ABSA GROUP LIMITED

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ABSA GROUP LIMITED

A value driver analysis

Determining the key value drivers of Absa Group Limited

Johannesburg, August 2005 Author:

Sydo Schikker Client:

Absa Group Limited (South Africa) Group Finance Supervisors University:

Dr. W. Westerman Drs. O.C.J. Lapp hn Supervisors Absa Group Limited:

Mr. Jacques Schindeh tte Mr. Johan du Toit

University of Groningen, The Netherlands Faculty of Management and Organisation Financial Value Management

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Absa Group Limited – A value driver analysis

This thesis is the result of a research that is conducted at the Johannesburg headquarters of Absa Group Limited, one of South Africa's largest financial services organisations, serving personal, commercial and corporate customers in South Africa. Absa wants to re- look at what drives value in the Group and draw managers attention to elements that really matter. Absa wants to maximize and ensure sustainable shareholder value creation.

Understanding what really drives value for Absa is important, so that Absa can take action on the value drivers or underlying factors to improve their performance. Therefore, the objective of this research is to determine the key value drivers of Absa Group Limited. The process that was followed to determine these key value drivers is described below.

The first part of the research sets the scene, where the organisation of Absa Group Limited and the South African economy in general are described. Furthermore, the research plan was provided and in the theoretical framework relevant theories concerning value creation, Value-Based Management, and performance measurement methods are given.

The second part of the research starts with Absa’s strategy. The concept of strategy, in itself, is not studied, so it can be seen as the context. It is discussed again in the final chapter, where the conclusions and recommendations are given.

To determine the key value drivers of Absa, it was essential to know at what level one wants to identify these drivers. It was decided to look at the generic level, whereby a value added-decomposition and a sensitivity analysis were done to identify the key value drivers for Absa Group Limited (as a whole organisation) and for five of Absa’s business units.

Conclusion was that the key value drivers at a Group level are: average assets, non- interest margin, net interest margin, and operating expenditure. Absa has a strong asset growth, but it seems to be unprofitable growth. Thus, it was concluded that Absa needs to improve the profitability, by focusing on non-interest margin and net interest margin.

Furthermore various recommendations were given. For strategy, it was recommended to set targets in a way that they can be aligned to the key value drivers. In this way Absa can review their performance. Further research into this subject was advised.

A recommendation concerning Value-Based Management was that it seems to be the ideal approach for Absa to become the value creating company they want to be. But further research is necessary to determine if Absa Group Limited is ready for the implementation of VBM.

A final recommendation concerns the process of identifying the key value drivers. It was recommended to use this process also for the identification of the key value drivers at a lower level in the organisation.

Executive summary

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This thesis is the result of the research that was conducted in order of and in co-operation with Absa Group Finance, division of Absa Group Limited at the headquarters in Johannesburg, South Africa. In December 2004 was the start of the research and the result of the research is this thesis. It is my final product for my study Management and Organisation, specialisation Financial Value Management, in order to obtain a masters degree.

The choice for conducting the research for Absa was an easy one to make. I have studied at the Randse Afrikaanse University (now University of Johannesburg) in Johannesburg from January 2004 to June 2004 as part of an exchange program. I had to make an assignment about regulation at banks in South Africa as part of that. And yes, I have done this assignment at Absa. I enjoyed it very much and during my 5 months stay in South Africa I fell in love with the country. At the moment Absa made me an offer with an interesting subject to study, I decided to accept this.

My acknowledgements go to my former colleagues at Absa. From the very first moment I felt at home and they were very co-operative with my research project. Special thanks go to two people. First of all to Jacques Schindehütte, not only for giving me the opportunity to conduct my research at Absa, but also for his support, advice and the fruitfull conversations we had about banking, finance, and life in general. Second to my mentor Johan du Toit, for the support he gave me, for everything he taught me about banking and for listening to and taken the time for me.

Furthermore, I would like to thank my supervisors of the University of Groningen, Wim Westerman and Otto Lappöhn, for the advice they gave during the research and the pleasant co-operation.

Finally, a word of thank goes to my family, and especially to my parents, for everything they have done for me and for their unconditional support during my stay in South Africa and throughout my life. Without them all this would not have been possible.

It was an exciting environment to spend seven months, wherein I have learned a lot. It has been a learn and life experience!

Sydo Schikker

Johannesburg, August 2005

Preface

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Management summary 1

Preface 2

Table of contents 3

List of Tables, Figures and Graphs 6

List of Abbreviations 8

Introduction 9

Chapter 1 Setting the scene 10

1.1 Introduction 10

1.2 Profile of Amalgamated Banks South Africa 10

1.2.1 The organisation 10

1.2.2 Financial results 11

1.2.3 Absa’s business segments and business units 11

1.3 Economic overview 13

1.3.1 South Africa: 1994 to 2004 13

1.3.2 Economic perspective 14

1.3.3 The banking industry in South Africa 14

1.3.4 Environmental forces 15

1.3.5 Black Economic Empowerment 16

1.3.6 Important features 17

1.4 Chapter summary 17

Chapter 2 Research plan and methodology 18

2.1 Introduction 18

2.2 The research project 18

2.3 The approach 19

2.3.1 Types of research 19

2.3.2 Role of the researcher 19

2.4 Problem statement 19

2.4.1 Research objective 20

2.4.2 Research question 20

2.4.3 Research conditions 20

Table of contents

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2.5 Boundary decision 21

2.6 Conceptual model and sub-questions 22

2.7 Data sources 23

2.8 Evaluation and report on the research 24

Chapter 3 Theoretical framework 25

3.1 Introduction 25

3.2 Strategy 25

3.2.1 General background 25

3.2.2 Strategic planning 25

3.2.3 Strategic intent and mission 25

3.2.4 Strategic focus 26

3.2.5 Conclusion 28

3.3 Value-Based Management 28

3.3.1 General background 28

3.3.2 Value-Based Management 29

3.3.3 Value creating company 30

3.3.4 Valuing value 31

3.3.5 Defining and measuring value creation 32 3.3.6 Value drivers 33 3.3.7 Performance measurement methods 38

3.3.8 Application 42

Chapter 4 Absa’s strategy 43

4.1 Introduction 43

4.2 Evolution of Absa and Absa’s strategy 44

4.3 Strategic focus 47

4.4 Key Success Factors and value drivers 48

Chapter 5 Value driver analysis at the Group level 53

5.1 Introduction 53

5.2 Performance measurement methods 53

5.3 Level of the value drivers 54

5.4 Value added-decomposition for the Group 57

5.5 Sensitivity analysis 65

5.6 Management influence on the value drivers 71

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Chapter 6 Value driver analysis at the business unit level 74

6.1 Introduction 74

6.2 Valuing the business units and identifying the

key value creators 74

6.3 Value analysis for the five business units 76

6.3.1 Absa Financial Services 76

6.3.2 Business Banking Services 80

6.3.3 Credit Card 83

6.3.4 Retail Banking Services 87

6.3.5 Home Loans 90

Chapter 7 Conclusions and recommendations 95

7.1 Introduction 95

7.2 Conclusions 95

7.3 Evaluation of the research 98

7.3.1 Research requirements 98

7.3.2 Value of the research for Absa Group Limited 99

7.4 Recommendations 99

Bibliography 101

Appendices 104

I Structure of Absa Group Limited 105

II Strategic migration map 109

III Calculation of drivers of change of the Group 110

IV Sensitivity analysis of the Group 111

V Value added per business unit 113

VI Absa Financial Services 115

VII Business Banking Services 126

VIII Credit Card 137

IX Retail Banking Services 147

X Home Loans 158

XI Absa’s strategy and key value drivers 169

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Figures

Figure 2.1 Group structure of Absa Group Limited with boundary decision Figure 2.2 Conceptual Model

Figure 3.1 Strategic and financial performance Figure 3.2 Value chain

Figure 3.3 Value driver matrix

Figure 3.4 Various levels of value drivers

Figure 3.5 Drivers of shareholder value for a bank

Figure 4.1 Strategic matrix for Banking and Financial Services Figure 5.1 Generic value driver tree

Figure 5.2 Value driver matrix

Tables

Table 4.1 Key Success Factors and the underlying value drivers Table 5.1 Absa Group value added-decomposition

Table 5.2 Drivers of change in incremental value added of Absa Group

Table 5.3 Incremental change of value added due to a percentage change in the value drivers of Absa Group

Table 5.4 Change of the value drivers to achieve a certain increase in value added Table 5.5 Importance of the value drivers of Absa Group

Table 6.1 Value added per main business unit of Absa Group Table 6.2 Importance of the value drivers of AFS

Table 6.3 Incremental change of value added due to a percentage change in the value drivers of AFS

Table 6.4 Importance of the value drivers of BBS

Table 6.5 Incremental change of value added due to a percentage change in the value drivers of BBS

Table 6.6 Importance of the value drivers of Credit Card

Table 6.7 Incremental change of value added due to a percentage change in the value drivers of Credit Card

Table 6.8 Importance of the value drivers of RBS

Table 6.9 Incremental change of value added due to a percentage change in the value drivers of RBS

Table 6.10 Importance of the value drivers of Home Loans

Table 6.11 Incremental change of value added due to a percentage change in the value drivers of Home Loans

Table 7.1 Overview of the value drivers of Absa Group and the SBUs

List of Tables, Figures and Graphs

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Graphs

Graph 5.1 Incremental value added over a period from 2003 to 2006 Graph 5.2 Drivers of change of incremental value added of Absa Group Graph 5.3 Drivers of change of profitability

Graph 5.4 Value drivers of non-interest Graph 5.5 Value drivers of net interest

Graph 5.6 Sensitivity of the value drivers of the Group Graph 6.1 Value added per main business unit of Absa Group Graph 6.2 Sensitivity of the value drivers of AFS

Graph 6.3 Sensitivity of the value drivers of BBS

Graph 6.4 Sensitivity of the value drivers of Credit Card Graph 6.5 Sensitivity of the value drivers of RBS

Graph 6.6 Sensitivity of the value drivers of Home Loans

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BEE Black Economic Empowerment CAPM Capital Asset Pricing Model CFROI Cash Flow Return on Investment COE% Cost of Equity %

CPM Corporate Performance Management CPI Consumer Price Index

EVA Economic Value Added FCF Free Cash Flow

GDP Gross Domestic Product

GEMI Global Environmental Management Initiative NPV Net Present Value

ROA Return on Assets ROE Return on Equity

ROIC Return on Invested Capital

SADC South African Development Community SWOT Strengths, Weaknesses, Opportunities, Threats TSR Total Shareholder Return

VBM Value-Based Management

WACC Weighted Average Cost of Capital

List of Abbreviations

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Absa Group Limited wants to maximize and ensure sustainable shareholder value creation and Absa wants to know and understand what actually drives value in the business, what is happening at this very moment by measuring performance, what should be done and finally focus on the rewards.

The research objective of this thesis is formulated as follows:

‘To determine the key drivers of value creation for Absa Group Limited in order to recommend the Group on how they can improve their performance for the benefit of their shareholders’

This thesis tries to identify what drove value in the past, what drives value at this moment, and what is expected (in 2006) to drive value for Absa. The structure of this thesis is as follows.

Chapter one, entitled setting the scene, provides the reader with a profile of Absa Group Limited and a general overview of the South African economy and banking industry. In chapter two the research plan of this thesis is given, wherein, among others, the research objective and research question are formulated. The theoretical framework is provided in chapter three, wherein strategy, Value-Based Management, value creation and various performance measurement methods are described. Chapter four presents the strategy of Absa Group Limited. Chapter five provides the reader with a value driver analysis at the Group level, wherein a value added-decomposition and sensitivity analysis are done to identify the key value drivers of Absa.

In chapter six a value driver analysis at a business unit level is presented, wherein the key value drivers of five of Absa’s business units are identified. Finally, in chapter seven the conclusions and recommendations are given

Introduction

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1.1 Introduction

The first chapter of this thesis ‘sets the scene’ and describes the organisation Absa Group Limited and gives a general description of the South African economy. The reason to start with this is because it is thought that in this way the remainder of this thesis can be understood better. In paragraph 1.2 a profile of the organisation is given and paragraph 1.3 is divided in sub paragraphs that respectively deal with the South African economy, the economic perspective, the banking industry in South Africa, Black Economic Empowerment, and important features. Finally, a chapter summary is given in paragraph 1.4.

1.2 Profile of Amalgamated Banks of South Africa (Absa)

1.2.1 The organisation

Amalgamated Banks of South Africa (Absa) is the product of two major mergers in the early 1990s. Absa was formed when Allied, United and Volkskas groups merged in April 1991 with the subsequent merger with Bankorp (including TrustBank and Bankfin), in April 1992. For the first years the four commercial banks in the Absa Group - Allied Bank, Trust Bank United Bank and Volkskas, traded under their original brand names. In 1997 the name of the holding company, Amalgamated Banks of South Africa Limited was changed to Absa Group Limited, consisting of three main operating divisions and in 1998 - due to the fact that customers and staff accepted the use of the Absa brand - the United, Volkskas, Allied and TrustBank brands were consolidated into a single brand, and Absa adopted a new corporate identity.

Nowadays, the Absa Group is one of South Africa's largest financial services organizations, serving personal, commercial and corporate customers in South Africa.

The Group also provides products and services to selected markets in the United Kingdom, Germany, the United States, China, Singapore, Hong Kong and elsewhere in Africa.

The Absa Group is dedicated to ensuring that its stakeholders are knowledgeable regarding the Group, the Group's board and management, the Group's corporate citizenship principles and achievements as well as the Group's financial and share performance.

The success of Absa depends on the Group's ability to build a powerful Absa brand, which Absa defines as a brand that:

• Creates a unique identity

• Allows customers to identify with Absa

• Is more attractive than competing brands

Chapter 1 Setting the scene

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Absa Group Limited aims to create value for all its stakeholders. These stakeholders are;

shareholders, customers, employees, the community and the governments and regulators.

For its shareholders the Group wants to achieve the financial targets, for its customers a continuous focus on customer service, for its employees the best company to work for in South Africa, for the community a focus on growing partnerships and for governments and regulators obedience to the laws of the countries in which the Group operates.

Because of Absa’s focus on creating value, the focus of this research is on value creation.

Absa Group wants to maximize and ensure sustainable shareholder value creation through appropriate Corporate Performance Management (CPM). Absa wants to know and understand what actually drives value in the business, what is happening at this very moment by measuring performance, what should be done and finally focus on the rewards. To identify the key drivers of value a value driver analysis is done at a Group level and at a business unit level, what is explained further in the next chapter, where the research plan is discussed.

1.2.2 Financial results

When Absa was formed in 1991, Absa had total assets of R51,8 billion, headline earnings amounted to R321,3 million and the RoE was 15,4%. After the merger with Bankorp in 1992, staff numbered 43 714.

The Absa of 2003/2004 is a much leaner organization, with 31 658 staff members. Total assets have increased almost six fold to R306,8 billion and headline earnings more than tenfold. For the 2003/2004 reporting period Absa Group Limited posted headline earnings of R4 447 million, an increase of 29,2%. Headline earnings per share increased to 682,8 cents per share compared with the 528,1 cents per share for the previous year.

Return on shareholders’ funds continue in its upward trend to 24,6% (F2003: 21,4%), well in excess of the Group’s cost of equity of 16,6% over this period. This translated to value creation of R1 441 million for shareholders, given the average shareholder capital of R18 108 million invested in the Group over the past year. A final dividend of 110,0 cents per share has been declared, bringing the growth in dividends for the year to 25,5%.

This translates into a dividend cover of 3,8 times¹. 1.2.3 Absa’s business segments and business units

The Absa Group consists of business units primarily serving the personal, commercial and wholesale markets in South Africa. In addition, the Group has a number of international operations, which offer a range of niche products and services to selected customer bases. These units employ a customer-centric business model, where the customer forms the core of the model. The model facilitates a matrix approach, which allows specific business to focus on the needs of identified target markets.

Approximately a decade ago, Absa segmented its market. The objective of this exercise was to understand customer attributes and tailor offerings to the Group’s identified segments. The segments identified were:

1 Absa Group Limited Annual Report 2004

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1. Personal Segment 2. Commercial Segment 3. Wholesale Segment 4. African Operations 5. Financial Services 6. Other Group Activities

Each of these segments consists of business units (SBU). According to Scott [1998] a SBU can be defined as a business where the nature of customer demand and the skills or competencies necessary to satisfy that demand are distinct. In appendix I a detailed overview of these SBUs and shows where these SBUs fit in the structure.

Personal segment

Absa is a leading player in South African personal banking. The Group had about 6,1 million customers in this market segment in September 2004².

The personal market can be divided into segment-focused SBUs and product-focused SBUs. The segment-focused SBUs are:

• Absa Private Bank (Private)

• Personal Financial Services (PFS)

• Retail Banking Services (RBS)

• Flexi Banking Services (Flexi)

• Small Business

• MLS Bank Limited

• Meeg Bank Limited The product-focused SBUs are:

• Absa Home Loans and Absa Credit Card Commercial segment

The commercial market is an important component of the Group's franchise. Absa enjoys a dominant market position in agribusiness, public sector financing, new-enterprise banking, franchising and the pre-owned vehicle market. As with the Personal segment, the commercial market can be divided into segment-focused SBUs and product-focused SBUs. The segment-focused SBUs are:

• Business Banking Services (BBS)

•

The product-focused SBU is Absa Vehicle and Asset Finance (AVAF).

Wholesale segment

Absa's wholesale banking operations offer financial solutions to the domestic corporate market and provide selected financial products and services in niche international markets, as well as institutional asset management.

2 Source: Absa Group Investor Relations

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The wholesale banking operations consist of domestic operations and international operations.

The domestic operations SBU is Absa Corporate and Merchant Bank (ACMB).

The international operations SBUs are:

• Absa Bank London in the United Kingdom

• Absa Bank Singapore in Singapore

• Absa Bank Asia Limited in Hong Kong

• Bankhaus Wölbern & Co in Germany

African operations

The Group presently has interests in four banks outside the borders of South Africa.

• Tanzania: National Bank of Commerce Limited (NBC)

• Mozambique: Banco Austral, Sarl

• Namibia: Capricorn Investment Holdings Limited

• Zimbabwe: Commercial Bank of Zimbabwe Limited Financial services

Absa's financial services arm houses the Group's assurance, insurance and wealth management operations. These financial services offerings are provided to Absa customers via a well entrenched and fully integrated bancassurance model.

Other Group Activities

Absa has a number of divisions that do not provide banking or financial services. The Group reports these divisions under "other Group activities". This section includes strategic subsidiaries or associates that are managed at Group level, shared services and specialist functions. Because of the fact that the divisions cannot be seen as SBUs, they are not part of the research, except for one, namely Allpay Consolidated Investment Holdings (Proprietary) Limited. This subsidiary will be evaluated and her financial performance will be measured in chapter 6, wherein Absa’s business units are the subject.

1.3 Economic overview

1.3.1 South Africa: 1994 to 2004

After the steady decline in annual Gross Domestic Product (GDP) growth during the apartheid years, South Africa has begun to experience economic growth since 1994.

Significant economic achievements have been recorded since 1994, including macro- economic stabilization, a profound restructuring of the real economy, and substantial export success. The critical challenge of strengthening the link between economic growth and export success, with employment creation, poverty alleviation, and a marked reduction in inequalities, remains.

Over the past ten years, the government has introduced a range of sound economic policies that have laid the foundation for the country’s present favorable ratings, boosted international confidence and created a basis for growth.

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The isolated pre-1994 economy has become more competitive, headline consumer inflation (CPI) has been reduced to its lowest level since the late sixties and interest rates are at a 20 years low.

The rand’s recovery against major currencies, particularly the underperforming United States dollar, has been a gratifying measure of confidence in the country. It has also had a positive effect on the fight against inflation and has boosted consumer confidence.

Despite all the positive developments, major challenges remain. Although the decline in nominal interest rates by 550 basis points from their high 2002 levels has significantly helped consumers, the economy is still not growing fast enough to create job opportunities for the huge pool of unemployed South Africans³.

1.3.2 Economic perspective

Economic growth in calendar year 2005 is expected to be slower compared with 2004.

High oil prices, rising interest rates and general over-indebtedness are the main factors constraining global growth. Global trade imbalances, focused mainly on the massive US trade deficit and Eastern Asia’s large surpluses, point to a significant degree of currency instability for 2005. The decline in the fortunes of the US dollar have reached a point which could be disruptive to the global financial system should it experience any further significant weakness. The global economy also appears vulnerable to upside risks in fuel prices and the recent respite from rampant oil prices could prove to be temporary.

South Africa is well placed to enjoy higher economic growth compared with the global average, as the economy is poised to benefit from continued strength in commodity prices and the relatively strong growth expected in the SADC region. Overall economic growth is forecasted at 4,1% in 2005, and being largest source of demand for final South African output, the South African household is expected to be the main driver of overall economic growth in 2005 despite an expected mild slowdown⁴.

1.3.3 The banking industry in South Africa

Moody’s has analysed the banking industry in South Africa, in their Banking System Outlook [2004], and came to the following strengths, opportunities, weaknesses, and threats:

Strengths/ Opportunities

• The largest banks have strong franchises and dominate the sector.

• Management caliber, good systems and focused strategies remain key strengths for the banks

• Loan quality is comfortable at most banks, helped by the fall in interest rates in recent years

• The financial sector is well regulated and supervised

3 Absa Group Limited Annual Report 2004

4 Internal document V: Absa Group Limited Financial Report: budget for the year-ended 31 March 2006

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Weaknesses/ Threats

• The banking sector relies on wholesale deposits and carries a large short-term maturity mismatch

• High level of operating costs could limit future profitability

• Although a large section of the population is unbanked, it represents a higher risk growth option for the banks

• The financial charter poses medium-term challenges in requiring a swift change in the way banks operate to include black South Africans and empowerment groups in their employees, shareholders, customers and business counterparts

The banking sector is characterised by heavy market concentration and the dominance of the large domestic banks. The big four banks collectively account for 87% of total banking assets, and over 90% of the mortgages, credit cards, installment sales and leasing business in South Africa. The large banks’ franchises derive strength from the fact that they follow the conglomerate, universal-banking model. They offer the full range of financial services – i.e. commercial and investment banking, securities trading, derivatives trading, underwriting, fund management and insurance products to both corporates and individuals. However, banks are required to conduct business in equity securities and insurance through legally separate subsidiaries.

The last years South African banks are enjoying a strong operating environment for retail banking. Strong consumer lending continues to fuel loan growth, and despite some concerns about overheating real estate prices, a hard landing is not foreseen.

Nevertheless, it is expected that a prospective gradual increase in interest rate levels may dampen down the strong growth in consumer lending. Household indebtedness seems to remain at manageable levels and as long as jobs are not lost, it is believed that borrowers should be able to meet their debt service obligations and banks’ loan quality will be maintained at acceptable levels. Furthermore, it is stated that South African banks earn good levels of profits, partly because of an oligopolistic setup. Their interest margins remain strong and fee income has been growing.

However, there is constant market criticism that banks charge high fees and, as this has resurfaced, it could put pressure on banks to adjust their charges downwards. Already, some banks have announced reductions in charges, but the impact of such moves on future profits is not known and cannot be predicted⁵.

1.3.4 Environmental forces

The domestic banking and financial services industry is impacted directly by the changes taking place in the global industry. However, due to the unique nature of the South African market place, there are a number of additional environmental forces that are shaping the industry. These are as follows:

5 Source: Moody’s Investor Service, Banking System Outlook, October 2004

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• Increased foreign competition – A number of banks have re-entered the SA market and have specifically started targeting the retail market (Stanchart – 20Twenty, HSBC and Barclays (Bluebean and the announced acquisition of a controlling stake in Absa)).

• The Financial Sector Charter - The charter is a framework with established principles upon which BEE can be implemented in the financial services sector, at sectoral, sub-sectoral and company level. The charter was signed on 17 October 2003. Banks are expected to report on their progress on the charter from December 2004. The charter revolves around:

Company structure – addressing areas such as employment equity and procurement;

Products and services – providing products and services to previously disadvantaged people;

Ownership – Addressing the black ownership of institutions to ensure broad based ownership; and

Finance – providing funding for various black economic empowerment initiatives.

• Moderate economic growth – During Absa’s 2004 financial year, real gross domestic product (GDP) grew by 1,5%. GDP growth is expected to increase to 3,2% in F2005 and thereafter to 3,0% in F2006. (Source: Group Economics)

• Changing customer demographics and behavior - This trend presents both opportunities and threats for banks and financial services organizations operating in South Africa. Revenue growth will come under pressure due to lower population growth as well as declining formal sector employment. However, there is an opportunity to increase revenue by focusing on the growing middle income Black market.

• Regulation - A number of current and proposed changes in the South African regulatory environment should be mentioned – these are as follows.

FAIS FIC

Amendment to the Banks’ Act Basel II

It is expected that these forces will result in an industry that is dominated by the four large banks with the key differentiating factor in the future being service excellence.

1.3.5 Black Economic Empowerment

The government defines Black Economic Empowerment (BEE) as an integrated and coherent socioeconomic process that directly contributes to the economic transformation of South Africa and brings about significant increases in the numbers of black people that manage, own and control the country's economy, as well as significant decreases in income inequalities.

The government launched its Broad-Based BEE Strategy on 24 March 2003.

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The BEE Strategy aims to address human resource development, employment equity, enterprise development, preferential procurement and investment, ownership and control of enterprises, and economic assets. The successful implementation of the BEE Strategy will be evaluated against the following policy objectives:

• a substantial increase in the number of black people who have ownership and control of existing and new enterprises

• a significant increase in the number of black-empowered and black-engendered enterprises

• a significant increase in the number of black people in executive and senior management positions of enterprises.

According to Moody’s Banking System Outlook [2004], the BEE is going to play a very important role in and for South Africa. Moody’s believe that a key determinant for consumer lending growth and quality will be the future success of the BEE initiatives being put into place with the aim of economically activating a greater part of the black population. The growing black middle class is now an important contributor to the strong increase in consumer demand. Given different definitions for standard of living, this class is said to have grown by 20% in the last three years, and comprises three million people.

Therefore, if the empowerment deals manage to generate stable jobs for the black population, it is believed that the growth in their numbers and spending power could be an important factor in fuelling future economic growth and banking finance.

Absa shares the opinion of Moody’s, in that the growth of the South African economy will largely depend on the extent to which black South Africans participate. The Group aims to facilitate increased participation by enhancing its engagement with black individuals and black-owned companies as shareholders, customers, suppliers, staff and the community. Capturing an increased share of the black market is a key business imperative and is important for supporting sustained economic growth, development and social transformation in South Africa.

1.3.6 Important features

On 20 May 2005, Barclays Bank PLC (Barclays), a leading international financial services institution, launched its offer to Absa shareholders to acquire a majority stake of up to 60% in the Group. On 27July 2005 the deal will be finalised and Barclays will be the controlling shareholder. Because the start of this research was before the Barclays offer, and it only became public on 20 May 2005, the consequences of this deal will not be taken into consideration in this research.

1.4 Chapter summary

In this first chapter ‘setting the scene’, a profile of Absa Group Limited and a general description of the South Africa economy and banking industry have been given. Absa wants to know and understand what actually drives value and that is the focus of this thesis, i.e. identifying the key value drivers of Absa Group Limited.

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Research: “by a systematic way searching for answers to questions”

A.C.J. DE LEEUW

2.1 Introduction

Conducting a research is a purposeful and methodical search for new knowledge in the shape of answers on predetermined questions. Before starting a research, it is important to determine what one wants to know, for whom and why, and on which research conditions for that objective.

A clear distinction exists between the research goal and the research question. Central to the research goal is ‘why’ the research is started and the ‘what’ question is central to the research question; what does the researcher want to know? The search is for specific knowledge, with which the determined goal can be achieved (Verschuren, 1999).

In this chapter the assignment is explained and the research plan for this research is presented. In paragraph 2.2 the research project itself is discussed, followed by the discussion of the approach of the problem in paragraph 2.3. As stated above, the problem statement consists of a research objective and a research question, which are described in paragraph 2.4. Furthermore, in paragraph 2.5 the boundary decision is discussed and the link between the research goal, research question and the several sub questions is explained by using a conceptual model that will be dealt with in paragraph 2.6. In the remaining paragraphs, the data sources, evaluation and report on the research, and the timetable are discussed.

2.2 The research project

The impact of the information revolution, the integration of capital markets, and the increased ability of investors to compare and contrast corporate performance has put shareholder value high on the corporate agenda. These days, investors injecting money into a company are looking for a financial return as good as, if not better than, if they had invested in any other. According to Black et al [2001], today’s businesses need to maximize value for their shareholders or watch their share price plummet as investors vote with their feet and transfer their money and their trust into competitors’ hands.

Absa Group wants to maximize and ensure sustainable shareholder value creation.

Understanding what really drives value for Absa is important here, so that Absa can take action on the value drivers or underlying factors to improve their performance. As stated previously, this ‘value creation’ is the focus of this thesis.

If one wants to transform his or her organization into a value maximizing one, the concept of Value Based Management (VBM) can be used.

Chapter 2 Research plan and methodology

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Properly executed, VBM is an approach to management in which the company’s overall aspirations, analytical techniques, and management processes are all aligned to help the company maximize its value by focusing management decision making on the key drivers of value.

An important part of VBM is a deep understanding of the performance variables that will actually create the value of the business; the key value drivers. This is exactly what Absa Group wants to know. The understanding is essential because an organization cannot act directly on value. It has to act on factors it can influence, such as customer satisfaction, cost, and capital expenditures. Moreover, it is through these drivers of value that senior management learns to understand the rest of the organization and to establish a dialogue about what it expects to be accomplished.

2.3 The approach

2.3.1 Types of research

According to De Leeuw [2000], five types of research can be distinguished:

• Pure scientific research

• Social relevant research

• Policy relevant research

• Policy supporting research

• Problem solving research

This research complies with the characteristics of policy supporting research, which ought to produce concrete knowledge that is useful in a specific situation for a specific client. This research provides useful knowledge for policy. Hereby is understood: a system of goals and measures for the benefit of management. De Leeuw [2001] states that it is research with the aim to improve the policy component in management processes.

2.3.2 Role of the researcher

In policy supporting research, the researcher will have a position where the distance with regard to the client is larger than when the research would be problem solving. In this research, the researcher will not act like one of the problem takers.

2.4 Problem statement

In short, a problem statement expresses what you want to know and why. According to De Leeuw [2000], a problem statement of a research exists of three components:

• Research objective

• Research question

• Research conditions

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De Leeuw [2000] states that the function of the problem statement is binary; it is adjustment with the client and the internal managing of the research.

2.4.1 Research objective

According to De Leeuw [2001] the research objective defines for who the research is done, what the outcomes are and why it is important for them. As said in the introduction, central to the research objective is the “why” question.

The research objective for this thesis is formulated as follows:

2.4.2 Research question

De Leeuw [2001] states that the research question formulates the central question that follows the research objective, but formulated in accessible terms for the research. The research question is the most important starting point for working it out in sub-questions.

Central to the research question is the “what” question. In pursuing this research statement, this thesis has the following research question:

In order to be able to answer the research question, it needs to be divided into several sub-questions, which will focus on Value-Based Management, strategy, the value driver analysis and the existing management practices of the bank.

2.4.3 Research conditions

The research conditions⁶ give constraints on which the research results and methods are subject to. They concern product conditions and process conditions.

Product conditions

• The end product must contain a scientific explanation and defense of the choices made

• The end product must restore a pluriform view of the situation that has been researched and a methodical sound, creative and flexible handle of the approach to the research

Process conditions

• The research has to be accomplished within a period of six to seven months;

• The research must be performed individually

6 “Handleiding Afstudeeropdracht, Faculteit Bedrijfskunde”

‘To determine the key drivers of value creation for Absa Group Limited in order to recommend the Group on how they can improve their performance for the benefit of their shareholders’

‘Using the concept of Value-Based Management, how can Absa Group Limited improve their performance at various levels of the organisation?’

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2.5 Boundary decision

Simply stated, the boundary decision is about what the research will cover. According to De Leeuw [2000] the boundary decision is the answer to the question where to draw the line between the system and the environment; what objects will be ranked among the system and which ones to the environment?

The structure of the Group is given in figure 2.1, with an explanation of the boundary decision. In appendix I, the structure of the segments and business units is given.

Figure 2.1 Group structure of Absa Group limited with boundary decision

This research will focus on two levels of the Group structure. Absa Group Limited, the Holding Company, will be the main focus. This is the first level.

Absa Bank Limited is a subsidiary of the Holding Company, where all banking activities take place (banking license resides with Absa Bank Limited).

Commercial Banking

ABSA GROUP LIMITED

ABSA BANK LIMITED

Personal Banking

Wholesale Banking

ABSA FINANCIAL SERVICES LIMITED

OTHER SUBSIDIARIES

Asset-based and product

SBU’s

Other

ASSOCIATED COMPANIES

Life Assurance

Short-term Insurance

Advisory Services

Wealth Management

Banking

Financial Services

Other

Banking

Financial Services

Other

Object of the system

Object of the environment

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Absa Bank Limited is divided into various business units, which are grouped into five main segments, namely; Personal Banking, Wholesale Banking, Commercial Banking, Asset-based and product business units, and Other Group Activities. The focus of this level will be on the Personal, Wholesale and Commercial Banking segment, Absa Financial Services, other subsidiaries and associated companies. This is the second level.

2.6 Conceptual model and sub-questions

To make the research feasible and in order to be able to answer the central research question, this question is divided into sub-questions. According to De Leeuw [2001] a conceptual model is needed for the derivation of the sub-questions. A conceptual model graphically shows how the different conceptions are related to each other. Furthermore, De Leeuw states [2001] that it expresses the global look that underlies the research. In figure 2.2, the conceptual model of this research is given. It indicates the frameworks in which it will be studied.

Figure 2.2 Conceptual model

Corporate strategy

Organisation

Value-Based Management

Performance Improvement

Value driver analysis at a Group

and SBU level Key Success

Factors

Key value drivers Key value drivers

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Explanation of the conceptual model

In this research, Value-Based Management is used to analyse the value drivers of Absa Group Limited and to determine the alignment between Absa’s strategy and key value drivers. The core of the thesis is the value driver analysis at a Group level in chapter 5 and at a business unit level in chapter 6. In these chapters the key value drivers are identified by doing a value added-decomposition and sensitivity analysis.

The organisation consists of Absa’s structure and processes. This information is used as background information. The corporate strategy influences the organisation and Absa’s business. If the corporate strategy changes, the organisation will probably change as well.

Adjustment of the organisation is of importance to make the execution of the strategy possible. Corporate strategy will influence the use of VBM.

The concept of corporate strategy is used to determine the key success factors for Absa according to that strategy. This can be seen as the context. Then the value drivers of these key success factors will be determined. In this way, one can examine the alignment between the strategy and the key value drivers. This is done in chapter 7, as a recommendation, and advising further research into this subject. If necessary, the corporate strategy of Absa Group Limited can be adjusted by management.

The result, after determining the key drivers of shareholder value creation, is the performance of Absa. The objective of this research is to give recommendations on how Absa can improve its performance to maximise shareholder value.

From the conceptual model, the following three sub questions can be derived:

1. What is the current corporate strategy of Absa Group Limited , what are the key success factors according to this corporate strategy and what are the accessory value drivers?(context)

2. What are the key value drivers of Absa Group Limited at the Group level? (core) 3. What are the key value drivers of Absa Group Limited at the business unit level?

(core)

The sub-questions are the operationalisation of the research approach. After these questions have been answered, an answer can be given to the research question of this thesis. By answering the research question the objective of this research is achieved.

2.7 Data sources

To be able to answer the research question and the sub-questions a broad area of data sources needs to be consulted. Basically, there are three ways to obtain research data:

• Desk research

• Observation

• Interview

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In this research the first two methods, desk research and interview, are used. With desk research (also internet), existing data, present within the company, is used. Internal and external documents of Absa have been studied and a literature study has been conducted.

Observation is used if behavior is an important factor. In this research behavior is not an important factor. Nevertheless, the method observation was used by attending meetings about corporate performance management and related subjects.

With interviews, distinction should be made between a verbal interview and a written interview. For this research, interviews have taken place to aid depth and comprehension to the research. These interviews were semi-structured in order to provide the answers the interview had to result in, but it also gave a broadened insight in the diversity of views.

2.8 Evaluation and reflection on the research

The report should answer the problem statement, which forms the starting point of the research. The outcomes must be reported to the client and the thesis must fulfill the requirements of a scientific sound research thesis. Baarda et al [1997] give three requirements.

The first requirement is controllability. The thesis should make it possible to check the proceeding of the research. Another researcher should not have problems with doing the research over again.

Furthermore, the thesis should make clear how reliable the results are; reliability is the second requirement.

The third and final requirement refers to validity. The research results should be valid; the researcher must prove what he promises.

Besides a reflection of design and outcomes, the report should also include an evaluation of the research design and the research results; the meanings of the results are discussed and the consequences for further research are given.

2.9 Chapter summary

In this chapter the assignment was explained and the research plan for this research was presented. First the research project was presented, followed by the discussion of the approach of the problem. The research objective, research question and sub questions were formulated. In the conceptual model it was shown that the core of the thesis is the value driver analysis at a Group level in chapter 5 and at a business unit level in chapter 6, because in these chapters the key value drivers are identified. In these chapters a value added-decomposition and a sensitivity analysis is done.