What Is Return Driven Strategy? How Do Businesses Achieve Superior Financial Performance? (Strategic Management)

By Frigo, Mark L.; Litman, Joel | Strategic Finance, February 2002 | Go to article overview

What Is Return Driven Strategy? How Do Businesses Achieve Superior Financial Performance? (Strategic Management)


Frigo, Mark L., Litman, Joel, Strategic Finance


In this month's column, we discuss Return Driven Strategy, the framework for designing, developing, and evaluating business strategy driven to create long-term, superior shareholder returns.

In our first column, we described two pillars of strategic management: business strategy and business execution. There are a plethora of methodologies for business execution, including the Balanced Scorecard and value-Based Management. But here's a quick introduction to a holistic, interactive model for business strategy aimed at creating significant financial returns.

Evolution

The Return Driven Strategy model is a set of foundations and tenets of business strategy aggregated from both detailed research and extensive real-world applications. The academic and clinical research is founded on a screening of great corporate performance over periods of 10 years or more and then subsequently examining the commonalities in business strategy that have led to that performance. We "best practice" the strategies of the best performers.

Turning to application, this strategy model has been used in conceptualizing and developing strategic initiatives in a multitude of firms ranging from start-ups to multinationals. That work has led to an ever-evolving, living, breathing framework. Return Driven Strategy helps us to make better strategic decisions that are focused on higher returns, abnormally high growth rates, and sustained competitive advantages. The framework is summarized in a set of foundations and a pyramid of tenets as shown in Figure 1.

The Pyramid and Its Tenets

Eleven tenets of Return Driven Strategy form a hierarchy of interrelated activities that companies must perform to become superstar financial performers. These tenets summarize major common themes of the strategies of great company performance--and point out flaws or failed initiatives when examining marginal or poor performers. The tenets are grouped as goal tenets, competency tenets, and supporting tenets. Great financial results are the direct result of management's focus and commitment to them.

The three goal tenets set the tone from the top. First and highest, business strategy must be focused on maximizing financial value creation, something many companies fail to do because of misaligned compensation plans and/or misdirected motivations. Common examples include managements that build fiefdoms instead of markets and ones that seek accounting profits instead of cash flows.

But when management's attentions are correctly aligned with shareholders, a clear path can be cut. Without question, that path is through customers. If a company dominates large and high-growth markets by fulfilling unmet customer needs, it will undoubtedly display exceptional cash flow returns on ever-increasing cash flow investments. Any other path cannot be so certain.

In the middle of the pyramid, the three competency tenets summarize the competitive bases upon which companies must approach their chosen markets. Superior financial performance follows innovation of offerings to increase need fulfillment, as Abbott Labs, Pfizer, Merck, and Eli Lilly have demonstrated for so many years. What company would not strive to emulate Emerson Electric and General Electric and the operational effectiveness and efficiency in which they have unquestionably excelled, conserving economic and consumer resources? Clearly, the attention to branding in companies like Coca-Cola, Gillette, and Colgate shows the value of creating an intellectual and emotional connection between the consumer and the company's offerings.

Interestingly enough, each of these companies mentioned makes for a great example of any of the competency tenets. Consumer goods companies with superior financial results are also experts in offering innovation. The pharmaceutical companies we mentioned understand and execute well on the value of branding their goods. …

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