Thursday, July 31, 2014

Correlating “As A Service” with ROIC and Shareholder Value

My thesis for some time has been that the value from adopting progressive “As A Service” operating models – through next-generation outsourcing, subscription-based contracting, and shared services – can be measured through enhanced shareholder value.  But, it’s been an elusive metric to prove.

Does the reduction of capital spend on dedicated assets by partnering with service providers, subscribing to SaaS or BPaaS offerings, and acceleration of Shared Services lead to definitive improvement in the value to shareholders?
I know from conversations with corporate executives that it is a high priority for companies to improve their ROIC.  This is a very tangible metric of strategy and execution.  Furthermore, the Private Equity world grasps this concept intimately – carve-outs are often built to run on SaaS platforms, and new products are almost always designed to be offered on a subscription basis.

To help Alvarez & Marsal be better informed and better positioned to offer clients actionable strategies for ROIC improvement, I commissioned research into the ROIC performance of market leaders in several key industries to identify today’s most promising strategies.
I am sharing a summary of the findings of one industry – US-based Restaurants – to generate further conversation on this topic and gain new insights on what other companies are doing to improve their ROIC. I’d love to hear your feedback.

Here’s what our research told us:
       Companies with high ROIC outperform those with low ROIC across virtually every financial measure

       Companies that improve ROIC the fastest post stronger revenue growth, higher margins and greater capital efficiency than competitors

       High ROIC growth companies can command superior valuations, with investors willing to pay higher prices per share

       ROIC is gaining more management and Board attention and becoming a greater factor in executive comp

Are unconventional levers – techniques borne through the adoption of “As A Service” principles – driving ROIC improvement?
Our findings led us to a hypothesis that several emerging techniques are helping leading companies improve their ROIC. These unconventional levers represent new and innovative thinking that fundamentally reframes business models, supplier relationships and enabling technology to help companies create substantial advantages. The levers include:

       Business process as-a-service
       Leveraged partner and provider networks and partner-based business models 
       Subscription-based procurement and contracting for services vs. products
       Expanded enterprise shared services
       Cloud computing for IT capacity
       Monetized data incidental to the core business
       Leveraged social platforms  
       Enhanced self-service business operations
Why are these strategies working over conventional approaches?  I think that conventional ROIC strategies carry limitations and risks. Most companies try to improve ROIC by improving net operating profit after taxes (NOPAT) through revenue enhancement, tax planning and cost-cutting, or by capital reduction, through divestiture or limiting working capital.  But attempts to increase NOPAT may decrease business agility and management flexibility, while reduction in invested capital may disrupt a company’s normal operations.

The emerging ROIC strategies have one thing in common: they use capital redeployment thereby decreasing invested capital by shifting it to outside parties or using new business models with lower capital intensity. As invested capital becomes more efficient, ROIC improves. Capital redeployment strategies are often more effective than conventional strategies in improving NOPAT because management has greater flexibility to manage invested capital and limit the effects of changes on the core business.

We’ve also observed that industries will benefit differently from ROIC improvement. Several industry sectors show an unusually strong correlation between ROIC improvement and strength in other performance indicators. Across the industries we analyzed, this relationship was more pronounced in Restaurants, Apparel, Food Retail, Personal Products and Construction & Farm Equipment. Many other industries, particularly those that are not highly capital-intensive, feature similarly promising opportunities to improve ROIC. I’ve attached a summary of our findings in the Restaurant sector.  
The influencers of ROIC improvement are of great interest to me and our A&M clients and I view this initial research as the start of many important management conversations on what is driving ROIC. I welcome your thoughts and opinions and will use this forum to update you as we expand our research.  



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