Shareholder Value In Inustrial Sector

There are many ways to measure shareholder value (SV), but the Stern’s Economic Value Added (EVA) concept is the most widely used. EVA uses accounting information, measuring the level of return to shareholders after cost of capital is subtracted from the capital employed. To maximise shareholder value, management are increasingly forced to opt for capital investment decisions that yield the highest net present value (NPV) which will boost the return on capital employed. (ROCE)

When this knowledge is placed in the context of the industrial sectors, it becomes evident that implementing this performance measure, (alongside the increasing demands from shareholders for higher ROCE, typically 12-15%) (Citation needed) is having catastrophic effects on many UK and American industrial sectors over the last 20 years. The fact that it appears to be largely corporations in these nations is no coincidence, as it is these nations that prioritise maximisation of shareholder value. German companies seldom make more than 1% ROCE, similar to that of Japan, yet it is these companies that are recording higher sales, incurring lower costs and having increased satisfaction from customers, whereas American and UK manufacturing firms are lessening by the year. I argue that it is the quest for increasing shareholder value that has ultimately crippled US and UK car manufacturing firms by forcing them to concentrate on short term issues, ignore investment in non-tangible assets such as knowledge and skills, in line with M. Porter’s similar argument. (Grant 1995)

Eastern manufacturing companies such as Toyota have been investing in such skills, and by utilising the value and skill of their workers they have been able to implement innovative techniques such as JIT and TQM, resulting in boosted quality and lessened costs, giving them a true advantage over US and UK firms in the same industry.

Without question, the manufacturing of motor cars is a mature market, almost saturated. A recent survey illustrates just how so, with 600 millions cars on the globe in 2003 and 6.2 billion people. (Number of cars 2003) roughly one for every 11 people. In North America there are more cars then there are drivers. The lack of growth in this market constricts the amount of sales that the car manufacturers are able to create, to take recent financial reports from a multitude of organisations in industrial sectors in North America, it is clear that the shareholder’s demands of 12-15% ROCE cannot be met, even in the case of a bull market. ROCE of oil and gas extraction, a primary industrial sector had an ROCE of 2.5% in 1998, and 2.9% in 1999, forestry and fishing had 5.9% and 6% ROCE respectively, more primary industrial sectors, construction industries had on average ROCE of 6.8% in 1998 and 7% in 1999, a secondary industry. (Baumgarten C. Leduc J. 2000) these results are only an average, which obviously could affect the accuracy of the results, but when compared to ROCE of other industries in the same time period, such as food and beverage stores with a ROCE of 33% and 32%, even healthcare, another labour intensive industry managed ROCE of 11.2% in 1998 and 13.1% in 1999.

Due to the nature of industrial sectors, management have to restructure constantly through hostile takeovers to be able to shave down the costs of production, rather than gain more profit via increased sales. The money invested in such business by industrial companies between 1975 and 1995 totals close to Ð'Ј241 billion pounds, half that spent on investing in machinery in the same time period. (Sukdev J. Williams K. Fraud J. 2000) this has resulting in the number of public listed companies (PLCs) plummeting. Of 500 listed in the FTSE 500 in 1980, only one third of these remain, proving that obtaining shareholder value through takeovers and mergers can only go on for so long. There must come a point where either such demanding return on SV is abandoned for manufacturing companies and even other industrial industries such as mining, construction, fishing, which are all industries with non-renewable resources, and only limited scope to shave costs, manufacturing companies will have to enter other markets with higher growth and profit margins, such as Ford’s entry to the bond market, competing with HSBC and the other banks. It may be the case that in the not too distant future Ford and possibly other car manufacturers will halt car production altogether.

Other than the saturation of the market, there is a far larger characteristic of the industrial market that prevents shareholder reaching their 12-15% return, and that is the dependency of the organisation on the workers.

No matter what industrial sector, labour is the highest cost after the purchasing of raw materials, goods and services. Typically in manufacturing, purchases account for 60-80% of operating costs (Slack N. Chambers S. Johnston R. 2004) it is argued that a reduction of 5% of these costs can have a huge impact on profit, which in theory is correct, but overestimates the fact that purchase costs are variable directly with the amount produced, and assuming that the best deals and cheapest stock is gained for the quality needed, cannot be reduced without lowering output, or dramatically redesigning the operational process, possibly using TQM or JIT, which subjects the firm to both high risk and huge costs, that may be more than the savings gained.

To achieve the best EVA, operating expenses need to be the lowest that they can, as described earlier, however the wages need to be very competitive to entice workers in the first instance, and to keep them working, as the monotony and lack of job satisfaction sees production have a high level of labour turnover. For example, the minimum wage in America 2000 was $5.15, yet the average wage of production workers was $13.74 (case study 3) resulting in the need to only reduce a small number of staff to reduce large costs. Downsizing has only been made easier through the American labour market being highly flexible, with short working contracts and generally reducing the cost of redundancy.

The disadvantage of restructuring and downsizing is the reduced motivation and commitment to the company by the labour force, which has proved to be essential in the implementation of the innovations introduced to manufacturing industries since the late 1980’s such as TQM and JIT. This is not the case in Japan, where the maximisation of SV is not a priority, but training of labour and high quality is. The culture of many Japanese and Korean firms includes a close relationship between management and workers, often workers are confident that they have a job for life, in return for huge commitment and sacrifice, much better for the implementation of such techniques. Toyota