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decline despite the fact that its plan involved substantial growth in the number of outlets and overall sales and earnings. To Ralph this could mean only one thing—the returns on investment in the business were too low. Foodco management was more focused on growth than returns. In contrast, the Woodco consolidation looked set to improve the value of the furniture businesses dramatically, while the newspaper, finance, and property businesses would improve somewhat, too.

At this stage, Ralph drew some conclusions. Consumerco would have to do even better, given its large impact on the company. Foodco would need to revamp its strategy to make sure it built value, not simply bulk. Woodco's consolidation was far more important than he had thought and would need to succeed to maintain EG's value. Finally, EG would need to run hard just to maintain shareholder value, and any missteps could spark a collapse in the share price.

EG's Potential Value with Internal Improvements

After looking at EG's value ''as is," Ralph's team tried to assess how much each business might be worth under more aggressive plans and strategies. The team first identified key value drivers for each business. The managers estimated the impact on the value of each business of increasing sales growth by 1 percent, raising margins by a point, and reducing capital intensity, while holding other factors in constant proportion. The results, shown in Exhibit 2.9, indicated that the key factors varied by business. Foodco was most sensitive to reductions in capital intensity and increased margins. At current margins and capital intensity, however, Foodco's value would actually decrease if it grew faster. Its growth would be unprofitable with Foodco earning a rate of return on invested capital less than its cost of capital. Woodco was most sensitive to improvements in operating margin, which he hoped would come about as a result of the consolidation of the companies. Consumerco was most sensitive to sales growth. Because of Consumerco's high margin and outstanding capital utilization, each dollar of sales generated large profits and cash flows.

The team next assessed the prospects for each business to improve its performance. One approach it used was simply to compare each EG business with similar companies to gauge relative operating performance. The team also broke down each

Exhibit 2.9 EG Corporation—Impact of Changes in Key Operating Measures

Percent

Consumerco ii

Growth Operating Working margin capital

Note: changes percentage of^ales in j ii

Growth Operating Working margin capital

Note: changes percentage of^ales in j

of EG's businesses into a business system that allowed it to compare—step by step—relative costs, productivity, and investment for EG versus the competition, based on observations and analyses provided by operating managers in each of the divisions. These analyses, coupled with the financial comparisons, showed that it was reasonable to assume that some of EG's businesses could indeed be made to perform at much higher levels.

Consumerco, despite its already high operating margin, seemed to have room to increase revenue significantly while simultaneously earning ever-higher margins:

• The team discovered that Consumerco had been holding down research and development (R&D) and advertising spending to generate cash for EG's diversification efforts and to buffer the impact of EG's poor performance in other parts of its portfolio. Ralph's team believed that increased spending in the short term would lead to higher sales volumes of existing products, as well as the introduction of additional high-margin products to the marketplace.

• Despite Consumerco's dominant position in its market categories, Consumerco's prices were actually lower than less popular brands. The team's research showed that most category leaders were able to charge higher prices. The team estimated that the value created by price increases would more than offset expected volume losses.

• Consumerco's salesforce was analyzed and the team found that it was less than half as productive as the salesforces at other companies selling through the same channels. Ralph had suspected opportunities here and the analysis confirmed that actions had to be taken to improve salesforce productivity.

• The team determined that cost of goods sold, particularly purchases and inventory management, held additional opportunities. The cost of sales could easily be reduced by one percentage point.

When the team factored in these improvements, they found that Consumerco's value could conservatively be increased by 25 percent, as shown on Exhibit 2.10.

Woodco, the furniture division, also had the potential to improve its performance beyond plan by a large margin, if it could transform itself and perform at the levels of other top companies in its industry. This would likely require a change in Woodco's strategy after the consolidation, to focus less on growth and more on developing higher margins. To do this, Woodco would need to build management information and control systems to keep a tighter rein on its businesses. Woodco would also need to consider sticking more to the basic, mass-market segment of the business where strong operating skills would provide an advantage. This would probably involve abandoning plans to move the business up market. While prices were higher and the potential rewards great in this segment, design skills were of utmost importance. Woodco would be better off focusing on its potentially strong core in the mass-market, basic-furniture segment and maximizing its advantage and returns there. Competitors' performance bore this out. Companies with the highest returns had either a strong operational focus in higher volume segments or played down manufacturing and won with innovative design. Companies who strayed into the middle ground—and there were many of them—turned in only marginal results.

Exhibit 2.10 EG Corporation—Value of Consumerco Internal Improvements

. millions-

Value per business plan

Reduce cost of sales by 1 percentage point

Reduce cost of sales force

Raise prices 3% real (suffer 3%volume decline)

Boost sales growth 5"i for 3 years with aggressive ad spending

Increase R&D yield 2594

Value with improvements

2,115 11S 50

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