VALUE CREATION THINKING FOR MANAGEMENTS BOARDS AND INVESTORS

www. Value. Creation. Thinking. com Madden unites the fundamentals of financial valuation with a unique emphasis on corporate purpose, culture, and knowledge. … He provides an important contribution to our understanding of capitalism at a critical moment and an illuminating roadmap for the future of business. —Dominic Barton, Global Managing Director, Mc. Kinsey & Co. “A free society is an engine of wealth creation … Bart Madden’s Value Creation Thinking is driven by the philosophy that an understanding of that [wealth creation] process defines a path to the long term increase in investor returns. … Beware the crony capitalist firm seeking profits from favors; the money is in creating value for customers. ” —Vernon L. Smith, Chapman University, Nobel Laureate in Economics, 2002 © 2016 Bartley J. Madden Value Creation Thinking 2

PURPOSE OF THE FIRM Vision Survive and Prosper Win-Win Partnerships Future Generations © 2016

KEY MANAGEMENT RESPONSIBILITY KNOWLEDGE-BUILDING CULTURE § Innovation § Efficiency § Resource Allocation / Valuation

VALUE CREATION AND RETURN ON INVESTMENT Value Creator ROI = 15% Average 6% ROI = Cost of Capital Value Dissipator ROI = 3% $115 $106 $100 High Reinvestment Beneficial © 2016 Bartley J. Madden $100 Improve Efficiency $100 $103 Restructure 5

COMPETITION, INNOVATION AND RESOURCE ALLOCATION Blockbuster ROI % 6% © 2016 Bartley J. Madden

LIFE-CYCLE FRAMEWORK High Innovation Competitive Fade 3 % FADE Mature 1 Economic Returns 2

LIFE-CYCLE VALUATION MODEL s e at er n e g Warranted = Value LIFE t =1 © 2016 Bartley J. Madden 1 Economic Returns 2 Reinvestment Rates 3 Fade Today’s Asset Base Net Cash Receiptst (1+ Investors’ Discount Ratet)t 8

EASTMAN KODAK dominated the film and camera market for decades but failed to adapt to changing technology (digital photography). Rising CFROIs Outperformed S&P 500 © 2016 Bartley J. Madden 6% Long-term cost of capital Long-term underperformance vs. S&P 500 Source: Credit Suisse HOLT Global Database 9

LIFE-CYCLE PERFORMANCE OBJECTIVE Economic returns above the cost of capital, and reinvestment rates supportive of maintaining a favorable long-term fade rate. PURPOSE Vision KNOWLEDGEBUILDING CULTURE Survive and Prosper Win-Win Partnerships Future Generations © 2016 Bartley J. Madden Value Creation Thinking 10

INTUIT sells financial software to consumers and is well known for its purpose-driven culture that focuses on experimentation and fast learning. Big improvement in CFROIs © 2016 Bartley J. Madden Source: Credit Suisse HOLT Global Database 11

BRAD SMITH, CEO INTUIT “The culture you create lays the foundation that enables every other part of the company to grow and succeed. … job one in creating a culture is building a purpose-driven culture. What is the mission of the company? What is the bigger idea that we are all part of? It is the CEO’s job to articulate and communicate this purpose across the company, so team members at every level have something to rally around. At Intuit, our mission is to improve our customers’ financial lives so profoundly they can’t imagine going back to the old way. … One way leaders can create an action-oriented environment is to match inspiration with rigor, adopting a rapid experimentation culture. Great ideas are simply hypotheses unless matched with tangible proof they deliver meaningful impact. A rapid experimentation culture cuts through hierarchy (especially if leaders hold their own ideas to the same scrutiny of testing), creating an environment where everyone can innovate, and debate turns into doing. ” Source: Brad Smith, “The Most Important Job of a CEO, ” January 28, 2016, Observer. © 2016 Bartley J. Madden Value Creation Thinking 12

LIFE-CYCLE PERFORMANCE OBJECTIVE Economic returns above the cost of capital, and reinvestment rates supportive of maintaining a favorable long-term fade rate. PURPOSE INTUIT Vision KNOWLEDGEBUILDING CULTURE Survive and Prosper Win-Win Partnerships Future Generations © 2016 Bartley J. Madden Value Creation Thinking 13

MEDTRONIC’S CEO Bill George “Beat the Fade” during his tenure 19912001. Outperformed S&P 500

BILL GEORGE, FORMER CEO MEDTRONIC “In my experience motivating employees with a sense of purpose is the only way to deliver innovative products, superior service and unsurpassed quality over the long haul. … An organization of highly motivated people is hard to duplicate. The motivation will last if it is deeply rooted in employees’ commitment to the intrinsic purpose of their work. ” Source: Bill George, Authentic Leadership, 2003, p. 66 15

BETHLEHEM STEEL’S extreme dysfunctional culture and repetitive failure to earn the cost of capital

NUCOR management’s win-win relationship with employees began with Ken Iverson. © 2016 Bartley J.

KEN IVERSON, CEO NUCOR 1965 -1996 “The great and terrible irony of modern business is that so many managers feel overburdened with responsibility, while so many employees feel unchallenged and unfulfilled in their jobs. … Instead of telling people what to do and then hounding them to do it, our managers focus on shaping an environment that frees employees to determine what they can do and should do, to the benefit of themselves and the business. ” Source: Ken Ivenson, Plain Talk, 1998, p. 98. 18

LIFE-CYCLE PERFORMANCE OBJECTIVE Economic returns above the cost of capital, and reinvestment rates supportive of maintaining a favorable long-term fade rate. PURPOSE Vision KNOWLEDGEBUILDING CULTURE Survive and Prosper Win-Win Partnerships NUCOR Future Generations © 2016 Bartley J. Madden Value Creation Thinking 19

AMAZON has made big investments to seize large-scale, new markets (Kindle, cloud data services, etc. ) Management chose to dampen CFROIs to accommodate massive reinvestment © 2016 Bartley J. Madden Value Creation Thinking Source: Credit Suisse HOLT Global Database 20

JEFF BEZOS, CEO AMAZON “Companies get skills-focused, instead of customer-needs focused. When [companies] think about extending their business into some new area, the first question is “why should we do that—we don’t have any skills in that area. ” That approach puts a finite lifetime on a company, because the world changes, and what used to be cutting-edge skills have turned into something your customers may not need anymore. A much more stable strategy is to start with “what do my customers need? ” Then do an inventory of the gaps in your skills. Kindle is a great example. If we set our strategy by what our skills happen to be rather than by what our customers need, we never would have done it. We had to go out and hire people who know how to build hardware devices and create a whole new competency for the company. ” Source: Bloomberg Businessweek, “Bezos On Innovation. ” Interview, April 16, 2008. © 2016 Bartley J. Madden Value Creation Thinking 21

KEY LIFE-CYCLE ISSUES High Innovation Competitive Fade Mature FADE % Economic Returns Failing Business Model Long-term Cost of Capital Reinvestment Rates Organize for both efficiency gains and innovation in order to produce a favorable fade of economic returns and reinvestment rates. Build or acquire capabilities that can provide sustainable competitive advantage. © 2016 Bartley J. Madden AMAZON 22

LIFE-CYCLE REVIEWS FOR THE FIRM’S BUSINESS UNITS ü Value-relevant track records ü Strategy and reinvestment ü Reality Check - % Future Improve Resource Allocation Decisions ü Intangible assets © 2016 Bartley J. Madden Value Creation Thinking 23

LIFE-CYCLE STAGES AND % FUTURE High Innovation Competitive Fade Mature FADE % Economic Returns Failing Business Model Long-term Cost of Capital Reinvestment Rates + Positive % Future © 2016 Bartley J. Madden Value Creation Thinking 0% Future Negative % Future + 24

% FUTURE COMPANY EQUITY $BIL + DEBT $BIL = TOTAL FIRM $BIL - EXISING ASSETS $BIL = FUTURE INVEST $BIL % FUTURE General Motors 47 50 97 122 -25 Tesla Motors 29 8 38 10 28 74 Kohl’s 7 7 14 18 -4 -28 336 25 361 113 248 69 Amazon Source: Value. Creation. Thinking. com, May 31, 2016 data from Credit Suisse HOLT global database © 2016 Bartley J. Madden Value Creation Thinking 25

TOP & BOTTOM LIFE-CYCLE PERFORMERS WWW. VALUECREATIONTHINKING. COM TOP PERFORMERS % FUTURE BOTTOM PERFORMERS % FUTURE Vantiv 79 Apache -123 Fleetcor Technologies 79 Devon Energy -77 Verisk Analytics 78 Andarko Petroleum -25 Expedia 76 Ford -22 Equifax 75 Norfolk Southern -19 Nielsen Holdings 74 Carnival -18 Fiserv 74 Barrick Gold -16 Roper Technologies 73 CSX -15 IMS Health Holdings 73 -13 Paychex 72 Royal Caribbean Cruises Arcelor. Mittal -12 Source: Value. Creation. Thinking. com, August 25, 2016 data from Credit Suisse HOLT global database © 2016 Bartley J. Madden Value Creation Thinking 26

KNOWLEDGE-BUILDING CULTURE ü Chapter 4 of Value Creation Thinking – The Pivotal Role of Worldviews in Building Knowledge ü You. Tube video – Reconstructing Your Worldview in Five Minutes © 2016 Bartley J. Madden Value Creation Thinking 27