How to choose between growth and ROIC

Investors reward high-performing companies that shift their strategic focus prudently, even if that means lower returns or slower growth.

- By Bin Jiang and Timothy Koller

Value-minded executives know that although growth is good, returns on invested capital (ROIC) can be an equally—or still more—important indicator of value creation.¹ Yet even executives at the best companies often wrestle with strategic decisions in order to reach the right balance between growth and returns. We repeatedly come across executives whose companies earn high returns on capital but who are unwilling to let those returns decline to encourage faster growth. Conversely, we see executives at companies with low returns working to promote growth instead of improving their ROIC.

Large companies in particular can find it difficult to grow without giving up some of their existing returns.² What’s more, many executives are accustomed to seeing growth and returns improve (or decline) hand in hand as market conditions change. As a result, decision makers may hesitate to alter strategic directions, fearing a lag in market acceptance.

To understand better how value is created over time, we identified all nonfinancial US companies that had a market cap of more than $2 billion³ in 1995 and had been listed for at least a decade as of that year. When we examined their growth and ROIC performance over the subsequent decade, we found clear patterns in the interaction between the two measures. These patterns can help guide value creation strategies suited to a company’s current performance.

For companies that already have high ROIC,⁴ raising revenues faster than the market generates higher total returns to shareholders (TRS) than further improvements to ROIC do. This finding doesn’t mean that companies with high ROICs can disregard the impact of growth on their profitability and capital returns. But executives do have the latitude to invest in growth even if ROIC and profitability erode as a result—as long as they can keep ROIC levels in or above the medium band.

About the Authors

Bin Jiang is a consultant and Tim Koller is a principal in McKinsey’s New York office.

This article was first published in the Fall 2007 issue of McKinsey on Finance.

Will buying bug-free software ever be possible?

LONDON: European researchers are working on mathematical foundations of programming to create fault free software in the future.

People are remarkably tolerant of software that goes wrong, but when it comes to faulty cars or TV sets, they would insist that they be set right without much ado, the researchers said.

“The software industry is still very immature compared to other branches of engineering,” says Bengt Nordström, computer scientist at Chalmers University, Göteborg.

“We want to see programming as an engineering discipline but it’s not there yet. It’s not based on good theory and we don’t have good design methods to make sure that at each step we produce something that’s correct.”

Nordström is for rethinking the whole approach to software design. The usual approach is to validate a programme via a lengthy testing process. Instead, he would like to see a design philosophy that guarantees from first principles that a programme will do what it says on the box.

The key lies in an esoteric reformulation of mathematics called ‘type theory’ based on the notion of computation. It is not that simple, of course, but so promising is type theory that since 1989 the EU has been funding a string of projects to develop it under the ‘Future and Emerging Technologies Programme’.

Nordström was coordinator of one of the projects, TYPES, which fosters co-operation on the topic among researchers at 15 European universities and research institutes, along with those at 19 associated academic and industrial organisations.

The TYPES partners are also releasing open source software packages that anyone can download, use and modify. These packages include several ‘proof editors’ that, in type theory, are the key to guaranteeing the correctness of programmes.

“European research in this field is the strongest in the world,” Nordström pointed out. “Many computer programmes are going wrong, they don’t work properly, and in the long run this research will help. This is a very slow process, it takes many years to get ideas from the universities into industry but I think it’s slowly taking place.”

Results from type theory are already finding their way into other projects. The EU-funded Mobius project is developing methods, known as ‘proof-carrying code’, for downloaded programmes to be certified as bug-free, reports Sciencealert.

Meanwhile, a France-based company is using ideas from type theory to design secure embedded computer systems such as those used for smart cards. Further research is also under way in Japan.

But type theory could also be important in the transport, defence and healthcare sectors, where mistakes can cost lives.

Virtual Workloads

Following its acquisition of virtualization company Platespin, Novell has embarked on a countrywide training program for its partners.

Starting October, the vendor will conduct advance training programs in five major cities—Mumbai, Bangalore, New Delhi, Kolkata and Chennai—on Platespin virtualization products.

Sandeep Menon, Country Head, Novell India, said, “The technical program will include hands-on training on installing, configuring and working with Platespin products on Novell platform. We recently completed the first phase of this program for large system integrators like Wipro, Pentagon Communications, GT Enterprises and Frontier Business Systems. In the second phase, we will target mid-size partners”

Novell acquired Platespin in March for $205 million. A 5-year old company, Platespin provides virtualization management software and services.

“Addition of Platespin makes our virtualization portfolio stronger. Platespin solutions provide conversion of workloads from physical to virtual machines and vice-versa, which compliments Zenworks range of products that help in categorizing and provisioning virtual workloads and backing it up thus providing disaster recovery control. Our partners have expressed excitement about the strong synergy between the two product lines,” added Menon.

US slowdown is definitely hurting the fab sector

Semiconductor fab (or chip-making units) spends are down globally by 30% and chip design and manufacturing companies in India are facing the heat due to slowdown in the US.

Companies are hoping that by year-end, demand in consumer electronics will pick up globally says Pradip K Dutta, corporate VP & India MD, Synopsys. Excerpts:

What are the major challenges for chip design and manufacturing firms ?

There are two basic challenges-technological and economic. The US slowdown is definitely hurting the industry. It’s been over a year that the industry has seen the economic challenges. But demand will pick up around Thanksgiving to Christmas season.

Then, there are the technological challenges like dealing with technological complexities. Companies are trying to overcome that by collaborating in terms of M&As, cooperating in innovation etc. We are also seeing major chip making companies moving towards asset- light models where they are outsourcing manufacturing to chip foundries and separating these units (like Philips did with NXP). Private equity companies are also buying out companies, like Freescale was bought by Blackstone for $17.6 bn.

Has the government’s chip policy given enough incentives to attract key fab players to India?

Yes, the government has given them a three-year window, which is a good thing as opposed to keeping it open-ended. The policy incentives will lapse by 2010. By summer of 2009, we expect to see some concrete proposals on the table. One can always debate whether the subsidies should be 20 or 40%, but the key element is that semiconductor manufacturing has been recognised as a key driver towards building a manufacturing ecosystem in India. Businessmen will invest $3-4 bn only if they see a profitable business case and enough demand. They cannot invest just because it gives an ego booster to India.

What are the kinds of chip fabs possible in India? Where should the initiatives come from?
There are three different types of fabs possible in India. In a R&D fab, the primary purpose would be to develop modules of process technology such epitaxy, diffusion, metal layer etc. The ideal home for these would be in central research institutes or IITs. Next would be a proto fab meant for small fabless companies to run their test designs. Finally, there’s a commercial chip fab which depends solely on the business case. States can compete to provide additional incentives and attract investments. Lack of proper infrastructure in India is a bottleneck. Water, electricity, ports, transportation is all very essential for fabs to run. We are lacking in many of these areas.

Are fabs investing globally to expand current capacities?

We are seeing a slowdown in spends by fabs on new investment. But the good news is that fabs capacity utilisation is almost 90-92% globally. Capex will pick up only when demand picks up. Innovation can boost demand. For instance, despite a slowdown, we see high demand in new innovative products like Apple 3G iPhone. Innovation will drive the market.

What are the consumer requirements that drive electronics sales in India?
The growth in the semiconductor industry is consumer electronics-driven. Primarily in the India and the Asia-Pacific region, where price point is always under pressure, it’s giving rise to innovation in design, manufacturing, bill of material and channel selling. However, the customer in these markets wants a product with same set of features and functions at one-third the price in the Western markets.

Captives – The 4-year trend

What do the parent MNCs are thinking when it comes to their captives in India – fluctuating currency or belt tightening or efficiency issues?

 

There is a striking clarity on the trend when you compare the below stark numbers produced by Zinnov :

 

2007 : Only 15 overseas tech firms opened India development units

2006 : 48 managed to do it

2005 : 70 firms opened shops in India

2004 : 76 firms had their captive centres established in India.

 

We need to wait and see whether this trend has any bearing with the fact that the demand for services by independent, thirdparty service providers like Aspire Systems expand at a rapid pace.

 

Zinnov research had covered 594 foreign firms that have set up captive or offshore development centres or ODCs in India. These include 390 software product development firms, 120 engaged in engineering services and 84 embedded service companies.

Strong at 28%

FY08 Revenue Performance and FY09 Forecast for the Indian IT Software and Services Sectors

• FY07-08 performance reflects sustained growth of 28% (currency adjusted)
• FY08-09 outlook strong with software and services revenue to grow by 21-24% (currency adjusted); Software and Services Exports forecast to reach USD 50 billion
• Industry rankings released for FY07-08
      o Genpact, WNS Global Services and IBM-Daksh lead the NASSCOM Top 15
         BPO rankings 
      o Tata Consultancy Services Ltd., Infosys Technologies Ltd. and
         Wipro Technologies Ltd. are Top 3 players in the NASSCOM Top 20 IT
         software and services exporters rankings and NASSCOM’s Top 20 IT-BPO
         employers

According to the annual NASSCOM survey, the Indian IT-BPO industry (including domestic market) recorded an overall growth of 28% (currency adjusted), clocking revenues of USD 52 billion in FY07-08 up from USD 39.6 billion in FY06-07. The software and services exports segment grew by 29% (in USD) to register revenues of USD 40.4 billion in FY07-08, up from USD 31.4 billion in FY06-07. The domestic segment grew by 26% (in INR) to register revenues of USD 11.6 billion in FY07-08.

Within the export segment, IT services exports have grown by 28% (in USD)  to clock revenues of USD 23.1 billion; while BPO exports are up by 30% (in USD) registering revenues of USD 10.9 billion. Engineering services and products exports clocked revenues of USD 6.4 billion, growing at 29% (in USD) in FY 07 -08.   

The survey also projects that the overall software and services revenues will grow by ~ 21-24% (currency adjusted) to touch ~ USD 50 billion in FY08-09.

“The Indian IT-BPO industry’s resilience is reflected in its FY07-08 performance, with a 28.2% overall growth rate and next year’s projected growth between 21-24 percent. Given that we are well on our way to achieve the target of USD 60 billion in exports by FY09-10, the industry is now focusing on improving productivity, efficiency, as well as opening up new markets and services”, says Mr. Som Mittal, President, NASSCOM

He further added “The next decade offers opportunities and challenges which will require new business models and the industry dynamics will also see significant changes leading to a many new industry drivers and enablers, and we will need to prepare ourselves for these. NASSCOM is developing a long term vision for 2020, to chart out the roadmap for all stakeholders and help them tap into this opportunity”.

CodeSmith

CodeSmith is the most powerful code generation tool on the market. With features such as template based code generation, a rich integrated template development environment including statement completion, and a highly extensible metadata system that includes database schema, XML, and many other sources standard. CodeSmith enables you to generate “Your Code. Your Way. Faster!”

eBroadcast on Contact Center Solutions

The Indian Contact Center Market is one of the fastest growing markets in the world with a CAGR of 45% over the past 5 years. Today, this growth continues to be driven by offshoring and outsourcing activities from North American and UK, as well as domestic demand from domestic Indian enterprises.  This boom has made the Indian market very competitive. As a result, there has been strong drive among contact centers to innovate themselves to be successful in this growth economy.

 

Experts in the contact center industry have identified scalability, flexibility and optimized costs as critical success factors to compete. The Hosted Contact Center approach with its utility-based pricing model, on-demand capacity, and virtualization/integration capabilities can often be the best solution for success.

 

eBroadcast on Tuesday, 15 July 2008   2:30 pm IST

 

Captives are meeting expectations !

Results from a new Everest Research Institute survey reveal that more than 85 percent of the key executives surveyed believe that company-owned offshoring operations in India, known as “captives,” are delivering on cost savings and service expectations despite contrary opinions. The Institute will host a Webinar on October 11 at 8 a.m. CDT, to present survey findings and insights.

“Performance is not dependant on the size of the parent company’s operations or industry. Most captives are doing well, despite a few instances, and this survey proves the viability of this sourcing decision,” said Nihal George, Research Director, Everest Research Institute. “We also noted that early stage captives are more challenged in meeting parent company’s service level expectations, but we expect them to overcome these obstacles in the long run.”

The survey, entitled Captive Value Diagnostic Study Market Update, polled 102 key executives from global companies, representing both parent and captive stakeholders, with sophisticated captive operations in India across a wide-range of industry verticals from hi-tech to banking to telecom. The companies also had varying locations, scales of operations and functions undertaken.

“The majority of captives being able to meet performance criteria is an incremental step for the future of captives’ business models,” said Nikhil Rajpal, Vice President of Global Sourcing for Everest Research Institute. “Our research indicates they now have an opportunity to elevate their roles and provide additional value for the company. Parent stakeholders are giving captives support to step up their efforts and deliver beyond cost savings, which creates a multitude of growth opportunities.”

In addition to strong captive performance and confidence from parent executives that they can deliver more value, the survey highlighted insights on the areas captives should focus future delivery on, including:

* Parent stakeholders’ desire to enhance capabilities and attain added value, but first captives must master incremental improvements such as productivity.

* Parent executives do not consider adding scale as a top priority for captives in order to enhance their value.

* Twelve percent of executives are willing to sacrifice short-term cost savings in favor of enhanced value down the line.

The survey noted several key capabilities required for captives’ success, such as the need to invest in multiple areas in order to become more integrated and provide additional value. Areas which stood out among parent executives include a need to focus on leadership skills and a need to build or enhance structured relationship management mechanisms.

“Parent stakeholders want leaders with strong influencing skills to eventually lead key initiatives, and truly enhance their significance within the overall organization,” said Rajpal. “To accomplish this, parent stakeholders must work with captives to establish value priorities and to evolve their capabilities, thereby reducing existing disconnects. Captives must view themselves as a partner in creating strategic value, and as a result, build depth in functional expertise and leadership.”

Gartner SOA Summit

Date : 15 & 16 July 08

Location: Tokyo Conference Center, Shinagawa ,Tokyo , Japan
Contact: http://www.gartner.com/it/page.jsp?id=632908&tab=overview_v2

Topic(s): Application Development, Application Integration and Middleware Software, Business Process Outsourcing, Enterprise Architecture, Service-Oriented Architecture, Web Services

Transformation to business Process Oriented IT Combining Offense and Defense. At SOA Summit 2008, we present recent trends, issues and practices around EA/BPM/SOA and related areas for building agile capability in both offense and defense.

An unpredictable state for enterprises becomes chronic in business environment, urging them to restructure for excellent capabilities in offense and defense. Overall optimization by establishing and merging rapid recognition, decision-making and implementation is essential.

Meanwhile, enterprise IT is expanding, becoming more complex and rigid, and radical IT reform for rapidly responding to business trends is another critical issue.

The need for EA, BPM and SOA is increasing to improve this situation. Efforts targeting SOA in Japanese enterprises are moving from consideration to implementation, and advances and expansion toward BPM have been seen, with an increasing number of advanced enterprises seeing the effects of SOA and BPM application.

At SOA Summit 2008, we present recent trends, issues and practices around EA/BPM/SOA and related areas for building agile capability in both offense and defense.

What’s New At This Event 

This Year’s Focus Points

• SOA Best Practices (2008)
• Enterprise Architecture (EA)
• Business Process Management (BPM)
• Application Platform as a Service (APaaS) and Integration as a Service (IaaS)
• Flexible Business Capacity Achieved by being Event-driven
• Web 2.0