Profitability and Productivity

Profitability has many interpretations, often competing with other metrics as a means of measuring corporate performance. The DuPont ratio spread is explored in this chapter as useful in identifying and providing meaningful interpretations across a range of management activities, strategic effectiveness, investment strategy, operating efficiency, and shareholder returns. However, there are differing views on what comprises “profit”. Kay (1993) argued that while organisations appraise success by size of sales, or share price performance, market share, return on a measure of investment or perhaps sales or growth rate, a realistic measure of corporate success is value added, a derivative of economic profit. To be of use as a performance metric, value added, requires to be quantified. Operating margins are one indication of value that is added at each stage of production. However, this has problems. One problem concerns the charge made for the use of capital in the production process. Here the concept of economic profit can be used. Economic Value Added (EVA) is a financial management technique developed by Stern and Stewart (1996), a financial consultancy that built upon Kay’s (1993) conceptual work. Other topics having an influence on profitability include cost driver analysis, total cost of ownership, and the importance of cross business network synergies. Walters and Rainbird (2007) discussed the application of EVA in the value chain network as have Walters and Helman (2020). We consider EVA to be a primary performance metric which implies managing EVA involves the cost items that operating management has responsibility for and, therefore, has immediate control over. It assumes that investment in operating assets be identified and omitted from the Operating EVA. Other interest income and other equity income are very unlikely to have a significant impact on operating decisions, therefore, we suggest this to be an Operating EVA.