Strategy and Performance Management|Human Resource Management
This case was written by Marjolein Bloemhof, Research Associate at INSEAD, under the supervision of Philippe Haspeslagh, Professor of Strategy and Management, and Regine Slagmulder, Associate Professor of Accounting and Control, both at INSEAD. It is intended to be used as a basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. Support from DSM in assembling the information presented in the case is gratefully acknowledged. Some case facts have been disguised for confidentiality reasons.
The authors gratefully acknowledge the financial support provided by the ABN AMRO Research Initiative in Managing for Value.
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It was April 2003, and Hans Dijkman, Business Group Director of DSM Melamine, had just attended a Business Strategy Dialogue (BSD) meeting. DSM Melamine was the global leader in the manufacture and marketing of melamine, a chemical compound used to make highly resistant surfaces, supplying almost one third of world demand. However, Dijkman and his team faced significant challenges in terms of cost competitiveness, aggressive competition, market maturity in Europe and the US, and emerging growth, particularly in 论文帮助/论文写作服务/负担得起我及时提交我最好的质量 – China.
Business Strategy Dialogues had been introduced at DSM in the mid-90s to help structure the firm’s strategy development process. The BSD process consisted of five distinct phases resulting in a thorough review of the industry, market trends, customer needs, competition and the position of the relevant business group. In 2001, as part of its new Value Based Business Steering (VBBS) system, DSM had also started to align its strategic planning and financial management processes by introducing Strategic Value Contracts. These contracts contained both performance indicators to monitor the implementation of strategy, and value drivers to measure economic value-creation.
BSDs were initiated whenever either the business or corporate felt the need, on average every three years. DSM Melamine was currently performing its fourth BSD at the request of Dijkman who felt that the current ‘actively maintain’ strategy would soon fail to achieve the financial performance targeted in his Strategic Value Contract.
Management of DSM Melamine had been discussing the possibility of pursuing a ‘grow and build’ strategy. They felt that they had reached the limits of cost reduction and that the only way to grow for DSM Melamine was by investing in new melamine plants. Dijkman, however, doubted whether corporate management would agree with this change. Would they emphasize the corporate strategy of becoming a specialties company and thus be reluctant to invest heavily in a commodity such as melamine, or would they let VBBS principles prevail and let themselves be swayed by Melamine’s financial track record?
From State Mines to Specialty Company
DSM origins go back to 1902 when the Dutch government founded Dutch State Mines (DSM) as a state-owned coal-mining company. In the 100 years of its existence DSM reinvented itself several times from what was originally a coal mining company, first, as a petrochemicals business, then a commodity chemicals business, and more recently a specialties company.
DSM became a public company in 1989. In 1993, Simon de Bree was appointed CEO and under his leadership DSM continued working on a portfolio shift towards advanced chemical and biotechnical products for the life sciences industry and performance materials. These activities were characterized by good earnings, quality, and strong growth. When de Bree stepped down in July 1999 he was hailed for having reduced the company’s exposure to cyclicality and improved its structure by shifting towards a larger share of value-added products. He left the company in good shape both financially and portfolio-wise. Peter Elverding, the board member in charge of integrating Gist Brocades at that time, succeeded de Bree as CEO. Under his guidance, DSM was able to complete its strategic transformation into a specialty chemical company.
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By 2003, the company had more than 20,000 employees spread across 200 offices and production sites in 40 countries. It was the leading producer of life science products, performance materials and industrial chemicals, and had a turnover of €6 billion in 2002 (see Exhibit 1 for key figures). Its headquarters were located in Heerlen, in the south of the Netherlands, close to the site of the former coal-mines. In 2002, on the 100th anniversary of its foundation, DSM was given royal status and re-named Royal DSM.
Vision 2005: “Focus and Value Strategy”
One year after his appointment, Elverding announced the outcome of the Corporate Strategy Dialogue conducted in 2000 and labeled ‘Vision 2005: Focus and Value’. With the implementation of Vision 2005, DSM would complete its strategic transformation into a specialty chemicals company. Elverding announced that DSM was planning to spin off its petrochemical business. This decision was not without emotion as the petrochemicals business was regarded by many as the ‘roots’ of the chemical company.
In addition, Elverding announced ambitious targets of increasing annual sales by approximately 60% to €10 billion by 2005, despite the planned withdrawal from the petrochemicals business, which provided one-third of the company’s turnover in 2000. At least 80% of sales would have to be generated by specialty products; the rest would come from industrial chemicals, such as melamine and caprolactam, where DSM was already the global leader. Acquisitions would account for half of the sales increase and the remainder would be achieved through organic growth, roughly 6% per year.
Besides focusing on a global leadership position in the specialties business, Vision 2005 also addressed DSM’s desire to increase its market capitalization as management felt that the company’s stock was undervalued. There were several reasons for this underperformance, including concerns about DSM’s portfolio breadth relative to the size of the company, but management believed that the main reason was the market’s perception that DSM still was a cyclical stock with predominantly a commodity profile. Management hoped that the implementation of Vision 2005 would turn DSM into a real specialties company, leading to a re-rating and appreciation of its market capitalization. A major part of the Vision 2005 strategy was accomplished when DSM successfully sold its petrochemicals business to Saudi مساعدة التعيين – خدمة كتابة المقالات من قبل كبار الكتاب العرب, Arabian Basic Industry Corp (SABIC) in June 2002. With a total net consideration of €2.25 billion, this transaction was the largest single deal in DSM’s history. In a separate transaction, DSM sold its entitlement to an annual portion of the net profits of EBN1 to the Dutch government in December 2001. These transactions created a solid cash cushion of over €3 billion to fund the expansion of the specialty portfolio targeted in Vision 2005. To protect its cash trove from unwanted parties, and to keep the funds and transformation process transparent, DSM took the unusual step of placing the revenues from the disposals of EBN and the petrochemicals business into a new subsidiary, DSM Vision 2005 BV. The use of these resources required approval by the governing board of the foundation, which consisted of three members of DSM’s managing board and three members of the supervisory board. After the divestment of petrochemicals, DSM had become a substantially smaller company,
1 EBN: Energie Beheer Nederland, the entity controlling the state participations in the exploration,
production and marketing of natural gas in the Netherlands, the management of which was entrusted by the State to DSM.
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but with a portfolio that matched the desired profile. Specialties now represented well over two-thirds of total sales, justifying a reclassification from ‘bulk commodity player’ to ‘specialty player’.
In February 2003, Elverding was able to announce the next step in implementing Vision 2005 as DSM signed a contract to acquire Hoffman-La Roche’s vitamins, carotenoids and fine chemicals business for €1.75 billion, the largest acquisition it had ever made.2 The acquisition would help restore its total sales, which had been reduced to less than €6 billion as a result of the divestment of petrochemicals, to over €8 billion. More importantly, it would boost the specialty part of DSM’s portfolio and help achieve the goal of 80% of sales in specialties two years ahead of the scheduled date (2005). Various analysts were skeptical about the acquisition, however, because of the price pressure and the low growth prospects of the business.
The DSM Organization
DSM had a decentralized organizational structure built around 15 business groups (consisting of various business units) that were empowered to execute all business functions. The business groups were grouped into three strategic clusters, mainly for reporting purposes. (see Exhibit 2). DSM believed that this structure ensured a flexible, efficient and fast response to market changes. The business group directors reported directly to the managing board of directors. Staff departments at corporate level supported the managing board and the business groups. The business groups contracted the services of a number of shared service departments, DSM Research, and intergroup product supplies at market prices.
The managing board of directors was a collegial board with five members. It was responsible for making decisions about the company’s strategy, its portfolio policy, and the deployment of resources. Most board members were ‘board delegates’ for various business groups. The top management team consisted of the 15 business group directors and the corporate vice- presidents reporting to the board. The third layer of management consisted of 300 senior executives. The top 300 were considered ‘corporate property’; they were on one central payroll and Corporate had the authority to relocate these executives within DSM if they felt the need to do so.
DSM’s corporate culture was traditionally informal and consensus-oriented, as is the case in many Dutch companies. Long-standing careers at DSM were encouraged. However, because DSM had been a cyclical company where 90% of the business results were the outcome of external circumstances that could not be influenced, DSM historically did not have a strong accountability culture.
The Strategic Planning Process at DSM
Until the early 1990s, DSM had operated a traditional strategic planning process with planning and budget cycles taking place throughout the year However, DSM management was no longer satisfied with this process. They felt that Corporate Planning owned the 2 The deal was closed in September 2003, after the final approval of the anti-trust authorities was obtained.
Roche’s Vitamins & Fine Chemicals business was renamed DSM Nutritional Products (DNP).
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strategic planning process and that it served too many different purposes (corporate, divisional, business and functional strategy, internal and external). The process had become routine over time and had degenerated into a ‘numbers exercise’. The link between strategy and performance was not clear, but more importantly, top management felt that the quality of strategy development was poor. Most of the strategies focused mainly on cost reduction. The primary beneficiary of such strategies was not the company but its customers, since most of the cost savings were typically passed on to them through price reductions. To enhance the quality of the strategy development process, a new approach called the Business Strategy Dialogue (BSD) was introduced in 1992. These BSDs led to Corporate Strategy Dialogues (CSDs) which were intended to improve the corporate strategy development process.
Corporate Strategy Dialogue
DSM’s strategy development process started with an extensive study of the current situation and the outlook for the company for the next few years. The Corporate Strategy Dialogue was held every three years with a team of 40-50 company-wide executives. It was aimed at developing a long-term corporate strategy, with evaluations and choices being made about portfolio composition, investment priorities and geographical spread. The whole process took six to nine months and was wide-ranging, involving intensive discussions in DSM Corporate top meetings, with the supervisory board and the Central Works Council. The end product was a shortlist of corporate top priorities.
The first CSD was performed in 1994, followed by another in 1997 and a third in 2000. Besides new themes that were defined in each CSD, a number of common themes had consistently been part of the CSD, such as profitable growth, leadership position, coherent portfolio, reduction of cyclicality, growth markets, reduction of dollar-sensitivity, geographical spread, and being an attractive employer.
Once the priorities were set, the corporate strategic plan was to be implemented over the next two to three years. Focusing all energy on realizing its corporate priorities had allowed DSM to achieve most of them before their target dates.
Business Strategy Dialogue
The businesses were responsible for developing and implementing their (approved) Business Strategy Dialogues (BSDs). The purpose of a BSD was to provide a consistent method and terminology to help structure the strategy development process and improve its quality. BSDs were mostly initiated by the business groups themselves, but were sometimes requested by corporate. They occurred at regular intervals of three years on average.
The BSD process consisted of five phases with several steps within each phase. The five phases were: Characterizing the Business Situation; Analyzing the Business System at Macro Level; Analyzing the Business System at Micro Level; Options and Strategic Choice and Action Planning and Performance Measurement (see Exhibit 3). But before a BSD could be started, some preparatory work had to be done.
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Starting up
One of the first things to be done was to identify a facilitator and a challenger. To facilitate the implementation of the BSDs, Corporate had trained around 30 “facilitators” to support the business teams in its creative thinking process. They were selected from the top 350 executives and asked by the Chairman of DSM to become a facilitator. The task of a facilitator was to prepare the strategy development process with the business group director by defining the scope of the exercise, discussing the composition of the core team, examining the time schedule, drafting a list of important strategic issues, and appointing a project manager who was responsible for the operational part of the strategy development process. The most important role of the facilitator, however, was to make sure that the BSD led to real strategic options and a real choice, as expressed by Marthijn Jansen, facilitator:
“The role of the facilitator is to make sure that the BSD focuses on the right issues, that in the “options phase” the conversation diverges, and that in the defining of the KPIs phase, everything converges to a clear path and a clear view of the implications of the choices made.”
In addition to a facilitator, a ‘challenger’ was selected. The challenger had an important role as he/she had to question the BSD team about the assumptions, analyses and conclusions it made. Challengers were chosen from the top 100 managers within DSM. In addition to the internal challenger, a business group could also ask ‘outsiders’ to challenge them on specific issues. These outsiders – often (technology) specialists – also shared their knowledge.
The core team in the BSD typically consisted of the complete business management team supported by specialists from further down the organization. They were advised not to have more than 10 to 12 people as management felt that larger groups did not allow for effective discussion and hampered the creativity of the process. In large or complicated businesses sub- groups were formed to address specific questions. The BSD process consisted of workshops and discussion sessions led by the facilitator. Input and participation by all concerned was considered very important.
Characterizing the Business Situation
The objective of this phase was to collect and structure the necessary information to be used as input to the BSD. The Group provided the businesses with a strategic data checklist of the information that might be useful for the BSD such as environmental and market analysis, competitor assessments and analysis of manufacturing, R&D, HRM, finance and processes. Data were supplied by functional discipline. In addition to data gathering, the checklist offered a useful format for summarizing and presenting the information. The data set was structured in accordance with questions such as:
• What business are you competing in?
• Which other businesses and products are you competing with?
• How attractive is the industry in terms of growth and profitability?
• What is your competitive position (benchmarks)?
• What are the dynamics? What trends can be expected in your business system?
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Practice showed that this phase could take two to four months. Corporate management emphasized that the businesses should not view this information-gathering phase as a checklist exercise but rather approach it from an ‘issue-driven’ angle.
Analyzing the Business System at Macro Level
In this phase, which took approximately two days, the industry in which the business unit competed was analyzed from the outside in, based on Porter’s Five Forces model. The discussion focused on the examination of the value added in the business chain, the customers, the competitors, the business dynamics and the drivers of the industry. An important step was the analysis of the different generic strategies followed by key competitors. Understanding generic strategies forced the businesses to categorize the different ways in which a business could compete in the industry. A strategic group was defined as a cluster of companies following the same generic strategy. The outcome of this phase included a basic understanding of the ‘rules of the game’, i.e. the strategic groups in which the business might compete and a preliminary view of the key success factors (KSFs) that must be met in order to compete successfully within a certain strategic group.
Analyzing the Business System at Micro Level
In this phase the organization was analyzed from the inside out, by looking at the internal process. Important tools for the analysis of the internal value chain were market segmentation, activity-based costing, internal or (preferably) external benchmarking of functions, and assessment of the technological position. The conclusions of the micro-discussion included an analysis of the business unit’s capabilities – both strengths and weaknesses – to compete in its strategic group. This phase took on average two days.
Options and Strategic Choice
After having assessed the competitive environment and the business unit’s capabilities to compete successfully in its environment, the outcome of both steps were compared, i.e. internal capabilities were compared with the list of KSFs (see Exhibit 4 for an example of DSM Melamine). This allowed the business to make a choice as to the strategic group in which it wanted to compete. Furthermore, it allowed the business to verify whether it really could serve the selected market segments and determine what steps were necessary to achieve or sustain leadership within the strategic group.
Action Planning and Performance Measurement
Once the strategic choice had been made, the strategy had to be translated into an action plan and linked to performance measurement. Based on the strategic mission and objectives of the business unit a limited number of performance indicators that were important to the corresponding KSFs were selected. Performance indicators monitored the implementation of the strategy and were the measurable part of the KSFs, allowing comparisons with competitors and performance monitoring over time. Examples of performance indicators included market share, pipeline of products, quality, customer satisfaction, and cost per unit. The objective of performance measurement was to provide periodic information on the progress made toward the defined targets for each performance indicator. Furthermore, it helped management set objectives and target levels for the next period.
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Annual Strategic Review (ASR)
The Annual Strategic Review (ASR) was performed by each business group, and comprised a progress report on the implementation of the BSD, an update or reassessment of major business risks, an updated sensitivity analysis and updated financial projections. The ASRs of the business groups constituted the building blocks of the corporate ASR whose purpose was to monitor the execution of the Corporate Strategy Dialogue. An important element in the review was the confirmation that the chosen strategy in the BSD was still valid and that the implementation was on track. Therefore, the validity of the main assumptions on which the strategy was based had to be checked and the consequences of changes in the business environment for the strategy evaluated.
Benefits and Challenges of the BSD System
Benefits
In 2000, six years after its implementation, the BSD had become an accepted system for developing business strategy. DSM management was pleased with the improved quality of strategy formulation and the team-building aspects. One business group director coming from outside DSM commented:
“The strategic planning process is very good at DSM. It is a robust and effective process. And it is a living system, contrary to many other companies where people just ‘feed’ the system.”
Many people valued the ‘challenger’ part of the BSD, where someone from outside the business group challenged the assumptions and outcomes of the BSD. One business group director recalled:
“Corporate said to us: ‘The BSD is nice but not rigorous enough. Come back when you have really looked at the intrinsic value of each market segment. Not at macro level, but at market segment level.’ This was very good because it forced us to get a real grounding in segments.”
People agreed that the BSD process greatly enhanced the insights and understanding of the business. In addition, it forced alignment, both across functions in the business unit and with respect to the strategy. Furthermore, people felt that the BSD gave legitimacy to initiate changes later on when the business got to the implementation phase. Another big advantage of the process was that strategy development became a three-yearly process with just an annual update. One top executive of corporate planning commented:
“Performing a BSD is a lot of work. But once you are done, you are done for two to three years.”
Challenges
The final phase of the BSD – translating strategy into performance measurement – remained a challenge. Hein Schreuder, Corporate Vice President Strategy & Development, expressed his concern:
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“DSM invests heavily in a good strategic diagnosis, but the ultimate focus should be on delivery.”
Although DSM had improved the quality of strategic thinking in the planning process, the question remained indeed how to link it with execution.
Value Based Business Steering
In 2000, Henk van Dalen, Director of the DSM Polyethylenes business group, was appointed to the managing board. He believed that the necessary step to implement Vision 2005 and its promise for performance was a more intense focus on value-creation in the businesses. According to the newly introduced Value-Based-Business Steering (VBBS) concept, the overall target for DSM was to create value for all of its stakeholders, i.e. shareholders, employees, customers, and society.
DSM approached VBBS from three different angles. The first was accountability as the basis for financial control. The second was alignment of DSM’s strategic business planning processes to materialize its promise for performance. The third was the introduction of new financial operating metrics that translated Vision 2005 and BSDs into economic value terms. DSM decided to start with the third angle because it had the biggest impact on the organization and was a first step in aligning strategy with performance measurement. As a result, VBBS was strongly driven by the finance department – at least initially.
New Financial Business Steering Metrics
A new set of performance metrics was developed for internally measuring and managing financial performance in terms of value-creation (see Appendix 1). Cash Flow Return on Investment (CFROI) became DSM’s new yardstick for measuring the performance of its businesses. Contrary to other value-based management companies, DSM decided to use CFROI only for internal reporting and financial performance measurement, while ROI remained the performance measure for external reporting. A reason for this decision was that DSM felt that the complex CFROI calculations were difficult to explain to investors. Furthermore, DSM first wanted to see if the new metrics would work.
Total Shareholder Return was an important external performance indicator related to value- creation for DSM as a whole, but could not be directly linked to the performance of individual business groups. DSM chose to introduce Cash Value Added (CVA) to translate value- creation from a capital market point of view into an objective internal DSM measure. CVA represented the cash surplus generated (“value realized”) by a business once all capital providers had been compensated. To determine the “value created” by a business, DSM measured the increase in value (delta CVA) from year to year. Because DSM was a decentralized company, the group did not impose delta CVA targets; instead, target setting was done in a bottom-up fashion. To achieve a positive delta CVA and thus create value, a business could work on two key value drivers: by improving CFROI or by investing in profitable projects.
Investments were evaluated against the Internal Rate of Return (IRR) hurdle, i.e. the before- tax weighted average cost of capital (WACC). If an investment met the WACC hurdle, it
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created value. However, DSM imposed an additional performance standard by plotting the current business position and the historical performance of a business group on a so-called “C-curve” (see Exhibit 5).
The C-curve provided a clear indication of the preferred route to value-creation for a business depending on its current return. Three basic scenarios could be distinguished. For businesses that generated returns below the WACC, restructuring and improving the return was priority number one. Businesses that had returns around the WACC needed to improve their performance and were encouraged to explore methods to increase CFROI. Finally, businesses that had returns well above the WACC found themselves in a position that was profitable; the way to create value for this kind of businesses was to grow while improving or maintaining CFROI.
Operationalizing VBBS
Value-creation for DSM as a whole was translated into the internal value-creation measure delta CVA. This measure could be applied at the business group level, but also at lower levels such as business units or product/market combinations. The next step in the VBBS process was to translate the abstract concept of value-creation into operational actions using the concept of value drivers. DSM defined a value driver as an “operational variable which can be influenced by acts of management and which has a direct link with value-creation.” Examples of value drivers included: working capital as a percentage of sales, raw material costs per ton, production costs per ton, and sales price per ton.
At this stage, the difference between value drivers and performance indicators became clear. Performance indicators were developed during the BSD and monitored the implementation of the strategy. Value drivers were developed during the VBBS analyses and monitored how the implemented strategy resulted in economic value-creation. Performance indicators applied to the strategic and tactical level and provided early warning signs (‘leading indicators’). In contrast, value drivers applied to the operational level of the organization and were financial and often results-based and therefore ‘lagging indicators’.
Value drivers and performance indicators did not necessarily have a one-to-one relationship. One performance indicator (e.g. market share) could influence multiple value drivers (e.g., volume, margin, cost), and vice versa, one value driver could be affected by several performance indicators. For the commodity businesses, value drivers and performance indicators often covered the same variables. For example, a value driver could be cost per ton, while the corresponding performance indicator would be a relative measure – costs compared to competitors. However, the link was much less clear for the specialty activities where factors such as the management of the innovation pipeline would be decisive for success. There could be a significant time lag between the filling of the pipeline with new products and the value-creation caused by higher sales volume resulting from these new products.
Once the metrics were defined and the concept of VBBS was clear, DSM started with the strategic assessment of its various businesses. These assessments yielded valuable new insights into the positioning of specific businesses. For example, some businesses that accounting wise (i.e., based on ROI) looked like diamonds in the portfolio, turned out to be value-destroying businesses from a CFROI perspective. Loek Radix, Director of Corporate Finance, explained:
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“I was almost physically attacked when I delivered that message. But the strategic assessments were a huge eye-opener about how we should manage a certain type of business. Before, there was an atmosphere of complacency in successful businesses. There was no mindset at all about delta value. However, it is not important what today’s value is; it is important what the evolution in value is.”
Although people got excited about the results from the VBBS assessments, implementing the new metrics and coming up with value drivers turned out to be a technically difficult and time consuming process. Although the consultants were able to explain the concept of CFROI and CVA, translating this into specific measures was extremely complex. According to Radix:
“The sweaty part starts when you really have to develop the metrics in detail. Questions like: ‘What do I do with foreign investment?’ or ‘What is the percentage of economic depreciation?’ were difficult to answer. We had to re- define items during the process. That was not really helping us in the introduction of VBBS and we got pushback from the operating managers.”
In early 2002, the general knowledge of the VBBS system in the DSM organization was still limited. Although top management understood the big picture, a survey testing more detailed knowledge showed that even at the
