Strategy debate moves to economic profit

The business strategy debate could soon be pushed towards relative outperformance, if a report by consultancy firm McKinsey, this month, wins advocates.

In the report McKinsey argues business strategy should be seen through the lens of economic profit (net operating profit minus the cost of capital). 

 It points out that the top quintile of the near 3000 large non-financial companies it analysed, generate $677bn in economic profit, which is on average70 times more economic profit than the groups in the second, third and fourth quintiles.  The bottom quintile destroyed $411bn in value, according to McKinsey. 

 McKinsey also found that 46% of companies had dropped out of this top quintile in the last decade, while only 11% of companies in the second, third and fourth quintiles rose to the top quintile. Its analysis shows 46% ascending to the top quintile were in industries making big moves, while a further 43% were from industries making moderate  moves. 

The report is a boon for those who believe corporate venturing and open innovation can transform company fortunes, as it suggests companies which wish to deliver the market beating value of the top quintile need to be quick to seize business opportunities, which many believe is helped by innovation and corporate venturing. Heidi Mason, managing partner of US-based consultancy firm Bell Mason Group, which is part of the Corporate Venturing and Innovation Initiative, said: “The McKinsey report suggests generating significant economic profit often requires ‘businesses to expand or reinvent themselves unusually rapidly,’ which is completely aligned with the conclusion we’ve reached from our work in the CV&I space.” 

Mason added: “We believe this is a great, very timely topic to inject into the current Corporate Innovation discourse, and an effective way to connect the output of corporate innovation to the enterprise in a more practical and meaningful way, offering additional support for making the case as to why corporate innovation must now be an integrated, ‘mainstream’ element in broader corporate strategy development and  management.”

One thing is certain, some corporates which have had a history of strong economic performance are highly aggressive in the way they use corporate venturing , even making a virtue of investing in regions which others shun . 

Last week, Marcos Battisti, Intel Capital’s head of Western Europe and Israel, at Barcelona-based conference White Bull, set out in an interview with White Bull’s founder Farley Duvall, how his group had invested more than $1.5bn in venture investments in Europe, the Middle East and Africa and $4.7bn in deals including larger investments such as ASML. Battisti also said the audience would be “shocked” by some of the regions which had driven its best returns, flagging up his good experiences in France, Sweden, Israel and also plugging the unit’s one deal in Spain, language technology company Indisys, which secured an exit to Intel this year.

We are highly keen to analyse the extent corporate venturing impacts the revenue and profits of parent companies. Any suggestions of practical examples of impact on the parent, or ways to measure this effectively,  would be much appreciated.