Performance measurement typically drives much of the way a large company works. We talked extensively in this book about how accounting profits or profit growth as a sole performance metric doesn’t lead to value creation. Supplementing profits with ROIC and revenue growth is a step in the right direction to ensure that the profits a business earns are actually creating value, not simply over-consuming capital that another company could better deploy. However, profits, ROIC, and revenue growth are backward looking. They don’t tell you how well the business is positioned for future growth and ROIC improvement.
One company we know had a particular business unit that consistently recorded growing profits and high levels of ROIC for about four years. Since the unit’s reported financial results were so good, the executives at the corporate headquarters didn’t ask many questions about the drivers of the unit’s profits – until it was too late. It turned out that the unit was driving profits by raising prices and cutting marketing and advertising expenditures. Higher prices and reduced advertising created an opening for competitors to take away market share, which they did. So while profits were rising and ROIC was high, market share was declining.
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About the Authors
McKinsey & Company is a global management consulting firm that helps leading private, public, and social-sector organizations make distinctive, lasting, and substantial performance improvements. With consultants deployed from more than 90 offices in over fifty countries, McKinsey advises companies on strategic, operational, organizational, financial, and technological issues.
Tim Koller leads the firm’s research activities in valuation and capital market issues. He advises clients globally on corporate strategy, capital markets, M&A, and value-based management. Tim is a coauthor of Valuation: Measuring and Managing the Value of Companies. To read Tim Koller’s complete biography, click here.
Richard Dobbs is a director of the McKinsey Global Institute, the firm’s business and economics research arm. He advises Korean and other Asian companies and governments on strategy, economics, and M&A issues. Richard is an associate fellow of University of Oxford’s Said Business School. To read Richard Dobbs’ complete biography, click here.
Bill Huyett advises clients in healthcare and other technology-intensive industries on corporate strategy, M&A, product development and commercialization, and corporate leadership. He is also a leader in the firm’s corporate finance practice. Bill is active on several not-for-profit boards in basic life sciences research. To read Bill Huyett’s complete biography, click here.