CHAPTER INTRODUCTION
In this chapter, we will focus on developing projections over the long term. We will build on the practices and techniques introduced in Chapter 12, Business Projections and Plans. Long‐term projections (LTPs) are required to evaluate new products, acquisitions, capital investments, and strategic plans.
In simpler times, LTPs could be easily developed by extrapolating historical performance trends or extending static business models. Over the past 30 years, factors such as globalization, technology developments, geopolitical events, demographics, and economic factors have significantly impacted markets and businesses.
Developing projections of performance over an extended period introduces some unique challenges that require a robust process to overcome. Uncertainty about the future should imply that most LTPs should be accompanied by multiple scenarios and thorough identification, testing, and evaluation of underlying assumptions.
Long‐term projections (LTPs) will have an extended time horizon, ranging from two to five or more years. The methods and considerations used for short‐ to midterm projections are usually not well suited to LTPs. There should be less emphasis on performance details and more understanding of strategic issues, market forces, and long‐term performance drivers.
The longer the horizon of our plan or projections, the greater the uncertainty. Few of us standing here now could have reasonably expected many of the events and changes experienced in just the past several years. Many of the strategic plans developed five years ago may appear absurd in hindsight, given the changes that could not have been anticipated. So why plan? Again, the value is in the planning, not the plan itself. If these organizations identified risks and opportunities and developed alternative scenarios, then they likely were better prepared to react to unforeseen changes that have unfolded.
The value in any plan is not the document or a single projection. The value is the critical thinking, anticipation, and identification of critical assumptions, critical success factors (CSFs), and performance drivers.
The model must be robust to consider radical changes to an organization's market, distribution channel, business model, and cost structure over a three‐ to five‐year period. One scenario should be a simple extrapolation of recent performance trends. Other scenarios should flex key assumptions about the economy, market drivers, key cost drivers, and other factors. An important aspect of strategic planning is the identification of alternative courses of action. The long‐term model must be able to portray the financial implications and results of various alternatives.
The key lies in the critical thinking the management team steps through in thinking about a range of potential scenarios.
Many organizations limit the content of long‐term projections to the income statement. Long‐term projections must include a complete view of the expected performance, including the balance sheet, cash flow and investment evaluation, and valuation. Any evaluation of future decisions or alternatives must include expected capital requirements, liquidity, a determination of the economic value created, and an evaluation of the investments contemplated in the plan. Why would any responsible executives embark on a plan that, if achieved, does not create value or cannot be financed by the firm?
Long‐term projections are developed and utilized for a number of applications. The format and content of the projections must be tailored to the specific application.
LTPs must be developed as part of any strategic planning process. These projections will estimate the results of a certain strategy and allow for the evaluation of strategic alternatives. The LTPs must be developed using a robust model that can project financial results over several years (the planning horizon).
The evaluation of potential new products should include a complete plan containing strategic plan, execution plan, and financial projections. New product development activities are investments and should be analyzed as such. The financial projections must include all investments in development and capital as well as projected sales and expenses. New product development projections are covered in Chapters 20 and 21.
The evaluation of potential new businesses should also include a complete plan containing strategic plan, execution plan, and financial projections. New business creation activities are investments and should be analyzed as such. The financial projections must include all investments in development and capital as well as projected sales and expenses. Projections for new business plans are covered in Chapters 20 and 21, and the valuation of businesses is covered in Chapter 22.
Mergers and acquisitions (M&A) represent substantial investments that must yield a return in the form of future financial results. The evaluation of potential acquisitions should also include a complete plan containing strategy, execution, and financial projections. The investment in an acquisition includes the purchase price, associated costs, and costs to implement synergies. Future projections must consider the stand‐alone results of the acquirer and the target and the projected synergies resulting from the combination. M&A is covered in detail in Chapter 23.
In addition to new products, new business, and M&A decisions, many other capital investment decisions will require long‐term projections. Examples include geographic expansion, purchases of manufacturing equipment, and plant expansions, which will all require the development of long‐term projections.
The process of developing an LTP is not simply a number‐crunching exercise. The analyst must work closely with key managers and become extremely familiar with the strategic issues and opportunities of the organization. Significant consideration of strategic issues, opportunities, markets, and competitors must be reflected in the LTP. Best practices such as market analysis, benchmarking, competitor analysis, and SLOT analysis should be employed.
As with any projection, LTPs must start with an assessment of the current situation and environment. This is particularly true with long‐term projections. This process must include an assessment of the organization's strengths, limitations (or weaknesses), opportunities, and threats (SLOT) (Figure 14.1). The external environment must be monitored and reflected in the plan. The analyst must also be familiar with the strategic plan. A determination of the status of previous strategic objectives must be made. Recent performance trends must be identified and their impact on future performance considered.
In developing the model for use in developing LTPs, it is important to incorporate history. This has two advantages. First, the inclusion of history helps to identify key drivers and assumptions that are critical to projecting future projections. Second, it provides confidence in the relationship between these drivers and the actual financial results posted in prior years represented in the LTP model.
Strategic issues must be considered in the development of LTPs. These may include changes in the overall market, competitive threats, weaknesses that must be overcome, and many other issues that will impact future financial performance.
Critical assumptions and business drivers that will affect future performance must be explicitly identified. Too often, these are buried in formulas in a model that prevent review and testing. These items will vary for each individual business. In some cases, market forces will be the most important. In others, product life cycles and introduction plans are critical. Key costs drivers must be identified and incorporated into LTP models.
Critical assumptions must be documented, reviewed, and tested. Sensitivity and scenario analysis should be integral elements of the plan.
One of the objectives of strategic planning is to consider alternatives to the company's existing or primary strategic direction. This may be the most important contribution of the strategic planning and LTP process. Examples of strategic alternatives include alternative distribution channels, entering new product or geographic markets, and acquisitions. Other scenarios that are often explored are competitive threats, disruptive technologies, or flexing broad economic assumptions. The LTP model must be flexible enough to develop these alternative scenarios efficiently.
This section briefly covers techniques for projecting key areas of financial performance. These will be illustrated with two models in this chapter. Of course, any model must be tailored to the specific situation of each organization. Additional models and best practices are included in Part Four, Planning and Analysis for Critical Business and Value Drivers.
Revenue is typically the most important driver and generally the most difficult to predict, both in the long term and in the short term. Accordingly, it warrants the most thought and attention. The drivers that are most important will vary greatly from company to company and may vary over time. In some cases, key revenue drivers will be product related and must consider new product introductions and product life cycles. This would certainly be important for Apple and other technology device providers. Other drivers may include market forces, foreign currency rates, macroeconomic trends, and competitors. Table 14.1 focuses on product drivers and market and competitive share.
TABLE 14.1 LTP: Revenue and Margin Projections
02-04-2018 14:23 | Revenue and Margins | LRP | ||||||||||
History | CY | Projections | CAGR | |||||||||
2014 | 2015 | 2016 | 2017 | 2018 | 2019 | 2020 | 2021 | 2022 | History | Future | Assumptions/Notes | |
Sales Product 1200 | 500 | 495 | 485 | 475 | 469 | 450 | 430 | 420 | 400 | −1.5% | −3.4% | Successful model slowly showing lower volume |
Gross Margin | 250 | 245 | 237.65 | 232.75 | 225.12 | 211.5 | 197.8 | 189 | 180 | |||
% | 50% | 50% | 49% | 49% | 48% | 47% | 46% | 45% | 45% | |||
Sales Product 1250 | 0 | 15 | 50 | 100 | 125 | 130 | 132 | 130 | 125 | 4.6% | Introduced 2015 | |
Gross Margin | 0 | 8.25 | 27.5 | 55 | 68.75 | 70.2 | 71.28 | 68.9 | 65 | |||
% | #DIV/0! | 55% | 55% | 55% | 55% | 54% | 54% | 53% | 52% | |||
Sales Product 1300 | 300 | 250 | 200 | 150 | 100 | 20 | 0 | 0 | 0 | −18.4% | −100.0% | Older model at tail end of product life cycle |
Gross Margin | 150 | 125 | 100 | 75 | 50 | 10 | 0 | 0 | 0 | |||
% | 50% | 50% | 50% | 50% | 50% | 50% | #DIV/0! | #DIV/0! | #DIV/0! | |||
Sales Product 1400 | 50 | 52 | 48 | 47 | 53 | 58 | 62 | 66 | 70 | −2.0% | 8.3% | |
Gross Margin | 24 | 26 | 24 | 23.5 | 26.5 | 29 | 31 | 33 | 35 | |||
% | 48% | 50% | 50% | 50% | 50% | 50% | 50% | 50% | 50% | |||
Sales Product 2000 | 0 | 0 | 0 | 25 | 75 | 200 | 300 | 500 | 600 | − | 88.8% | Introduced 4th quarter of 2019 |
Gross Margin | 0 | 0 | 0 | 12.5 | 37.5 | 80 | 120 | 200 | 240 | |||
% | #DIV/0! | #DIV/0! | #DIV/0! | 50% | 50% | 40% | 40% | 40% | 40% | |||
Sales Total | 850.0 | 812.0 | 783.0 | 797.0 | 822.0 | 858.0 | 924.0 | 1,116.0 | 1,195.0 | −4.0% | 8.4% | |
Gross Margin | 424.0 | 404.3 | 389.2 | 398.8 | 407.9 | 400.7 | 420.1 | 490.9 | 520.0 | |||
% | 50% | 50% | 50% | 50% | 50% | 47% | 45% | 44% | 44% | |||
Revenue Growth Y/Y ($M) | −10 | −38.0 | −29.0 | 14.0 | 25.0 | 36.0 | 66.0 | 192.0 | 79.0 | |||
Revenue Growth Y/Y % | 2% | −4.5% | −3.6% | 1.8% | 3.1% | 4.4% | 7.7% | 20.8% | 7.1% | |||
Market Size and Share | ||||||||||||
This Company | 850.0 | 812.0 | 783.0 | 797.0 | 822.0 | 858.0 | 924.0 | 1,116.0 | 1,195.0 | −4.0% | 8.4% | |
Competitor 1 | 50.0 | 50.0 | 50.0 | 50.0 | 50.0 | 50.0 | 50.0 | 50.0 | 50.0 | 0.0% | 0.0% | |
Competitor 2 | 500.0 | 600.0 | 700.0 | 800.0 | 900.0 | 950.0 | 1,050.0 | 1,125.0 | 1,250.0 | 18.3% | 9.3% | |
Competitor 3 | 145.0 | 159.5 | 175.5 | 193.0 | 200.0 | 220.0 | 242.0 | 266.2 | 292.8 | 10.0% | 8.7% | |
Competitor 4 | 200.0 | 175.0 | 150.0 | 100.0 | 75.0 | 50.0 | −13.4% | −100.0% | ||||
Total Market | 1,745.0 | 1,796.5 | 1,858.5 | 1,940.0 | 2,047.0 | 2,128.0 | 2,266.0 | 2,557.2 | 2,787.8 | 3.2% | 7.5% | |
Market Share | 48.7% | 45.2% | 42.1% | 41.1% | 40.2% | 40.3% | 40.8% | 43.6% | 42.9% | |||
Market Growth | 51.5 | 62.0 | 81.5 | 107.0 | 81.0 | 138.0 | 291.2 | 230.6 | ||||
Market Growth Rate | 3% | 3% | 4% | 6% | 4% | 6% | 13% | 9% | ||||
Our Share of Market Growth | −74% | −47% | 17% | 23% | 44% | 48% | 66% | 34% |
Gross margins are impacted by several factors, including product mix, margins on new products, production and commodity costs, transportation costs, and currency. In our example in Table 14.1, the gross margin projection is incorporated into the revenue plan.
Projecting costs and expenses over several years presents some unique challenges (Table 14.2). Many organizations start with a simple extrapolation of historical costs. For some types of expenses this is a practical approach. However, for significant expenses or those subject to high volatility, this approach is too simplistic, especially over a term of three to five years. Some expenses will vary with revenue levels. Others are driven by projects or investments that are incurred long before the associated revenue. Many others are highly volatile, including health care, commodity prices, and staffing. For these volatile and unpredictable costs, different scenarios or sensitivity analysis should be incorporated into the plan. They also should be reviewed for potential mitigating actions over the course of the plan.
TABLE 14.2 LTP: Operating Expense Projections
Operating Expenses | LRP | |||||||||||
History | CY | Projections | CAGR | |||||||||
2014 | 2015 | 2016 | 2017 | 2018 | 2019 | 2020 | 2021 | 2022 | History | Future | Assumptions/Notes | |
Research and Development | ||||||||||||
Base | 75.0 | 79.5 | 84.3 | 89.3 | 94.7 | 100.4 | 106.4 | 112.8 | 119.5 | 6.0% | 6.0% | |
Incremental Project Expenses | ||||||||||||
Product 1250 | 12.0 | 7.0 | 4.0 | Competed 2016 | ||||||||
Product 2000 | 10.0 | 40.0 | 20.0 | Product Development started 2017 | ||||||||
All Other | 5.0 | 7.0 | 12.0 | 17.0 | ||||||||
Total R&D | 87.0 | 91.5 | 95.3 | 99.3 | 134.7 | 120.4 | 106.4 | 124.8 | 136.5 | 4.6% | 6.6% | |
Y/Y Growth ($M) | 0.05 | 5% | 4% | 4% | 36% | −11% | −12% | 17% | 9% | |||
% of Sales | 10% | 11% | 12% | 12% | 16% | 14% | 12% | 11% | 11% | |||
Marketing | ||||||||||||
Base | 50.0 | 53.0 | 56.2 | 59.6 | 63.1 | 66.9 | 70.9 | 75.2 | 79.7 | 6.0% | 6.0% | |
Product Launch 1250 | 12.0 | Launch Costs based on Product Development | ||||||||||
Product Launch 2000 | 5.0 | 22.0 | ||||||||||
Product Launch Other | 1.5 | 1.0 | ||||||||||
Total Marketing | 50.0 | 65.0 | 57.7 | 59.6 | 68.1 | 88.9 | 70.9 | 75.2 | 80.7 | 7.4% | 6.3% | |
Y/Y Growth ($M) | 0.05 | 30% | −11% | 3% | 14% | 31% | −20% | 6% | 7% | |||
% of Sales | 6% | 8% | 7% | 7% | 8% | 10% | 8% | 7% | 7% | |||
Selling, General and Administrative | ||||||||||||
Base | 115.0 | 121.9 | 129.2 | 137.0 | 145.2 | 153.9 | 163.1 | 172.9 | 183.3 | 6.0% | 6.0% | |
Initiatives‐Cyber Security Program | 2.0 | 12.0 | 5.0 | 3.0 | 3.0 | 3.0 | ||||||
Legal Settlement | 2.0 | 12.0 | ||||||||||
Consultant Strategic Plan | 4.0 | |||||||||||
IT New System | 1.0 | 4.0 | ||||||||||
Total SG&A | 117.0 | 121.9 | 141.2 | 143.0 | 157.2 | 158.9 | 166.1 | 175.9 | 186.3 | 9.9% | 5.4% | |
Y/Y Growth ($M) | 5% | 4% | 16% | 1% | 10% | 1% | 5% | 6% | 6% | |||
% of Sales | 14% | 15% | 18% | 18% | 19% | 19% | 18% | 16% | 16% | |||
Total Operating Expenses | 254.0 | 278.4 | 294.2 | 301.8 | 360.0 | 368.2 | 343.4 | 375.9 | 403.5 | 7.6% | 6.0% | |
% of Sales | 29.9% | 34.3% | 37.6% | 37.9% | 43.8% | 42.9% | 37.2% | 33.7% | 33.8% | |||
Y/Y Growth ($M) | 24.4 | 15.8 | 7.7 | 58.2 | 8.2 | −24.7 | 32.4 | 27.7 | ||||
Y/Y Growth % | 10% | 6% | 3% | 19% | 2% | −7% | 9% | 7% |
In developing LTPs we must consider two capital requirements: (1) working capital and (2) property and equipment.
Working Capital. Working capital requirements can be a significant cash requirement, especially in growth situations. These can easily be estimated in the future by using key metrics such as days sales outstanding (DSO) and inventory turns to project receivables and inventory balances in the future. However, these metrics may change in the future owing to changes in distribution channels, markets, manufacturing, and integration decisions.
The Capsule Financial Summary table at the end of this main section includes projected working capital based on historical measures for DSO, days sales of inventory (DSI), and accounts payable and accrued as a percentage of sales.
Property, Plant, and Equipment (PP&E). If significant, future estimates of PP&E should be based on the existing bases of assets and future capital requirements. Depreciation and accumulated depreciation should be based on the anticipated additions.
Most organizations have a base level of expenditures to support general business and replacement requirements. To this base level of capital expenditures, we must estimate any large expenditures to support strategic initiatives, for example manufacturing facilities to support new product introductions and also to expand manufacturing facilities.
Once the capital plan is developed, depreciation expense can be estimated using a model similar to Table 14.3.
TABLE 14.3 LTP: Capital Assets and Depreciation
The LTP model generally should include balance sheet and cash flow projections. In addition to working capital and PP&E, other important balance sheet captions can be incorporated into the model. For many captions such as prepaids, other assets, or accruals, these can be estimated using the historical percentage to sales. Each should be examined for any unique driver that would warrant further analysis and thought.
After estimating future these future asset and liability levels (and profit and loss), we can model the financing and capital requirements and cash balances or shortages. Some strategic plans will result in self‐financing scenarios, whereas others will require significant additional capital to fund future growth and investments. By developing an integrated model, we can estimate the cash generation or requirements derived by the plan. We can also project and evaluate any potential conflicts with existing financing restrictions or loan covenants.
Our simple model effectively projects cash flow, cash balances, and financing requirements in Table 14.4.
TABLE 14.4 LTP: Capsule Financial Summary
History | CY | Projections | Historical | Future | |||||||
2014 | 2015 | 2016 | 2017 | 2018 | 2019 | 2020 | 2021 | 2022 | CAGR | CAGR | |
Income Statement | |||||||||||
Sales | 850.0 | 812.0 | 783.0 | 797.0 | 822.0 | 858.0 | 924.0 | 1,116.0 | 1,195.0 | −2% | 8% |
Gross Margin | 424.0 | 404.3 | 389.2 | 398.8 | 407.9 | 400.7 | 420.1 | 490.9 | 520.0 | ||
% | 50% | 50% | 50% | 50% | 50% | 47% | 45% | 44% | 44% | ||
Operating Expenses | 254.0 | 278.4 | 294.2 | 301.8 | 360.0 | 368.2 | 343.4 | 375.9 | 403.5 | 6% | 6% |
Income from Operations | 170.0 | 125.9 | 95.0 | 96.9 | 47.9 | 32.5 | 76.6 | 115.0 | 116.5 | ||
% | 20.0% | 15.5% | 12.1% | 12.2% | 5.8% | 3.8% | 8.3% | 10.3% | 9.7% | ||
Other Income (Loss) | 1.0 | −1.0 | 1.5 | 0.7 | 0.5 | 0.7 | 0.8 | 0.6 | 0.5 | ||
Profit Before Taxes | 171.0 | 124.9 | 96.5 | 97.6 | 48.4 | 33.2 | 77.4 | 115.6 | 117.0 | ||
Net Income | 111.2 | 81.2 | 62.7 | 63 .4 | 31.4 | 21.6 | 50.3 | 75.2 | 76.0 | ||
% | 13.1% | 10.0% | 8.0% | 8.0% | 3.8% | 2.5% | 5.4% | 6.7% | 6.4% | ||
Balance Sheet | |||||||||||
Cash | 47.8 | 83.9 | 134.0 | 161.6 | 139.0 | 130.9 | 107.2 | 125.9 | 169.8 | ||
Receivables | 158.0 | 175.0 | 170.0 | 174.7 | 168.9 | 176.3 | 189.9 | 229.3 | 245.5 | ||
Inventory | 120.0 | 145.0 | 140.0 | 147.3 | 153.2 | 169.1 | 186.4 | 231.2 | 249.7 | ||
Property & Equipment | 52.0 | 64.0 | 77.0 | 92.0 | 137.0 | 154.0 | 217.0 | 236.0 | 257.0 | ||
Accumulated Depreciation | −38.4 | −47.2 | −56.6 | −68.0 | −81.9 | −97.8 | −117.2 | −137.7 | −159.5 | ||
Other | |||||||||||
Total Assets | 339.4 | 420.7 | 464.4 | 507.5 | 516.1 | 532.5 | 583.3 | 684.7 | 762.6 | ||
Accounts Payable | 125.0 | 132.0 | 141.0 | 119.6 | 98.6 | 103.0 | 110.9 | 133.9 | 143.4 | ||
Accrued Liabilities | 60.0 | 68.0 | 51.0 | 63.8 | 74.0 | 77.2 | 83.2 | 100.4 | 107.6 | ||
Other | 4.4 | ||||||||||
Long‐Term Debt | 0.0 | 0.0 | 0.0 | 0.0 | 0.0 | 0.0 | 0.0 | 0.0 | 0.0 | ||
Other | |||||||||||
Capital | 40.0 | 40.0 | 40.0 | 40.0 | 40.0 | 40.0 | 40.0 | 40.0 | 40.0 | ||
Retained Earnings | 110.0 | 180.7 | 232.4 | 284.2 | 303.5 | 312.4 | 349.3 | 410.4 | 471.6 | ||
Total Liabilities and Equity | 339.4 | 420.7 | 464.4 | 507.5 | 516.1 | 532.5 | 583.3 | 684.7 | 762.6 | ||
Proof | 0.0 | 0.0 | 0.0 | 0.0 | 0.0 | 0.0 | 0.0 | 0.0 | 0.0 | ||
Operating Capital | 88.6 | 120.0 | 118.0 | 138.7 | 149.5 | 165.3 | 182.2 | 226.2 | 244.3 | ||
Cash Flow | |||||||||||
Net Income | 111.2 | 81.2 | 62.7 | 63.4 | 31.4 | 21.6 | 50.3 | 75.2 | 76.0 | ||
Add: D&A | 8.4 | 8.8 | 9.4 | 11.4 | 13.9 | 15.9 | 19.4 | 20.6 | 21.8 | ||
Capital Expenditures | −7.0 | −12.0 | −13.0 | −15.0 | −45.0 | −17.0 | −63.0 | −19.0 | −21.0 | ||
(Increase) Decrease in Operating Capital | −5.0 | −31.4 | 2.0 | −20.7 | −10.8 | −15.8 | −16.9 | −44.0 | −18.1 | ||
Operating Cash Flow | 107.6 | 46.6 | 61.1 | 39.2 | −10.4 | 4.7 | −10.3 | 32.8 | 58.7 | ||
Debt Borrowings (Payments) | |||||||||||
Dividends | −10.0 | −10.5 | −11.0 | −11.6 | −12.2 | −12.8 | −13.4 | −14.1 | −14.8 | ||
Cash Flow | 97.6 | 36.1 | 50.1 | 27.6 | −22.6 | −8.1 | −23.7 | 18.7 | 43.9 | ||
Key Metrics | |||||||||||
Y/Y Revenue Growth | −4% | −4% | 2% | 3% | 4% | 8% | 21% | 7% | |||
Operating Expense % of Sales | 29.9% | 34.3% | 37.6% | 37.9% | 43.8% | 42.9% | 37.2% | 33.7% | 33.8% | ||
Tax Rate | 35% | 35% | 35% | 35% | 35% | 35% | 35% | 35% | 35% | ||
Days Sales Outstanding | 68 | 79 | 79 | 80 | 75 | 75 | 75 | 75 | 75 | ||
Days Sales Inventory | 103 | 130 | 130 | 135 | 135 | 135 | 135 | 135 | 135 | ||
Accounts Payable % Sales | 14.7% | 16.3% | 18.0% | 15.0% | 12.0% | 12.0% | 12.0% | 12.0% | 12.0% | ||
Accrued Expenses % Sales | 7.1% | 8.4% | 11.0% | 8.0% | 9.0% | 9.0% | 9.0% | 9.0% | 9.0% | ||
Debt to Total Capital | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | ||
Return on Assets | 32.7% | 19.3% | 13.5% | 12.5% | 6.1% | 4.1% | 8.6% | 11.0% | 10.0% | ||
Return on Equity | 74.1% | 36.8% | 23.0% | 19.6% | 9.2% | 6.1% | 12.9% | 16.7% | 14.9% | ||
Return on Invested Capital | 73.7% | 37.1% | 22.7% | 19.4% | 9.1% | 6.0% | 12.8% | 16.6% | 14.8% | ||
Estimated Enterprise Value | 1,020.0 | 755.3 | 569.9 | 581.4 | 287.3 | 195.2 | 459.8 | 690.2 | 698.9 | ||
Estimated Value of Equity | 1,020.0 | 755.3 | 569.9 | 581.4 | 287.3 | 195.2 | 459.8 | 690.2 | 698.9 |
For most organizations, the overall objective is to create value for shareholders. It would be inappropriate to prepare a strategy and an LTP that do not estimate and evaluate the levels of returns (e.g. ROIC) and value creation (estimated share price or value of business). The results for ROIC and shareholder value in Table 14.3 would certainly provide cause for reevaluating this plan!
The models used to develop projections of performance well into the future are likely to be complex. The results of the LTP model must be summarized and presented for effective communication and presentation. The best way to accomplish this is to prepare a well‐designed presentation summary (see Figure 14.2) and integrate it directly into the LTP model. This will facilitate presenting the outcome of revisions and scenario analysis.
Many organizations are facing significant changes in their market or disruptive forces such as technology or nontraditional competitors. Such is the fate of traditional brick‐and‐mortar retailers as e‐commerce retailers continue to drastically cut into their market share.
In the past, a projections model for a retailer would focus on maintaining sales for existing stores and opening new stores. Table 14.5 is a high‐level summary of the key drivers. Revenue growth would be driven by opening new stores and increasing sales per store.
TABLE 14.5 Traditional Retail Model
Retailer Traditional Model | |||||||||
Existing Stores | 2012 | 2013 | 2014 | 2015 | 2016 | 2018 | 2019 | 2020 | |
# of Stores | 865 | 911 | 957 | 1008 | 1064 | 1120 | 1181 | 1242 | |
Average Revenue per Store ($M) | 12.5 | 12.6 | 12.7 | 12.8 | 12.9 | 12.9 | 12.9 | 12.9 | |
Revenue Existing Stores | 10,813 | 11,479 | 12,154 | 12,902 | 13,726 | 14,448 | 15,235 | 16,022 | |
Total Store Margin | 2,163 | 2,296 | 2,431 | 2,580 | 2,745 | 2,890 | 3,047 | 3,204 | |
% | 20.0% | 20.0% | 20.0% | 20.0% | 20.0% | 20.0% | 20.0% | 20.0% | |
Store Closings | 4 | 4 | 4 | 4 | 4 | 4 | 4 | 4 | |
New Store Openings | |||||||||
# of Stores | 50 | 50 | 55 | 60 | 60 | 65 | 65 | 70 | |
1st Year Revenue per Store ($M) | 4.0 | 4.0 | 4.0 | 4.0 | 4.0 | 4.0 | 4.0 | 4.0 | |
Revenue from New Stores | 200.0 | 200.0 | 220.0 | 240.0 | 240.0 | 260.0 | 260.0 | 280.0 | |
Capital Investments | |||||||||
Capital Investment New Store | 1.2 | 60.0 | 60.0 | 66.0 | 72.0 | 72.0 | 78.0 | 78.0 | 84.0 |
Capital Investment Store Refurb* | 0.5 | 43.3 | 45.6 | 47.9 | 50.4 | 53.2 | 56.0 | 59.1 | 62.1 |
Total Capital Investment Stores | 103.3 | 105.6 | 113.9 | 122.4 | 125.2 | 134.0 | 137.1 | 146.1 | |
* Remodel/Update 10% of stores per year | |||||||||
Total Store Operations | |||||||||
# of Stores, end of year | 915 | 961 | 1,012 | 1,068 | 1,124 | 1,185 | 1,246 | 1,312 | |
Total Revenue | 11,013 | 11,679 | 12,374 | 13,142 | 13,966 | 14,708 | 15,495 | 16,302 | |
Store Margins | 2,163 | 2,296 | 2,431 | 2,580 | 2,745 | 2,890 | 3,047 | 3,204 | |
% | 20% | 20% | 20% | 20% | 20% | 20% | 20% | 20% | |
Capital Investments | 103.3 | 105.6 | 113.9 | 122.4 | 125.2 | 134.0 | 137.1 | 146.1 | |
Y/Y Growth | 6.0% | 6.0% | 6.2% | 6.3% | 5.3% | 5.4% | 5.2% |
Now these retailers are faced with declining sales in their stores and are forced to offer more promotions and discounts to retain customers. Some are attempting to change the product offerings and store experience to stem the tide. Many traditional retailers are also attempting to build online businesses to participate directly in this new retail segment. Consider how these dynamics would be represented in a long‐term projections model. (See Table 14.6.)
TABLE 14.6 New Reality for Established Retailers
Retailer | |||||||||
The New Reality | |||||||||
Existing Stores | 2012 | 2013 | 2014 | 2015 | 2016 | 2018 | 2019 | 2020 | |
# of Stores | 865 | 911 | 957 | 987 | 967 | 932 | 904 | 900 | |
Average Revenue per Store ($M) | 12.5 | 12.6 | 12 | 11 | 10.5 | 10.5 | 10 | 9 | |
Revenue Existing Stores | 10,813 | 11,479 | 11,484 | 10,857 | 10,154 | 9,786 | 9,040 | 8,100 | |
Total Store Margin | 2,163 | 2,296 | 2,297 | 2,171 | 2,031 | 1,957 | 1,808 | 1,620 | |
% | 20.0% | 20.0% | 20.0% | 20.0% | 20.0% | 20.0% | 20.0% | 20.0% | |
Store Closings | 4 | 4 | 10 | 25 | 40 | 40 | 16 | 16 | |
New Store Openings | |||||||||
# of Stores | 50 | 50 | 40 | 5 | 5 | 12 | 12 | 12 | |
1st Year Revenue per Store ($M) | 4.0 | 4.0 | 4.0 | 4.0 | 4.0 | 4.0 | 4.0 | 4.0 | |
Revenue from New Stores | 200.00 | 200.00 | 160.00 | 20.00 | 20.00 | 48.00 | 48.00 | 48.00 | |
Capital Investments | |||||||||
Capital Investment New Store | 1.2 | 60.0 | 60.0 | 48.0 | 6.0 | 6.0 | 14.4 | 14.4 | 14.4 |
Capital Investment Store Refurb* | 0.5 | 43.3 | 45.6 | 95.7 | 98.7 | 96.7 | 93.2 | 90.4 | 90.0 |
Total Capital Investment Stores | 103.3 | 105.6 | 143.7 | 104.7 | 102.7 | 107.6 | 104.8 | 104.4 | |
* Remodel/Update 20% of Stores per Year | |||||||||
Total Store Operations | |||||||||
# of Stores, end of year | 915 | 961 | 997 | 992 | 972 | 944 | 916 | 912 | |
Total Revenue | 11,013 | 11,679 | 11,644 | 10,877 | 10,174 | 9,834 | 9,088 | 8,148 | |
Store Margins | 2,163 | 2,296 | 2,297 | 2,171 | 2,031 | 1,957 | 1,808 | 1,620 | |
% | 20% | 20% | 20% | 20% | 20% | 20% | 20% | 20% | |
Capital Investments | 103.3 | 105.6 | 143.7 | 104.7 | 102.7 | 107.6 | 104.8 | 104.4 | |
Y/Y Growth | 6.0% | −0.3% | −6.6% | −6.5% | −3.3% | −7.6% | −10.3% | ||
Same store sales growth | |||||||||
E‐Commerce | |||||||||
Invest in E‐commerce Platform | 100 | ||||||||
Sales | 50.0 | 250.0 | 500.0 | 1,000.0 | 1,700.0 | 2,500.0 | |||
Margin | 15% | 7.5 | 37.5 | 75.0 | 150.0 | 255.0 | 375.0 | ||
% | 15% | 15% | 15% | 15% | 15% | 15% | |||
Total Retail Operations | |||||||||
Revenue | 11,013 | 11,679 | 11,694 | 11,127 | 10,674 | 10,834 | 10,788 | 10,648 | |
Margins | 2,163 | 2,296 | 2,304 | 2,209 | 2,106 | 2,107 | 2,063 | 1,995 | |
% | 20% | 20% | 20% | 20% | 20% | 19% | 19% | 19% | |
Y/Y Growth | 6.0% | 0.1% | −4.8% | −4.1% | 1.5% | −0.4% | −1.3% | ||
Capital Investment | 103.25 | 105.55 | 243.70 | 104.70 | 102.70 | 107.60 | 104.80 | 104.40 |
This simple model allows us to consider the dynamics of the new reality for retailers, including:
Figure 14.3 provides a comparison of the traditional retail environment to the new reality. This comparison of the traditional versus the new reality retail environment clearly demonstrates the challenges faced by brick‐and‐mortar retailers and the significant change in their business models going forward.
Long‐term projections are utilized to evaluate a wide range of business decisions. The longer horizon introduces more risk and greater uncertainty in the projections. The models need to focus on critical assumptions and performance drivers and allow the user to flex these assumptions and easily estimate performance under various scenarios.
LTPs should present a comprehensive view of performance, extending beyond the income statement to investment requirements, cash flow, returns, and valuation.