Starting situation – “size matters” – the squeakiest wheel gets the most oil!
Our client was an internationally established holding company for several wholesale and retail companies in the food, non-food, and consumer electronics sectors. Our client faced the challenge of distributing its scarce capital resources among the divisions in such a way as to ensure the maximum value added for the entire company. However, the company lacked a key element for the decision-making basis, namely the return risk profiles for the individual markets. The same cost of capital was estimated as the hurdle rate for all investments, irrespective of the operational business risk or regional footprint involved.
Project approach – differentiated cost of capital system and mapping of the country risk provided a transparent view of the return-risk profiles
The operational business risks our client faced were just as diverse as its divisions. In addition, some divisions operated in a number of high-risk countries, while others did business almost exclusively in Central Europe. For these reasons, the first step taken was to determine differentiated cost of capital as hurdle rates that were commensurate with the risks. A multi-factor model was developed for this, which, in addition to specific risk factors for each division, incorporated each one’s regional footprint into the result. Next, as part of a portfolio model, all the factors determining the return side were evaluated alongside the risks. A relative, mutual evaluation of all investment areas allowed clear statements to be made on strategic initiatives, ranging from disinvestment to growth and high capital allocation.
Finding – you can allocate your capital in a way that creates value only if you know all the risks and opportunities
Seemingly high return opportunities frequently encourage hasty investments. You can judge investments in terms of added value only if you have also made suitable allowance for all the risk factors involved. The actual operational business risk needs to be determined for the business model in question, and no standard requirements should be set across several industries. The regional footprint of a division also represents a risk driver that should not be discounted, and which must likewise be included in the return-risk profile.
- Fixing of segment-specific cost of capital as hurdle rate, while making allowance for all business and country risks
- Creation of a risk-return profile and derivation of strategic initiatives for all existing and potential future markets