate darkens further.

This cannot be achieved with the burden ofunprofitable business units, nor with the all-too-common practice of allocating capitaldemocratically between units, especially if any areunprofitable (CFROI below the weighted averagecost of capital). Unprofitable growth, as weshowed earlier, destroys value.

General Dynamics, a US defense contractor,demonstrates the value of ensuring that all unitsare profitable. All four of its businesses achievedCFROI above the weighted average cost of capital,enabling it to invest heavily and generate a steepincrease in both fundamental value and, mostcrucially, shareholder value (Fig. 17). Since 1996 itsfundamental value grew by 26 percent a year onaverage and its TSR by 20 percent.

The company’s growth in asset productivity isparticularly noteworthy. As Figure 22 shows, top-quartile TSR firms have substantially higher assetproductivity than the other three quartiles. Theyalso increase their cash flow margins much moreaggressively.

This rigorous approach to both profitability levers –

III. Manage your business units as a portfolio of value creators and destroyers

Ensure all your businesses are profitable. Shed units that cannot be turned around

and allocate capital to the fundamentally healthy units on the basis of their value

creation potential.

Aviation with highest earnings and margin (2001)

WITH COMPARABLE WEIGHT

Each Performing at High Profitability

General Dynamics Revenues (2001)

30%

25%

20%

25%

Combatsystems Warships

and nuclearsubmarines

Commandand control

systemsAviation

(Gulfstream,Galaxy

Aerospace)

About 60 percent of revenues from the US government and no.2 shipbuilder for the US Navy

Source: Company Reports, Reuters, BCG analysis

Operating earnings in M$

Operating margin in %

310238

625

260

8.6%

19.1%

10.8%9.3%

0

250

500

750

1,000

Marine Combat Aviation Systems0%

5%

10%

15%

20%

Profitable growth in every business unit as key to successful stock performanceProfitable growth in every business unit is key to successful stock performance

WACC 2001:8.5%

Fig. 17 General Dynamics: four major business areas with comparable weight

. . . overall Profitability And Cash Flow Margin Improved Immediately After Rover Divestiture

Source: T.F. Datastream, BCG Analysis

Financial

Profitability

Investment growth

Cash flow margin

Capital turns

Internal value creation

Sales/gross investment

CVA (in M$)

Grossinvestment (in B$)

27.0 28.033.8

30.5

40.8

0

10

20

30

40

'97 '98 '99 '00 '01

9.7

9.46.96.9

7.4

0 %

5 %

10 %

15 %

'97 '98 '99 '00 '01

Cash flow/salesCFROI

0.841.03

0.911.01 1.02

0.0

0.5

1.0

'97 '98 '99 '00 '01

8.19.76.27.1

7.5

0 %

5 %

10 %

15 %

'97 '98 '99 '00 '01

-269

319

-916

-326-169

-1000

-500

0

500

'97 '98 '99 '00 '01

BMW splitsup Rover

BMW splitsup Rover

Note: Result for BMW in 1999 had been adjusted for extraordinary restructuring expenses for Rover

Fig. 18 Although BMW’S CVA went through a deep dip . . .

22



BCG

asset productivity and cash flow margins – needsto be applied to all units, especially those with sub-optimal CFROI. And if they can’t be turnedaround? Hard-nosed decisions have to be made.Although shedding an unprofitable business canbe internally painful in the short run, the long-termbenefits, both in terms of fundamentals andshareholder value, can be significant. BMW’sdivestiture of Rover is a case in point. Itsprofitability increased almost immediately and cashvalue added (CVA) moved up significantly, fuellingits stock price growth (Fig. 18).

More generally, corporations need to activelymanage their portfolio of businesses, fixing ordiscarding the weak and investing in businessesproportionate to their value creation potential. Toidentify the strategic options available for each unit,you have to analyse their value creation plansrelative to their current profitability. The matrix inFigure 19 provides a conceptual framework fordealing with this issue. Each quadrant has differentstrategic implications:

● Value creators: Invest in these units even ifCFROI is declining. Provided CFROI remainsabove the weighted average cost of capital,long-term value will be created.

● Value melters: These are profitable but growthpotential is declining. Look for niche growthmarkets and analyse individual investments.

● Value laggards: These units are either in thestart-up or turnaround phase. Analyse boththeir plans and progress carefully. Are theirplans realistic? Is the anticipated rise inCFROI to be reinvested in value creation orstockpiled as cash? Are the units subject tocyclical factors? If so, how can these bereduced? How can they increase cash flow orreduce their investment base to push CFROIabove the cost of capital?

● Value destroyers: Push for a miracleturnaround but plan to divest them.

Value-Based Portfolio Management

Above costof capital

Below costof capital

Negative Positive0

CFROI

CVA

Value melter

• Check CFROI

• Growth potentialdeclining

• Check singleinvestment

Value creator• Aggressive profitable

growth• Improvement of CFROI

• Acceptance of CFROIreduction possible

Value destroyer

• Divestment

Value laggards

• CFROI improvement• Reduction of capital

invested

Hurdle

∆

Fig. 19 Profitability and cvhange in CVA (cash value added) must both be considered

The value of high CFROI in a downturn

-4.0

(1) Relative CFROI spread = (75th percentile CFROI – 25th percentile)/medianNote: S&P 500 Non-financial companiesSource: Economy.com, BCG Value Science Center

0

10

20

30

40

50

60

70

80

90

100

1972 1977 1982 1987 1992 1997

-2.0

0.0

2.0

4.0

6.0

8.0 GDPgrowth(%)

Relativeprofitability

spread(%)

GDP Growth

Relative CFROI spread(1)

Times of low GDP growth and high spread

Fig. 20 The performance gap opens in downturnsCompanies with high profitability measured

by CFROI are significantly less likely to suffer

an erosion of profitability during a downturn,

enabling them to maintain CFROI above the

cost of capital and pursue fruitful acquisition

growth in these periods (see below for the

value creation potential of downturn M&As).

This is evident in Figure 20. In boom periods

the spread between companies’ profitability

is quite small. However during a downturn it

widens substantially, indicating that top

CFROI is less sensitive to economic declines.

23



BCG

In the drive to hit quarterly earnings forecasts overthe last decade, many businesses have pursuedthe easiest options – improved cash flow throughacquisition growth. Increasing sales throughacquisitions are obviously easy to communicate toanalysts, but the success rate of acquisitions hasbeen historically low. However, new BCG researchhas not only found that organic growth is theoverwhelming driver of long-term shareholderreturns, but that the chances of success withM&As – measured by their long-term valuecreation – are substantially higher if they areexecuted during downturns.

The importance of organic growth can be seen inFigure 21, based on a 30-year analysis of the S&P1500. Over this period, organic growth is thedominant driver of TSR in both the short and longterm. The impact of margins and asset productivityremains relatively stable. The comparatively lowcontribution of margins is understandable: there isa natural limit to how far these can be driven down.The small but negative influence of assetproductivity is an anomaly in view of its importancefor the top-quartile TSR businesses, indicating thatit is an under-exploited source of value, on average.

Two key factors drive organic growth: assetproductivity and innovation. As Figure 22demonstrates, asset productivity is much higheramong the top quartile TSR businesses. Althoughinnovation is difficult to quantify, few wouldquestion the likelihood that it is also morepronounced in this group – it is the principal engineof organic growth and organic growth is the maindriver of shareholder returns.

IV. Concentrate on organic growth but seize opportunities for acquisition growth during downturns

Profitable growth is the strongest driver of shareholder returns, in both the short and

long term. And organic rather than acquisition growth is generally the most important

component. Innovation, coupled with superior asset productivity, is vital to achieve

this. Don’t ignore M&A possibilities, though, especially in downturns. These are ideal

times to pursue M&As.

Note: Top Quartile TSR selected from S&P 1500 companies; ten year averages from 1983 to 2001Source: Compustat, BCG Value Science Center

Contribution to TSRFor top quartile companies – ten year averages

30%

25%

20%

15%

10%

5%

0%

13.6%

3.4%

4.6%

5.2%

-1.1% 1.2%

26.8%

Organicgrowth

Acquisitivegrowth

Marginimprovement

Growth inmultiple

Asset prod.improvement

Dividendyield

TSR

Fig. 21 TSR for top quartile companies primarily driven by organic growth

-100

0

100

200

300

'96 '97 '98 '99 '00 '01

Profitability

Internal value creation

Investment

Cash flow margin

Asset productivity

CFROI Cash flow/sales

Sales/Gross investmentInvestment (in B$)

CVA (in M$)

PRODUCTIVITY

And Largest Improvements In Cash Flow Margin

0%

4%

8%

12%

16%

'96 '97 '98 99 '00 '01

0

4,000

8,000

12,000

16,000

'96 '97 '98 '99 '00 '01

9%

13%

17%

'96 '97 '98 '99 '00 '01

0.60.70.80.91.01.11.21.3

'96 '97 '98 '99 '00 '01


Note: Analysis based on all top 565 companies of total sample, quartiles made according to five-year TSR (Total Shareholder Return); similar industry mix in all quarters

Source: T.F. Datastream; annual reports, BCG analysis

Fig. 22 Top TSR performer show significantly higher asset productivity

24



BCG

This is most evident in the pharmaceutical industry,where innovation – or, more specifically, thepromise of a firm’s R&D pipeline – is the keydistinguishing factor between businesses’performances. The German company Schering isone example. It recently launched major newproducts giving it footholds in new growth marketsand has several highly promising drugs in clinicaltrials. Together, these innovations have helped liftits stock price significantly above the WorldPharmaceutical Index.

Despite the importance of organic growth forlong-term TSR, this doesn’t mean that M&Asshould be written out of the equation. Historically,these have failed to deliver additional value for avariety of reasons, including inappropriatestrategic alignment, poor post-merger integration(PMI) and, most commonly, overpriced deals. Thiswas particularly the case in the 1990s whenvaluations were too optimistic and led toexcessive expectation premiums. A deeperunderstanding of what drives these premiums(see below) would have prevented manycompanies overpaying.

More significantly, it would have been more fruitfulin many cases to have waited until a downturn. Arecent BCG study, soon to be published, hasfound that M&As executed during these periodshave a much higher probability of generating long-term shareholder returns than those implementedin boom times (Fig. 23). On average, 53 percent of

downturn M&As produce long-term valuemeasured by RTSR compared to 41 percent ofboom-time M&As.

This isn’t just because downturns tend to bebuyers’ markets. Lower expectation premiums,tighter due diligence in severe capital marketconditions and lower resistance to PMI cost-cutting initiatives also help to make these periodsfavourable for M&As. Other key factors, which willbe examined in BCG’s forthcoming M&A report,are also critical.

41%

53%

0

10%

20%

30%

40%

50%

60%

Boom Downturn

Success chances(2)

Downturns are the better acquisition timesDownturns are the better acquisition times

( 1 ) RTSR (Relative Total Shareholder Return) success criteria defined as combined post-deal RTSR in N + 1 and N + 2 larger than zero( 2 ) Significantly different at above 95 percent levelNote: Analysis based on a total number of 386 companiesSource: VM research system; SDC; Compustat; BCG study ‘M&A in downsturns’

(1)

% of dealswithpositiveRTSR development

Fig. 23 Success chances for acquisitions madein a downturn are siqnificantly higher

25



BCG

The strategic implications of relativeexpectation premiums

One of the common misconceptions about stockmarket cycles is that nearly all companies are inthe same boat, apart from businesses thatnaturally benefit from particular points in the cycle.In boom times, the boat rises and in downturns itsinks. We’re generally all affected equally. There isan element of truth to this. Various macro-economic drivers and other forces tend to affectthe absolute expectation premium (the differencebetween market and fundamental value) of mostindustries and companies relatively equally.

However, although the absolute rise and fall instock prices is important to investors, it is therelative differences between companies’expectation premiums that is key. And thesealways exist in all market conditions. Figure 24,which shows the relative expectation premiums forthe top TSR corporations in the pharmaceuticalssector, illustrates how widely these can vary.

The reality is that companies are not in the sameboat; they are all in very different vessels on thesame tidal sea. And how businesses deal with theirrelative premiums can determine whether theirboats sink, simply stay afloat, or rise.

Relative expectation premiums have severalimportant implications for businesses’fundamentals and long-term shareholder returns,depending on the scale and direction of theirpremiums. These potential threats andopportunities are reflected in the matrix in Figure25. Each quadrant has different implications:

V. Manage your relative expectation premium

Expectation premiums provide strategic opportunities to improve and sustain

shareholder returns in both good and bad times. But they also present risks to value

creation potential. Although you cannot influence absolute premiums, which are

shaped by macroeconomic forces and other factors including ‘market sentiment’, you

can control many of the drivers of your relative premium.

Top Ten Companies According to TSR Ranking

Avg. expectation premium: top ten companies

Companyvalue(1)

Expectation PremiumFundamental Value

(3)

33%28%23%25%29%37%46%

67%72%77%

75%

71%63%

54%

0

50

100

150

200

250

300

350

400

450

'96 '97 '98 '99 '00 '01 '02

298

428

349

207

137

100

397

(2)

( 1 ) Market value of equity plus debt, 1996 = 100( 2 ) Estimated fundamental value; market value as of 31 October 2002Source: T.F. Datastream; BCG analysis

Fig. 24 Expectation premiums in the pharma industry

Currentexpectation premium

I IV

IIIII

Industry average

Industry average

Low performance,punished by investors Focus on

fundamentals Convince investors of

turnaround potential

High fundamentalperformance rewardedby investors Use the premium

strategically

"Optimist" "Consolidator"

"Underperformer""Hidden

champion"

Historic fundamentalperformance (TBR)

High market valuewithout correspondingfunda-mental growth

Focus onfundamentals

Good fundamental valuesbut investors do nottrust it Remove value reducing

factors (transparency,credibility, sharestructure, ...)

Fig. 25 Value Option Portfolio

26



BCG

● Quadrant 1, The Underperformer: Anybusinesses in this position are relativelyundervalued but justifiably so due to theircomparatively poor fundamentalperformance. Unless investors can beconvinced the business can be turnedaround – lifting its premium to at least theaverage – its situation is likely to deteriorate.Undervalued companies often find it difficultto raise investment capital.

● Quadrant 2, The Optimist: The company’sfundamental performance does not justify itsrelatively high premium. A share pricecorrection is imminent. And as wedemonstrated, if this relative premium ispositive and unjustifiably high, the business islikely to suffer a disproportionately large dropin RTSR during a market correction. To avoidthis fate, the firm must improve itsfundamentals or possibly acquire anotherbusiness with strong fundamentals but alower relative premium. Companies inQuadrant 4 (The Hidden Champions) arepossible targets.

● Quadrant 3, The Consolidator: The idealposition to be in. The fundamentally strongConsolidator could use its relative premiumadvantage to acquire a Hidden Champion.

● Quadrant 4, The Hidden Champion: Therobust fundamentals of the Hidden Championhave not been rewarded by investors. It mustremove the factors that are suppressing itspremium (see below, Managing the drivers ofrelative premiums), otherwise it could bevulnerable to a takeover by a Consolidator, oreven an Optimist.

Figure 26 demonstrates how this approach can beapplied in practice.

Managing the drivers of relative expectationpremiums

Two broad categories of drivers influence relativeexpectation premiums: value blockers and valuecreators. Both types of drivers can be controlledby corporations to establish sustainableimprovements in their relative expectation

premiums (positive and negative) and, byimplication, their stock price.

More importantly, it is possible to quantify the scaleof these premiums and, using tools developed byBCG, to identify the principle drivers of relativeexpectation premiums and their relativecontributions. Although it is currently not possibleto explain the total relative difference in yourpremium, a high percentage can be explained.

Removing value blockers

Value blockers increase investors’ risks or the costof equity, leading to stocks trading at a discountrelative to their intrinsic value. There are variousways to reduce these obstacles:

● Improve transparency: How and what youcommunicate to shareholders is pivotal toyour stock’s brand identity. Handled correctly,it can reduce the cost of equity – and,consequently, increase your marketcapitalisation – by up to 20 percent (Fig. 27).There are two prerequisites. First, you need toprovide full and open disclosure ofinformation to instil trust. Second, you have totailor your messages to core investorsegments (see next section) to reassure themthat your initiatives are in line with theiraspirations.

Top Ten pharmaceutical Companies According to TSR Ranking

Fundamental performance vs. expectation premium

Expectation premium 2001 (in %)

TBR 1997-2001 (in %)

( 1 ) Weighted average of the total sample, minimum market value 2001: $5bn, 39 companiesSource: T.F. Datastream; BCG analysis

-100

-50

50

100

-100 -50 50 100

A

vg. 6

2 %(1

)

Forest Labs.

Laboratory Corp.

Biomet

Serono

AllerganAmgen

Altana

Guidant Corp.

Novo Nordisk

Medtronic

Avg. 18 %(1)

I

II

IV

III

Fig. 26 Expectation premiums matrix of the pharma industry

27



BCG

● Increase the liquidity of your stock: Theeasier it is to buy and sell your stock, thelower the entry and exit costs, reducinginvestor risk. As Figure 28 illustrates,corporations with the most liquid shares (thelowest bid-offer spread) have at least a 10percent share price premium over less liquidstocks. There are three main ways to increaseliquidity:

i) Stock splits typically add 2 to 3 percent to a firm’s stock price, irrespective of the number of splits.

ii) Overseas listings increase liquidity bywidening the pool of shareholders. Theyalso lower market risk. On average, non-US companies that have listed in the UShave reduced their cost of equity (andincreased their market capitalisation) by1.3 percent on average, according to arecent study. UK companies achievedthe biggest savings (2.65 percent),followed by Asian and Australian firms(2.07 percent and 1.23 percentrespectively)4.

iii) Listings in major indices can also have asignificant impact, as Shell recentlyexperienced when it was excluded fromthe S&P Index, which is now focusing onUS corporations. Shell’s market valuedropped by 7 percent. Althoughcompanies cannot elect to be part of amajor index, firms that are includedshould strive to remain in these indices.This may rule out splitting a business, atactic that could push it out of the index.

● Manage your corporate reputation: Onaverage, firms with the best reputations enjoyaround a 25 percent share price premium. Inindividual cases, the gap can be as high as50 percent (Fig. 29). This isn’t surprising. Acompany renowned as a first-class employer,for instance, is likely to attract higher-qualitystaff. Similarly a business with a high-calibremanagement team and a commitment to

first-class standards is likely to encounterfewer product faults and other business risks.

There is also growing evidence that sociallyresponsible corporations generate above-averageshareholder returns. There are two possiblereasons for this. First, responsibility equalspredictability and consequently low risk, therebyincreasing demand for the stock. Second, someinvestors might be drawn to these types of firms

5

9

5

12

14

0

2

4

6

8

10

12

14

16

Small Midsize Large

Percentagereductionin CoE(1)

Midsize companies become more interesting for investorswhen disclosing more information

Midsize companies become more interesting for investorswhen disclosing more information

(1) Reduction relative to former Cost of EquitySource: Dorsman, van Dijk and de Ruiter in Financieel Management, BCG analysis

Fig. 27 Midsize companies benefit most from information disclosure by investor relations

Managing your liquidity can have a significant impacton shareholder value

Managing your liquidity can have a significant impacton shareholder value

-15

-10

-5

0

5

10

15

20

Bid-ask spread(2)

Premium(1)

(%)

Low High

(110)

(110)

(110) (110)

(111)

(1) Premium compared to industry median(2) Bid-ask spread as a Source: BCG analysis

measure for illiquidity

Fig. 28 Premium is dependant on liquidity

4. See G.A. Karolyi (Financial Markets Institutions & Instruments: “Why do companies list shares abroad”

28



BCG

for emotional not just financial reasons, just assome football fans invest in their clubs.

A strong corporate reputation, however, doesn’t justreduce the cost of equity. Academic research hasfound that a strong reputation can limit the impact ofan economic downturn on a firm’s share pricerelative to businesses with weaker reputations.

● Enhance and promote your managementcredibility: Investors will give businesses apremium – ‘a vote of confidence’ – if themanagement team has a track record ofsuccess. A close relationship with coreinvestors will help them understand yourteam’s potential, instilling greater trust.

● Make your strategy appealing to yourdominant investor segment: This is a majorissue worthy of a separate section. Weexplore this in more detail below.

Exploiting value creators

Certain drivers of expectation premiums can givecompanies sustained positive premiums: they canprolong businesses’ cash flow growth againstcompetitive pressures. Below are severalmeasures to generate these protective premiums:

● Focus on innovative growth: Premiums arestrongly related to fundamental valuecreation. And, as we mentioned earlier, themost fruitful source of growth in terms ofsustainable shareholder returns is organicgrowth. Innovation is an especially rich sourceof this, particularly when protected by patentsand other intellectual property rights.

● Aim for market leadership: Market leadersare usually rewarded with the highestpremiums. In 2001, for example, Pfizer’spremium was 21 percent larger than Merck’s(Fig. 30). BCG experience shows that marketleaders have the highest consolidationpotential within their industry. Furthermore, adownturn is a particularly good opportunity tocapture the high ground via low-cost M&Asas shown previously.

● Build strong brands: Brands help cementcustomer loyalty, providing cross-sellingopportunities and reducing the fade rate ofyour cash flow.

-30

-20

-10

0

10

20

30

40

50

60Median relative ExpectationPremium(1)

Worst reputation Best reputation(2)

(1) Premium on MV/Fundamental Value, relative to industry median. (1998); fundamental value is calculated with BCG double fade valuation model(2) Reputation based on quartiles of Fortune's most admired companies per 1998Note: Analysis based on a total number of 275 companiesSource: BCG analysis

Premium for reputation

+49%

0%-8%-24%

Fig. 29 Companies with a top reputation have a valuation premium of 49 percent relative to their industry

Expectation premium 2001 Expectation premium 2001‘Market leader’

Coca Cola

Wal-Mart

Intel

Hennes & Mauritz

‘Peer’

Pepsi Cola

Target

Motorola

GAP

70%

65%

61%

62%


63%

Pfizer Merck67% 46%

-12%

59%

43%

LVMH Richemont32% 1%

SAP Oracle83% 61%

Fig. 30 Market leadership and expectation premiums

29



Developing an effective customer-oriented strategy isa central pillar of good business practice but fewcompanies apply this principle to their ultimatecustomers – investors.

This is a dangerous oversight. Just as consumers ofproducts and services have different needs, differentinvestors have different appetites for growth,profitability, cash flow generation, and risk. Failure toalign your strategy with your core investors’aspirations – to match supply with demand – canlead to a significant short- to medium-term gap – orexpectation premium between your market andfundamental value. Typically, it means a negativeexpectation premium, a common complaint amongCEOs, especially today.

Although fundamentals drive long-run shareholder

returns, in the short- to medium-term thesepremiums can have a significant impact onfundamental performance and, by implication, long-term TSR. Negative expectation premiums, forexample, can make it harder to raise additionalcapital, distract management and reduce theeffectiveness of stock-related incentives. In extremecases it can lead to a takeover. High, positiveexpectation premiums are also risky. As wedemonstrated earlier – and as many companies haverecently experienced, unrealistically high premiumswill be disproportionately punished by the capitalmarkets (see above).

New research from BCG and Thomson Financial,however, shows that corporations that harmonisetheir strategies with their dominant investors’requirements, based on a BCG investor alignment

VI. Make your strategy appealing to your dominantinvestor segment

Different investors have different aspirations. Some, for example, want growth, others

value. Corporations that harmonise their initiatives with their core investor segments’

expectations are significantly less likely to have gaps between their market and

fundamental values and all the difficulties this can create.

5. The investor alignment index measures the consistency of the fundamental data in relation to the investor base. A score of 1 indicates that the fundamentalsare aligned with the investors’ criteria.

BCG

y = 0.0026x + 0.06R2 = 0.22

-0.2

-0.1

0

0.1

0.2

0.3

0.4

0.5

0 20 40 60 80 100

UTX

Textron Inc.Goodrich Corp.

Boeing COFortune Brands Inc.

American Standard COS Inc.

Stanley Works

Ingersoll-Rand CO Ltd.

Honeywell International Inc.

Deere & CO

Danaher Corp.

Illinois Tool Works

Snap-On Inc.

ITTIndustriesInc.Caterpillar Inc.

Dover Corp.

y = 0.005x - 0.6R2 = 0.53

-0.8

-0.6

-0.4

-0.2

0

0.2

0.4

0 20 40 60 80 100

BaxterInternational Inc.

Abbott Labo-ratories

Johnson&Johnson

Lilly (Eli) &CO

Amgen Inc.Merck&CO

Schering-Plough

Bristol MyersSquibb

Biogen Inc.

y = 0.0027x - 0.26R2 = 0.60

-0.4

-0.3

-0.2

-0.1

0

0.1

0.2

0 20 40 60 80 100

CVS Corp.

Best Buy CO Inc.

Gap Inc.

CostcoWholesale

Corp.Staples Inc.

WalgreenCO

Target Corp. TJXCompaniesInc.

Lowes COS

MAY Department Stores CO

LimitedBrands Inc.

Kohls Corp.

Investor Alignment IndexInvestor Alignment Index

Investor Alignment Index

Industrial Pharma

Retail

Valua-tionGap

Valua-tionGap

AGM. Growth GARP Value Yield

Wal-MartStores

Note:Investors classified into different kinds: (AGM = aggressive growthand momentum; GARP = growth at reasonable price)The Investor Alignment Index measures the consistency of thefundamental data in relation to the investor base. A score of 1indicates that the fundamentals are aligned with the criteria of theinvestors.Valuation, gap defined as (MV - FV)/FV; MV = market value (as of28 March 2001), FV = fundamental value, calculated by proprietary BCG Value Science methodologySource: BCG Value Science CenterSource: Thomson Financial, BCG analysis

Fig. 31 Investor alignment has material impact on valuation gap

30



BCG

index5 are less likely to experience these gaps. Figure31 illustrates this. The closer the alignment, the lowerthe gap in general.

Investor alignment isn’t a silver bullet. Other factorsinfluence expectation premiums – some within yourcontrol, others not – and we address this in the nextsection. Nor does this strategy mean that corporationsshould slavishly follow investors’ whims. However itcan reduce your valuation gap and, equally crucially,illuminate how strategic decisions will be received byshareholders. Here we briefly outline the main stepsrequired to harmonise your strategy with your coreinvestors.

Identify your dominant investor segment’s style.Most companies have a variety of investor segments,institutional and private, with varying aspirations suchas yield, value and ‘growth at a reasonable price’(GARP). These different styles of investors and therelative weightings they tend to ascribe to differentperformance measures of a business are summarisedin Figure 32. The first important step is to identify yourdominant investor style. To do this you need toconduct a detailed fact-based analysis of your investorbase. For example, what are your major institutionalshareholders’ objectives and how do these fit yourstrategy and which peer groups, for instance, do theybenchmark performances against? In collaborationwith Thomson Financial, BCG has developed anumber of tools to carry out this analysis to help youunderstand how different styles of investors will reactto corporate initiatives.

Understanding your dominant investors’ style, andparticularly the importance these shareholders attachto quantitative and qualitative measures such asrevenue growth and risk, is a vital step in formulatingstrategies that will be positively reflected in your stockprice. One BCG client with a long history of deliveringmodest but profitable organic growth illustrates thispoint: several years ago the company’s seniorexecutives were considering a new acquisition and amajor geographical expansion to justify the firm’spositive expectation premium and close the gapbetween its market and fundamental value. But at theeleventh hour after discussions with theirshareholders, they realised this was precisely whatinvestors did not want. The company’s dominantinvestor style was ‘GARP’ – shareholders wereprimarily interested in stability, not risky internationalexpansion.

Marry your strategy and internal processes with

their expectations. It’s not your aspirations, or for thatmatter investment analysts’ forecasts, that should setthe pace. It’s what your dominant investor segmentrequires. The first port of call is to align youroverarching RTSR goal with their desires. Next, younot only need to ensure your corporate and businessunit plans are in tune with this goal, but that they reflectyour dominant segment’s particular appetite forgrowth, risk and other drivers. Staff incentives shouldalso be in sync with these objectives. Equally crucially,you should develop internal control systems tocapture and analyse data on how you are performingagainst these specific targets.

Establish a close, direct dialogue with your coreinvestor segment. The best investor-orientedcompanies don’t view communication with investorsas simply a regulatory duty or an exercise in spinninga consistently positive story. Nor do they rely onanalysts to filter and interpret their strategy andperformance for the investment community. Theyengage directly, regularly and non-defensively withtheir core investors, usually face-to-face. Somecorporations even rotate line managers through theinvestor relations (IR) function to help them think howto run their units in a more investor-focused manner.

Building a closer relationship with investors has severalmajor advantages. For example, it gives firms adeeper understanding of the strategic trade-offs whentaking particular actions. Investors can also providevaluable strategic insights and information based ontheir meetings with similar companies. Moresignificantly, it helps cement trust and managementcredibility, one of the drivers of expectation premiums.

Summary of Practical Experience

Investment objective

Dividend yield

EPS growth (projected)

Sales growth

PEG ratio

Average EPS surprise

P/E ratio

Yield Value GARP(1) Growth AGM(2)

(1) Growth At Reasonable Price(2) Aggressive Growth and MomentumSource: T.F Datastream, BCG analysis

Long-termyield

> 2%

—

—

—

—

< 20

Value not fullyrecognized by

the market

> 1.8%

7%-14%

—

< 2

—

10-20

High growthnot fully

valued by themarket

—

> 12%

> 6%

—

< 20%

20-30

High growthwith minimal

regard tofundamental

risks

—

> 15%

> 10%

—

< 20%

—

Capital gainsand

reasonablerisk

—

> 12%

4%-10%

< 2

—

< 20%

Primaryimportance

Fig. 32 Investors of the same style have similar philosophyand inclusion criteria

Source: Thomson Financial, BCG analysis

31

Hope for the best, plan for the worst


BCG

Why contingency planning is essential

During a major economic downturn, companiesrarely have time to think and plan properly.Decision-making times shrink substantially.Without a well-structured contingency plan, thedanger is that incorrect decisions will remainunchallenged in this pressure-cooker environmentand be amplified into a major financial crisis astheir impact filters into other parts of theorganisation. This is a well-documented problemin complex systems including corporations. Therisk is even greater today as many managers willhave to cope with the threat of a severe recessionfor the first time.

To avoid these hazards, it is essential to formulatesystematic contingency plans for a range ofpossible scenarios – good, bad and expected.This involves three broad elements:

● Bullet-proofing your cash flow at both thecorporate centre and business unit levels.

● Having plans to use your superior cash foreach of your scenarios.

● Ensuring internal functions and systems areable to support these plans.

Even if a downturn never materialises, theseprocesses will generate a number of competitiveadvantages. It will:

● Bolster your cash flow.

● Pinpoint your competitors’ vulnerabilities andyour relative strengths.

● Reduce the distraction of uncertainty.

● Increase risk awareness in your company.

● Spark creative ideas by encouragingmanagers how to succeed in extremeconditions.

Establish likely scenarios

Different companies will have different economicoutlooks, depending on the personal view of theirboards, the countries in which they operate and their

Hope for the best, plan for the worst– and profit whatever happens

We all hope the markets and economy will pick up. But you can’t manage a company

on hope. You not only need to plan for your expected outcome but also the best and

worst scenarios. This process, detailed in this section, will improve your fundamentals

and highlight competitive opportunities, regardless of which direction the economy takes.

Index S&P 400 average

BY PERIODS OF UNDERSHOOTING

Note: Assumptions: 100 percent long-term average of MV/FV is only marginally violated, under-valuation by 15 percent, 35 percent and 50 percent, recovery after four to six years.

Source: S&P Security Price Index Record Statistical Service; BCG analysis

19900

500

1,000

1,500

2,000Possible Scenarios

1993 1996 1999 2002 2005 2008

'Downturn scenario'

Crash Scenario

Side step

BCG Scenario analysis for S&P 400

Fig. 33 Periods of overshooting always followed by periods of undershooting

32



BCG

industries. To develop contingency plans, at leastthree scenarios need to be considered – the board’sexpected outcome and the best and worstscenarios. Globally, based on currently circulatingviews, there seem to be three possible scenarios: aslow recovery, stagnation or deep recession (Fig. 33).

Appoint a crisis management team

A dedicated crisis management task forcereporting directly to your executive board shouldbe established with a mandate to perform threemain functions:

● Conduct a recession check to establish thesensitivity of your company’s cash flow toyour scenarios and recommend remedialactions to correct weaknesses.

● Develop plans for each scenario that willenable your firm to use your superior cashflow to profit from competitors’ vulnerabilities.

● Assist in operating the company, inconjunction with the board, if a crisis occurs.

The team should be composed of senior executivesfrom all key business units and functions to ensureall perspectives and interactions of your businesssystem are taken into account. Collectively, itsmembers should embrace a broad cross section ofprofessional, personal and intellectual skills, rangingfrom analytical and communication skills to ‘bigpicture thinking’ skills. Each individual should alsohave a clearly defined role.

Conduct a three-stage recession healthcheck

Even the most financially robust corporation willhave weak points in its cash flow, sometimes in astrategically important business sometimes inperipheral units. In fact, experience has shownthey tend to be found across all functions. Each ofthese Achilles heels must be addressed:collectively, they can severely undermine your cashflow in a downturn.

To identify these fault lines, you have to conduct athree-stage recession check, testing the resilienceof your company’s cash flow against differentlevels of severity of a downturn (Fig. 34). Each ofthese scenarios will indicate the type and urgencyof different cash flow improvement measures that

need to be implemented if these scenarios occur.The most extreme will reveal hidden weaknessesthat need to be corrected immediately.

● Establish the vulnerability of key marketsfor each downturn scenario. Analysinghistoric volatility of prices and volumes in coremarkets and industries will give an initialindication of each market’s vulnerability todifferent conditions. To gain a deeper insightinto these elasticities of demand, you willneed to assess a number of product-,customer-, supplier- and customer-relatedfactors. If there are a large number ofcompetitors in a market, for example,volumes and prices are likely to be highlysusceptible to a downturn, particularly if theproducts have long life cycles.

● How would these market sensitivitiesaffect your businesses’ sales and cashflow during a recession? Group yourbusiness units by high and low strategicpriority. Assess the potential impact ofdifferent volumes, prices and costs on thecash flow of the individual units in each ofthese two groups based on their price-volumeelasticities calculated earlier. This type of cashflow simulation can be done simply andquickly using a spreadsheet. Competitors’relative vulnerabilities should also be analysedin order to identify strategic opportunities toimprove market share (see below).

● Evaluate the impact on the company’s

Starting Point: Recession Scenario

Recession

portfolio

Recession

portfolio

Deviation analysis andensuring of survival


To what extent are the markets in which the

company operates able to resist crisis?



To what extent are theindividual business units able to

resist crisis?


resist crisis?

Crisis taskforce

Crisis taskforce

Business segment audit


Industryaudit

Industryaudit

Financingaudit

Financingaudit

1

2

4

To what extent is the current financial

structure able to resist crisis?



3Recession

portfolio

Recession

portfolio


Deviation analysis andensurance of survival



To what extent are the markets, in which the

company operates, able to resist crisis?


resist crisis?


resist crisis?

Crisis taskforce

Crisis taskforce



Industryaudit

Industryaudit

Financingaudit

Financingaudit

1

2

4





3

Fig. 34 Three phase recession check

33



BCG

overall cash flow. This should includeprojected cash flows during the crisis forthree key areas: operating units, financialliabilities such as debt, and investments.Each of these three links in the cash flowchain (and their relevant subcomponents)should be clearly visible. This will enable youto identify relative weaknesses and takeprioritised steps to correct cash flowweaknesses – such steps as costreductions, debt rescheduling andconsolidation of locations.

Treat your cash flow weaknesses

● Fixing cash flow weaknesses. As Figure 35illustrates, the relative sensitivity of eachbusiness unit to a crisis, coupled with theimmediacy of the crisis, determines themeasures that you need to take to plug cashflow holes. If a business is highly sensitive toa downturn and a crisis is imminent, forexample, measures to strengthen it includereducing costs, increasing efficiency and, if itis a marginal activity, disposing of it.

● Integrating crisis readiness into yourorganisation. At a corporate level, create amore flexible organisational and coststructure in order to make it more responsiveto time pressures during a downturn. Inaddition, hold management workshops toexplain the plans and the strategic guard-rails that need to be in place. You should alsointroduce systems to track early warningsigns that a particular scenario is evolving.

Use your cash flow fitness to profit from a crisis

● Increase market share through M&As.Historically, many of the biggest shifts inmarket share have occurred duringdownturns, fuelled by M&As. One of the mostdramatic was Rockefeller’s consolidation ofthe US network of thousands of small, mainlyfamily-run oil businesses, to create StandardOil. To exploit this opportunity, develop atarget list of prospective M&A candidates,taking into account their relative fundamentalperformances and expectation premiums.

● Invest against the tide. One of the biggest

Daily Liquidity Management: Control of the ‘Five Money Traps’ andRating of Receivables

Five money traps Rating of receivables

1. Control all accounts

2. Control the cost of personnel,especially hiring and overtime

3. Control all orders with a view toimplementing the reduction ofinvestments

4. Control all payment instructions,especially checks, money transfersand cash payments

5. Control selling prices by specifiying minimum price and maximum discounts

1. Regularly review all accountsreceivable

2. Realistically rate their collectibility

3. Use rating result to provide the basis forreceivables included in rollingbudget of payment reserves

Fig. 35 Crisis management (I):

Fig. 36 Crisis management (II):

Fig. 37 Crisis management (III):

34



BCG

mistakes that companies make in economicdownturns is to retreat into their shells and cutinvestments such as marketing and R&D thatdon’t deliver immediate cash flow. The realityis that this is precisely the time to step upthese activities, using your superior cash flowor existing reserves. With these strengths youwill be able to capitalise on your competitors’weaknesses and improve market share, a keydriver of sustainable positive expectationpremiums (see above). The earlier analysis ofyour competitors’ relative vulnerabilities to acrisis will pinpoint where to most fruitfullymake many of your investments.

Different investment plans should be created foreach of your scenarios. Areas to consider include:

Sales and marketing

● Strengthen any brands by increasingadvertising expenditures.

● Focus price offensives and geographicexpansion on competitors’ strongholds.

R&D

● Increase research expenditure to gain orextend the technological lead.

● Innovate through new products and services.

Production and logistics

● Expand low-cost leadership by investing inyour production platform.

● Establish new logistics models to increasespeed and reliability of delivery and reducestorage costs.

Personnel and training

● Improve competencies by poaching seniormanagers from competitors.

● Increase employee satisfaction by intensifyingtraining initiatives.

35


BCG

The study is based on the annual returns of 4,000companies in Datastream’s global market indicesfor the period 1997 to 2001. Collectively, theyrepresent around 70 percent of the world’s totalmarket capitalisation.

Businesses were selected from Datastream’sdatabase using three main criteria:

● Listed for at least five years.

● Satisfied minimum market capitalisationhurdles: different capitalisation hurdles wereset for each country and sector to reflect theirrelative economic weight (see Figures A1 and A2).

● Could be classified into one of fourteen industrial sectors.

Several companies that met these criteria wereexcluded from the final sample as they had beeninvolved in major mergers or acquisitions over thestudy period (1997 to 2001) and were believed todistort the study.

All financial figures were converted into dollars,using the exchange rate as of 31 December 2001.

Study background

Source: T. F. Datastream, BCG analysis

88

411

428

556

721

779

819

992

1,016

1,367

2,529

2,622

3,089

5,751

0 500 1,000 1,500 2,000 2,500 3,000 3,500 4,000

Market capitalization (B$)

Hurdle = US$3bn Hurdle =US$5bn

Technology

Banks

Pharma & Health Care

Consumer Goods

Insurance & Assurance

Industrial goods

Multibusiness

Retail

Utilities

Media & Entertainment

Automotive & Supply

Chemicals

Travel, Transport & Tourism

Pulp & Paper

Hurdle = US$10bn

Fig. A1 Market capitalisation hurdles for each industry

0 5,000 10,000 15,000 20,000 25,000

Source: T.F. Datastream, BCG analysis

Global

North America

Europe

Asia-Pacific

Market capitalization(US$bn)

Hurdle = US$5bn

Hurdle = US$10bn

Fig. A2 Market capitalisation hurdles for each region

36


BCG

37


BCG

Regional and industry rankings

BCG38

TSR Ranking

WORLD

-100

-50

0

50

100

-100 -50 0 50 100

Company value(2)

Expectation premium

Fundamental valueTBR 1997-2001 (in %)

(3) I

II

IV


4%(1)

49

%(1

)

III

Best Buy

Nokia

Qualcomm

Forest

Avg.

Avg

.

Labs.

Dell

Taiwan Semicon. Mnfg. Samsung

Kohls

SK TelecomLowe's

44%39%43%20%42%58%86%

56%

61%57%80%

58%

42%14%

-50

100

250

400

550

700

850

1000

1150

1300

'96 '97 '98 '99 '00 '01 '02

1080

821

658

401

182100

812

Rank Company name Country CVA2001M$

EP(3)

31 Oct

2002 year to date

3502,371-422123

1,649-207931246582455

8%54%93%86%55%46%51%70%23%56%

41%35%23%19%61%31%29%44%31%35%

MV 2001M$

95%61%60%59%52%49%49%48%48%40%

TBR1997–2001

TSR1997–2001

EP2001

TSR1 Jan-31 Oct

-59%-40%-32%20%

5%-42%24%

-17%-16%-10%

61%69%95%84%48%64% 37%74%26%60%

Best Buy Nokia QualcommForest Labs.Dell ComputerTaiwan Semicon Mnfg . Samsung ElectronicsKohls SK Telecom Lowe's

123456789

10

15,765122,061

38,60314,58470,85842,09332,14423,59418,19035,936

USFNUSUSUSTAKOUSKOUS

GlossaryCVA = Cash Value AddedEP = Expectation PremiumMV = Market value (equity)TBR = Total Business Return (fundamental performance)TSR = Total Shareholder Return (market performance)


Notes(1) Weighted average of the total sample, minimum

market value 2001: $10bn, 138 companies

(2) Market value of equity plus debt, 1996 = 100

(3) Estimated Fundamental value; market value as of31Oct 2002

Fundamental performance vs. expectation premium Avg. expectation premium top 10 companies

BCG 39

TBR Ranking

39

WORLD

Company value(2)

Expectation premium

Fundamental value

(3) -100

-50

0

50

100

-100 -50 0 50 100

TBR 1997–2001 (in %)

I

II

IV


Avg. 14 %(1)

A

vg.

49 %

(1)

III

Dell

Kohls

Capital One

Paychex

BB&T

Ahold

Best Buy

Sun Microsystems

MBNA

Oracle

72%56%43%

19%32%49%50%

28%

44%

57%81%

68%

51%50%

0

100

200

300

400

500

600

700

'96 '97 '98 '99 '00 '01 '02

640

555

318318

148100

429


EP(3)

2002 year to date

1,649246319179793350

1,614937

2,249377

55%70%-1%76%

-48%8%

-242%32%52%38%

61%44%43%42%41%41%40%40%38%38%

MV 2001M$

52%48%36%29%17%95%31%25%24%18%

TBR1997 –2001

TSR1997 –2001

EP2001

TSR

5%-17%-43%-16%-60%-59%-76%-13%-26%

4%

48%74%44%78%13%61%

0%44%61%38%

Dell ComputerKohlsCapital One PaychexAhold Kon.Best BuySun MicrosystemsMBNA OracleBB & T

123456789

10

70,85823,59411,59213,06026,75315,76539,87229,98375,91616,360

USUSUSUSNLUSUSUSUSUS

31 Oct 1 Jan-31 Oct







Avg. expectation premium top 10 companiesFundamental performance vs. expectation premium

BCG40

TSR Ranking

ASIA

-120

-80

-40

0

40

80

120

-120 -80 -40 0 40 80 120

Company value(2)

Expectation premium


(3) I

II

IV


Avg. 7 %(1)

A

vg. –

22 %

(1)

III

Wipro

Infosys Technologies

Hon Hai Prec.

Taiwan Semicon.Mnfg.

Samsung Electronics SK Telecom

Woolworths

Wesfarmers

Posco

Reliance Inds.

61%59%87%

44%94%68%118%

39%41%

13%56%

6%

32%

-18%

-100

0

100

200

300

400

500

'96 '97 '98 '99 '00 '01 '02

453

387

449

183

169

100

487


EP(3)

2002 year to date

6274

152-207931582208

54-1,254

-40

84%74%51%46%51%23%52%57%

-44%15%

69%114%53%31%29%31%20%23%13%40%

MV 2001M$

136%113%53%49%49%48%35%35%31%26%

TBR1997 –2001

TSR1997 –2001

EP2001

TSR

-14%-5%-9%

-42%24%

-16%13%

-13%-6%

-13%

86%73%50%64%37%26%47%65%-32%2%

Wipro Infosys Technologies Hon Hai Precision Taiwan Semicon Mnfg . Samsung ElectronicsSK Telecom WoolworthsWesfarmers PoscoReliance Inds .

123456789

10

7,6165,4128,088

42,09332,14418,190

5,9785,8748,6936,011

ININTATAKOKOAUAUKOIN

31 Oct 1 Jan-31 Oct

GlossaryCVA = Cash Value AddedEP = Expectation PremiumMV = Market value (equity)TBR = Total Business Return (Fundamental performance)TSR = Total Shareholder Return (Market performance)



market value 2001: $5B, 89 companies




BCG 41

TBR Ranking

41

ASIA

Company value(2)

Expectation premium

Fundamental value

(3) -120

-60

0

60

120

-120 -60 0 60 120

TBR 1997-2001 (in %)

I

II

IV


Avg. 7 %(1)

A

vg. –

22 %

(1)

III

Wipro

Infosys

Hon HaiPrec.

Reliance Inds.

Tenaga National

Samsung

Hutchinson Whampoa SK Telekom

JapanTelekom

Taiwan Semic.Mnfg.

76%70%77%

39%70%63%71%

24%

30%23%

61%

30%37%

29%

0

50

100

150

200

250

300

350

'96 '97 '98 '99 '00 '01 '02

303

269 262

127119100

300


EP(3)

2002 year to date

7462

152-40

1,024582

-207931

-1,755-382

74%84%51%15%

-62%23%46%51%

0%10%

114%69%53%40%39%31%31%29%26%25%

MV 2001M$

113%136%53%26%-5%48%49%49%9%-2%

TBR1997 –2001

TSR1997 –2001

EP2001

TSR

-5%-14%

-9%-13%-18%-16%-42%24%

-34%-16%

73%86%50%

2%-65%26%64%37%28%

9%

Infosys TechnologiesWiproHon Hai PrecisionReliance Inds .Japan TelecomSK TelecomTaiwan S emicon Mnfg .Samsung ElectronicsHutchinson WhampoaTenaga National

123456789

10

5,4127,6168,0886,0119,581

18,19042,09332,14441,142

8,748

ININTAINJPKOTAKOHKMY

31 Oct 1 Jan-31 Oct








BCG42

TSR Ranking

EUROPE

Company value(2)

Expectation premium

Fundamental value

(3)

55%37%

46%

31%69%92%110%

45%

63%

54%

69%

31%8%

-10%-50

50

150

250

350

450

550

650

750

'96 '97 '98 '99 '00 '01 '02

682714

367

259

161

100

578


EP(3)

2002 year to date

2,37147

158148337161

-174-2,261

212420

54%78%39%

-27%57%15%

-19%38%46%72%

35%23%37%27%33%30%1%2%

24%27%

MV 2001M$

61%48%45%38%37%36%35%34%34%33%

TBR1997 –2001

TSR1997 –2001

EP2001

TSR

-40%-44%13%

-27%-17%-43%-42%-45%

-6%-47%

69%89%38%3%

65%53%26%57%55%83%

Nokia Mediolanum Porsche Bouygues Hennes & Mauritz SeronoFinmeccanicaPhilipsTF1 SAP

123456789

10

122,0616,5336,685

10,88715,10810,180

7,27539,115

5,35941,387

FNITBDFRSDSWITNLFRBD

-100

-50

0

50

100

-100 -50 0 50 100

TBR 1997-2001 (in %)

I

II

IV


Avg. 11 %(1)

A

vg. 2

5 %

(1)

III

Nokia

Mediolanum

Porsche

Bouygues

Hennes &Mauritz

Serono

Finmeccanica

PhilipsTF1

SAP

31 Oct 1 Jan-31 Oct








BCG 43

TBR Ranking

43

EUROPE

Company value(2)

Expectation premium

Fundamental value

(3)

82%54%41%30%46%

70%73%

18%

46%

59%

70%

54%

30%27%

0

100

200

300

400

500

600

700

800

'96 '97 '98 '99 '00 '01 '02

660 685

347339

152100

5265


EP(3)

2002 year to date

501793358267364158

2,371-95756337

-41%-48%-43%44%

-24%39%54%21%

-21%57%

43%41%40%40%37%37%35%34%34%33%

MV 2001M$

14%17%25%13%10%45%61%20%22%37%

TBR1997 –2001

TSR1997 –2001

EP2001

TSR

-16%-60%-35%18%

-13%13%

-40%-43%-53%-17%

-19%13%

0%36%-4%38%69%39%48%65%

Dixons Gp.Ahold Kon.CRHCastorama DuboisKBC PorscheNokiaPinault PrintempsAegonHennes & Mauritz

123456789

10

6,55426,753

9,2028,088

10,0476,685

122,06115,75838,49715,108

UKNLIRFRBGBDFNFRNLSD

-100

-50

0

50

100

-100 -50 0 50 100

TBR 1997–2001 (in %)

I

II

IV


Avg. 11 %(1)

A

vg.

25 %

(1)

III

Dixons

Ahold

CRHKBC

Porsche

Castorama Dubois

Nokia

Pinault Printemps

H&MAegon

31 Oct 1 Jan-31 Oct








BCG44

TSR Ranking

NORTH-AMERICA

Company value(2)

Expectation premium

Fundamental value

(3)


-100

-50

0

50

100

-100 -50 0 50 100

TBR 1997-2001 (in %)

I

II

IV

Avg. 10 %(1)

A

vg.

43 .%

(1)

III

Best Buy

Qualcomm

Forest Labs.

Dell Computer

Kohls

Lowe's

BCE

Harley-Davidson

Home Depot

46%41%40%20%34%56%73%

54%59%

60%

80%

66%

44%27%

0

100

200

300

400

500

600

'96 '97 '98 '99 '00 '01 '02

603

412 396

330

161100

464Wal Mart Stores


EP(3)

2002 year to date

350-422123

1,649246455

5,422820304

1,639

8%93%86%55%70%56%60%

-62%64%48%

41%23%19%61%44%35%26%13%32%37%

MV 2001M$

95%60%59%52%48%40%39%38%36%36%

TBR1997 –2001

TSR1997 –2001

EP2001

TSR

-59%-32%20%

5%-17%-10%

-7%-23%

-4%-43%

61%95%84%48%74%60%62%-62%69%70%

Best Buy Qualcomm Forest Labs.Dell Computer Kohls Lowe'sWal Mart StoresBCE Harley-DavidsonHome Depot

123456789

10

15,76538,60314,58470,85823,59435,936

256,50518,16516,441

119,199

USUSUSUSUSUSUSCNUSUS

31 Oct 1 Jan-31 Oct








BCG 45

TBR Ranking

NORTH-AMERICA

-100

-50

0

50

100

-100 -50 0 50 100

Company value(2)

Expectation premium

Fundamental value

(3)

TBR 1997-2001 (in %)

I

II

IV


Avg. 10 %(1)

A

vg.

43 %

(1)

IIIPaychex

KohlsBestBuy

Oracle

BB & T

Dell Computer

SBC Communications

Capital One

Sun Microsystems

91%75%63%

36%50%

66%70%

9%25%

37%64%

50%

34%

30%

0

100

200

300

400

500

600

700

'96 '97 '98 '99 '00 '01 '02

614

543

315

318

171

100

421MBNA


EP(3)

2002 year to date

1,649246319179350

1,614937

3,1822,249

377

55%70%-1%76%

8%-242%

32%-42%52%38%

61%44%43%42%41%40%40%39%38%38%

MV 2001M$

52%48%36%29%95%31%25%11%24%18%

TBR1997 –2001

TSR1997 –2001

EP2001

TSR

5%-17%-43%-16%-59%-76%-13%-32%-26%

4%

48%74%44%78%61%

0%44%

-14%61%38%

Dell ComputerKohlsCapital One PaychexBest BuySun MicrosystemsMBNA SBC CommunicationsOracleBB & T

123456789

10

70,85823,59411,59213,06015,76539,87229,983

131,67275,91616,360

USUSUSUSUSUSUSUSUSUS

31 Oct 1 Jan-31 Oct








46

Automotive

TSR Ranking

BCG

Company value(2)

Expectation premium

Fundamental value

(3)

111%98%112%109%

124%108%109%

-11%

2%

-12%-9%-24%

-8%-9%

-100

-50

0

50

100

150

200

250

'96 '97 '98 '99 '00 '01 '02

162179

206

140126

100

213


EP(3)

2002 year to date

158304

-873-476-269107

-288545

-1,6281,360

39%64%

-49%9%9%

28%20%

-44%-10%-16%

37%32%20%14%19%16%30%20%16%16%

MV 2001M$

45%36%28%21%20%19%17%16%12%10%

TBR1997 –2001

TSR1997 –2001

EP2001

TSR

13%-4%-8%23%-8%2%

15%-2%

-25%-16%

38%69%-31%7%

20%34%24%-29%6%8%

PorscheHarley-DavidsonPeugeotRenaultBMWPaccarHyundai MotorJohnson ControlsVolkswagenHonda Motor

123456789

10

6,68516,44111,016

8,54223,009

5,0364,4877,078

18,42838,884

BDUSFRFRBDUSKOUSBDJP

-70

-35

0

35

70

-70 -35 0 35 70

TBR 1997-2001 (in %)

I

II

IV


Avg. 12 %(1)

A

vg. –

15 %

(1)

III

Porsche

Harley-Davidson

Peugeot

Renault

BMW

Paccar

HyundaiMotors

Johnson Controls

VolkswagenHonda Motor

31 Oct 1 Jan-31 Oct








47

Automotive

TBR Ranking

BCG

Company value(2)

Expectation premium

Fundamental value

(3)

TBR 1997–2001 (in %)

Premium 2001 (in %)

-100

-50

0

50

100

-100 -50 0 50 100

I

II

IV

Avg. 12 %(1)

A

vg. –

15 %

(1)

III

Porsche

Harley-Davidson

Magna Intl.

Hyundai Motor

Peugeot

Johnson Controls

BMW

DaimlerChrysler

Fuji Heavy Inds.

Honda Motor 135%118%120%108%

109%103%

115%

-35%-18%-20%

-8%-9%-3%-15%

-100

-50

0

50

100

150

200

250

'96 '97 '98 '99 '00 '01 '02

100

181 181 187

159

135

201


EP(3)

2002 year to date

158304267

-288-873545

-269130

-7,8641,360

39%64%

-65%20%

-49%-44%

9%-108%

-49%-16%

37%32%32%30%20%20%19%18%18%16%

MV 2001M$

45%36%8%

17%28%16%20%5%1%

10%

TBR1997 –2001

TSR1997 –2001

EP2001

TSR

13%-4%

-15%15%-8%-2%-8%

-32%-26%-16%

38%69%

-55%24%

-31%-29%20%

-58%-21%

8%

PorscheHarley-DavidsonMagna Intl.Hyundai MotorPeugeotJohnson ControlsBMWFuji Heavy Inds.DaimlerChryslerHonda Motor

123456789

10

6,68516,441

4,9044,487

11,0167,078

23,0093,201

43,63438,884

BDUSCNKOFRUSBDJPBDJP

31 Oct 1 Jan-31 Oct








BCG48

TSR Ranking

BANKS

Company value(2)

Expectation premium

Fundamental value

(3)

56%44%40%44%42%49%67%

44%56%

60%

56%

58%

51%

33%

0

50

100

150

200

250

300

350

400

450

500

'96 '97 '98 '99 '00 '01 '02

302

435

329

258

180

100

393

Rank Company name Country AVE2001M$

EP(3)

2002 year to date

319421

-124379361218232255

-326526

-1%-7%36%35%67%41%74%53%84%

-23%

43%33%25%32%37%22%7%

26%3%

25%

MV 2001M$

36%34%30%29%29%29%28%28%27%27%

TBR1997 –2001

TSR1997 –2001

EP2001

TSR

-43%-20%-40%11%

5%-42%23%

-20%-41%

-8%

44%17%63%33%67%68%71%65%91%-3%

Capital OneLehman BrothersMediobancaBank of IrelandFifth Third Bancorp.Northern TrustSLMState StreetCharles SchwabDanske Bank

123456789

10

11,59215,919

8,7209,341

35,43713,37613,17217,00021,14211,839

USUSITIRUSUSUSUSUSDK

-100

-50

0

50

100

-100 -50 0 50 100

TBR 1997-2001 (in %)

I

II

IV


Avg. 14 %(1)

A

vg.

47 %

(1)

III

Capital One

LehmanBrothers

Mediobanca

Bank of Ireland

Fifth ThirdBancorp.

Northern TrustSLM

State Street

Charles Schwab

DanskeBank

31 Oct 1 Jan-31 Oct

GlossaryAVE = Added Value to EquityEP = Expectation PremiumMV = Market value (equity)TBR = Total Business Return (fundamental performance)TSR = Total Shareholder Return (market performance)







BCG 49

TBR Ranking

BANKS

Company value(2)

(3)

TBR 1997–2001 (in %)

Premium 2001 (in %)

Avg. 14 %(1)

A

vg.

47 %

(1)

Expectation premium

Fundamental value

(3)

80%66%54%

58%42%49%59%

20%34%

46%

42%58%

51%

41%

0

50

100

150

200

250

300

350

400

'96 '97 '98 '99 '00 '01 '02

228

322

287

235

167

100

331


EP(3)

2002 year to date

319216937377988361

2880131421379

-1%26%32%38%

-73%67%

5%18%-7%35%

43%40%40%38%37%37%36%33%33%32%

MV 2001M$

36%13%25%18%15%29%20%7%

34%29%

TBR1997 –2001

TSR1997 –2001

EP2001

TSR

-43%20%

-13%4%

-58%5%

-5%-2%

-20%11%

44%20%44%38%33%67%15%29%17%33%

Capital One Charter One MBNA BB & THousehold Intl.Fifth Third Bancorp.Freddie MacUnion PlantersLehman BrothersBank of Ireland

123456789

10

11,5926,102

29,98316,36026,52035,43745,561

6,20015,919

9,341

USUSUSUSUSUSUSUSUSIR

31 Oct 1 Jan-31 Oct

-100

-50

0

50

100

-100 -50 0 50 100

I

II

IV

III

Capital One

Charter One

MBNA

BB & T

Household Intl.

Fifth ThirdBankcorp.

Freddi Mac

Union Planters

Lehman Brothers

Bank of Ireland

GlossaryAVE = Added Value to EquityEP = Expectation PremiumMV = Market value (equity)TBR = Total Business Return (Fundamental performance)TSR = Total Shareholder Return (Market performance)



market value 2001: $5B, 62 companies




BCG50

TSR Ranking

CHEMICALS

-80

-40

0

40

80

-80 -40 0 40 80

Company value(2)

Expectation premium


(3) I

II

IV


Avg. 8 %(1)

A

vg. –

11 %

(1)

III

Shin-Etsu Chemical

Akzo Nobel

Johnson Matthey

DSM

Nitto Denko

Air Liquide

Solvay

Engelhard

BASF

Dow Chemicals

108%104%108%101%

136%129%136%

-8%-4%

-8%-1%

-36%-29%-36%

-50

0

50

100

150

200

'96 '97 '98 '99 '00 '01 '02

161 162

145

120116100

167


EP(3)

2002 year to date

476280100

-20562

-45-138116

-2,236-1,947

-5%8%

24%-48%23%

2%-48%18%-7%10%

18%9%

19%12%11%17%8%

12%8%4%

MV 2001M$

18%16%15%15%13%12%10%10%10%9%

TBR1997 –2001

TSR1997 –2001

EP2001

TSR

-20%-38%

-8%8%7%

-5%-8%

-19%-8%

-21%

4%27%22%-67%9%-1%-53%25%-11%16%

Shin- Etsu ChemicalAkzo NobelJohnson MattheyDSMNitto Denko Air Liquide SolvayEngelhard BASF Dow Chemicals

123456789

10

15,18612,771

3,0324,1694,017

12,7285,0793,593

22,88630,466

JPNLUKNLJPFRBGUSBDUS

31 Oct 1 Jan-31 Oct








BCG 51

TBR Ranking

CHEMICALS

-100

-50

0

50

100

-100 -50 0 50 100

Company value(2)

Expectation premium

Fundamental valueTBR 1997–2001 (in %)

(3) I

II

IV


Avg. 8 %(1)

A

vg. –

11 %

(1)

III

Nan Ya PlasticsJohnson Matthew

Shin-Etsu ChemicalPotash Sask

Air Liquide

Formosa Plastics

Sherwin WilliamsPraxair

Air Products

DSM

88%94%88%81%101%

89%87%

12%6%12%

19%

-1%

11%

13%

-50

0

50

100

150

200

'96 '97 '98 '99 '00 '01 '02

143 146143

118117100

148


EP(3)

2002 year to date

-935100476

-142-45

-493201101169

-205

32%24%-5%21%

2%55%20%14%

6%-48%

21%19%18%17%17%14%13%12%12%12%

MV 2001M$

-5%15%18%-2%12%-4%2%5%8%

15%

TBR1997 –2001

TSR1997 –2001

EP2001

TSR

22%-8%

-20%9%

-5%29%

2%0%

-5%8%

17%22%

4%8%

-1%41%13%

5%1%

-67%

Nan Ya PlasticsJohnson MattheyShin-Etsu ChemicalPotash SaskAir LiquideFormosa PlasticsSherwin-WilliamsPraxAirAir ProductsDSM

123456789

10

4,4483,032

15,1863,178

12,7283,8884,2478,887

10,6584,169

TAUKJPCNFRTAUSUSUSNL

31 Oct 1 Jan-31 Oct








BCG52

TSR Ranking

CONSUMER GOODS

Company value(2)

Expectation premium

Fundamental value

(3)

51%47%41%45%50%65%77%

49%53%59%

55%50%

35%

23%

0

50

100

150

200

250

300

'96 '97 '98 '99 '00 '01 '02

208

260241

191

134

100

253


EP(3)

2002 year to date

97498109463

-3421,018

1733,038

210330

17%61%51%72%30%62%57%32%49%39%

24%21%15%16%5%

13%39%10%35%19%

MV 2001M$

37%28%28%23%22%22%22%21%20%20%

TBR1997 –2001

TSR1997 –2001

EP2001

TSR

-5%22%

-12%-6%-2%-4%25%-9%-1%-4%

23%55%59%75%39%66%48%41%52%45%

Weston GeorgeSyscoBeiersdorfL'OrealDanone Colgate-PalmoliveStarbucksNestleCintas Heineken

123456789

10

8,51617,476

9,45448,69918,23831,862

7,24484,426

8,14920,166

CNUSBDFRFRUSUSSWUSNL

-100

-50

0

50

100

-100 -50 0 50 100

TBR 1997-2001 (in %)

I

II

IV


Avg. 13 %(1)

A

vg.

34%

(1)

III

Weston George

SyscoBeiersdorf

L'Oreal

Danone

Colgate-Palmolive

StarbucksNestle

CintasHeineken

31 Oct 1 Jan-31 Oct








BCG 53

TBR Ranking

CONSUMER GOODS

Company value(2)

Expectation premium

Fundamental value

(3)

73%74%62%

57%71%69%

64%

27%26%38%

43%

29%

31%

36%

0

50

100

150

200

250

'96 '97 '98 '99 '00 '01 '02

182198 202

146

125

100

191


EP(3)

2002 year to date

173210119

97-54462148498203608

57%49%58%17%33%28%

-19%61%20%12%

39%35%25%24%24%22%22%21%21%21%

MV 2001M$

22%20%20%37%17%5%4%

28%0%2%

TBR1997 –2001

TSR1997 –2001

EP2001

TSR

25%-1%

-12%-5%1%1%

27%22%20%

6%

48%52%65%23%37%32%

-26%55%13%15%

StarbucksCintasHermes Intl.Weston GeorgeFosters GroupLVMHCoca Cola Ents .SyscoNewell RubbermaidConagra

123456789

10

7,2448,1495,6718,5165,070

19,9348,423

17,4767,352

12,769

USUSFRCNAUFRUSUSUSUS

-100

-50

0

50

100

-100 -50 0 50 100

TBR 1997-2001 (in %)

I

II

IV


Avg. 13%(1)

A

vg. 3

4%(1

)

III

Hermes Intl.

Sysco

CintasStarbucksFosters Group

Newell RubbermaidConagra

Weston George

Coca Cola

LVMH

31 Oct 1 Jan-31 Oct








BCG54

TSR Ranking

INDUSTRIAL GOODS

Company value(2)

Expectation premium

Fundamental value

(3)

117%88%80%

79%97%99%

118%

-17%

12%20%

21%3%

1%

-18%

-50

0

50

100

150

200

250

300

350

'96 '97 '98 '99 '00 '01 '02

255

308

239188

138

100

304


EP(3)

2002 year to date

69148

-174-1,254

114358180

-70690

173

63%-27%-19%-44%14%

-43%-1%

-29%-38%38%

31%27%1%

13%47%40%35%30%21%31%

MV 2001M$

39%38%35%31%25%25%22%22%21%21%

TBR1997 –2001

TSR1997 –2001

EP2001

TSR

-35%-27%-42%

-6%-20%-35%-68%-21%-29%

-4%

77%3%

26%-32%27%0%

52%-10%1%

41%

WatersBouygues Finmeccanica Posco Centex CRH Bombardier Lafarge Vulcan Materials Danaher

123456789

10

5,06910,887

7,2758,6933,4699,202

14,19112,144

4,8568,620

USFRIT

KOUSIRCNFRUSUS

-100

-50

0

50

100

-100 -50 0 50 100

TBR 1997-2001 (in %)

I

II

IV


Avg. 13 %(1)

A

vg. 0

,3 %

(1)

III

Waters

Bouygues

Finmeccanica

Posco

Centex

CHR

Bombardier

Lafarge

Vulcan Materials

Danaher

31 Oct 1 Jan-31 Oct








BCG 55

TBR Ranking

INDUSTRIAL GOODS

Company value(2)

Expectation premium

Fundamental value

-100

-50

0

50

100

-100 -50 0 50 100

TBR 1997-2001 (in %)

I

II

IV


Avg. 13% (1)

A

vg. 0

,3%

(1)

III

Waters

Danaher

Bombardier

CentexGeneral Dynamics

Atlas Copco

Rolls-Royce

Lafarge

CRHBouygues

110%85%73%

68%81%

86%79%

-10%

15%27%

32%

19%

14%

21%

-50

0

50

100

150

200

250

300

350

'96 '97 '98 '99 '00 '01 '02

259

312

253

182

134

100

312

(3)


EP(3)

2002 year to date

114358608180417173

69-706

59148

14%-43%27%-1%

-65%38%63%

-29%-88%-27%

47%40%36%35%32%31%31%30%29%27%

MV 2001M$

25%25%20%22%10%21%39%22%-5%38%

TBR1997 –2001

TSR1997 –2001

EP2001

TSR

-20%-35%

1%-68%-16%

-4%-35%-21%-33%-27%

27%0%

31%52%

-37%41%77%

-10%-36%

3%

CentexCRHGeneral DynamicsBombardierAtlas Copco DanaherWatersLafargeRolls-RoyceBouygues

123456789

10

3,4699,202

16,07014,191

4,5938,6205,069

12,1443,878

10,887

USIRUSCNSDUSUSFRUKFR

31 Oct 1 Jan-31 Oct








BCG56

TSR Ranking

INSURANCE

Company value(2)

Expectation premium

Fundamental value

(3)

49%34%29%31%37%45%55%

51%

66%71%

69%

63%

55%

45%

0

100

200

300

400

500

'96 '97 '98 '99 '00 '01 '02

352

444

282

249

162

100

385


EP(3)

2002 year to date

47-166

-1083

-181472523756

-153101

78%54%

-72%62%18%64%58%

-21%70%47%

23%-2%14%22%26%27%24%34%-2%30%

MV 2001M$

48%32%30%29%29%28%26%22%21%21%

TBR1997 –2001

TSR1997 –2001

EP2001

TSR

-44%-72%-61%

4%-8%

-11%-21%-53%-31%-40%

89%88%37%63%30%71%69%48%81%65%

Mediolanum Skandia Baloise Great West Lifeco Power Financial Marsh & McLennan American Intl. Aegon Transatlantic Alleanza

123456789

10

6,5337,4165,0977,9428,273

29,539208,122

38,4974,7527,859

ITSDSWCNCNUSUSNLUSIT

-100

-50

0

50

100

-100 -50 0 50 100

TBR 1997-2001 (in %)

I

II

IV


Avg. 16 %(1)

A

vg.

61 %

(1)

IIIMediolanumSkandia

BaloiseGreat West Lifeco

Power Financial

Marsh & McLennanAmerican Intl.

Aegon

Transatlantic

Alleanza

31 Oct 1 Jan-31 Oct

GlossaryAVE = Added value to EquityEP = Expectation PremiumMV = Market value (equity)TBR = Total Business Return (fundamental performance)TSR = Total Shareholder Return (market performance)







BCG 57

TBR Ranking

INSURANCE

Company value(2)

Expectation premium

Fundamental value

(3) -100

-50

0

50

100

-100 -50 0 50 100

TBR 1997-2001 (in %)

I

II

IV


Avg. 16%(1)

A

vg. 6

1%(1

)

IIIMediolanum

Marsh & McLenan

Power FinancialJefferson Pilot

ING Groep

Aflac Alleanza Great West Lifeco

American Intl.

Aegon

54%39%40%

36%39%45%54%

46%

61%

60%

64%

61%

55%

46%

0

100

200

300

400

500

'96 '97 '98 '99 '00 '01 '02

320

414

259239

158

100

347


EP(3)

2002 year to date

756101472

-181523

2,5994783

220343

-21%47%64%18%58%-2%78%62%17%60%

34%30%27%26%24%24%23%22%22%21%

MV 2001M$

22%21%28%29%26%18%48%29%15%19%

TBR1997 –2001

TSR1997 –2001

EP2001

TSR

-53%-40%-11%

-8%-21%-39%-44%

4%-12%25%

48%65%71%30%69%42%89%63%33%53%

AegonAlleanzaMarsh & McLennanPower FinancialAmerican Intl.ING GroepMediolanumGreat West LifecoJefferson PilotAflac

123456789

10

38,4977,859

29,5398,273

208,12250,529

6,5337,9426,961

12,825

NLITUSCNUSNLITCNUSUS

31 Oct 1 Jan-31 Oct

GlossaryAVE = Added Value to EquityEP = Expectation PremiumMV = Market value (equity)TBR = Total Business Return (fundamental performance)TSR = Total Shareholder Return (market performance)







BCG58

TSR Ranking

MEDIA

Company value(2)

Expectation premium

Fundamental value

(3)

82%58%63%

54%79%

69%89%

18%

42%37%

46%

21%

31%

11%

0

50

100

150

200

250

300

'96 '97 '98 '99 '00 '01 '02

262 269

232

179

149

100

295


EP(3)

2002 year to date

-226212546

74842527-36-4991

-2,850

-10%46%

6%68%27%

3%-68%-42%42%42%

21%24%32%14%16%15%16%21%11%19%

MV 2001M$

55%34%33%31%24%23%22%20%19%19%

TBR1997 –2001

TSR1997 –2001

EP2001

TSR

-55%-6%

-35%10%

7%-48%-53%

-3%13%

-32%

40%55%41%64%31%54%-11%-25%42%60%

Shaw Comms . TF1Omnicom Intl. Game Tech.McGraw-Hill Nintendo Rogers Comms .LagardereNY TimesNews Corporation

123456789

10

5,0445,359

16,6064,977

11,78724,538

3,5905,7756,520

37,326

CNFRUSUSUSJPCNFRUSAU

-70

-35

0

35

70

-70 -35 0 35 70

TBR 1997-2001 (in %)

I

II

IV


Avg. 11 %(1)

A

vg. 3

0 %

(1)

III

Shaw Comms.

TF1 Omnicom

Intl.Game Tech.

McGraw-Hill

Nintendo

Rogers Comms.

Lagardere

NY Times

News Corp.

31 Oct 1 Jan-31 Oct








BCG 59

TBR Ranking

MEDIA

Company value(2)

Expectation premium

Fundamental value

(3)

TBR 1997-2001 (in %)


Avg. 11 %(1)

A

vg. 3

0%(1

)

91%72%68%

61%85%75%

85%

9%28%32%

39%

15%

25%

15%

0

50

100

150

200

250

300

'96 '97 '98 '99 '00 '01 '02

245260

226

164143

100

262


EP(3)

2002 year to date

546-172212108208-49281

-226-2,850

619

6%15%46%14%

-40%-42%

-5%-10%42%-3%

32%26%24%23%21%21%21%21%19%18%

MV 2001M$

33%15%34%16%10%20%11%55%19%12%

TBR1997 –2001

TSR1997 –2001

EP2001

TSR

-35%29%-6%

-13%-28%

-3%39%

-55%-32%

-9%

41%6%

55%29%

9%-25%-24%40%60%12%

OmnicomTribuneTF1 Daily MailNippon TV NetworkLagadereWashington PostShaw Comms .News CorporationThomson

123456789

10

16,60611,150

5,3593,5945,4025,7754,1185,044

37,32619,062

USUSFRUKJPFRUSCNAUCN

31 Oct 1 Jan-31 Oct

-100

-50

0

50

100

-100 -50 0 50 100

I

II

IV

News Corporation

TF1

OmnicomShaw Comms.

Thomson

Nippon TV Network Tribune

Washington Post

Daily Mail

Lagardere Groupe

III








BCG60

TSR Ranking

MULTIBUSINESS

Company value(2)

Expectation premium

Fundamental value

(3)


-100

-50

0

50

100

-100 -50 0 50 100

TBR 1997-2001 (in %)

I

II

IV

Avg. 15 %(1)

A

vg.

39%

(1)

III

Wipro

Wesfarmers

ITC

Reliance Inds.

SiemensITTIndustries

Hutchinson Whampoa

3M General Electric

Dovers

70%52%46%36%47%

48%55%

30%

48%54%

64%

53%

52%

45%

0

50

100

150

200

250

'96 '97 '98 '99 '00 '01 '02

241 236

170169

131

100

218


EP(3)

2002 year to date

6254

-1,367-40784200131

1,12693

-1,755

84%57%11%15%26%36%36%50%

2%0%

69%23%15%40%19%-2%41%9%

11%26%

MV 2001M$

136%35%27%26%21%18%15%10%9%9%

TBR1997 –2001

TSR1997 –2001

EP2001

TSR

-14%-13%-36%-13%-36%30%-8%9%

-32%-34%

86%65%37%2%

45%24%45%49%33%28%

WiproWesfarmers SiemensReliance Inds . General ElectricITT Industries ITC 3M DoverHutchison Whampoa

123456789

10

7,6165,874

59,4676,011

397,8894,4643,445

46,3487,504

41,142

INAUBDINUSUSINUSUSHK

31 Oct 1 Jan-31 Oct








BCG 61

TBR Ranking

MUTIBUSINESS

Company value (2)

Expectation premium

Fundamental value

(3) -100

-50

0

50

100

-100 -50 0 50 100

TBR 1997-2001 (in %)

I

II

IV

Expectation Premium 2001 (in %)

Avg. 15 %(1)

A

vg. 3

9%(1

)

IIIWipro

Wesfarmers

ITC

HutchinsonWhampoa

Reliance Inds.

Siemens

Dover

3M General Electric

MG Technologies

71%52%45%34%43%

45%50%

29%

48%55%66%

57%

55%

50%

0

50

100

150

200

250

'96 '97 '98 '99 '00 '01 '02

238230

166167

129

100

213


EP(3)

2002 year to date

62131-40

-1,75554

784-18

-1,36793

1,126

84%36%15%

0%57%26%

-129%11%

2%50%

69%41%40%26%23%19%17%15%11%9%

MV 2001M$

136%15%26%9%

35%21%-9%27%9%

10%

TBR1997 –2001

TSR1997 –2001

EP2001

TSR

-14%-8%

-13%-34%-13%-36%-31%-36%-32%

9%

86%45%

2%28%65%45%

-85%37%33%49%

WiproITCReliance Inds.Hutchison WhampoaWesfarmersGeneral ElectricMG TechnologiesSiemensDover3M

123456789

10

7,6163,4456,011

41,1425,874

397,8891,634

59,4677,504

46,348

INININHKAUUSBDBDUSUS

31 Oct 1 Jan-31 Oct








BCG62

TSR Ranking

PAPER

Company value(2)

Expectation premium

Fundamental value

(3)

151%144%164%125%

175%156%143%

-51%-44%-64%

-25%

-75%-56%-43%

-150

-100

-50

0

50

100

150

200

'96 '97 '98 '99 '00 '01 '02

161 158175

114108100

183


EP(3)

2002 year to date

-52380

42-4

146-112

-1031

-328-5

-41%-62%-55%-20%-83%-41%-36%-87%-26%

-108%

16%19%2%1%

28%12%30%13%21%26%

MV 2001M$

22%21%18%18%18%17%16%10%10%9%

TBR1997 –2001

TSR1997 –2001

EP2001

TSR

-9%0%

-1%46%

-40%-10%

1%28%

2%15%

-34%-59%-51%-58%-48%-41%-35%

-122%-26%

-112%

UPM- Kymmene SCAHolmenUnipapelNorske SkogSuzanoGrupo Empresarial Ence Mayr- Melnof KartonCMPCM-Real

123456789

10

8,1216,3271,815

692,501

306323568

1,8301,106

FNSDSDESNWBRESOECLFN

-130

-65

0

65

130

-130 -65 0 65 130

TBR 1997-2001 (in %)

I

II

IV


Avg. 13 %(1)

A

vg. –

12 %

(1)

III

UPM-Kymmene

SCAHolmen

Unipapel

Norske Skog

SuzanoGrupo Empresarial Ence

Mayr-Melnhof M-Real

CMPC

31 Oct 1 Jan-31 Oct



Notes(1) Weighted average of the total sample, no

minimum market value 2001: 34 companies




BCG 63

TBR Ranking

PAPER

Company value(2)

Expectation premium

Fundamental value

(3)

162%147%154%110%

177%150%134%

-62%-47%-54%

-10%

-77%-50%-34%

-150

-100

-50

0

50

100

150

200

'96 '97 '98 '99 '00 '01 '02

180 168 170

104103100

188


EP(3)

2002 year to date

-10-203146-64

-5-328

8380

7-413

-36%-6%

-83%-53%

-108%-26%-35%-62%-75%-78%

30%29%28%28%26%21%20%19%17%16%

MV 2001M$

16%8%

18%7%9%

10%9%

21%-1%3%

TBR1997 –2001

TSR1997 –2001

EP2001

TSR

1%-8%

-40%-19%15%

2%26%

0%7%

-55%

-35%-2%

-48%-43%

-112%-26%-49%-59%-77%-46%

Grupo EmpresarialDomtarNorske SkogTembecM-RealCMPCMiquel Y CostasSCADaio PaperGeorgia Pacific

123456789

10

3232,2682,501

6861,1061,830

1226,327

7696,344

ESCNNWCNFNCLESSDJPUS

-120

-60

0

60

120

-120 -60 0 60 120

TBR 1997-2001 (in %)

I

II

IV


Avg. 13%(1)

A

vg. –

12%

(1)

III

Domtar

Daio Paper

SCA

M-Real

Grupo Empressarial Ence CMPC

Norske SkogMiquel Y CostasGorgia Pacific Tembec

31 Oct 1 Jan-31 Oct



Notes(1) Weighted average of the total sample, no

minimum market value 2001: 34 companies




BCG64

TSR Ranking

PHARMA

Company value(2)

Expectation premium

Fundamental value

(3)

33%28%23%25%29%37%46%

67%72%77%

75%

71%

63%54%

0

50

100

150

200

250

300

350

400

450

'96 '97 '98 '99 '00 '01 '02

298

428

349

207

137100

397


EP(3)

2002 year to date

123161135161162776127408370713

86%24%64%15%61%75%54%23%21%71%

19%31%24%30%22%22%22%35%16%28%

MV 2001M$

59%41%36%36%35%33%29%28%28%25%

TBR1997 –2001

TSR1997 –2001

EP2001

TSR

20%-40%

-4%-43%-24%-18%-12%-41%-38%-12%

84%52%68%53%72%76%62%55%54%76%

Forest Labs. Laboratory Corp.Biomet Serono AllerganAmgen Altana Guidant Corp. Novo Nordisk Medtronic

123456789

10

14,5845,6868,344

10,1809,845

59,0096,988

15,15612,21461,996

USUSUSSWUSUSBDUSDKUS

-100

-50

0

50

100

-100 -50 0 50 100

TBR 1997-2001 (in %)

I

II

IV


Avg. 18 %(1)

A

vg. 6

2 %(1

)

IIIForest Labs.

Laboratory Corp.

Biomet

Serono

AllerganAmgen

Altana

Guidant Corp.

Novo Nordisk

Medtronic

31 Oct 1 Jan-31 Oct








BCG 65

TBR Ranking

PHARMA

Company Value(2)

Expectation premium

Fundamental value

(3)

48%38%24%30%24%31%39%

52%62%

76%

70%76%

69%61%

0

50

100

150

200

250

300

350

400

450

'96 '97 '98 '99 '00 '01 '02

210

354

229226

149

100

279


EP(3)

2002 year to date

1495,247

408143161161713332135

5,129

43%57%23%45%24%15%71%

-44%64%39%

50%36%35%33%31%30%28%25%24%23%

MV 2001M$

24%25%28%25%41%36%25%18%36%10%

TBR1997 –2001

TSR1997 –2001

EP2001

TSR

-36%-19%-41%-48%-40%-43%-12%-45%

-4%-6%

65%67%55%73%52%53%76%22%68%46%

BiogenPfizerGuidant Corp.App li ed BiosystemsLaboratory Corp. SeronoMedtronicUCBBiometMerck

123456789

10

8,482248,852

15,1568,3235,686

10,18061,996

5,9088,344

133,753

USUSUSUSUSSWUSBGUSUS

-100

-50

0

50

100

-100 -50 0 50 100

TBR 1997-2001 (in %)

I

II

IV


Avg. 18%(1)

A

vg.

62%

(1)

IIIMedtronic

UCB

Merck

Biogen

Applied Biosystems

Biomet

Guidant Corp.

Laboratory Corp.

Serono

Pfizer

31 Oct 1 Jan-31 Oct








BCG66

TSR Ranking

RETAIL

Company value(2)

Expectation premium

Fundamental value

(3)

453%37%37%21%31%47%63%

55%

63%

63%79%

69%

53%

37%

0

100

200

300

400

500

'96 '97 '98 '99 '00 '01 '02

482

383 375

306

158

100

454


EP(3)

2002 year to date

350246139455

5,422337144

1,639208

1,009

8%70%77%56%60%57%51%48%52%27%

41%44%44%35%26%33%32%37%20%21%

MV 2001M$

95%48%41%40%39%37%36%36%35%34%

TBR1997 –2001

TSR1997 –2001

EP2001

TSR

-59%-17%

5%-10%

-7%-17%

3%-43%13%

-26%

61%74%76%60%62%65%50%70%47%43%

Best BuyKohlsBed Bath & BeyondLowe's Wal Mart Stores Hennes & Mauritz Family $ Stores Home Depot Woolworths Target

123456789

10

15,76523,594

9,84535,936

256,50515,108

5,169119,199

5,97837,059

USUSUSUSUSSDUSUSAUUS

-80

-40

0

40

80

-80 -40 0 40 80

TBR 1997-2001 (in %)

I

II

IV


Avg. 21 %(1)

A

vg. 4

3 %

(1)

III

Best Buy

KohlsBed Bath & Beyond

Lowe'sWal Mart Stores

H&M

Family $ Stores

Home Depot

WoolworthsTarget

31 Oct 1 Jan-31 Oct








BCG 67

TBR Ranking

RETAIL

-100

-50

0

50

100

-100 -50 0 50 100

Company value (2)

Expectation premium

Fundamental value

(3)

TBR 1997-2001 (in %)

I

II

IV


Avg. 21%(1)

A

vg. 4

3%(1

)

IIIBed Bath and Beyond

KohlsHome Depot

CDW Computer CentsBest Buy

Dollar Tree Stores Castorama Dubois

Ahold Kon.

Dixons Gp.

Tiffany & Co.

68%45%43%

23%30%43%50%

32%

55%

57%77%

70%

57%

50%

0

100

200

300

400

500

'96 '97 '98 '99 '00 '01 '02

492

409

321313

159

100

485


EP(3)

2002 year to date

122139246501110793350267137

1,639

54%77%70%

-41%35%

-48%8%

44%31%48%

49%44%44%43%42%41%41%40%38%37%

MV 2001M$

29%41%48%14%22%17%95%13%29%36%

TBR1997 –2001

TSR1997 –2001

EP2001

TSR

-1%5%

-17%-16%-15%-60%-59%18%

-17%-43%

57%76%74%

-19%44%13%61%36%42%70%

CDW Computer Cents.Bed Bath & BeyondKohlsDixons Gp.Dollar Tree StoresAhold Kon.Best BuyCastorama DuboisTiffany & CoHome Depot

123456789

10

4,7419,845

23,5946,5543,470

26,75315,765

8,0884,560

119,199

USUSUSUKUSNLUSFRUSUS

31 Oct 1 Jan-31 Oct








BCG68

TSR Ranking

TECHNOLOGY

-100

-80

-60

-40

-20

0

20

40

60

80

100

-100 -50 0 50 100

Company value(2)

Expectation premium


(3) I

II

IV


Avg. – 17%(1)

A

vg. –

24

%(1

)

III

Nokia

Qualcomm

Dell

Taiwan Semicon Mnfg.

Samsung

SK Telecom

BCE

Applied MatsPhilips

SAP

48%41%53%

24%55%76%108%

52%

59%47%

76%

45%

24%

-8%-50

100

250

400

550

700

'96 '97 '98 '99 '00 '01 '02

770

568

412

289

170

100

540


EP(3)

2002 year to date

2,371-422

1,649-207931582820295

-2,261420

54%93%55%46%51%23%

-62%53%38%72%

35%23%61%31%29%31%13%19%2%

27%

MV 2001M$

61%60%52%49%49%48%38%35%34%33%

TBR1997 –2001

TSR1997 –2001

EP2001

TSR

-40%-32%

5%-42%24%

-16%-23%-25%-45%-47%

69%95%48%64%37%26%-62%60%57%83%

NokiaQualcomm Dell Computer Taiwan Semicon . Mnfg . Samsung Electronics SK Telecom BCE Applied Mats. Philips SAP

123456789

10

122,06138,60370,85842,09332,14418,19018,16532,84239,11541,387

FNUSUSTAKOKOCNUSNLBD

31 Oct 1 Jan-31 Oct








BCG 69

TBR Ranking

TECHNOLOGY

Company Value(2)

Expectation Premium

Fundamental Value

(3) -100

-50

0

50

100

-100 -50 0 50 100

TBR 1997–2001 (in %)

I

II

IV

Expectation Premium 2001 (in %)

Ø 17 %(1)

Ø 2

4 %

(1)

III

Dell

Paychex

Sun Microsystems

SBC Communications

OracleMicrosoft

Nokia

Linear Tech

Alltel

SK Telecom

62%52%54%24%

36%51%54%

38%

48%46%

76%

64%

49%46%

0

100

200

300

400

500

600

700

800

'96 '97 '98 '99 '00 '01 '02

691

472

319338

161100

425


EP(3)

10/31

2002 year to date

1,649179

1,6143,1822,2494,4472,371

2521,206

582

55%76%

-242%-42%52%60%54%48%

-41%23%

61%42%40%39%38%36%35%34%34%31%

MV 2001M$

52%29%31%11%24%26%61%29%17%48%

TBR1997 –2001

TSR1997 –2001

EP2001

TSR1/1-10/31

5%-16%-76%-32%-26%-19%-40%-29%-18%-16%

48%78%

0%-14%61%64%69%59%

-32%26%

Dell ComputerPaychexSun MicrosystemsSBC CommunicationsOracleMicrosoftNokiaLinear Tech.AlltelSK Telecom

123456789

10

70,85813,06039,872

131,67275,916

356,806122,061

12,35919,16218,190

USUSUSUSUSUSFNUSUSKO








BCG70

TSR Ranking

TRAVEL

-80

-60

-40

-20

0

20

40

60

80

-80 -60 -40 -20 0 20 40 60 80

Company value(2)

Expectation premium


(3) I

II

IV


Avg. – 11%(1)

A

vg. –

21 %

(1)

III

Yamamoto Transport

Accor NationalRailway

Harrahs Entert.

Carnival

Fedex

SW Airlines

TUI

103%96%93%75%83%

91%110%

-3%

4%7%

25%

17%9%

-10%

-50

0

50

100

150

200

250

300

'96 '97 '98 '99 '00 '01 '02

241228

220201

150

100

238

Lufthansa

RoyalCaribbean Cruises


EP(3)

2002 year to date

172-578

44425-96156

73-66

-882-271

14%6%3%

-26%31%-7%26%-9%-7%0%

25%30%14%20%7%

31%24%14%15%33%

MV 2001M$

34%26%19%18%16%13%13%12%10%9%

TBR1997 –2001

TSR1997 –2001

EP2001

TSR

-21%-13%

-9%3%

-29%14%-6%

-31%-23%16%

29%12%10%-29%48%-14%30%4%2%-5%

SW Airlines National RailwayAccor FedexYamato Transport Harrahs Entertainment Carnival TUI LufthansaRoyal Caribbean Cruises

123456789

10

14,1709,2527,210

15,4788,6944,153

16,4594,7335,1313,114

USCNFRUSJPUSUSBDBDUS

31 Oct 1 Jan-31 Oct








BCG 71

TBR Ranking

TRAVEL

Company Value(2)

Expectation premium

Fundamental value

(3) -100

-50

0

50

100

-100 -50 0 50 100

TBR 1997-2001 (in %)

I

II

IV


Avg. – 11 %(1)

A

vg. –

21 %

(1)

III

Carnival

SW Airlines

National Railway

Hilton Group

FedEx

HarrahsEntertainm.

Royal CarribeanCruises

Air France

109%103%98%87%87%

90%101%

-9%-3%

2%

13%13%

10%

-1%

-50

0

50

100

150

200

250

300

'96 '97 '98 '99 '00 '01 '02

205 210 209198

145

100

220

Lufthansa

BAA


EP(3)

2002 year to date

-271156

-578172

73-4210

42512

-882

0%-7%6%

14%26%

-14%-111%

-26%-6%-7%

33%31%30%25%24%24%20%20%18%15%

MV 2001M$

9%13%26%34%13%2%5%

18%6%

10%

TBR1997 –2001

TSR1997 –2001

EP2001

TSR

16%14%

-13%-21%

-6%-14%-27%

3%6%

-23%

-5%-14%12%29%30%

0%-84%-29%

-9%2%

Royal Caribbean CruisesHarrahs EntertainmentNational RailwaySw AirlinesCarnivalHilton GroupAir FranceFedexBAALufthansa

123456789

10

3,1144,1539,252

14,17016,459

4,8643,217

15,4788,5205,131

USUSCNUSUSUKFRUSUKBD

31 Oct 1 Jan-31 Oct








BCG72

TSR Ranking

UTILITIES

Company value(2)

Expectation premium

Fundamental value

(3)


-60

-40

-20

0

20

40

60

-60 -40 -20 0 20 40 60

TBR 1997-2001 (in %)

I

II

IV

Avg. – 12%(1)

A

vg. –

42 %

(1)

III

Southern

National Grid

PPLFirst Energy

Enbridge

DominionDuke Energy

Union FenosaPSEG

Am. Water Works108%116%111%

126%121%120%133%

-8%-16%-11%-26%-21%-20%-33%

-100

-50

0

50

100

150

200

250

'96 '97 '98 '99 '00 '01 '02

150

202 207

157140

100

214


EP(3)

2002 year to date

128-134-661-484

-86-420-991

-1-1,293

-430

41%33%-7%-6%21%

-13%-15%-46%-25%-25%

25%18%18%6%

17%10%21%30%31%10%

MV 2001M$

21%21%19%19%19%16%16%15%15%14%

TBR1997 –2001

TSR1997 –2001

EP2001

TSR

9%4%

-40%23%10%

-29%-18%-47%

-4%3%

-13%25%2%

-31%8%-9%-18%-14%-34%-39%

National Grid Enbridge Union FenosaSouthernAmerican Water WorksPSEGDominionDuke EnergyFirst Energy PPL

123456789

10

9,2634,4284,932

17,6224,1748,753

15,75930,47110,412

5,104

UKCNESUSUSUSUSUSUSUS

31 Oct 1 Jan-31 Oct








BCG 73

TBR Ranking

UTILITES

Company Value(2)

Expectation premium

Fundamental value

(3) -100

-50

0

50

100

-100 -50 0 50 100

TBR 1997-2001 (in %)

I

II

IV


Avg. – 12 %(1)

A

vg. –

42 %

(1)

III

CenterPoint Energy

UnitedUtilities

American Electr. Power

Hong Kong Electric

First Energy

Dominion

Williams Cosmetics

CLP Holdings

National Grid

Duke Energy132%

128%105%

115%99%96%

112%

-32%-28%

-5%-15%

1%4%

-12%

-100

-50

0

50

100

150

200

250

'96 '97 '98 '99 '00 '01 '02

158

228

194165149

100

222


EP(3)

2002 year to date

-1,293-1

-421128209602139

-761-991255

-25%-46%

-106%41%

-130%6%

-32%-57%-15%13%

31%30%26%25%24%24%24%22%21%21%

MV 2001M$

15%15%10%21%9%6%7%7%

16%7%

TBR1997 –2001

TSR1997 –2001

EP2001

TSR

-4%-47%-92%

9%-68%13%

1%-38%-18%15%

-34%-14%-18%-13%-75%-10%-44%-42%-18%

-3%

First EnergyDuke EnergyWilliams Cos.National GridCenterPoint Energy CLP HoldingsUnited UtilitiesAmerican Electric PowerDominionHong Kong Electric

123456789

10

10,41230,47113,152

9,2637,9079,2384,955

14,02715,759

7,937

USUSUSUKUSHKUKUSUSHK

31 Oct 1 Jan-31 Oct








74


BCG

75

Appendix


BCG

1. Calculating expectation premiums

A company’s expectation premium is thedifference between its market value plus debt andits fundamental value. The scale of the premiumdepends on three main factors:

● The market value of the companymeasured by its market capitalisationplus debt. BCG used calendar year data forthis (Fig. A3).

● Robustness of the valuation model. Fig.A4 demonstrates that over the five-yearperiod from 1997 to 2001 the differencebetween the annual market performance andthe annual fundamental performance wasbetween +/- 15 percent for almost threequarters of the companies in the sample.

● The assumptions used to calculate thecompany’s fundamental value. BCG usedstandard cash flow projections based on thebusiness’s current profitability and historicalgrowth. We assumed that profitability wouldfade by 10 percent per annum to theweighted average cost of capital over 40years due to competitive pressure and otherfactors. In addition, it was assumed thatgrowth would fade by 20 percent per annumto an average economic growth rate of 1.5percent over the same period (Fig. A5).

● The data used to calculate the company’sfundamental value. BCG used fiscal data for this.

2. Different ways to measure value creation

To effectively manage value creation, companiesrequire multiple measures to be used in differentapplications and at different levels of theorganisation. Figure A6 depicts the range ofmeasures our clients have found most useful formanaging value creation at different levels in theorganisation.

Setting explicit external aspirations: TSR

Beginning at the corporate level, executives must

set an explicit value creation aspiration that willenergise their organisations, drive stretch thinkingor performance, and focus the agenda onprogrammes that must be implemented.

We believe the most appropriate measure foraspiration setting is total shareholder return (TSR)relative to a local market index or industry peergroup. Achievement of this external value creationaspiration should be embedded in the incentiveplans for corporate executives and key businessunit leaders.

Technical notes

Fig. A3 How Expectation Premiums are calculated

0 0 0 0

3

4

9

11

1817

15

9

6

3

1 1 1 1 1

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

VALUATION MODEL

% of companies (1)

Annual Market Performance (TSR) – Annual Fundamental Performance (TBR)1997–2001

-45% -40% -35% -30% -25% -20% -15% -10% -5% 0% 5% 10% 15% 20% 25% 30% 35% 40% 45%

Expectation premiumis shrinking

Expectation premium is growing

(1) Sample: 586 companies meeting capitalization hurdle requirements

Market TSR and fundamental TBR grow with same speed

Source: T.F. Datastream, BCG analysis

Fig. A4 Normal distribution demonstrates robustness of Valuation Model

Value ofgrowth of‘current

operations’

Value of‘current

operations’

ExpectationPremium

Market valueof the

company

III

II

I

Marketcapitalisation

+ debt

Currentperformance

discounted to perpetuity

Present valueof additional

cash flow due to growthand profitability using

BCG 'fade model'

Result

Fundamental value current performance +

future expectations

Evaluationmethod/source

Expectation premium market value -

fundamental value

76

Appendix


BCG

Aligning internal aspirations and plans : TBR

The next requirement is to cascade down theoverall TSR value creation aspiration into internalcorporate and business unit goals and targets andassess the gap between plans and aspirations atall levels.

The Total Business Return (TBR) measure is anaccurate and useful measure for this purpose (Fig.A7). The TBR measure is an internal mirror ofactual external TSR. It represents the ‘intrinsic’capital gain and dividend yield from a businessplan – either at the corporate or business unit level.

Many of our clients have found the TBR measure tobe a powerful tool for converting TSR aspirationsinto performance goals at the business unit leveland to drive a portion of long term incentives forbusiness unit management accordingly. In thatcontext, TBR can also be used as a rich planningtool to assess the value creation potential ofbusiness plans and help managers close the gapbetween aspirations and performance.

TBR is an important high level tool to assess therelative performance of a corporation or abusiness unit and to set future targets. It also

provides a way to link other measures used fordetailed value driver analysis or for settingoperational targets back to the TSR aspiration.

Measuring and setting targets for the internal value creation drivers: CVA

Cash value added, CVA (or its financial servicesequivalent, AVE, Added Value to Equity), is anabsolute measure of operating performance

Fig. A5 Fade Rate Assumptions

Fig. A6 Framework of Value Measures

CVA

Time

> 0

0

Positive CVA fades towards

‘ 0 ’ (1)

CVA

Time0

< 0

Negative CVA fades towards

Avg. long-term

growthand profi-tability(1)

(‘fade-torates’)

Pressure from

competition(‘fade down’)

Pressure from investors

(‘fade up’)

Growthor profit-ability

Time

Growth and profitability fades toaverage market values … … and CVA converges to zero

(1)

Source: BCG analysis

Assumption: long-term profitability equals WACC

‘ 0 ’

Management applications

Set company value creation aspirationsLink to senior management incentives

Assess gap between aspirations & plansCascade aspirations down to BUsUse for long-term BU incentivesDetermine targets for other measures

Determine priority value driversEvaluate value driver plus tradeoffsDirectionally signal value creationimprovementDecompose aspirations into operating metricsUse for annual incentives

Benchmark operating efficiencySet departmental prioritiesUse for departmental incentives

Relevant measures

TSR

TBR

CVA

Profitability ofassets

Growth in assets

Cash margin Asset turns

Measure againstmost relevantassets: capital,

people,customers

KPIs KPIs

Fundamental value creation

Primary value drivers

External value creation

∆

77

Appendix


BCG

contribution to value creation. It provides a strongdirectional indication of when and how valuecreation is being improved. The CVA measurereflects operating cash flow minus a cost of capitalcharge against gross operating assets employed.The CVA measure is a very powerful tool to helpmanagers pull the appropriate levers to createvalue. It can accurately assess the contribution ofthe economic assets that actually drive abusiness. In some cases they are tangible assets,in others they are either people or customers.

The CVA measure is an accurate tool fordetermining priority value drivers and assessingvalue driver trade-offs. In particular, it is a usefulstrategic indicator that allows managers tobalance the high level trade-offs betweenimproving profitability versus growing thebusiness. Because its measurement is based oncash flow and original cash investment, it avoids

the key accounting distortions that can causemeasures such as EVA™ to give misleadingtrends in capital intensive businesses.

Many clients have also found CVA to be aneffective measure for annual incentives at thebusiness unit and operational levels. Moreover,CVA can easily be broken down further into thekey performance indicators (KPIs) that are relevantto each management area. KPIs form the basis forinternal and external performance benchmarkingand for establishing annual incentive targets.

This brief description of value creation measurementtools does not address the many nuances ofapplying them effectively. Further information on howto quantify aspirations, tailor the measure to fit yourtype of business, or identify the highest priority KPIs,can be provided upon request.

Fig. A7 TBR is the internal analog to TSR

High correlation

TSR

Change in share price Dividends

External measure

TBR

Change in estimatedequity value

EquityFree cash flow

Internal measure

Change in equity value is analogous to share price, andfree cash flow is analogous to dividends

Stock market observed of public company• Historical only• Requires share price

Estimate of public or private company• Historical or forecast• Requires estimated value

78


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