Wealth = Quality x Quantity

‘The production of wealth,’ as 19th century philosopher John Stuart Mill observed, ‘has its necessary conditions’. New research by Juno Partners, summarised in this series of articles, reveals that for companies, the two necessary conditions can succinctly be described as ‘quality’ and ‘quantity’.

Most senior managers today would agree that the job of a corporation is to create wealth. In our capitalist, democratic society, we create different institutions for different purposes. We create charities to fund good causes, governments to set and enforce laws and businesses to create wealth.

When they focus on the creation of sustained gains in wealth, businesses provide the lifeblood of our economy. When businesses forget about wealth creation or the importance of the long term, the economy and all our institutions suffer.

For senior executives therefore, and directors in particular, few things could be more important to understand than the ‘necessary conditions’ for the production of wealth.

In this series of articles, we’ll share the findings of our research into wealth creation in Australian equity capital markets and layout a clear framework that describes the necessary conditions for the production of wealth.

In the first article, we’ll look at the basis of our research and present the findings of our research which highlights the importance of quality and quantity.

The second article looks at the importance of investor expectations to wealth creation.

The third article then returns to the themes of quality and quantity, examining the link between wealth created and Economic Profitability.

The forth article discusses the hazardous impact that competition can have on wealth.

Key takeaway
The production of wealth has its necessary conditions. Boards and senior managers play a critical role in guiding that production, but only if they understand the importance of quality and quantity and ensure every aspect of their business is managed with them in mind.

A pdf version of this series is available here:

Juno Partners Wealth = Quality x Quantity 2012

 

Glossary of commonly used terms

For the sake of clarity, here are definitions for some of the technical terms used on this site.

Wealth Created
We define Wealth Created as the difference between the Enterprise Value of a business and the Capital Employed in the business as at a specific date.

For the purposes of our published research, Enterprise Value is calculated at 30 June and Capital Employed is based on the financial year-end closest to that date, adjusted for any significant capital raisings between year-end and 30 June, were applicable.

Capital Employed
The total funds invested in the business by lenders and shareholders as at the most recent balance date to 30 June.

Adjustments are made to book values to establish a better picture of the underlying performance of the business including capitalising non-cancellable operating leases, capitalising significant items, capitalising research & development expenditure and reversing goodwill amortisation.

Enterprise Value
The market value of the company’s debt and equity as at 30 June. Where debt is not publicly quoted, the book value of debt is used.

Weighted Average Cost of Capital (WACC)
The weighted average cost of debt and equity capital. This is equivalent to what investors could expect to earn elsewhere over the long term at similar levels of risk.

Net Operating Profit After Tax (NOPAT)
NOPAT is the underlying operating profits of the business. Adjustments are made to statutory results to calculate NOPAT, including adding back interest and significant items, capitalizing research & development expenditure and reversing goodwill amortisation.

Return on Capital Employed (ROCE)
ROCE is calculated as the NOPAT of the business divided by the two year average Capital Employed.

Economic Profit Spread (EP Spread)
Calculated as ROCE – WACC, the EP Spread tells us about the quality of the business. A high quality business is one that can consistently put investor funds to work at a rate greater than what investors can earn elsewhere at similar risk (the WACC).

Businesses with positive EP Spread are generating returns in excess of their WACC.

Economic Profit (EP)
The profits made by the company after charging for the expected return on all Capital invested – debt & equity. A number of adjustments are made to reported profits and Capital to see through
to the underlying performance of the business. Formulaically,
EP = (ROCE – WACC) x Average Capital,
or Quality x Quantity.

Is your business engineered to create wealth? Part 5: Incentives

Most CEOs would prefer to create more wealth for shareholders than less.

But most companies are not ‘engineered’ to create wealth – internal processes often act to hinder wealth creation, rather than encourage it.

In this article we look at the role of incentives in wealth creation and why incentive programs often do more harm to shareholders interests than good.

At-risk pay has grown to be a significant part of the way managers in Australian companies are remunerated. For many public companies, the use of share based incentives has brought a renewed focus on growing the value of the company for shareholders, but ironically, short term incentives remain anchored in measures and structures that often encourage managers to destroy, rather than create wealth.

Of course short term incentive plans differ from company to company, but let’s review some of the most damaging aspects of the more popular plans before outlining a different approach that is engineered for wealth creation.

Wealth destroying measures
As the amounts available under short term incentive plans (STIs) increase, Boards are demanding more objective and formulaic measures of performance.

Unfortunately, that too often means formulas based on EBITDA or EPS growth. As we’ve seen in parts one and two of this series, these measures and a host of similar ones encourage managers to invest large amounts of money at low rates of return, destroying wealth.

Any incentive plan that has EBITDA or EPS at its heart is actually paying managers to destroy shareholder wealth.

Many managers understand that investing funds at low rates of return will destroy wealth for shareholders, but find themselves in the invidious position of having to choose between what’s best for shareholders and what’s best for their families.

Having established an understanding of what creates wealth and put in place performance measures, investment appraisal and planning processes to match, it makes sense to cement the focus on wealth creation by structuring STI plans around Economic Profit. This has the
added benefit of increasing the value of share based rewards as well.

Incentive targets set from budget
One of the most significant barriers to wealth creation in typical incentive plans is the use of the budget as the incentive target. Any manager with a few years of experience understands that under this approach, there are two ways to increase their bonus: 1) increase performance and 2) reduce the budget.

Unfortunately reducing the budget does nothing to create wealth for shareholders and it needs to be engineered out of the incentive process.

I suggest that, rather than using the budget, the target for the incentive plan be based on shareholder expectations, as implied in the market value of the company.

As part one of this series demonstrates, when investors form the opinion that a business is capable of generating and sustaining high returns on the capital entrusted to it (ie Economic Profit), the price they are prepared to pay for the business rises well above the capital invested by shareholders and wealth is created.

Using this logic in reverse, Boards can take the market value of the firm as a starting point and derive the EP growth that is implied and use this as the target for incentive payments. Figure 1 illustrates this process.

Figure 1: Derive EP growth targets from the market value of the business

Derive growth targets from shareholder expectations

 

 

 

 

 

 

 

Crucially, setting targets based on shareholder expectations decouples the budgeting process from the incentive program. It removes the incentive to sandbag budgets and makes that process more productive and a better use of shareholder funds and management time. It puts managers back in alignment with shareholders and means managers no longer have to choose between what’s best for the company and what’s best for them and their families.

Finally, by deriving targets from shareholder expectations, high levels of rewards are only paid when those expectations are exceeded and lower rewards flow from falling short of shareholder expectations: greater alignment is achieved.

Short term focus
As we’ve seen from part one of this series, wealth is created by sustaining high returns on capital. Yet the vast majority of cash incentive plans in Australia pay for short term performance; usually just one year.

Most business people accept it takes two to three years to become confident that performance gains can be sustained and that, therefore, a reward is truly deserved.

So an incentive plan that is engineered to create wealth would pay for sustained gains in Economic Profit, not a single year spike in performance. To do so, the Board should set rolling three year targets and give managers the headroom and the accountability to improve performance within that time frame.

Don’t ratchet up targets just when the business is improving and don’t negotiate a lowering of targets when things turn sour. Instead invest the time up front to agree to a set of targets that everyone can stick to, come what may.

To further reinforce the importance of sustained gains in performance, use an incentive reserve that holds a meaningful percentage of each year’s rewards at risk and subject to loss if performance cannot be sustained.

Capped
If an incentive plan is capable of paying managers to destroy wealth, as any plan that rewards gains in EBITDA or EPS does, or it pays for short-term gains, without any reference to sustainability, then it makes sense to limit rewards with caps on payments.

But caps have unintended consequences. They send a signal to managers to take their foot off the pedal once the cap is reached and push good performance into next year (where they’ll get paid for it). Caps encourage managers to defer revenue and bring forward expenditure (because it has no impact on the current year’s rewards and may even increase next year’s) and few shareholders would ever want that.

And perhaps even more damaging than that, caps are an admission that the incentive plan does not pay for wealth creation. If it did, why would a Board ever put a cap on payments?

So it may be better to ask the Board, ‘Under what circumstances would you accept no caps on an incentive plan?’

Most directors (and institutional investors and governance advisors for that matter too, in my experience) are not fundamentally opposed to an uncapped incentive plan. But they rightly expect significant safeguards to be put in place if the plan is to be uncapped.

Safeguards like using a measure of performance that takes into account the key drivers of wealth creation, that is, the quality of the business and quantity of funds invested in it. Setting targets not from the budget, but by reference to shareholder expectations. Making some payments annually, but deferring full payment until gains have been sustained for three or more years. Calibrating the plan in such a way that outsized rewards are only available for truly outsized and sustained gains in wealth creation.

With safeguards like these in place, managers can be put on an incentive plan that truly is engineered to create wealth.

Figure 2: If the incentive plan pays for sustained wealth creation, why cap payments?

Incentive plan alternatives

Is your business engineered to create wealth? Part 4: Planning

Most CEOs would prefer to create more wealth for shareholders than less.

But most companies are not ‘engineered’ to create wealth – internal processes often act to hinder wealth creation, rather than encourage it.

In this article we argue the planning process needs to be more than just a governance tool, it needs to produce an ambitious, clear strategy to deliver a step change in the value of the company.

Every large organisation needs a plan to coordinate the activities of its people, whose job is often just a cog in a much larger machine. And in any company, the objective of that plan should be to grow wealth. That is after all, the job of business in our society.

But plans and budgets in most companies are also used as governance tools, to hold managers responsible for performance. Not surprisingly, managers respond to this by putting forward highly conservative plans. This practice is so common it has a name, ‘sandbagging’.

The outcome of all this for shareholders is a high degree of accountability for a plan that often produces little gain in wealth.

But with care, this barrier to wealth creation can be turned into a powerful platform for the creation of it.

We’ll discuss the problem of sandbagging and how to remove it in the fifth article in this series, but let’s first look at how planning would be conducted if it was all about wealth creation.

If the job of business in our society is to create wealth, then the planning process should address the two key drivers of wealth and clearly address the questions:

  1. How is the business is going to achieve and sustain high returns on capital (quality); and
  2. How will the business find ways to put large amounts of capital to work at those rates (quantity)?

CEOs should not be responsible for changes in the value of their company in the short
term, but they should be responsible for changes in value over a three to five year time
horizon. And it is that horizon that the planning process should consider with questions
like, ‘How will high returns be achieved or sustained over the next three to five years?’
and, ‘How much capital can we put to work at those rates over that period?’

With that overarching goal, it helps then to break the planning process down by thinking
about each business unit in terms of fix, grow or sell.

Fix
Businesses with negative Economic Profit Spreads, that is over the past five years or over the forecast period suffer returns (ROCE) less than the cost of capital, need to be fixed. As we saw in part one of this series, for established businesses, negative EP Spreads are highly correlated with wealth destruction. If returns remain low, investing more capital in these businesses will only destroy more wealth.

The challenge for the managers of these business units is to develop credible plans to improve returns. For many, competitive forces are to blame for low returns. Where products or services are largely commoditised, profits and ROCE are driven down. Only those with a sustained cost advantage will be able to sustain high returns in a commoditised market.

In this instance, plans must either be about how to achieve a sustainable cost advantage
or how to differentiate the offering and achieve some pricing power.

Grow
Once a business has achieved high returns on capital (a positive EP Spread), it’s time to accelerate wealth creation by growing the business and finding ways to invest, without reducing returns below the cost of capital.

The challenge for the managers of these business units is to develop credible plans that show how high returns can be sustained. It is the nature of our competitive capitalist society that businesses that enjoy high returns attract competition. This is evident in the research summarised in part one of this series. Many low return businesses enjoyed at some stage in their history high levels of ROCE.

But competition brings with it lower prices and more benefits for customers, which usually come at the expense of margins and returns. As if that wasn’t enough, if the business is dependent on a key supplier (such as a landlord, or unique component supplier), they may be able to increase input costs to capture the wealth-creating high returns for themselves.

These businesses need to demonstrate a thorough understanding of the ‘moat’ around their business that will prevent competitors, suppliers and even governments from taking their high returns and in their plans, show how they will deepen and widen that moat, while all the time investing behind it.

Sell
We have discussed how high return businesses attract competition, usually driving down returns. Where industry returns are persistently low, the reverse process is often observed: low returns lead to a thinning out of competitors, allowing returns to rise for the remaining players.

If a business is not in a position to lead the rationalisation of the industry by buying out competitors, it can often create wealth by selling into it. These businesses usually trade at a discount to the amount of capital invested in them (ie their book value), reflecting investors’ belief that capital will continue to be invested at low rates of return.

In selling out, vendors can often achieve at least book value for their businesses, thereby creating wealth (taking a negative back up to zero).

Of course it is not just low return businesses that can be sold at a profit; a company that is engineered for wealth creation will also maintain internal valuations for each of its business units and be ready to sell at the right price.

Is your business engineered to create wealth? Part 3: Capital allocation

Most CEOs would prefer to create more wealth for shareholders than less.

But most companies are not ‘engineered’ to create wealth – internal processes often act to hinder wealth creation, rather than encourage it.

In this article we look at how capital allocation processes can fail shareholders and some simple steps that can be taken to drive greater accountability into investment decisions.

The big capital spends, be they investments in new markets, new products or acquisitions, often represent the signature, transforming achievements of a CEO. And for shareholders, they often have a transforming impact on wealth.

So when faced with these opportunities, CEOs need clear, reliable tools to assess investment opportunities. Unfortunately, the tools that they are most likely to use are anything but.

If wealth creation is the goal of the business, then for any investment evaluation tool to be of use it must address the quality and quantity issues we saw in part one of this series as the key determinants of wealth creation.

This rules out using EBITDA and EPS growth, which both fail to capture the funds invested in a business and say nothing of the quality of the business. Sophisticated investors know this and mark down businesses that trumpet EPS accretion, if the investment fails to deliver reasonable returns on capital invested.

Other, more sophisticated tools, like Internal Rate of Return (IRR) and Discounted Cash Flow (DCF) address the draw backs of EBITDA and EPS by forecasting all the capital required for an investment and all the cash that will be generated by it and boiling them down to a single number; a percentage in the case of Internal Rate of Return (IRR) which can then be compared with the company’s hurdle rate, and a dollar figure in the case of Discounted Cash Flow (DCF), showing how much wealth will be created from the investment.

But while IRR and DCF can be used to accurately calculate the wealth impact of an investment decision, they are only ever as useful as the forecasts used and this is where IRR and DCF analysis fall down.

The best users of DCF look to key drivers, such as margins, volumes and inventory turns to assess the reasonableness of forecasts. If the acquisition requires industry best results across all key drivers to create wealth it’s time to negotiate a better price, or walk away.

But one key reasonableness test every CEO should ask is, ‘What is the forecast ROCE of this investment, in each year of the forecast period?’ If ROCE forecasts are beyond reasonable upper limits then warning bells should sound.

As the chart below shows, drawing on our research into returns achieved by Australia’s largest companies and summarised in the table in part one of this series, only the top 25% of companies are able to sustain returns 5% or more in excess of the cost of capital over any given five year period. This analysis probably understates how rare high returns on capital are in the broader economy, given businesses that have failed or who are yet to be consistently profitable are excluded from our research.

Figure 1: Returns significantly above the cost of capital are rare

Returns above the cost of capital are rare

 

In my experience, when DCF analysis is recut to include ROCE and Economic Profit data on an annual basis it often forecasts ROCE starting low and gradually growing larger and larger, past the 75th percentile and eventually into the top decile of what companies have historically been able to achieve.

Few companies are able to generate let alone sustain these returns, due to the competitive forces they face. If one player in a market is able to invest and generate such attractive returns, others will follow and unless the investment is made behind, as Buffett would call it, a deep ‘moat’ of a hard to copy competitive advantage, returns will begin to fall, not rise, as time goes on.

Given 75% of companies fail to make returns more than 5% above the cost of capital, the default assumption for DCF analysis should be that returns will revert to the cost of capital over time, in the absence of a very clear and proven set of competitive advantages that will keep competitors, suppliers and even governments at bay.

Equipped with the forecast annual EP Spread of the investment and a thorough knowledge of the competitive forces of the industry in which the business operates, a CEO is in a much stronger position to make career defining capital investment decisions.

The second and important step in this phase is to close the accountability loop for investment decisions. And that comes back to the performance measure chosen by the CEO. EBITDA and similar measures ignore the capital invested in a business and send a signal to all managers that capital is free.

Economic Profit by contrast, constantly reminds managers of the funds invested in their business and the need to generate sufficient returns. By holding managers accountable for sustained gains in EP, the rigour of investment proposals increases: managers know while putting together their forecasts that unless the investment generates and sustains high returns, the Economic Profitability of their business will fall.

As one client put it, ‘EP is like DCF with a memory’.

Is your business engineered to create wealth? Part 2: Performance measures

Most CEOs would prefer to create more wealth for shareholders than less.

But most companies are not ‘engineered’ to create wealth – internal processes often act to hinder wealth creation, rather than encourage it.

In this article we look at one of the most pervasive barriers to wealth creation: performance measures.

As we’ve seen in part 1 of this series, wealth is created when funds are invested at high rates of return and destroyed when funds are invested at low rates of return. But incredibly, the most popular financial performance measures in use today such as Earnings Before Interest Tax Depreciation and Amortisation (EBITDA) and Earnings Per Share (EPS) are silent on the rate of return, or quality of the business. And what’s worse, they actually encourage managers to destroy wealth by investing the money entrusted to them at low rates of return.

Consider a manager faced with an opportunity to add a new customer. If the business
goes ahead with the terms proposed by the customer, the impact on the Group’s financials
will be as follows.

Figure 1: Growing profits, destroying wealth

Growing profits destroying wealth

 

Any of the most popular performance measures, such as sales, margins, EBITDA and even ROCE improve if the manager takes this deal. But in doing so, they encourage him to invest the capital entrusted to the business at 8.2%, less than the 10% that investors could get elsewhere at equivalent risk – that is, these measures will encourage the manager to destroy wealth.

Indeed a manager can grow EBITDA or EPS, two of the most popular measures of performance in use today, by investing funds for a return as little as 1%.

As a consequence, all the creativity and hard work of a management team can unwittingly lead to wealth destruction if the compass that they use to guide decisions is a simple but misleading one, such as EBITDA.

Using EBITDA or any other measure that fails to capture quality and quantity of the business keeps the truth of the performance of the business back from managers and acts as an enormous barrier to the creation of wealth.

CEOs can remove this barrier by replacing EBITDA or similar measures with sustained gains in Economic Profit. Economic Profit is the only measure that captures both the quality of the business and the quantity of funds invested in it.

Figure 2: Economic Profit captures the key drivers of wealth creation

Economic Profit formula

 

Because EP goes down when funds are invested at low rates of return and up when they are invested at high rates of return, it guides managers, through all their efforts during a year, to create wealth, rather than destroy it. And it can be measured right down through the business, sharing responsibility for wealth creation throughout the management ranks.

Is your business engineered to create wealth? Part 1: Education

If the job of business is to create wealth, how strange it is then that so few managers really
understand how wealth creation works.

If you think this is unfair, try asking a manager this question, ‘How is it that Qantas has turned
the $15.2 billion entrusted to it into a business worth just $11.6 billion?’ Or, ‘How has
Cochlear been able to take $925 million and turn it into a company worth $3.8 billion?’

Shouldn’t every manager entrusted with other people’s life savings, be able to explain,
at least in high level terms, what has happened to these two companies and translate
those lessons into their everyday decision making?

If we expect our managers to create wealth, the first barrier we must address is education, by
giving all managers a clear and shared understanding of what is required to create wealth.

So what are the necessary conditions for creating wealth? Our research of Australia’s largest
listed companies summarised in the tables that follow, shows who has created (or
destroyed) wealth and the root causes. [1]

Figure 1: The 2013 Juno Partners Wealth Creators Report

1-5051-100101-150151-200

The data shows that, for example, BHP Billiton (ranked #1) at 30 June 2013 had taken $137 billion of capital from shareholders and lenders and turned it into a business worth $208 billion, creating a staggering $71 billion of wealth.[2]

By contrast, Newcrest Mining (#200) had taken $22.4 billion and turned it into $11.8 billion, destroying $10.6 billion.

How do businesses create wealth?
How does a business like BHP Billiton create $71 billion of wealth?

Being at the epicentre of the global mining boom would seem to help, but being a leader in the mining sector is not enough. OZ Minerals (#198) has managed to destroy $4.9 billion of wealth, turning every dollar entrusted to it into $0.20.

Wealth is also not just a matter of size. BHP Billiton is a very large company and created the most wealth, but Qantas (#196) is also a very large business, but its size did not save it from destroying billions.

Even growth per se does not matter. Both OZ Minerals (#198) and Westpac (#4) have grown their balance sheets in excess of 20% compound over the five years to 30 June 2013 but by the end of it, Westpac had turned $51 billion of investors’ funds into a business worth $90 billion, creating $39 billion, while OZ Minerals, turned $6.2 billion into just $1.3 billion, destroying $4.9 billion.

Instead, our research shows that the two most important conditions necessary for the creation of wealth can be characterized as ‘quality’ and ‘quantity’.

The importance of quality
Let’s look at the first condition: quality. Quality, of course, is a relative measure – it means something of a higher grade; better than the rest. If we apply that thinking to investing, a good quality investment is one that is capable of generating higher returns than what investors could achieve elsewhere, at similar risk.

To measure the quality of each of our sample of 200 Australian businesses, we calculated the return on capital employed (ROCE) of each and compared it to what investors could earn elsewhere at similar risk (the business’ Weighted Average Cost of Capital or WACC).

We call the net result, a business’ Economic Profit Spread, or EP Spread for short. Further explanation of these terms and others used in this article is included in this Glossary.

For example, Wotif, the on-line travel business (#57) earned 49.5% on the funds entrusted to it in 2013, compared to the 9.2% investors would expect, to justify the risks involved in the business, leaving an EP Spread of 40.3%.

Intuitively, generating 40% more than the return required for risk is good performance, but when you consider a little under three quarters of businesses covered in our research failed to generate more than 5% above what investors could expect for risk, then you begin to appreciate what a rare jewel Wotif is.

Quantity: the great accelerator of wealth creation
The second condition necessary for the creation of wealth is quantity, in this case the quantity of funds that can be invested at high rates of return. The more capital that can be put to work at high rates of return, the more wealth will be created.

This is best exemplified by BHP Billiton (#1) who not only enjoyed a median return on capital employed 10% above the return required for risk over the past five years, but also was able to employ an average of $83 billion a year at those rates, creating nearly $39 billion more profits than investors would require for the risk associated with their investment.

Quantity is the great accelerator of wealth creation. As good as Wotif’s returns are, the service nature of its business means that it does not organically generate large capital investment opportunities. It is hard to see how Wotif could ever employ $83 billion of capital in their business. Ultimately this restricts the wealth that the business is able to generate.

But quantity without quality is a recipe for wealth destruction
But while the ability to put capital to work is important, quality must always come first.

Investing large amounts of capital in low return, low quality businesses is a recipe for wealth destruction.

Newcrest Mining Limited (#200) is a good example of this. Over the past five years Newcrest suffered returns on average 2.3% below what investors required for risk. At the same time, it expanded its capital base, investing billions at low rates of return. The result was a valuation $10.6 billion less than what investors had poured into the business as at 30 June 2013.

Warren Buffett put it this way in his 1992 letter to fellow Berkshire Hathaway investors,

‘Leaving the question of price aside, the best business to own is one that over an extended period can employ large amounts of incremental capital at very high rates of return. The worst business to own is one that must, or will, do the opposite – that is, consistently employ ever-greater amounts of capital at very low rates of return.’

Key points

  • Competitive challenges make creating wealth difficult. That challenge can be made a little easier if all managers at least share a common and accurate understanding of how wealth is created.
  • Wealth is a function of Quality and Quantity. Can the business generate returns on the capital entrusted to it in excess of what investors could earn elsewhere (Quality), and how much money can be put to work at those rates (Quantity)?

Qantas (#196) has destroyed $2.9 billion of wealth because it has put large amounts of capital ($15.2 billion by June 2013) to work at low rates of return (on average 3.5% less than what investors require for risk) and is expected to do so well into the future.

Cochlear (#27) has created $3 billion of wealth because it has put the $925 million of capital entrusted to it to work at high rates of return (on average 14% above what investors require for risk) and is expected to do so well into the future.

______________________________________

[1] For the purposes of this study, our database comprised the 200 largest Australian domiciled public companies as at 30 June 2013, excluding investment businesses, such as listed investment companies, insurance and real estate businesses, those with less than five years of publicly available financial reports and those who made losses in three or more of the past five years.

[2] Note that in the table of data we list the 2013 average Capital Employed balance, being the average of the year-end results for 2012 and 2013. The 2013 year-end values cited in the main text of this article and used to calculate Wealth Created, will usually be a little larger.

Is your business engineered to create wealth?

Most CEOs would prefer to create more wealth for shareholders than less. After all, in our society, we create different institutions for different needs: governments to create and enforce laws, charities for good causes and businesses as places to store and grow our wealth.
The job of business is to create wealth.

But most companies also face barriers to that goal. Even if you are able to create a great product or service that will improve the lives of customers, competitors will do all in their power to steal those customers, suppliers will squeeze higher prices for their inputs if they can and even governments will sometimes impose special taxes on businesses deemed to be too profitable.

To take on these challenges, every CEO must ask themselves, ‘Is my business engineered
to created wealth?’

In the five articles that follow, we’ll examine the most common internal barriers that businesses
face in trying to create wealth and how CEOs can remove them and in the process,
engineer their business to create wealth.

Figure 1: Barriers to wealth creation

barrier_large

In the first article, we’ll look at research into why some businesses create wealth, while others destroy it.

The second article looks at the impact internal measures of performance can have on decision making and wealth creation.

The third article addresses capital allocation and what can be done to close the accountability loop for investment decisions.

The fourth article looks at budgeting and planning, calling for a greater focus on how the business will create wealth and less on governance and accountability.

Finally, the fifth article addresses incentive structures, outlining some of the most damaging aspects of the more popular plans before outlining a different approach that is engineered for wealth creation.