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CompensationMaster Newsletter Article, December 2001 While there are a number of factors that impact the share price
of a company, the two basic drivers remain earnings (or profit) and the
multiple applied to earnings.
Two companies with the same profit, working in the same overall
environment, frequently have different multiples; these multiples dramatically
impact the value of the company and therefore the share price.
For example, a company with a $10,000,000 profit and a multiple
of 5 times earnings receives a $50 million valuation, while another company
with the same profit and a 7.5 times multiple has a value of $75 million.
While many companies focus on increasing profit, and therefore
shareholder value, relatively few focus the same effort on improving their
multiple. So, what drives this multiple?
The first driver is economic expectations. If the economy is
deteriorating, even though profits have not yet fallen, share prices will drop
and multiples retract on expectations of leaner times. Despite the fact that
this is outside of management's direct control, it is important to note that
some companies do not drop as significantly as their counterparts.
This is due to the influence of the second driver, corporate
expectations. These expectations are a function of the company's ability to
lead the industry. Proven leaders typically have higher multiples than others
in the same industry, regardless of economic expectations. One of the key
leadership criteria is whether or not a company has a sustainable competitive
advantage.
So if a company's compensation plans strengthen the company
financially, increasing profit immediately and protecting earnings in a
downturn, it would provide such a sustainable advantage.
Such a solution does exist today and has stood the test of
time. It is particularly effective when the primary distribution channel is
through people whose skill is key in binding the consumer to the company.
Examples range from industries that use a typical sales force, like real estate
and manufacturing, to professional service organizations, such as law firms and
dental offices.
The companies that have used this bold new approach have
experienced increased productivity from their existing staff and improved
ability to recruit key revenue providers from their competitors. They typically
have seen an immediate increase in profit and have been able to retain their
lead even after competitors copied their strategy.
An article outlining the approach was published in the January
2001 issue of Compensation & Benefits Review and can be viewed in Adobe
Acrobat format at http://www.compensationmaster.com/resources.html.
The essence of the approach is:
1. Design compensation plans so that after the company has recovered
its costs plus a profit from each revenue-producing individual, those
individuals can then receive substantially more of the revenue they bring in.
This drives productivity and immediately increases profit. It
also creates a naturally cost-efficient environment and improves recruiting.
2. Offer choices that empower the individual to find the right
compensation fit; usually this involves selecting the risk-reward relationship
that works best for each revenue-producer.
This maximizes recruiting and retention and lowers the
breakeven point of the company, increasing its survivability and maintaining
profitability, even in a downturn.
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