Beyond ROI
Ultimately, ROI translates to profit, Trombetta says, but ending your analysis there can be misleading he warns.
By on Jul 24, 2006Ultimately, ROI translates to profit, Trombetta says, but ending your analysis there can be misleading he warns. A company may show strong growth - but digging a little deeper reveals that it is not growing as fast as the rest of its industry and is losing market share.
We always need to know a benchmark, he warns. How fast are we growing and who are we up against? You need to be growing at least as fast as the industry.
So Trombetta suggests supplementing ROI analysis with other measures to get a better assessment. First he recommends analyzing sales versus assets.
To me, it's one of the top three methods, he says. It determines how well you'sre using your assets. Nobody's in business to own assets. You'sre in business to use assets. So, what kind of assets do you have and what's the return?
Johnson & Johnson is a good example, he says. In a 2003 analysis Trombetta did for Pharmaceutical Executive magazine, J&J's profit to sales ratio was 17%, below the industry average of 23-24% - ranking it 9th out of 14 pharmaceutical companies. But the company's sales to assets ratio was 0.94 (2nd only to GlaxoSmithKline). And that means J&J had a 16% profit to assets ratio ranking it 4th out of 14 companies.
It's a much better metric than profit to sales, he argues. But what's the crunch metric?'s If you'sre on a desert island and can only bring one metric, what is it? It's not ROI!
Branding, in particular corporate branding, is a valuable metric, Trombetta says. He believes, like Baruch Lev of New York University, that companies should be putting intellectual assets on their balance sheets.
You have to assess whether you have any brand equity, Trombetta says. It stated with Marlboro cigarettes back in the 60s. The Marlboro brand was 20% of Philip Morris's sales, but 50% of its profits. Sounds a lot like Lipitor and Pfizer, doesn'st it?
A branded pharmaceutical company is worth about five times it annual sales, he says. Pfizer paid $60 billion for Pharmacia, whose annual sales were $12 billion. But when it comes to generics, Teva only pays 1.2 to 2.5 times the annual sales for a generics acquisition.
Trombetta says companies should consider how to build brand equity and essentially force the use of their products the Intel inside concept of branding.
Companies have three assets that drive earnings: cash, which returns 4.5%; physical, plant and equipment assets, which return 7%; and intellectual capital or brand equity, which has proven to return about 10.5%.
Trombetta says consumers today don'st really care if your toothpaste gets their teeth 2% cleaner than the competition. I care about what your company stands for, what your position is. Are you a company that pollutes the environment? Do you contract work out overseas? But, oh boy, that's another seminar!
The point, however, Trombetta says, is that the pharma industry has an opportunity to develop that kind of value in its business. He points to another Philip Morris example.
Six months before a new advertising campaign, the company polled people asking whether they agreed that it was making things better in the US. At that time, only 9% agreed strongly.
Then they ran a series of ads showing a Philip Morris truck pulling into a storm ravaged town with a supply of drinking water, Trombetta says. Six months after the campaign, 49% of those polled agreed strongly that the company was doing things to benefit the country.
So PR and all of these things are there for us, he says. It's another metric.
Another important area to consider is customer and individual brand profitability, Trombetta says. One company, he says, showed a $2 million profit, but when you looked at their three main products, one made $3 million, one broke even and one lost $1 million.
You'sre sure better off knowing that breakout, than just saying Wow, we made $2 million last year, he says. What if you'sre J&J and you have 150 operating companies in 100 countries with maybe 100 product lines with an average profitability of 25%. If you could just change the profitability on any below average ones by 0.1% can you imagine the impact on your overall profitability?
Trombetta says it is an interesting way to think about metrics that doesn'st readily come to mind at most companies.
Customer satisfaction is another metric to consider, he stresses. If you turnover is 40% and you can cut that to 30%, the impact on lifetime value over 5 years is fairly significant, Trombetta says. Because it costs more to gain new customers than to keep existing ones, if you focus more on retaining customers, he says, although sales may not increase, profit to sales will due to lower marketing costs.
But the real crunch metric, Trombetta says, is enterprise value to sales. Pfizer has the highest enterprise value, he says, simply because they do $55 billion in sales. But in his 2006 analysis for Pharmaceutical executive, he says, Genentech had the highest enterprise value to sales.
Enterprise value to sales is everything! Trombetta insists. IBM's sales are much higher then Microsoft's, but Microsoft's enterprise value is twice as high.
He also stresses the importance of growth. Home Depot beats Lowe's on every metric you can come up with, except Lowe's is growing faster and so their stock costs more, he says. Growth is a key and the correlation of growth is innovation.
Executives surveyed about innovative companies outside their own industries don'st name a single pharma in the top 25, Trombetta says. We us innovation to justify our prices and were not in the top 25?
Genentech is 27th, J&J is 53rd, Pfizer is 55th and Amgen is 87th according to Trombetta. And they'sre all behind Coca-Cola, he says. When was the last time they did anything innovative? This affects share value and growth.
There are three kinds of innovators: true product innovators, process masters and business model revolutionaries, he says. And innovation is measured by overall revenue growth, percent revenue from new products and new product success ratios.
Jeff Immelt of GE say 60% of his company's future growth will come from emerging countries, Trombetta reports. There are 4 billion people on the planet that make two dollars or less a day, but to be successful in emerging markets, companies must think differently about things like access and affordability, he says.
But he says companies also must be innovative in addressing negative metrics, like chief executive compensation. Something has to change fast, he says.
The bottom line, Trombetta says, is not to leave traditional ROI assessments behind, but to begin to also look to other performance metrics to determine the true impact of a company's actions on the total value of its business.