Operationalizing DuPont Formula, Part 3

Recall the DuPont Formula can be deconstructed into several components:

ROE = (1-T) x (ROAI + (Leverage*(ROAI - Cost of Debt)) where

• T = Effective Tax Rate of the firm, Tax Expense/Earnings Before Taxes

• ROAI = Earnings Before Interest Expense and Tax Expense (EBIT) / Asset Investment (AI). Recall, Asset Investment = Equity + Interest Bearing Debt

• Leverage (L) = Interest Bearing Debt/Equity, and

• Cost of Debt = Interest Expense/Interest Bearing Debt, this ratio estimates the interest rate paid on the firm's debt over the time period under study.

So, where to focus? First, the place to emphasize improvement in ROE is to focus on ROAI and Cost of Debt. In the case of Dry Bean, they were clearly in a great position using our benchmark of ROAI - Cost of Debt > +2%.

In the quest to enhance Return on Advertising Investment (ROAI), businesses can explore various strategies and approaches aimed at boosting their productivity and profitability. One effective way to achieve this is by implementing comprehensive practices across different aspects of the organization. These practices may include refining marketing strategies, streamlining operational processes, optimizing resource allocation, and enhancing customer engagement. By adopting a holistic approach, companies can create a synergy that maximizes the impact of their efforts and resources.

In a series of upcoming blog posts, we will delve deeper into these broader practices and dissect their individual components to provide a more detailed understanding of how they contribute to improving ROAI. By examining each practice in isolation, we can uncover specific techniques, tools, and methodologies that companies can leverage to drive better results. From analyzing market trends and consumer behavior to fine-tuning advertising campaigns and refining sales processes, there are numerous avenues for organizations to explore in their pursuit of enhancing ROAI.

By breaking down these practices into separate blog posts, we can offer a more focused and in-depth exploration of each topic, allowing readers to gain valuable insights and practical knowledge that they can apply within their own business contexts. Through this structured approach, we aim to empower companies with the information and strategies needed to optimize their ROAI and achieve sustainable growth and success in today's competitive landscape.

Broadstroke Strategies to Improve ROAI

Improving ROAI usually focuses on improving EBIT as a first step. Typically, price increases, increased sales volume, and expense control are critical to increasing operating profits. To encourage the team to focus on higher EBIT, there are a variety of policy steps a firm can implement including:

• Company-based Goal programs: In his book The Great Game of Business, During the pivotal transition period at Springfield Remanufacturing, Jack Stack played a crucial role in revolutionizing the company's approach to incentivizing employees. The implementation of a bonus program marked a significant shift in the organization's culture, motivating every employee to strive for excellence. By setting a minimum EBIT threshold based on EBIT/Sales ratio, Stack ensured that the company's financial performance was closely tied to the bonus structure. As Springfield Remanufacturing exceeded this threshold, the bonus system came into effect on both a quarterly and annual basis, creating a sense of achievement and recognition among the workforce. This strategic move not only boosted morale but also fostered a strong sense of ownership and accountability among employees, driving them to contribute their best to the company's success. As the company evolved, Stack introduced more sophisticated bonus programs that aligned individual and team goals with specific operational and financial targets. This approach not only encouraged collaboration and teamwork but also ensured that employees at all levels were actively engaged in working towards the company's overarching objectives. Overall, Jack Stack's emphasis on implementing a structured and performance-driven bonus program at Springfield Remanufacturing not only transformed the organization's incentive system but also laid the foundation for a culture of excellence, innovation, and continuous improvement.

• Implement performance improvement frameworks like "Gainsharing" programs. Gainsharing is a performance-based incentive program that aligns employees' interests with company success by improving specific metrics or KPIs. It involves measuring performance against a baseline, sharing savings or improvements with employees, and includes elements like performance measurement, financial sharing, employee involvement, and supporting systems.

  • Gainsharing benefits small businesses by motivating employees, improving teamwork, and driving continuous improvement. Key implementation considerations include setting clear goals, transparency, fairness, regular evaluation, and legal compliance. This approach incentivizes employee contribution to company growth, boosting profitability and sustainability, leading to improved performance and employee satisfaction.

• Evaluate Alternative Business Models like Co-ops - A cooperative (Co-Op) is a business model where individuals collectively own and operate the business for mutual benefit. In small businesses, cooperatives can be worker, consumer, producer, or purchasing cooperatives. Some characteristics of Co-ops:

  • Democratic Governance - Each member typically has one vote.

  • Member Financial Participation: Members contribute to and control the cooperative's capital.

  • Education, Training, and Information: Provided to enhance members' contributions to the cooperative's growth.

  • Inter-Cooperation: Collaboration to strengthen the cooperative movement.

  • Benefits for small businesses include collective bargaining power that enhances negotiation leverage with suppliers; Risk Sharing among members; and community backing with enhanced ties within the local community.

• Employee Stock Ownership Programs (ESOPs) - An Employee Stock Ownership Plan (ESOP) is an employee benefit plan that provides workers with ownership interest in the company they work for, typically in the form of company stock. ESOPs are designed to align the interests of employees with those of the company's shareholders, fostering a sense of ownership and investment in the company's success.
  

  • Establishment and Financing: An ESOP is set up as a trust fund where companies contribute either newly issued shares, cash, or borrow funds to acquire shares.
    

  • Allocation: Shares are distributed to individual employee accounts within the trust based on factors such as compensation or years of service.

  • Vesting: Employees' entitlement to shares typically vests gradually, with complete vesting usually occurring within three to six years.
    

  • Distribution: Upon retirement, termination, or departure, employees receive the value of their shares, with private companies being obligated to repurchase them at fair market value.

In the upcoming series of blog posts, I am excited to delve deeper into these concepts by intertwining personal anecdotes with a thorough analysis of various research studies. By exploring the nuances and practical applications of these models and policies, we can gain a richer understanding of their impact on organizational productivity. It is important to recognize that while there may not be a perfect model or policy, the integration of any of these practices can often yield substantial enhancements in a company's performance metrics, such as Return on Assets Invested (ROAI) or Return on Equity (ROE). Through real-world examples and empirical evidence, we will uncover the intricacies of how these strategies can be tailored and implemented to drive tangible improvements in business outcomes. Stay tuned for insightful discussions that blend theory with practice to illuminate the path towards enhanced productivity and success in the corporate landscape.

Return on Assets Invested

		2020	2021	2022
EBIT		199	241	354
Assets Inv
Equity		78	178	340
Int BearDebt		91	141	105
Assets Invested		169	319	445
ROAI		118%	76%	80%