Capital management key to linking strategy and value growth.

• Author: Kissel, Neal

Profitable growth is the key to unlocking long-term value creation, and no management process exerts more influence on the profitability of growth than capital management. However, the key role played by capital management in value growth is seldom reflected in the attention paid to it. At most companies, capital is allocated during the annual budgeting process, and focuses on requests to fund projects rather than strategies. The result can be an investment strategy that is not connected to business strategy and that will not deliver superior performance.

Yet, some management teams have achieved exceptional growth in the value of their companies by replacing this traditional "taxi-rank" approach to capital management with a more critical, better-informed and more flexible capital management process that links strategy more closely to long-term value creation.

A recent study by Marakon Associates of about 800 leading corporations in North America, Europe and Asia confirmed what senior executives of the world's top-performing companies already knew: that exceptional value growth requires superior profitability in the short term and superior growth in the long term. Both are necessary, but neither is sufficient, and the evidence suggests that the often conflicting requirements of growth and profitability can only be reconciled when capital management decisions take into account the cash flow potential of all strategic alternatives.

Based on experience, top performers--those that sustain top-quartile total shareholder returns (TSRs) over time relative to industry peers--manage their capital within an integrated strategic and economic framework, and make allocations according to clear standards and decision rules.

Figure 1 shows the linkages that must be managed if capital allocation is to support strategy and value growth. Linkage 1 is achieved by a value-focused strategy development process. Linkage 2 ensures good capital is not thrown after bad, and Linkage 3 makes sure good strategy is delivered. How the linkages are managed in practice will vary from company to company, but the important point is to develop a system that allows these linkages to be managed together. Making clear the distinction between three stages of capital management--allocation, sanctioning and monitoring--can help.

[FIGURE 1 OMITTED]

Three Stages of Good Capital Management

Every capital management process involves allocation decisions, sanctioning decisions and monitoring (which may or may not lead to reallocation decisions). But in the traditional capital management process, the CEO reviews a queue of new project investment requests on a first-come, first-served basis. The distinctions between the stages are then blurred because allocation is presumed to guarantee sanction, and strategic decisions tend to be set in stone.

In good capital...