Tweet

Return on Investment

Written by: Douglas Long

Article Overview: How do we measure return on investment for people at any level in any organisation? I think that it comes down to the question of “What value does this person add?” With established operations, when I am looking at the organisation structure, I have one request that invariably causes problems. It’s a simple: “Please tell me exactly what the people answering to you do; and then tell me what you do that justifies your position.”

Return on Investment

On February 12, 2010 a writer in The Sydney Morning Herald, Michael Pascoe, made the following statement about the past CEO of Telstra in Australia. In an article entitled "Sol Trujillo was worse than he looked" Pascoe wrote: "When Trujillo and Co departed, it wasn't immediately possible to rank his performance. Parts were obviously bad, parts had promise. By the look of yesterday's interim results, the bits with promise were nowhere near enough to make up for the bad. More hat than cattle, as the saying goes, looking at where Telstra stands 5 years later."

The Sydney Morning Herald's "Good Weekend" of February 13, 2010 (p.14) had a similar theme. In an article entitled "Outrageous Fortune", Jane Cadzow points out that in 2003 Sydney University researcher John Shields concluded that the 20 best performing Australian companies paid their CEO's substantially less than did the 20 worst-performing companies. Shields is quoted as saying that "Against three criteria - return on equity, share price change, and change in earnings per share - statistical analysis shows that high executive pay levels actually coincide with a lower bottom line." Shields is quoted as saying that the 2003 research is still broadly true in 2010.

When I talk with Directors and senior executives I hear a lot about for need for measuring return on investment. It is one of the justifications I hear when companies are considering laying off staff, reducing their workforce by using part time workers, or outsourcing work to countries where far lower wages are paid. Usually we do a lot to measure the return received for work done by lower level echelons in most organisations and the drive for increasing the use of technology is based on the premise that the company can obtain better financial returns.

Why don't we apply this to the top echelons? If it can be done for the lower levels (and it both can and is) then surely it can and should be applied at the top - including Director remuneration.

For almost 20 years I have been arguing that remuneration at the top should be genuinely performance based. Although the myth is that this currently happens, the fact of huge bonuses and termination pays being made when the company is going backwards illustrates the discrepancy between myth and fact.

I suggest that the time is right for leaders - Company Directors, Legislators, Regulators, and Owners (shareholders) - to make a stand and insist on measuring return on investment at all levels and paying accordingly. By all means pay huge amounts (well into the $millions) if you believe that is what it takes to get the people you want at the top or anywhere else. I've no argument with that. But pay the bonus components on what happens to the organisation in the subsequent 5 years - especially in the event of a termination pay. In other words, if the organisation thrives after you leave then your money is assured: if it isn't then, "sorry, but you've done your dough!".

I'm not convinced that there is enough intestinal fortitude around for this to happen. Those executives who actually do provide long-term positive benefit to their companies - ie those who actually do provide a value-added component that sets the company up for on-going growth and success - have nothing to fear. I suspect it's the others who will prevail.

I think that's the point Pascoe is making, too.

Cadzow's article, however, makes a salient point between Company Executives and Entrepreneurs. Like me, she has no problem with entrepreneurs reaping the benefits of their labours - these are people who have taken a risk, established a business by a combination of hard work and some luck, have generally provided employment opportunities, and, in short, have contributed to the real wealth of the nation. Most company executives, in contrast, have usually risked none of their own money (equity as a bonus or a part of very high remuneration doesn't really count) and they know that in the event of corporate failure they will at least receive something.

We seem to have lost sight of this in most parts of the world. The result is that entrepreneurs can find it very hard to obtain support (especially in the very early days) and many of the people who withhold this support are men and women who have never taken a major financial risk in their lives despite themselves using other people's money in attaining their own goals. I think that very often people at the top end of organisations lose sight of the fact that they are employees - not entrepreneurial owners.

So how do we measure return on investment for people at any level in any organisation?

I think that it comes down to the question of "What value does this person add?"

With established operations, when I am looking at the organisation structure, I have one request that invariably causes problems. It's a simple: "Please tell me exactly what the people answering to you do; and then tell me what you do that justifies your position."

For people at the grass roots of an organisation it's easy. They never have any difficulty in explaining how they take various inputs and turn them into something else. But once I start dealing with various management levels the issue can quickly become clouded. Its hard to justify a pay differential between you and your reports if all you are doing is checking their work - essentially another clerical task - or if you are simply a clearing house that collates a variety of reports before passing them up the chain - often complete with original errors in spelling and grammar.

When this is then coupled with the question: "And now, please explain to me exactly how your actions add value to the overall wealth of the company and the nation", the excreta can hit the air-conditioning very quickly. I have found that the more senior the position the more rapidly the person wants to terminate the interview and/or avoid answering. "Waffling" or "beating around the bush" become common ways of responding.

Elliott Jaques in Requisite Organization (1998, Cason Hall & Co) suggests that managers add value because of their greater ability to deal with complexity and to see a bigger picture. He suggests that a unit manager should be able to deal with these from at least a 2-year perspective, a General Manager from at least a 5-year perspective, and a Corporate VP or CEO from at least a 20-year perspective.

Yet what I find is that time and again people at very senior levels are making decisions based on very short time perspectives - the next quarterly report, the annual budget, or the length of time before their contract expires. And under those conditions there are always difficulties justifying the value added that is claimed. The senior executive of most organisations seem to have great difficulty in giving me any understanding of how what they are doing now is going to impact on where the company hopes to be 10 or 20 years' hence.

Some useful questions about return on investment:

• What steps does your organisation take to measure the ROI on the remuneration you receive?
• As entrepreneurs, what steps do you take to measure the ROI on the people you employ to run your business?
• What are the time frames within which this ROI is to be measured?
• How does what you do add to the real wealth of the organisation and of the nation?

Related Articles
  Rates of Return: The Effects of Human Capital on Economic Development
  Understanding Return on Investment: How Can You Use This Data?
  Learn Basic ROI Calculation
  If you are going to buy a business, you need to accept business risk.
  Make More Money the Easy Way

Article Tags: organisation structure, remuneration, return on investment, value



Related Forum Posts
Investment Advisors vs Faciltators - Investment advisors provide advise to investors on public companies or investments. Leadsco is a telemarketing company for advisors - providing leads. Investment advisors will not put you in touch with investors. Violates compliance regulations. Facilitators are the best way to help you with strategy and offering for private investors or venture capital.
Which kind of industries are you interested in? - Ecological or E-business or Investment or Finance or Management or Non-Profit or Retailer or others.
How to valuate a business - Hi Garth - here is how we did it at Northern Crown Capital when I was helping them raise venture capital for Toronto-based entrepreneurs. Assume the start date is 2003 so 2008 projections are 5 years out: How Northern Crown Capital Valuates a Business 2008 Financial Projections Earnings Before Tax $5,865,000 Tax Rate 42% Taxes $2,463,300 Net Earnings $3,401,700 Amount Seeking to Raise Today $3,500,000 Discounted Value of Future Opportunity, 5 Years Out 2008 P/E Ratio 15 Value of Company in 2008 $51,025,500 Discount Rate Applied 30% Year 2008 $51,025,500 Year 2007 $35,717,850 Year 2006 $25,002,495 Year 2005 $17,501,747 Year 2004 $12,251,223 Value of Company at Investment in 2003 $12,251,223 Less: Investment Amount $3,500,000 Present Value $8,751,223 Discount for Risk & Private Company 40% Less: Discount for Risk & Private Company $3,500,489 Private Company Value $5,250,734 Present Value (What the Owner Keeps) $5,250,734 60.00% Financing (What the Investor Gets) $3,500,000 40.00% Total $8,750,734 100.00% I hope this helps!
Re: Invest in Real Estate or Stocks? - You can consider investing in Real Estate Investment Trusts (REITs). Buy and sell shares like stocks so they are easy to buy and sell, diversify and management is included.
CBC Entrepreneur Shows - Great suggestions JWGM! Venture is a great show and should be a staple for entrepreneurs looking to get motivation for their business and ideas that other companies are using. There aren't so many shows around anymore with the closure of Investment Television. I hope the Dragon's Den is getting good ratings and other networks will begin their own entrepreneur tv shows!


Share this article with your friends. Fund someone's dream.

Leave a comment below or share on the left and you'll help support entrepreneurs in Africa through our partnership with Kiva. Over $50,000 raised and counting - Please keep sharing! Learn more.

Tweet

Newsletter

Get advice & tips from famous business
owners, new articles by entrepreneur
experts, my latest website updates, &
special sneak peaks at what's to come!

Name:
Email:

Popular Articles

Selling On Ebay The Good The Bad And The Ugly

Fighting the Saw-Tooth Affect

Quick Tips on Buying a Business

Suggestions

Email us your ideas on how to make our
website more valuable! Thank you Sharon
from Toronto Salsa Lessons / Classes for
your suggestions to make the newsletter
look like the website and profile younger
entrepreneurs like Jennifer Lopez.