Friday, November 5, 2010

Purpose-Profit Balanced Sustainable Value Equation Framework

Happy Diwali (or the festival of light) to our readers from both east and the west alike!

Based on the extensive coverage of purpose-profit value concepts in the last few weeks - one of our fellow bloggers posed an informal observation – "while it all sounds great to talk about the purpose agenda, the thing that matters the most at the end of the day is just profit – as profit is the primary variable within the valuation formula". As we thought more about this observation, there seems to be some merit in that argument- given the fact, most of the modern day valuation frameworks are being built with just profit variables- and so, we decided to come up with a valuation hypothesis - with an enhanced WACCP (Weighted Average Cost of Capital and Purpose) that is calculated as a weighted average of WACC and WACP.

Let us face it – the reason we discount the free cash flow (FCF) with WACC within the valuation formula is - that it does not make sense to valuate (or run) a business that does produce the minimum hurdle rate of WACC- like wise, our hypothesis also proposes that - it does not make sense to valuate (or run) a business that does not meet the minimum purpose hurdle index of WACP. Assuming we have a behind-the-scene formula for accurately arriving at the WACP index (using the purpose scores we had proposed in our previous blog) that is further "weight averaged" (with WACC and WACP) with appropriate weight factors– our renewed sustainable value equation will look as outlined on the top of the page.

At this juncture, we also would like to remind our readers that this is a hypothesis based formula and so will need lot more analysis and research before we can publish this as a working formula. Under the normal circumstances where WACC and WACP happen to be the same (say 10%) with an equal weight factor(say, 0.5+0.5), then our sustainable value equation formula will indeed work like the Mckinsey’s valuation formula. On the other hand, on scenarios( with ROIC of 15% , growth rate of 5% and WACC of 10%), where WACP is changed by a percentage point, we have seen the valuation changing by (+ or - ~10%), the intended effect we were hoping for. However, lot more regression testing and research needs to be done before proposing this as a working formula - and until that time, please treat this as a hypothesis formula.

With this renewed sustainable value equation definition as the foundation– we then did some more qualitative analysis to strengthen our hypothesis using the Purpose-Profit balanced Value quadrant framework as outlined on the top of the page. With the tough economic conditions still lingering- most of the H&W/Green minded consumers, of late, have started changing their buying patterns - that they have started to buy their products and services only from those corporations whose purposes and values align with that of theirs. In addition, our research has also found that over 35% consumers say that they are likely to do business with only greener brands (source: “2010 ImagePower Green brands Survey) and among them, a substantial percentage of consumers are also looking for a better value deals while buying their products/services.

This is definitely a new trend and another compelling reason for corporations to be purpose minded - and so we did some more “deeper dive analysis” on the extent of purpose adoption within various corporations. The insights we garnered was all the more intriguing - that most corporations, not only have started pursuing purpose initiatives , but also have started revising the way they measure their internal successes. In other words, corporations have started measuring their performances with both profit and purpose KPI’s like corporate sustainable index and corporate social responsibility index etc.- which is very encouraging.

At the same time, with all things being equal, the extent of the purpose adoption, however varied from corporation to corporation (and industry to industry) - and rightfully so, our valuation numbers did end up being all over the map as well. With this variety of values in our findings – we then grouped the resultant values under five value categories and plotted them within our framework – with “degree of profit” on X axis and “degree of perceived purpose” in Y axis as outlined below and on the top of the page.

  • Surviving Value – addressing the “ordinary outcome” quadrant -where most corporations start (or arch) their purpose journey from. As the name suggests – although most corporations can survive by being on this quadrant for a period of time, they are advised to move on to other quadrants to be relevant in the 21st century.

  • Sacrificial Value – addressing the “extraordinary" outcome” quadrant where purpose driven corporation’s angle there for a period of time, before moving on to the other quadrants. These are corporations who go the extra mile to fulfill their mission – at times even at the cost of not meeting their profit goals. Although not a place to be in for a longer period of time, definitely a worthwhile quadrant as it teaches us the discipline of what it takes to practice what we preach.

  • Startling Value – addressing the “aggressive outcome” quadrant – where corporations aim to achieve the startling profit performance with “just good enough” purpose agendas to keep the momentum going. Although, it is a good path way quadrant to be in, sustaining the profit performance without sufficient purpose agenda for a longer period of time is not an easy thing to do -and so, they are advised to move on to other quadrants!

  • Soaring Value – addressing the “utopia” quadrant – where corporations aspire to achieve the perfect performance numbers in both purpose and profit dimensions. Although, an ultimate path to aspire for, a very difficult quadrant to sustain the numbers for a longer period of time!

  • Sustained Value – addressing the “optimal outcome” quadrant – where corporations ace towards achieving the optimum values in both purpose and profit dimensions and it is indeed a perfect quadrant to be in - as it produces "sustainable purpose profit balanced value" for the long haul!

Interestingly enough, four of these value categories fell perfectly in to the four quadrants of the framework with an exception of one category – which got placed in the centre of the framework covering all the four quadrants. What does this tell us? There is a new reality or a “new sustained value equation formula” seems to be evolving within the context of corporations balancing purpose and profit when it comes to assessing their intrinsic value. This new reality - is indeed a wake up call for most corporations – and so, it is time that corporations to reevaluate their internal business units and capital investments with this sustained value equation mindset to respond effectively to the emerging consumer spending pattern changes towards purpose brands. This does not mean that businesses have to become charitable organizations – rather, the optimal goal is acing in to the sustainable value quadrant as outlined in the framework and summarized in the poem below.

We have a dream, where all businesses bubble up by,
Balancing profit with purpose as their ultimate way, (via)
Arching in to the “surviving” quadrant as the initial lay,
Angling through the “sacrificing” quadrant as the mid day, (yet)
Aspiring to the “soaring” quadrant as the ultimate way, (but),
Aiming for the “startling” quadrant as a path way, (yet)
Acing in to the “sustaining” quadrant as the best way,
That’s the dream; we wish that it comes true today!

1 comment:

  1. Charles, this is an amazing post. It extends the value of quadrants and adds more weight to the balanced quadrant, the one in the center. Truly enough turning purpose into a mathematical formula into an equation is not an easy job; in contrast making us feel its worth is decisive. You have done that admirably well. One day people will grasp the potential of your forthcoming ideas. At least, you made us visualize the purpose quadrant. This is not a little achievement.