Value-based management at a closely-held firm

Value-based management at

a closely-held firm

The performance variables that create value

Gerrit Jan Oude Booijink Groningen, February 2009

Rijksuniversiteit Groningen

Master of Science in Business Administration

Master Thesis Gerrit Jan Oude Booijink

Value-based management at

a closely-held firm

The performance variables that create value

February 2009

Master thesis

Rijksuniversiteit Groningen

Faculty of Economics and Business

Master of Science in Business Administration

Specialization Organisational and Management Control

Author Gerrit Jan Oude Booijink

Student number s1335987

Address Saffierstraat 174

9743 LM Groningen, The Netherlands

Email g.j.oude.booijink@student.rug.nl

Supervisor University of Groningen prof. dr. G.J. van Helden

Second Assessor University of Groningen drs. A. Smeenge RA

Master Thesis Gerrit Jan Oude Booijink

Abstract ...4

1. Research approach ...5

1.1 Problem formulation ...5

1.2 Research objective ...6

1.3 Main question ...6

1.4 Research questions ...6

1.5 Methods of data collection ...7

2 Theoretical Framework ...9

2.1 Introduction ...9

2.2 Creating shareholder value ... 11

2.3 Measuring shareholder value ... 13

2.4 Managing shareholder value ... 16

2.5 The value tree ... 17

2.6 Drawbacks of value-based management ... 19

2.7 Value-based management in context of Selo ... 20

3. Research Methodology ... 21

3.1 Research strategies ... 21

3.2 Case study ... 21

3.3 Data collection ... 22

4. Case study, value-based management at Selo ... 24

4.1 Introduction of Selo ... 24

4.1.1 History of Selo ... 24

4.1.2 Organizational chart of Selo ... 24

4.2 The departments of Selo Holding BV ... 25

4.2.1 Selo Verpakking BV... 26

4.2.2 Selo Service BV ... 29

4.2.3 Selo BV ... 32

4.2.4 Selo System Engineering BV ... 35

4.2.5 Selo Food Technology BV (Liquid foods) ... 39

4.3 Presentation of the report ... 42

5. Case-analysis and conclusions ... 43

5.1 The consolidated value tree of Selo ... 43

5.1.1 Gross margin ... 43

5.1.2 The other costs ... 44

5.2 Conclusions ... 44

5.2.1 key value drivers ... 44

5.2.2 Using value-based management and the monthly reports ... 45

References ... 46

Appendix I - Tasks and responsibilities of the employees ... 48

Appendix II – Report Selo Service BV ... 55

Master Thesis Gerrit Jan Oude Booijink

Abstract

The aim of this master thesis is to develop formats for monthly management reports for the Executive Board of Selo. These formats are derived from a value-based management mind set. After an exploration of value-based management in general, this master thesis provides specific value trees for the departments of Selo and a value tree of the entire company, Selo Holding BV.

Master Thesis Gerrit Jan Oude Booijink

1. Research approach

1.1 Problem formulation

The management team of Selo consists of the Chief Executive Officer (CEO), two directors, the Chief financial Officer (CFO) and four managers.

The CEO (also director of liquid food), the CFO, the director commodities and the director equipment are also shareholders of Selo.

Two years ago there was a due diligence of Selo, and at that time it became clear that there was no formal management information system. Information needed by the management team is obtained in an informal way. For example, by walking around and talking with the people on the work floor and checking all incoming mail the directors of Selo have a clear view of what is going on in the company. Most knowledge and information needed to run the business is present in the minds of the four directors. Every single director knows what needs to be done to run the company and to solve (potential) problems when these problems arise. The CFO has the most complete view of the company, while the other three directors are specialised in certain parts of the different activities of the company. Decisions taken by the directors are based on knowledge and experience of the company and its activities. Important factors that influence the performance of Selo are hardly documented or kept record in one way or another. The directors thought that documenting certain factors that are important to know how the different businesses are doing, was not always necessary, because they know what is important to monitor and what to do in certain cases. In other words, documenting how the business is managed and which information is needed to manage the company, was not the first priority. The due diligence made clear to the directors that when they all would leave the company at the same time and be replaced by a new management team, the new management at that time would not have the right information system available to run the company properly. Most of the experience, knowledge and information of the current management team would be lost. Therefore, the Selo management took the initiative to design a formal management report. The goals of the monthly report are twofold. The first purpose is that the management can see whether the separate activities are doing well and what causes the problem when they are not doing well. The second objective of the report is that management is able to better forecast future developments and when necessary change the budgets when there are certain developments.

Organizations serve a purpose. They exist to deliver certain values. Organizations use a tremendous amount of time, effort and investments. Therefore it makes sense to ensure that value is created. Value-based management is about creating value.

Master Thesis Gerrit Jan Oude Booijink

A deep understanding of the performance variables that will actually create the value of the business is essential, because an organization cannot act directly on value. It has to act on things it can influence. Moreover, it is through these drivers of value that senior management learns to understand the organization and to establish a dialogue about what it expects to accomplish.

Value-based management is an approach to focus management decision making on the key drivers of value. The reasoning behind value-based management is simple, value is created only when companies invest capital at returns that exceed the cost of capital. When returns on capital are less than the cost of capital then capital is destroyed, hence value is lost.

1.2 Research objective

The aim of this research is to prepare a proposal to the Executive Board of Selo for making a model for monthly management reporting, by exploring literature search and by giving insight which performance variables are actually creating value for the business at Selo, the key value drivers.

1.3 Main question

How can theory on value-based management inform an analysis of the performance variables that will actually create the value of businesses and how can these findings be used to determine which performance variables actually contribute to creating value in a closely-held firm?

Below follows an explanation of some terms used in the research objective and main question. Value creation:

It is generally agreed that the primary objective for profit organizations is to maximize the value of the firm, subject to some constraints, such as compliance with laws and adequate concern for employees, customers and other stakeholders (Wenner and LeBer, 1989).

Value driver:

“A value driver is any variable that affects the value of the company” (Koller, 1994). To be useful, value drivers need to be organized so that managers can identify which have the greatest impact on value.

Closely-held firm:

Ownership structure whereby amounts of ownership claims are held by management (Jermias and Gani, 2005).

1.4 Research questions

Master Thesis Gerrit Jan Oude Booijink

performance variables that will actually create the value of businesses? The first question can be answered by the following research questions:

- What is value-based management? - How to create shareholder value?

- How to measure the contributions of value drivers? - How to manage shareholder value?

- What is a value tree?

- What are the disadvantages of value based management?

The second question is which performance variables actually contribute in creating value in a closely-held firm? This question is the empirical part of this research and can be answered by confronting the answer of the first question with the separate activities of Selo. Therefore, the research questions that will find an answer on the second question are as follows:

- What are the variables that influence the performance of the department? (These variables are called value drivers)

- Which value drivers are controlled by the department / Selo? - What are the responsibilities of the members of the department? - How are value drivers measured?

- How should the report be presented to make it easy to use? (This includes the frequency of reporting and the different levels in which the reports are presented).

1.5 Methods of data collection

As has been noticed in section 1.4 the main question can be divided in two parts. As a consequence, the two parts can have different methods of data collection. The first part will be an exploring literature search, while in the second part the results of the first part will be confronted in practice with the situation of Selo. The goal of the literature search is to get a clear view of how can be looked at the businesses of Selo. The literature search can be carried out by doing a desk research. A desk research is a study whereby the researcher uses material produced by other people, or by evaluation of existing literature the researcher tries to come to new insights.

Master Thesis Gerrit Jan Oude Booijink

Master Thesis Gerrit Jan Oude Booijink

2 Theoretical Framework

This research aims at preparing a proposal for a formal management information system by giving insight which performance variables are actually creating value for the businesses at Selo. This chapter will give an introduction, including a definition of value-based management (2.1), how value is created (2.2), how the contributions of the value drivers are measured (2.3) and how the shareholder value is managed (2.4). The value tree is described in section 2.5. This chapter finishes with the drawbacks of value-based management (2.6) and value-based management in the context of Selo (2.7).

2.1 Introduction

This section discusses what value-based management is and why it is useful.

Organizations serve a purpose. They exist to deliver certain values. Therefore it makes sense to ensure that value is created. Value-based management is a management control system that supports the creation of value. Targets need to be clear and need to be aligned with the organizational goals. It is generally agreed that the primary objective for profit organizations is to maximize the value of the firm, subject to some constraints, such as compliance with laws and adequate concern for employees, customers and other stakeholders (Wenner and LeBer, 1989).

A deep understanding of the performance variables that will actually create the value of the business is essential, because an organization cannot act directly on value. It has to act on things it can influence. Moreover, it is through these drivers of value that senior management learns to understand the organization and to establish a dialogue about what it expects to accomplish.

Value-based management is an approach to focus management decision making on the key drivers of value. The reasoning behind value-based management is simple, value is created only when companies invest capital at returns that exceed the cost of capital. When returns on capital are less than the cost of capital then capital is destroyed, hence value is lost.

Value is a good performance measure, because it is a performance measure which requires complete information. To understand value creation, a long-term strategic point of view is needed. It is necessary to manage all cash flows on the income statement and to manage the balance sheet. Knowledge about how to compare cash flows from different time periods on a risk adjusted basis is essential as well. Therefore, it is impossible to make good decisions without complete information. According to Copeland et al. (2000) value is the only performance measure that uses complete information.

Master Thesis Gerrit Jan Oude Booijink

Value-based management is defined by many authors, however most definitions of value-based management are a sign of the same way of thinking. Some authors focus on the output of value-based management when defining it. Some examples are:

“Value-based management is essentially a management approach whereby companies‟ driving philosophy is to maximize shareholder value by producing returns in excess of the cost of capital‟‟(Simms, 2001).

“Value-based management is a term that describes a management philosophy based on managing a firm with Economic Value Creation principles‟‟ (Armitage and Fog, 1996).

“Value-based Management is based on the notion that the central objectives for all public traded companies is to maximize shareholder value. Because it offers companies a logical and systematic way to pursue improvements in shareholder value, it has received considerable action in the business press‟‟ (Bannister and Jesuthasan, 1997).

Other authors focus on the process and the outcome of value-based management. Examples of this are: “Value-based management is a combination of beliefs, principles and processes that effectively arm the company to succeed in the battle against competition from the outside and the institutional imperative from the inside. These beliefs, principles and processes form the basis of a systematic approach to achieving the company‟s governing objective‟‟ (Mc Taggart et al.,1994).

“Value-based management can be all embracing. It aligns strategies, policies, performance, measures, rewards, organization, processes, people and systems to deliver increased shareholder value‟‟ (Black et al., 1998).

Boulos, Haspeslagh and Noda (2001) define value-based management as a process:

“Value-based management is a holistic management approach that encompasses redefined goals, redesigned structures and systems, rejuvenated strategic and operational processes, and revamped human-resources practices. Value-based management is not a quick fix but a path requiring persistence and commitment‟‟.

All of the above definitions focus on specific parts of value-based management, however the following definition combines inputs, outputs and processes:

“An approach to management whereby the company‟s overall aspirations, analytical techniques and management processes are aligned to help the company maximize its value by focusing management decision making on the key drivers of value‟‟ (Copeland et al.,2000).

Copeland‟s definition is the most complete definition.

It is generally understood that value-based management includes the following key components:

- Creating value

- Measuring value

- Managing value

Master Thesis Gerrit Jan Oude Booijink

In the previous section it was stated that companies should be managed to create value. Obviously it is easy to say that companies should strive to create shareholder value, but providing guidance to achieve this in the best way is quite another thing.

In most successful companies that implemented value-based management the commitment of the top management to shareholder value is crucial. The entire organization must have a value mindset (Koller, 1994). The value mindset starts at the level of senior management, i.e. value maximization should be the financial objective of a company. Senior management must keep in mind how this objective weighs in against other objectives, such as employment or environmental goals. According to Koller (1994) there should be different types of goals: financial goals and inspirational goals which motivate the performance of the entire organization. Examples of non-financial goals are customer satisfaction and employee satisfaction. Objectives should be set according to the layers in the hierarchy of the company. For senior management this may mean value creation measured in financial terms, but for a manufacturing manager objectives may include cycle time, productivity or product quality. A value creation mindset ensures that members of senior management are clear among themselves that their financial objective is maximizing value. Furthermore, a value creation mindset makes sure that the senior management has clear rules for deciding when other objectives outweigh maximizing value. It is important to define what creating value is (Bear et al., 2000). There are enough metrics available, all of which have their own advantages and shortcomings. The metrics are discussed in the following section (2.3). No single metric can fit all management requirements. Therefore, various metrics can be used to measure different aspects of performance at different levels in the company. Metrics alone do not lead to value creation. However, the metrics can be used to measure how much value is created.

When commitment in the company is developed, a supporting corporate context needs to be established. This corporate context needs to align three elements (Bear et al., 2000). The first element, aspirations and targets, need to be developed in such a way that it corresponds to the organization‟s strategic direction. Aspiration is the vision of the company, thus a statement of where the company wants to go. The targets can be both qualitative and quantitative and are used to measure the progress towards achieving the company‟s vision. Successful organizations that focus on creating shareholder value have developed aspirations that provide a vision with which the entire organization can identify and support. Value-linked targets mark the path toward a company‟s aspiration (Bear et al., 2000). An example is to target the key-value drivers. The key-value drivers can be expressed in financial or operational terms.

Master Thesis Gerrit Jan Oude Booijink

2000). While the first element of the corporate context makes clear what the organization wants to achieve, the second element states how the company should achieve the company‟s vision.

The third element of the corporate context is a coherent portfolio of business. Creating a business portfolio that fits with the organization‟s strategic direction and aspiration is vital. This means that businesses that do not fit or destroy value should be removed from a business portfolio. The right corporate context is an important factor for creating shareholder value, because it clarifies direction and ensures the basic value-creation.

When the corporate context is clear, some organizational changes may be needed to support value creation (Bear et al., 2000). Normally a flat decentralized organizational structure is best for creating shareholder value, because a decentralized structure permits transparency and clear communication. Companies that successfully use value-based management define their business-units according to scope, control and materiality. These companies also define overall performance responsibility per business-unit and on individual level.

Once the actions of committing to value, setting the corporate context and the organizational deployment are taken, the next step will be to define the key-value drivers. With these key-value drivers, management knows where to focus on to create value.

Master Thesis Gerrit Jan Oude Booijink

Exhibit 2.1 Path of creating shareholder value (Derived from: Bear et al., 2000)

2.3 Measuring shareholder value

In the previous section it was already mentioned that there are several metrics available, all of which have their own advantages and shortcomings. No single metric can fit all management requirements. Therefore, various metrics can be used to measure different aspects of performance at different levels in the company. This section describes the metrics required for different company situations.

Companies that focus on this year‟s net income tend to have a myopic point of view. The myopia problem is a tendency to make managers excessively short-term oriented (Merchant & Van der Stede, 2007). Another consequence for companies focussing on this year‟s net income is that they tend to ignore balance sheet opportunities, such as working capital improvement or capital expenditure efficiency. Decision making can be influenced by the performance metric. Therefore, it is important that measures of organizational performance take into account the need for a long-term point of view and the need to manage the company‟s balance sheet. The discounted cash flow (DCF) valuation handles both adequately.

Value Thinking

Value Mindset

Metrics

Corporate Context

Organizational Design

Defining Value Drivers

Performance Management

Master Thesis Gerrit Jan Oude Booijink

Exhibit 2.2 mentions the key metrics required for different company situations, along two dimensions.

Exhibit 2.2 Key metrics (source: Copeland et al.,2000)

This section continues with considering how each metric, mentioned in exhibit 2.2, is calculated and with identifying some complications of using them in practice.

An important economic relationship underlying value-based management is that shareholder value is determined by discounting cash flows companies expect to receive over a long-term period at the minimum acceptable rate of return the company receives, the cost of capital (Young & O‟Byrne, 2001). Cash has a time element, which means that people rather have it today than have to wait for it (Brealy et al., 2004). The function of the riskiness of the estimated cash flows results in the discount rate. The cost of capital and the riskiness are the elements of the present value rule. Therefore, the Discounted Cash Flow (DCF) model is:

t=n Present Value = ∑ CFt / (1 + r)t

t=1

Where n = The economic life of the investment

DCF or Economic Profit

Growth of net

income

Net income,

return on sales

ROIC-WACC,

Economic Profit (one year)

Operating value

drivers

High

Low

Need for

long-term view

High

Low

Master Thesis Gerrit Jan Oude Booijink

There are four ways in which companies return cash to their investors (i.e. pay dividends, or buy back shares), and therefore, the expectations of such cash flows will be the ultimate determinant of a company‟s value, from a capital market perspective (Young & O‟Byrne, 2001). The element of the DCF model that is not totally clear yet, is the level of the discount rate. Traditional accounting measures only take the cost of debt into account to calculate profits. Value-based management metrics include a charge for all investors, including the shareholders. The addition can be made by using a capital charge, the WACC (Weighted Average Cost of Capital), over invested capital. A firm‟s WACC can be calculated by using the following formula:

WACC = (E / K) * y + (D / K) * b (1-Tc)

Where E = Total equity of the firm K = Total assets of the firm D = Total debt of the firm y = Cost of equity b = Cost of debt Tc = Corporate tax rate

Normally, estimating the cost of debt is not very hard. In most cases it is clear how much a company has to pay to its bankers or bondholders for debt finance. However, the cost of equity is more difficult to estimate. The cost of equity is usually higher than the cost of debt finance, because the cost of equity involves a risk premium. Calculating this risk premium is one thing that makes calculating WACC complicated. The tax rate is important because interest payments are tax-deductible.

A second key metric is the economic profit (EP) approach. EP describes the surplus earned by a company in a period after the deduction of all expenses, including a capital charge. Economic profit is the difference between the return of capital and the cost of capital. Economic profit can be calculated by using the following formula:

EP = (r – k) * C0

Master Thesis Gerrit Jan Oude Booijink

“Too often companies focus on either size (earnings or growth of earnings) or ROIC. Focusing on size could destroy value if returns on capital are too low. Conversely, earning a high ROIC on a low capital base may mean missed opportunities” (Copeland et al.,1996). Thus, the strength of economic profit is that it combines size with ROIC into a single result.

A drawback of using economic profit is that it uses traditional accounting numbers. Effects like inflation could undermine the validity of the calculations. Return on invested capital (ROIC) is part of the economic profit formula. ROIC can de defined as:

ROIC = NOPLAT / Invested Capital

The Net Operating Profit Less Adjusted Taxes (NOPLAT) represents the after-tax profits of the company after adjusting the taxes to a cash basis, making taxes the only adjustment to the profit and loss account (Copeland et. al., 1996). The latter is the consequence of the fact that the provision for income taxes in the income statement does not equal the actual taxes paid in cash by the company due to differences between financial accounting and tax accounting. The adjustment to a cash basis can generally be calculated from the change in accumulated deferred income taxes on the company‟s balance sheet (Copeland et al., 1996).

Invested capital represents the amount invested in the operations of the business, and is calculated as the sum of operating working capital, net property, plant and equipment, and net other assets.

The value-based measures described above include a charge (WACC) for all investors, this includes the shareholders as well. This is an addition to the accounting measures. This should lead to more consciousness in the organization that money has its prize. Accounting-based metrics use book values to determine invested capital. However, from a financial perspective these values can be considered as sunk costs and therefore are irrelevant for decision making. The financial perspective argues that assets should be valued at market values, based on expected cash flows from these assets (Claes, 2008).

2.4 Managing shareholder value

Master Thesis Gerrit Jan Oude Booijink

value creation. Value drivers must be developed down to the level of detail that aligns the value driver with the decision variables direct under the control of line management. Value drivers can be useful at three levels: (i) generic level, (ii) business units level and (iii) operating level (Copeland, et al.,2000). This will be discussed in further detail in section 2.5. Although value drivers are useful, more is needed to actually generate results.

Organizations must go beyond defining the focus of their businesses to manage the performance of their organizations to capture the most possible value (Bear et al., 2000). Top management must ensure that every organizational level and unit has its own key performance indicators. These key performance indicators are linked to the company‟s value drivers, but identify the specific performance focus for which each business unit is responsible. Once key performance indicators are identified, management must implement a method to measure it.

Once the key performance indicators are implemented managers need to set opportunity-based targets founded on what is in fact achievable rather than purely on historical performance (Bear et al., 2000). Creating opportunity-based targets can be done on a base of benchmarks, analysis of the market opportunity, theoretical limits and trends interpreted in the context of market dynamics. It can result in bottom-up commitment to targets.

Finally, according to Bear et al. (2000) management must review and improve the company‟s performance by making a clear report of the business performance and discuss performance with the right people to further improve performance. In order to do this, business performance review meetings should be kept. The business review is important, because it translates information about performance into action of performance. If reviews are not kept, value drivers and key performance indicators will contribute little to value creation.

2.5 The value tree

Section 2.1 introduced value-based management and the value drivers. A value driver is any variable that affects the value of the company (Koller,1994). To be useful, value drivers need to be organized so that managers can identify which have the greatest impact on value. A method to organize the value drivers is by creating a value tree. An example of a value tree is presented on the next page. When a value tree is created, the value drivers which have the greatest impact on value can be identified. Once these value drivers have been identified, responsibility for their performance can be assigned to individuals, who can contribute to meet the targets of the organization.

Master Thesis Gerrit Jan Oude Booijink

the business-unit level drivers „customer mix‟ and „sales force productivity‟. The third level is the operational level (Exhibit 2.3). In the operational level the business-unit value drivers are translated into operating value drivers. For example the business-units value driver „sales force productivity‟ can be made operational with the operating value drivers „unit revenues‟ and / or „euros per visit‟.

Overhead Costs ROIC Margin Invested capital Revenue Costs Marketing costs Level 1: Generic Examples Examples Level 2: Business-unit specific Level 3: Operating Value drivers - Customer mix - Salesforce productivity (expense revenue) - Percent accounts revolving - Euros per visit - Unit revenues - Fixed costs / allocations - Capacity management - Operational yield -Billable hours to total payrol hours - Percen capacity utilizited - Cost per delivery -Accounts receivable terms & timing

- Accounts payable terms & timing

Exhibit 2.3 A value tree (source: Copeland et al., 2000)

Master Thesis Gerrit Jan Oude Booijink

An survey of management accounting (Ernst &Young and Institute of Management Accountants, 2003) showed that 30% of companies claim to use value-based management. About the same percentage of companies claim to have tried value-based management, but rejected it. Apparently, value-based management is not a success for every company. This section will provide some possible reasons why some organizations do not have a positive experience with value-based management. The first reason is that value-based management is not an easy approach, neither conceptually nor in practice. Many companies have competing priorities, which makes the discipline of value-based management difficult to apply. Value-based management does not make strategic planning more predictable. “It is not a crystal ball, or a replacement for management judgement” (Knight, 1998). A second explanation is that some companies believe that they do not have the resources available, or the required commitment to make any real development. Implementation of value-based management is usually expensive. Many companies use consultants, which result in a significant expense. Investments in training and the opportunity cost of the time spend to the programme contribute to high implementation costs as well.

Furthermore, even for companies that have success in implementing value-based management, sustaining initial gains is a challenge. Many companies lose focus and go back to old habits of managing. A summary of the disadvantages of value-based management is given in Exhibit 2.4.

Exhibit 2.4, the disadvantages of value-based management (source: Cooper et al., 2001)

Disadvantages of value-based management

Different forms of value-bases management and methods complicate the

tasks

Relatively disappointing at the subordinate business level, because of the

difficulty of forecasting value

Technical measurement difficulties, such as the cost of capital

Difficult to translate the financial measures into operating customer

measures

Master Thesis Gerrit Jan Oude Booijink

The theoretical framework explained the basic concepts of value-based management. Most research about value-based management has been conducted at corporations which are listed at a stock-exchange. These companies are usually quite large in terms of capital and / or employees. However, not much research has been performed at smaller companies, for example closely-held firms. Jermias and Gani (2005) conducted a research about the performance of widely-held and closely-held companies. They found that widely-held companies perform better than their closely-held equivalent. This section will briefly describe the context of Selo regarding value-based management. This section is required because Selo has its own unique features and circumstances.

The first characteristic which is typical for Selo is the ownership structure. Stock-listed companies have a separation of ownership and management. The separation of ownership and management can result in problems which are better known as the agency problem. The agency problem occurs when there are conflicting interests between principals and agents, under the condition of asymmetric information (Eisenhardt, 1989). In companies, the shareholders are the principals and the top-management is the agent. At Selo, the principal-agent problem does not exist, since top top-management partially owns the company. Top management support to use value-based management should not be difficult to realize at Selo, because top management will be rewarded directly when value is created. Disadvantage of the ownership-structure which Selo has is “that with limited access to financial resources and professional executives, and a more family-oriented management style, closely-held companies might find it difficult to compete against widely-held companies” (Jermias and Gani, 2005).

Master Thesis Gerrit Jan Oude Booijink

3. Research Methodology

This chapter describes how the research has been conducted in order to find answers to the questions which are stated in section 1.4. The research questions which contribute to the answer on the first main question are answered in the Theoretical Framework chapter. As a consequence, this chapter will only describe the research methods for finding an answer on the second main question of the research. The chapter starts with a motivation why the case study method has been used. Subsequently, the research methodology and the method of data collection are described.

3.1 Research strategies

This section describes the motivation for choosing case study research. Yin (2003) distinguishes different research strategies:

- Experiment

- Survey

- Archival analysis

- History

- Case study

Yin (2003) states that there are three conditions for using each strategy. These conditions are (i) the type of research question posed, (ii) the extent of control an investigator has over actual behavioral events, and (iii) the degree of focus on contemporary as opposed to historical events.

The relevant situation for the Case study according to the three conditions is:

(i) The form of research questions: how, why?

(ii) Requires control of behavioral events? No

(iii) Focus on contemporary events? Yes

The form of the research questions of this research complies with the form of research questions which are best-suited to answer in a case study. This research is conducted at Selo, and therefore there is a focus on contemporary events. It is possible to directly observe the events being studied and it is possible to interview the persons involved in the events. However, relevant behaviors cannot be manipulated. Of the research strategies that Yin (2003) mentions, the conditions of this research correspond best with the case study research. That explains why for performing this research the case study has been chosen.

3.2 Case study

Master Thesis Gerrit Jan Oude Booijink

- investigates a contemporary phenomenon within its real-life context, especially when

- the boundaries between phenomenon and context are not clearly evident.

2. The Case study inquiry

- Copes with the technically distinctive situation in which there will be many more variables of

interest than data points, and as one result.

- Relies on multiple sources of evidence, with data needing to converge in a triangulating fashion, and as another result.

- Benefits from the prior development of theoretical propositions to guide data collection and analysis.

Furthermore, Yin (2003) distinguishes different types of case study research. The first distinction he makes in designing case studies is between single- and multiple-case designs. This research will have a single-case study design. The second distinction Yin makes is the holistic versus the embedded case studies. In a holistic case there is one unit of analysis, while the embedded case study has multiple units of analysis even though the case study is about a single organization. This research has more than one unit of analysis, because all different departments of Selo are taken into account. Performing a study at just one department of Selo would not be proper, because all departments have their own unique activities. Therefore, the study of one sub-unit cannot be generalized to all other sub-units.

3.3 Data collection

In order to collect the data a case study protocol has been prepared. The protocol is described below. The protocol includes the research question, the motivation for choosing which people to interview and the main questions for conducting the interviews. The questions used in the interviews are derived from the research which is presented in the Theoretical Framework chapter.

This research uses semi-structured interviews. This structure makes sure that all relevant topics are discussed during the interview, but also allows some freedom in asking the questions throughout the interview.

The case study protocol starts with the research question:

How can theory on value-based management inform an analysis of the performance variables that will actually create the value of businesses and how can these findings be used to determine which performance variables actually contribute to creating value in a closely held firm?

Master Thesis Gerrit Jan Oude Booijink

company‟s context. The second interviewee is the manager of the department. The interview with the manager of the department is essential, because it uncovers the thoughts and purposes of people who actually need to create value. An interview with the CFO about the company as a whole is the starting point of this part of the research. The objective of this interview is to get the top management objectives and a clear view of the company as a whole.

Topics that are discussed during the interviews are:

1.The variables that influence the performance of the department, these variables are called value drivers;

2.The value drivers that are controlled by the department / Selo; 3.The responsibilities of the members of the department; 4. How are value drivers measured;

5. How should the report be presented to make it easy to use, this includes the frequency of reporting and the different levels in which the reports are presented.

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4. Case study, value-based management at Selo

This chapter starts with a short description of Selo. The chapter continues with describing the value drivers and how the most important value drivers are controlled and measured per department of Selo. The chapter finishes with describing how the reports should be used, including the frequency of reporting.

4.1 Introduction of Selo

This section will shortly describe the history of Selo. To get a clear view of the structure of the organisation, an organizational chart is presented as well. The departments of Selo are discussed in more detail further on in this chapter.

4.1.1 History of Selo

Selo (a compression of its founders names, Seffelaar and Looyen) is active in the food processing industry on a worldwide scale. Selo was founded in The Hague in 1944. Initially, the company operated within the Netherlands but in the sixties it began to develop its export business. This was coupled with an increased concentration on the design and implementation of complete projects for all its markets. To provide a high quality service in its main export markets, bases were established in Germany and England. A subsidiary was established in Mettmann, near Dusseldorf, to serve the German, Swiss and Austrian markets. A joint-venture was undertaken with R.W.Bollans Ltd, based in Birkenhead, to serve the UK and Irish markets. The company has maintained a keen eye for new developments that could be beneficial to the meat industry. Over the last fifty years Seffelaar & Looyen has played a leading roll in the development of many new products and services.

This combination of leading brands, comprehensive technical and technological services and more than fifty years of experience has given Selo its unique position in the worldwide food processing industry (source: www.selo.nl).

4.1.2 Organizational chart of Selo

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Selo Holding B.V.

Selo Verpakking B.V.

Selo Food processing

and packaging B.V. Selo Uk Ltd (UK)

Selo Deutschland Gmbh (Germany) NVA Capital B.V. Q-tech B.V. Royal B.V. J. Wijers Holding B.V. OPM Mabayo B.V. 50% 12,5% 12,5% 12,5% Selo B.V. Selo Service B.V. Selo System Engineering B.V. Selo Food Technology B.V.

Selo Nordic A.S. Denmark

12,5%

Exhibit 4.1 Organizational chart of Selo.

The BV companies at the top of the chart are the companies of each of the four directors of Selo. Each director possesses one of the companies mentioned. Every BV at the top of the chart has a 12,5% stake in NVA Capital BV. The remaining 50% of the shares of NVA Capital is owned by the Overijsselse Participatie Maatschappij (OPM), which on its turn is owned by Friesland Bank Investments. The NVA capital BV has 100% of the shares of Selo Holding BV. Selo Holding BV contains all other companies/departments mentioned in the organizational chart.

4.2 The departments of Selo Holding BV

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4.2.1 Selo Verpakking BV General description

Casings are natural (animal) or artificial (collagen, plastic or fibre based) intestines, predominantly used in the production of sausages. Selo offers a wide range of artificial casings based on collagen, from the German producer Naturin which is part of the Spanish Viscofan group, the largest artificial casing supplier in the world. Selo operates as a distributor of these products, supplying companies in the Dutch food manufacturing sector. Due to increased demand for assembly space in the Oldenzaal location, management has made the strategic decision to outsource the warehousing and distribution functions of its casing activities and to focus on the marketing and sales function of this department. Selo takes customer orders from clients and then gives directions to the distribution centre to deliver the required order. The distribution centre is supplied at least once a week with casings by Naturin. Clients can order off-the-shelve products, but also tailor made and printed casings.

This department has a total of three employees, one managing director, one account manager, and one administrative employee. The managing director of casings performs similar tasks as the account manager

Suppliers

Selo‟s main supplier of casings is Naturin (95%), whose Spanish owner Viscofan is the largest player and an industry consolidator. Viscofan has acquired a number of selected casing manufacturers with the aim to further broaden and strengthen its product range. Other suppliers include Unipack and Visco.

Clients

The clients for this department are nearly all meat companies, including well-known Dutch companies like Zwanenberg and Stegeman and international companies active in the Netherlands, like Hilton Meats.

Key competitors

Important players in the casings market are:

- Van Hessen, a Dutch company, which is the market leader and has a large assortment of casings; - Kallo Nalo, a German company, which has a large assortment of casings at stock and this company uses an aggressive price strategy;

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The tasks and responsibilities of the employees

The tasks and responsibilities of the administrative employee

The administrative employee works most of the time at his office and is handling incoming orders of clients. Clients place their orders by fax, email or phone. The administrative employee transfers this order to the warehouse. In the warehouse the order will be prepared to be distributed. When the demanded products are on stock, the products are delivered at the client the next day. When the demanded products are not on stock, the administrative employee has to contact the suppliers to order the products, or asks the supplier when the already ordered products will be delivered. The delivery of the suppliers has been problematic lately, the suppliers have problems with their production capacity and therefore it takes a very long time to deliver certain products. It is very important that the administrative employee orders certain products in time, to prevent from running these products out of stock.

The tasks and responsibilities of the account managers

The account managers are the salesmen of Selo. The account managers keep in touch with the clients, one of the tasks is to advice the clients about which casing fits best to the clients product and / or production process. Another task is to inform the clients about new products and try to run tests with these new products to show the customers the benefits of these new products. Another task of the account managers is to handle customer complaints. The account managers then try to solve the problem. When necessary, Selo can ask assistance of the technicians of the supplier as well. Whatever the problem is, the account managers have the technical knowledge and a wide experience to solve the problems in most cases.

The variables that influence the performance of the department, the value drivers

The value drivers of Selo Verpakking are put together in a value tree. The value tree is presented in Exhibit 4.2. To increase the comprehensibility of this value tree some of the value drivers are explained.

Inventory costs

Cost of placing the order. Every time an order is placed to buy inventory, a number of transactions are needed which incur costs to the organization. Examples of this type of costs are the task of preparing the order and all the documentation linked with it, arranging the delivery to be made and preparing to pay the supplier for the delivery.

Working capital costs. These are the costs for funding the stock. The cost for funding stock exist because there will be a lag between paying the suppliers and the payment received by customers. The opportunity cost of not investing the money, which is paid for the inventory, elsewhere is associated with it.

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Obsolescence costs. The cost associated with the risk that goods might become obsolete or deteriorate with age.

The value tree also mentions stock-out costs, these costs can occur when Selo fails to supply to its customers. The stock-out costs cannot be measured easily. However, it is possible that they occur and these costs will affect value, that is why they are mentioned in the value tree.

Company value Gross Margin Inventory costs Delivery costs Gross margin per product Number of transactions Cost of placing order Stock-out costs Working capital costs Obsolescence costs Payment time of customers Payment time to suppliers Customer satistaction Selo's reputation Lead time Product quality Trips per transaction Number of transactions Cost per trip

Inventory cycle time

Key areas of focus

Exhibit 4.2 Value tree of Selo Verpakking BV

The key value drivers

This section describes why the three key value drivers are chosen and how they are measured.

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stock. The lead time can be directly measured in Exact, the software programme that is used by Selo Verpakking. The report of Selo Verpakking includes the lead-time.

The second key value driver is the payment time of the customers. Most customers have a payment time of 30 days. However, a lot of customers exceed this payment time. Currently there is a total of €320.038,- above due date. The average time of paying too late is 35 days. Thus, the customers that do not pay in time have an average time of 65 days before paying. To measure the payment time, an aging analysis has been made which is also presented in the report of Selo Verpakking. The aging analysis also includes more detailed information of which customer has to pay a certain amount of money and how long he has exceeded his payment time.

The third key value driver is the inventory cycle time. The section about the responsibilities of the administrative employee already mentioned that the delivery of the suppliers has been problematic lately. This and some other factors have resulted in a high level of inventory. The opportunity cost of not investing the money, which is paid for the inventory is associated with this high level of inventory. In order to measure the inventory level of the products, the current stock is compared with the goods already sold during 2008. The report of Selo Verpakking shows an overview of the stock in sales days per product. The overview of the stock in sales days per product is comparable to the overview of the stock in sales days per product of Selo Service BV, which can be found at Appendix II. Please note that the numbers mentioned in Appendix II and III are fictive.

4.2.2 Selo Service BV General description

Service is an important and recurring revenue stream for Selo. Service revenue is growing on the back of the increasing number of machines and process lines that Selo has installed during the past years. Under different types of contracts, Selo offers its customers extensive after sales, repair and maintenance service. Selo Service is responsible for installing and maintaining machines that are sold by Selo BV, at the client. Furthermore, Selo Service contains the supply of spare parts and overhauling of machines and production lines for the food processing industries. Selo operates this activity with a total of twenty employees, one manager, three service callers, three administrative employees, one salesman of spare parts and twelve service mechanics.

Suppliers

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The tasks and responsibilities of the administrative employees

The three administrative employees have divided their work, it means that they all have their own type of work. The first administrative employee makes the invoices. The invoices consist of the spare parts used by the service mechanics, the hours worked at the client by the service mechanics and other costs made. This invoice is called a service order, or SO in short. The administrative employee makes a concept of the invoice and sends it to manager. The manager checks the invoice and when the invoice is approved by the manager, the administrative employee makes the eventual invoice. The administrative employee is responsible to list the working hours made by the service mechanics. The second administrative employee is in charge of the purchase of spare parts. The administrative employee prints a purchase recommendation list from Exact two times per week. By means of this list, the administrative employee looks which spare parts to order. It is likely that the system recommends to order a certain spare part, but that it is better not to order this part yet. There are many reasons for the administrative employee not to order certain parts, that is why the administrative employee has to overlook the purchase recommendation list for every single part.

The third administrative employee focuses on the overhauling of parts. In many cases, the service mechanic changes the part that needs to be overhauled with a new part. The administrative employee contacts the supplier of the component and the supplier will repair the component and when the component is repaired it is send back to Selo. The overhauled component is treated like a new component.

The tasks and responsibilities of the service callers

The service callers handle the phone calls they receive from customers. When a customer calls, the service caller tries to find out what the problem is and what type of machine the customer has. Sometimes the service caller can solve the problem by phone, however in most cases the service caller needs to send a service mechanic. When the service caller has a good view of the problem he needs to pick the right service mechanic. He has to look which service mechanic is available and whether he is close enough to the client, to get at the client on time. In most cases the clients want the problems solved in a very short time, because when the machine is broken, the whole (or an important part of the) production process can be down.

The tasks and responsibilities of the salesman of spare parts

The task of the salesman of spare parts is quite obvious. Customers call, fax or e-mail the salesman about which parts they need. Another task the salesman performs is when Selo B.V. sells a machine the salesman makes a list of parts that are liable to wear and sends it to the customer.

The tasks and responsibilities of the manager

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He checks the invoices made by the administrative employees and approves them or makes adjustments to it. In coordination with the service callers he plans the service mechanics on the different customers. When one of the service callers is on holidays or is ill he is able to take over their job. He has the knowledge and skills to do so. In other words, he has a close look on the work of the other employees at Selo Service.

The variables that influence the performance of the department, the value drivers

The value drivers of Selo Service are put together in a value tree. The value tree is presented in Exhibit 4.3. To make this value tree more clear some of the value drivers are explained on the next page. The different inventory costs are already described in the section of Selo Verpakking.

Company value Gross Margin Equipment expense Margin on spare parts Margin on service mechanics Number of mechanics Equipment needed Key areas of focus Number of transactions Inventory costs Cost of placing order Stock-out costs Working capital costs Obsolescence costs Payment time of customers Payment time to suppliers Inventory cycle time Storage costs Percent occupancy Costs per hour Hourly rate

Failure costs

Number of failures Costs of failure

Exhibit 4.3 Value tree of Selo Service BV

Selo Service obtains revenue by selling spare parts and by selling hours of service mechanics. That explains why the margin on the hours of the service mechanics and the margin on the spare parts together form the total gross margin for this department.

The equipment expense does not require special management attention. Every single service mechanic has its own set of tools. Furthermore, every service mechanic is responsible for its set of tools, when tools get lost, for example, they have to replace the tools themselves.

The key value drivers

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The first key value driver for Selo Service is the occupancy of the service mechanics. The degree of occupancy determines how much money the service mechanics earn for Selo and therefore it is vital that this degree of occupancy should be as high as possible. For example, if the degree of occupancy is about 50% every month it is likely that Selo is hiring too much service mechanics. The degree of occupancy can be calculated by the number of hours invoiced to customers in a month, divided by the number of service mechanics multiplied by the number of normal working hours they work every month. Appendix II shows the occupation of the service mechanics during 2008. Please note that the numbers mentioned in Appendix II are fictive.

The second key value driver is failure costs. Failure costs are the costs that incur, because service mechanics can make mistakes. The amount of failure costs can be derived from the software programme Exact. Appendix II shows that the Service and guarantee costs incurred in 2008 is €15.000. This is an enormous decrease compared to the €150.000 that incurred in 2007.

The third key value driver is the inventory cycle time. This key value driver was used in Selo Verpakking as well. This key value driver is measured in the same way. However, in this report product groups are measured and not stock in sales days per product. The reason for using product groups at Selo Service, is that Selo Service uses an older version of Exact. Appendix II shows an overview of the stock in sales days per product group.

The fourth key value driver is the payment time of the customers. This key value driver was used in Selo Verpakking as well. This key value driver is measured in the same way. Appendix II shows which amount is above due date. The average time of paying too late is 80 days.

4.2.3 Selo BV General description

Selo BV operates a trading business for processing and packaging equipment. With many of the equipment manufacturers, Selo has had long lasting relationships, representing some for more than 50 years. Selo keeps a limited number of single machines in stock. Selo specialises in the most modern types of equipment, with high hygiene and flexibility requirements. Selo UK ltd is also included in the equipment trading and service. At Oldenzaal and at Selo UK, Selo keeps a stock of single machines from a number of manufacturers. These are typically the most frequently ordered models. After the clients order a machine, Selo transports and installs the machine at the client.

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Suppliers

The suppliers are the same as for Selo Service. However, Selo BV orders the machines, while Selo Service orders the spare parts. The most important suppliers for Selo BV are Interpack, KS, Omori, Seydelmann and Toyo Jidoki.

Clients

The clients for single machines cover a number of industries, some well-known clients include Unilever, Kraft and Hilcona.

Key competitors

The number of manufacturers and agents active in the food equipment and packaging equipments is huge, and as such the single machine market is highly competitive. Selo differentiates itself from its competitors in the Benelux, by its large service department and the ability to make adjustments to off-the-shelve machines. Some of the other larger players in the Benelux and German markets are:

- CFS, large Dutch company, active in different types of equipment;

- Fuji, large Japanese producer of packaging equipment;

- Handmann, large German company, active in different types of equipment;

- Tevopharm, Dutch producer of packaging systems, part of Robert Bosch;

- Ulma packaging, large Spanish producer of different packaging machines.

The tasks and responsibilities of the account managers

The account managers are the salesmen of Selo BV. The account managers try to find out whether a potential client needs a packaging system in the near future. It is possible that the account managers make the customer aware of an automation which the customer never thought of. When a customer is interested or already has an idea about how he would like to have his packaging process, the account manager makes sure he has a clear view of the customer demands and then contacts a logistic employee. Every account manager is attached to a logistic employee. The account manager wants to know whether it is technically possible what the customer is demanding and the account manager would like to have an indication of the price of the packaging system to the customer.

The tasks and responsibilities of the logistic employees and the logistic manager

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Another task the logistic employee performs is the purchase of certain parts and machines. Most of these machines are bought in Japan and need to be shipped. The delivery time for these machines therefore is quite high. Most of the machines and parts contain a high value. The logistic employee has to keep some machines on stock, because of the delivery time. However, there cannot be kept to many machines on stock, because of the high value.

The logistic manager does technically the same work as the logistic employees. However, whereas the logistic employees focus on a selection of the orders, the logistic manager has a more complete view of all running orders. The logistic manager coordinates with Selo Service and Selo System Engineering. Both departments perform work for Selo B.V.

The variables that influence the performance of the department, the value drivers

The value drivers of Selo BV are put together in a value tree. The value tree is presented in Exhibit 4.4. Company value Gross margin Number of employees Costs Revenue

Cost per person Personnel costs Transportation costs Installation costs Key areas of focus Sales force productivity Number of transactions Hours spend per transaction Cost per transaction Number of visits Number of prospects Inventory costs

Exhibit 4.4 Value tree of Selo BV

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The key value driver

This section describes why the key value driver has been chosen and how it is measured. Selo BV focuses on sales of machines. The installation of machines is performed by Selo Service. When a machine for instance needs a special belt, then Selo BV outsources this activity to Selo System Engineering. Stated differently, for special circumstances Selo BV makes use of other departments of Selo Holding. The essential task that Selo BV performs is selling machines to customers. The key value driver for Selo BV therefore is the productivity of the sales force. The report of Selo BV shows the activity of the sales force measured by the number of customer visits and the number of prospects given per salesman. Furthermore, a sales monitor for every month of 2008 is presented in the report. The sales monitor includes reasons for losing a number of prospects and the value associated with the lost prospects. Appendix III shows the report of Selo Food Technology BV. This report contains the same elements as the report of Selo BV.

4.2.4 Selo System Engineering BV General description

Selo System Engineering performs back-office activities for Selo BV. Selo offers clients entire product handling and packaging lines, consisting of a standard packaging machine combined with a custom designed handling system of conveyers, belts, etc. Selo offers these systems with guaranteed outputs and maximum downtimes. After analysing a specific handling and packaging need for a client, Selo designs a customized setup to offer clients the most efficient processes possible. Selo has a project organisation available for this activity, together with a test kitchen for demonstration and test purposes. Based on its extensive knowledge of handling and packing problems and solutions, Selo designs, engineers and builds entire packaging lines. Driven by client specific needs, Selo System Engineering custom designs a solution. From a blue print, different steel working companies produce components. These components, together with components manufactured by Selo itself, are then assembled with a principle supplied packaging machine into its final setup in one of the halls in Oldenzaal. Selo initially performs a number of extensive tests before dis-assembling and shipping the entire packaging line to the client. At the client facility the line is re-assembled by Selo and again tested before being activated for the client. Selo operates this activity with a total of fifteen employees, one manager, six engineers, one administrative employee and seven production employees.

Suppliers

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Clients

This group of clients mainly consist of the larger international branded food companies, with companies like Unilever and Kraft.

Key competitors

While the number of companies capable of offering packaging machines is large, the number of companies capable of internationally offering tailor-made packaging systems is limited. Selo differentiates itself by its expertise and by offering more of a solution than a packaging machine. In local markets, Selo encounters system engineers companies and in the international market place it encounters only a limited number of players.

In the Benelux and German markets where Selo is predominantly active with this activity, Selo encounters the following international system engineers:

- Alimento, a Dutch company acting as an agent for multiple manufacturers;

- EBM Techniek, a subsidiary of Dutch listed company TKH Group. EBM is focussed on

handling and packaging lines and equipment for the food industry;

- SIG Manzini and SIG Comaco, recently bought by the Italian packaging equipment group Catelli;

- PFM Packaging, a large Italian company, active on a global scale.

The tasks and responsibilities of the engineers

There are two types of engineers at Selo System Engineering, mechanical engineers and electronic engineers. The mechanical engineers have a wide responsibility. When an account manager of Selo B.V. has contact with a customer about a packaging line he gets in touch with the manager and with one of the mechanical engineers. The mechanical engineer makes an estimation of how much the custom made packaging line will cost and if it is technically possible to make a packaging line that fulfils the customers wishes. When a product is sold by the account manager, the engineer does two things. The first thing he does is to make a pre-calculation of the project, this is a better and more detailed calculation of the project then the previous estimation. This calculation is the budget of the project. The second thing the engineer does, is start designing the packaging line. When the engineer has finished the design he makes a bill of material and sends it to the administrative employee. The mechanical engineer has the responsibility that the packaging line is made in the corresponded time and that the packaging line is built within the budget.