CS 222 01Programming Assignment 03 Chapter 0120 PointsDueFrida.docx

CS 222 01Programming Assignment 03 Chapter 0120 Points
Due:Friday, February 23, 2018
Write an Employee class that keeps data attributes for the
following pieces of information:
Employee name
Employee number
Be sure to include the appropriate accessor an mutator methods.
Next, write a class named ProductionWorker that is a subclass
of the Employee class. The ProductionWorker class should
keep data attributes for the following information:
Shift number (an integer such as 1, 2, or 3)
Hourly pay rate
The workday is divided into two shifts: day and night. The shift
attribute will hold an integer value representing the shift that
the employee works. The day shift is shift 1 and the night shift
is shift 2. Write the appropriate accessor and mutator methods
for this class.
Once you have written the classes, write a program that creates
an object of the ProductionWorker class and prompts the user to
enter data for each of the object’s data attributes. Use the
mutator methods to enter data into the objects. Store the data in
the object and then use the object’s accessor methods to retrieve
it and display it on the screen.
Add the following comments to the beginning of the program.
Name:Your Name
Class and Section:CS 222 01
Assignment:Program Assignment 03
Due Date:See above
Date Turned in:

Program Description:You write a short description of what the
program will do
When you complete the program, do the following.
1. Turn in a printout of the source code
2. Create a folder with the following name: Program 03
3. Copy your program and any related files to this folder
4. Copy the folder to the following location: I:koppinboxCS
222 01your name where your name is a folder located in
I:koppinboxCS 222 01.
Extra Credit: 5 points
Add an __str__ method to each of the classes. The __str__ for
the ProductionWorker class should call the __str__ of the
Employee class before constructing and returning its own data.
Add to the test program code to test __str__ through a print
statement.
2
Are share buybacks
jeopardizing future growth?
6
A better way to understand
internal rate of return
13
Profiling the modern CFO:
A panel discussion
19
Building a better
partnership between
finance and strategy

23
How M&A practitioners
enable their success
Perspectives on Corporate Finance and Strategy
Number 56, Autumn 2015
Finance
McKinsey on
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Table of contents
2
Are share buybacks
jeopardizing future

growth?
Fears that US companies
underinvest by paying
too much back to share-
holders are unfounded.
Rather, the rise in buybacks
reflects changes in
the economy.
6
A better way to
understand internal rate
of return
Investments can have the
same internal rate of return
for different reasons.
A breakdown of this metric
in private equity shows
why it matters.
2319
Building a better
partnership between
finance and strategy
The growing strategic role of
CFOs may create tension
with top strategists. That’s
a missed opportunity
for teaming up to improve
company performance.
Companies that are best at

transactions approach
M&A differently—but there’s
room for improvement
across the board.
13
A panel discussion
Seasoned finance chiefs
explore revamping business
models and coping with
new competitors, currency
risks, and changing
capital structures.
Interested in reading McKinsey on
Finance online? Email your name, title,
and the name of your company to
[email protected],
and we’ll notify you as soon as new
articles become available.
2 McKinsey on Finance Number 56, Autumn 2015
Returning cash to shareholders is on the rise for
large US-based companies. By McKinsey’s calcula-
tions, share buybacks alone have increased to
about 47 percent of the market’s income since 2011,
from about 23 percent in the early 1990s and less
than 10 percent in the early 1980s.1 Some investors
and legislators have wondered whether that
increase is tantamount to underinvestment in assets
and projects that represent future growth.

It isn’t. Distributions to shareholders overall,
including both buybacks and dividends, are
currently around 85 percent of income, about the
same as in the early 1990s. Instead, the trend
in shareholder distributions reflects a decades-long
evolution in the way companies think strategically
about dividends and buybacks—and, more
broadly, mirrors the growing dominance of sectors
that generate high returns with relatively little
capital investment.
In fact, ever since the US Securities and Exchange
Commission loosened its regulations on buy-
backs in 1982,2 companies have been changing the
way they distribute excess cash to shareholders.
So while dividends accounted for more than 90 per-
cent of aggregated distributions to shareholders3
before 1982, today they account for less than half—
the rest are buybacks (Exhibit 1). The shift makes
good sense. Empirically, the value to shareholders
is the same,4 but buybacks afford companies
more flexibility. Executives have learned that once
Are share buybacks jeopardizing
future growth?
Fears that US companies underinvest by paying too much back
to shareholders are unfounded. Rather,
the rise in buybacks reflects changes in the economy.
Tim Koller
© PM Images/Getty Images

3
they announce dividends, investors tend to
expect that the dividends will continue in
perpetuity unless a company falls into financial
distress. By contrast, a company can easily
add or suspend share buybacks without creating
such expectations.
Regardless of the proportion of buybacks to
dividends, there’s little evidence that distributions
to shareholders are what’s holding back the
economy. In fact, on an absolute basis, US-based
companies have increased their global capital
investments by an inflation-adjusted average of
3.4 percent annually for the past 25 years5—and
their US investments by 2.7 percent.6 That exceeds
the average 2.4 percent growth of the US GDP.
Furthermore, replacement rates have remained
similar. Capital spending was 1.7 times depreci-
ation from 2012 to 2014, compared with 1.6 times
from 1989 to 1999.7 The only apparent decline
is in the level of capital expenditures relative to the
cash flows that companies generate, which fell
to 57 percent over the past three years, from about
75 percent in the 1990s.
That’s not surprising, given how much the makeup of
the US economy has shifted toward intellectual
property–based businesses. Medical-device, pharma-
ceutical, and technology companies increased their
share of corporate profits to 32 percent in 2014,

Are share buybacks jeopardizing future growth?
Exhibit 1 Overall distributions to shareholders have fluctuated
cyclically since deregulation in
the mid-1980s, though the ratio of buybacks to dividends has
grown.
MoF 2015
Share buybacks
Exhibit 1 of 2
Share
buybacks
Dividends
1 For US nonfinancial companies with revenues greater than
$500 million (adjusted for inflation).
Source: Corporate Performance Analysis Tool; McKinsey
analysis
Distributions as % of adjusted net income, 5-year rolling
average1
90
100
110
80
70
60

50
40
30
20
10
0
1985 1990 2000 2010
of its profits. So a higher return on capital leads to
higher cash flows available to disburse to share-
holders at the same level of growth.
That is what’s happened among US businesses
as their aggregate return on capital has increased.
Intellectual property–based businesses now
account for 32 percent of corporate profits but only
11 percent of capital expenditures—around
15 to 30 percent of their cash flows. At the same
time, businesses with low returns on capital,
including automobiles, chemicals, mining, oil and
gas, paper, telecommunications, and utilities,
have seen their share of corporate profits decline
to 26 percent in 2014, from 52 percent in 1989
(Exhibit 2). While accounting for only 26 percent of
profits, these capital-intensive industries account
for 62 percent of capital expenditures—amounting
to 50 to 100 percent or more of their cash flows.

Here’s another way to look at this: while capital
spending has outpaced GDP growth by a small
amount, investments in intellectual property—
research and development—have increased much
faster. In inflation-adjusted terms, investments
in intellectual property have grown at more than
double the rate of GDP growth, 5.4 percent a
year versus 2.4 percent. In 2014, these investments
amounted to $690 billion.
Exhibit 2 The composition of the US economy
has shifted away from capital-
intensive industries.
MoF 2015
Share buybacks
Exhibit 2 of 2
1 Other includes capital goods, consumer staples, consumer
discretionary, media, retail, and transportation.
Source: Corporate Performance Analysis Tool; McKinsey
analysis
Share of total profits and capital expenditures
for US-based companies, %
After-tax
operating
profits
13
52

35
1989
32
26
42
2014
Technology,
pharmaceuticals, and
medical devices
Other1
Automotive, mining, oil,
chemicals, paper,
telecommunications,
and utilities
Capital
expenditures
56
33
1989
11
62

27
2014
11
from 13 percent in 1989. Since a company’s rate of
growth and returns on capital determine how much
it needs to invest, these and other high-return
enterprises can invest less capital and still achieve
the same profit growth as companies with lower
returns. Consider two companies growing at
5 percent a year. One earns a 20 percent return on
capital, and the other earns 10 percent. The
company earning a 20 percent return would need
to invest only 25 percent of its profits each year
to grow at 5 percent, while the company earning a
10 percent return would need to invest 50 percent
5Are share buybacks jeopardizing future growth?
1 For US nonfinancial companies with revenues greater than
$500 million (adjusted for inflation). Income is before
extraordinary items, goodwill write-downs, and amortization
of intangibles associated with acquisitions.
2 Rule 10b-18 of the US Securities and Exchange Commission
“provides companies with a voluntary ‘safe harbor’ from
liability
for manipulation under the Securities Exchange Act of 1934.”
3 Among nonfinancial companies in the S&P 500.
4 Bin Jiang and Tim Koller, “Paying back your shareholders,”

McKinsey on Finance, May 2011, mckinsey.com.
The author wishes to thank Darshit Mehta for his
contributions to this article.
Tim Koller ([email protected]) is a principal in
McKinsey’s New York office.
Copyright © 2015 McKinsey & Company.
All rights reserved.
Certainly, some individual companies are probably
spending too little on growth—just as others spend
too much. But in aggregate, it’s hard to make a broad
case for underinvestment or to blame companies
returning cash to shareholders for jeopardizing
future growth.
5 US-based nonfinancial companies with more than $500
million
in revenues. Using the aggregate GDP deflator, capital
expenditures increased by 2.6 percent, versus 3.4 percent
for the capital-expenditure deflator (as a result of lower
inflation on capital items).
6 National Income and Product Accounts Tables, US
Department
of Commerce Bureau of Economic Analysis, accessed August
2015, bea.gov.
7 This is lower than it was in the 1970s and 1980s—decades
affected by high inflation.

Executives, analysts, and investors often rely on
internal-rate-of-return (IRR) calculations as
one measure of a project’s yield. Private-equity
firms and oil and gas companies, among others,
commonly use it as a shorthand benchmark
to compare the relative attractiveness of diverse
investments. Projects with the highest IRRs
are considered the most attractive and are given
a higher priority.
But not all IRRs are created equal. They’re a
complex mix of components that can affect both a
project’s value and its comparability to other
projects. In addition to the portion of the metric
that reflects momentum in the markets or the
strength of the economy, other factors—including
a project’s strategic positioning, its business
performance, and its level of debt and leverage—
also contribute to its IRR. As a result, multiple
projects can have the same IRRs for very different
reasons. Disaggregating what actually propels
them can help managers better assess a project’s
genuine value in light of its risk as well as its
returns—and shape more realistic expectations
among investors.
Since the headline performance of private equity,
for example, is typically measured by the IRR
of different funds, it’s instructive to examine those
funds’ performance. What sometimes escapes
scrutiny is how much of their performance is due to
each of the factors that contribute to IRR above a
A better way to understand

internal rate of return
Investments can have the same internal rate of return for
different reasons. A breakdown of this metric in
private equity shows why it matters.
Marc Goedhart, Cindy Levy, and Paul Morgan
© Peter Dazeley/Getty Images
7A better way to understand internal rate of return
baseline of what a business would generate without
any improvements—including business performance
and strategic repositioning but also debt and
leveraging. Armed with those insights, investors
are better able to compare funds more mean-
ingfully than by merely looking at the bottom line.
Insights from disaggregating the IRR
Although IRR is the single most important per-
formance benchmark for private-equity
investments, disaggregating it and examining
the factors above can provide an additional
level of insight into the sources of performance.
This can give investors in private-equity
funds a deeper understanding when making
general-partner investment decisions.
Baseline return. Part of an investment’s IRR comes
from the cash flow that the business was expected
to generate without any improvements after acquisi-
tion. To ensure accurate allocation of the other
drivers of IRR, it is necessary to calculate and report

the contribution from this baseline of cash flows.
Consider a hypothetical investment in a business
acquired at an equity value of $55 and divested
two years later at a value of $100 (Exhibit 1). The
business’s operating cash flow in the year before
acquisition was $10. At unchanged performance,
the investment’s cash return in year two,
compounded at the unlevered IRR, would have
been $23.30. In other words, the return from
buying and holding the investment without further
changes contributed ten percentage points of
the 58 percent IRR. Strong performance on this
measure could be an indicator of skill in acquir-
ing companies at attractive terms.
Improvements to business performance. The best
private-equity managers create value by rigorously
improving business performance: growing the
business, improving its margins, and/or increasing
its capital efficiency.1
In the hypothetical investment, revenue growth
and margin improvement generated additional
earnings in years one and two, amounting to a com-
pounded cash-flow return of $3.30. In addition,
earnings improvement in year two translated into
a capital gain of $20, bringing the cash return
for business-performance improvements to
$23.30 and its IRR contribution to ten percentage
points. This is an important measure of a private-
equity firm’s capacity to not only choose attractive
investments but also add to their value during
the ownership period.
Strategic repositioning. Repositioning an

investment strategically also offers an important
source of value creation for private-equity
managers. Increasing the opportunities for future
growth and returns through, for example,
investments in innovation, new-product launches,
and market entries can be a powerful boost to
the value of a business.
Consider, for example, the impact of the change in
the ratio of enterprise value (EV) to earnings before
interest, taxes, depreciation, and amortization
(EBITDA) for our hypothetical investment. The
business was acquired at an EV/EBITDA mul-
tiple of 10 and divested at a multiple of 12.5—which
generated a cash return of $30. This translates
into 13 percentage points of the project’s 58 percent
IRR. This measure could indicate a firm’s ability
to transform a portfolio company’s strategy to cap-
ture future growth and return opportunities.
Effect of leverage. Private-equity investments typi-
cally rely on high amounts of debt funding—
much higher than for otherwise comparable public
companies. Understanding what part of an
investment’s IRR is driven by leverage is important
as an element of assessing risk-adjusted returns.
In our hypothetical example, the acquisition was
partly funded with debt—and debt also increased
Exhibit 1 Disaggregating returns reveals how much of the
internal rate of return is attributable

to different sources.
MoF 2015
IRR
Exhibit 1 of 3
Year
Investment financials
Equity value
Net debt
Earnings before interest, taxes,
depreciation, and amortization (EBITDA)
Constant revenues, no taxes, no capital expenditures
Acquisition per end of year 0
Without interest
1
11.0
Enterprise value (EV)
EV/EBITDA
2
100.0
(50.0)

12.0
150.0
12.5
Year
Levered and unlevered internal
rate of return (IRR)
Operating cash flow
1
11.0
2
12.0
Year
FractionDecomposition of IRR from:
Present
value (PV)
of year 21
Contribution
to IRR21 2
Baseline Cash flow 10.0 10.0
1 Cash flows compounded at unlevered IRR to year 2.
2 Calculated as each lever’s PV (year 2)/total PV (year 2) ×

unlevered IRR.
3 Calculated as [EBITDA (entry) – EBITDA (exit)] × EV
multiple (entry).
4 Calculated as [EV multiple (exit) – EV multiple (entry)] ×
EBITDA (exit).
5 Calculated as residual between unlevered and levered return.
0
55.0
(45.0)
10.0
100.0
10.0
0
Cash flow from debt 5.0 (50.0)45.0
Unlevered cash flow 11.0 162.0(100.0)
Cash flow on exit/acquisition 150.0(100.0)
16.0Levered cash flow 112.055.0
0
Leverage5
Levered return
20.0Capital gain3

Strategic repositioning 30.0Capital gain4
1.0Business performance 2.0Cash flow
11.0Unlevered return 62.0
23.3
20.0
30.0
3.3
76.6
10%
13%
33%
10%
25%
58%
0.30
0.39
0.26
0.04

1.00
IRR
58%
33%
over the next two years. In that time frame,
earnings increased by 20 percent and the company’s
EV-to-EBITDA ratio rose by more than two per-
centage points. The IRR of the acquisition, derived
from the investment’s cash flows, would be
58 percent.
How much does the company’s debt affect its
IRR? Adding back the cash flows for debt financing
and interest payments allows us to estimate the
company’s cash flows as if the business had been
acquired with equity and no debt. That results
in an unlevered IRR of 33 percent—which means
leverage from debt financing contributed 25 per-
centage points, about half of the investment’s total
levered IRR. Whether these returns represent
value creation for investors on a risk-adjusted basis
is questionable, since leverage also adds risk.
The disaggregation shown in Exhibit 1 can be
expanded to include additional subcomponents of
performance or to accommodate more com-
plex funding and transaction structures.2 Managers

may, for example, find it useful to further dis-
aggregate business performance to break out the
effects of operating-cash-flow changes from
revenue growth, margin expansion, and improve-
ments in capital efficiency. They could also
separate the effects of sector-wide changes in valua-
tion from the portion of IRR attributed to strategic
repositioning. Moreover, if our hypothetical
investment had involved mergers, acquisitions,
or large capital investments, further disag-
gregation could separate the cash flows related
to those activities from the cash flows due to
business-performance improvements—as well as
strategic repositioning.
Comparing projects beyond the bottom line
The example above illustrates the basic principles
of disaggregating IRR, which ideally should be done
before any comparison of different investments.
Consider, for example, two investments by a large
private-equity fund, both of them businesses
with more than €100 million in annual revenues
(Exhibit 2). Each had generated healthy bottom-
line returns for investors of 20 percent or more on
an annualized basis. But the sources of the
returns and the extent to which these represent
true value creation differed widely between
the businesses.
The investment in a retail-chain company had
generated a towering 71 percent IRR, with more
than three-quarters the result of a very aggres-
sive debt structure—which also carried higher risk.
On an unlevered basis and excluding sector and
baseline contributions, the risk-adjusted return to

investors was a much lower but still impressive
21 percent. By improving margins and the capital
efficiency of the individual retail locations, manage-
ment had contributed around 5 percent a year to
IRR from business performance. A successful stra-
tegic transformation of the company formed the
Understanding the true sources of internal rates
of return provides insight not only into the evaluation of
individual investments but also into collections
of investments.
biggest source of management contributions to
IRR. Utilizing the company’s real estate and
infrastructure, management was able to launch
additional customer services with more stable
margins, which translated to a higher-valuation mul-
tiple on exit and drove 17 percent annual IRR.
Exhibit 2 Sources of returns can differ widely among
businesses.
MoF 2015
IRR
Exhibit 2 of 3
32
Retail chain Rental equipment
Internal rate of return (IRR),1 %

Business performance
Efficiency improvement
Organic growth
Margin increase
Capital investment
Sector
Transformation strategy
Unlevered IRR
Levered IRR
M&A
Strategic repositioning
Baseline
Leverage
1
5
5
4
13

21
27
44
71
5
9
5
14
4
4
15
23
24
10
34
0
0
4

2
2 1
17
IRR is due more to
financial engineering
than business
performance or
transformation
strategy
IRR is due almost
entirely to business
performance and
transformation
strategy
1 Figures may not sum, because of rounding.
In contrast, the equipment-rental business turned
out to be one where management made more of
a difference when it came to business performance
and strategic transformation, which, when com-
bined, contributed 32 percent to the business’s IRR.
Most of this was due to higher growth and improved
margins in its core industrial-equipment seg-
ments, combined with significant divestments of its
consumer-rental business. Unfortunately, nearly

14 percentage points of the overall IRR was wiped
out as the credit crisis reduced opportunities across
the sector for future growth and profitability.
With leverage adding ten percentage points, the
IRR for investors ended up at 34 percent.
Understanding the true sources of IRR provides
insight not only into the evaluation of individual
investments but also into collections of invest-
Exhibit 3 Disaggregating internal rates of return for a portfolio
of projects can reveal
a fund’s strength.
MoF 2015
IRR
Exhibit 3 of 3
Retail (1) Retail (2) Tech (1) Tech (2)Power (1) Power (2)
Power (3)
Real
estateRetail (3)
5-year annualized returns,1 %
Business performance
Efficiency improvement
Organic growth
Margin increase
Capital investment
Strategic repositioning

Sector
Transformation strategy
Unlevered internal rate
of return (IRR)
Levered IRR
M&A
Baseline
Leverage
≤0% <2% <5% <10% ≥10%
1
2
2
5
4
N/A
13
17
0

5
27
44
71
(1)
(4)
6
1
(1)
12
2
13
(1)
14
27
14
41
0

1
7
N/A
7
7
7
14
13
(2)
32
4
36
3
2
N/A
5
N/A
6

4
9
1
1
16
7
23
(1)
0
(1)
(2)
N/A
3
3
5
(1)
6
8

5
13
1
2
(2)
1
N/A
0
1
1
0
4
6
3
9
(16)
14
N/A

(2)
6
9
4
19
0
(10)
7
0
7
0
0
3
2
4
2
0
6

0
1
9
(4)
5
(9)
4
11
6
(6)
14
(1)
7
(15)
5
4
(2)
2

1 Figures may not sum, because of rounding.
Marc Goedhart ([email protected]) is
a senior expert in McKinsey’s Amsterdam office;
Cindy Levy ([email protected]) is a director
in the London office, where Paul Morgan
([email protected]) is a senior expert.
1 Joachim Heel and Conor Kehoe, “Why some private-equity
firms do better than others,” McKinsey Quarterly, February
2005, mckinsey.com.
2 We have, for example, developed a decomposition approach
to an investment’s so-called cash multiple rather than its
internal
rate of return.
3 Assuming that the higher-valuation multiple is entirely
driven by repositioning the business—and not by sector-
wide appreciation.
ments, such as within a single private-equity fund
or within an investment portfolio of many different
private-equity funds. Such an analysis revealed
that one fund, for example, was most successful in
transforming acquired businesses through rigor-
ous divestment of noncore activities and resetting
strategic priorities (Exhibit 3). As with many
private-equity funds, leverage was the second-

most-important driver of investor returns.
From a fund-investor point of view, a high level of
dependence on financial leverage for results
raises questions, such as whether a firm’s perfor-
mance will be robust across economic scenarios—
or whether it has a track record of successful
interventions when high leverage becomes problem-
atic for its portfolio companies. By contrast,
reliance on business improvements is inherently
more likely to be robust across scenarios.
Investors can conduct a similar analysis to identify
which funds in their portfolios contribute
the most to their returns and why. For example,
separating leverage components reveals which
funds boost their IRR by aggressive debt funding
and are therefore more exposed to changes in
underlying business results. Understanding where
broader sector revaluations have driven IRR
can help investors understand which funds rely on
sector bets rather than improvements in business
performance or strategy. Investors can also assess
how well a general partner’s stated strategy
matches its results. A firm touting its ability to add
value from operational improvements should
get substantial portions of its IRR from managerial
changes and strategic repositioning, while
a firm more focused on its financial-engineering
skills might be expected to benefit more from
the leverage effect.3
IRR calculations can be useful when fully under-
stood. Disaggregating the effect of IRR’s various
components can help managers and investors alike
more accurately assess past results and contribute

to future investment decisions.
13
At McKinsey’s annual Chief Financial Officer
Forum, in London this June, CFO and chief oper-
ating officer Samih Elhage of Nokia Networks,
Manik (“Nik”) Jhangiani of Coca-Cola Enterprises,
and former Alstom CFO Nicolas Tissot took up
some of the challenges facing today’s finance chiefs.
Over the course of an hour, the panelists explored
the pricing threat posed by a new breed of low-cost
competitors now rising in emerging markets,
the risks from the resurgent volatility of currency
markets, and the brave new world of cheap debt
financing and its implications for capital structures.
The discussion, moderated by Financial Times Lex
column editor Robert Armstrong, shapes a profile
of the skills and tactics that define the modern CFO.
The edited highlights below begin with the ques-
tion of whether CFOs should make challenging the
existing business model part of their role.
Nik Jhangiani: A business never gets to the point
where it has the ideal model. The world is changing
so fast around us. Even in a business that you
think is stable and predictable, the operating model
needs to continue to evolve, just given what
technology is doing. At Coca-Cola Enterprises, we
don’t conclude, at a single point in time, that the
business model needs to change—that’s something
we challenge ourselves on through our long-

range-planning process every year.
For example, we have probably the largest sales
force in Europe of any packaged-goods com-
pany, and I almost have to challenge that. Is it
A panel discussion
Seasoned finance chiefs explore revamping business models and
coping with new competitors, currency
risks, and changing capital structures.
© Philip and Karen Smith/Getty Images
Profiling the modern CFO: A panel discussion
really bringing us the value today that it did five
years ago? How many people want a salesperson
calling on their stores or outlets helping them
to place an order and to merchandise when so much
more can happen through call centers and
technology? You definitely don’t want to lose the
human touch and the relationships, but you
do want to allow your sales force to be more efficient,
effective, and focused on what the customers
view as an added value.
This is something you, as CFO, need to challenge
almost every day—to ask if your company’s business
model is fit for purpose today and, more impor-
tant, if it is fit for purpose for the future. What do

we need to change, without suddenly having to
make a wholesale change tomorrow? It needs to be
constantly adapted.
Robert Armstrong: When you realize that a major
change has to be made, how do you deal with your
executive board?
Nicolas Tissot: Among the members of executive
committees, CFOs are probably best positioned
to challenge the businesses. They are independent
from operations. And they are the only ones,
apart from the CEO, who have a comprehensive
vision of the company. The role of a CFO who
goes beyond being a bean counter is clearly not only
to be a business partner but also to be a business
challenger. This is not the easiest part of the job, but
it is definitely a part of the modern CFO role.
Samih Elhage: In a fast-moving industry like
Nokia’s, technology life cycles are becoming much
shorter. In our case, the transformational aspect
of the business is becoming a way of life. We can’t
say, definitively, that this is really my process;
this is my business; this is how I sell; this is how I buy.
We can say that we’re in a continuous-improvement
process—and the process itself has to evolve.
This isn’t about squeezing the budget to reduce
costs. It’s about significantly changing the com-
pany’s processes and mode of operation. In
many cases, you have to change the way you sell
certain products and the way you charge
particular customers. And, in some cases, you
have to exit specific areas of the business.

When I first came to Nokia, we were operating in
ten different segments. Since then, we’ve made
Manik (“Nik”) Jhangiani
Education
Holds a bachelor’s degree in accounting and
economics from Rutgers University
Career highlights
Coca-Cola Enterprises
(2013–present)
Senior vice president and CFO
(2012–13)
CFO, Europe
Bharti Enterprises
(2009–12)
Group CFO
Coca-Cola HBC
(2000–09)
Group CFO
Fast facts
Married, with 2 children
Lives in Central London
15Profiling the modern CFO: A panel discussion
incisive and, I think, courageous changes, divesting
eight of these businesses to focus intensely on
the two that would give us the operating perfor-

mance we were looking for.
Competitive dynamics and pricing
Robert Armstrong: Let’s talk a little about com-
petitive dynamics. Samih, you are in a unique
position there. How do you manage the company
when you are constantly under pressure from
large, low-cost emerging-market competitors?
Samih Elhage: Well, competition is undeniably
an important element in our day-to-day operations
because of its implications for our cost structure
and for pricing. But we resist being driven reactively
by the actions of competitors. We have a strong
pricing strategy and controls to ensure that prices
are being set at the right level—one that ensures
our customers are getting value for money and that
we are able to fund investment in R&D and
healthy performance for our stakeholders. And, in
a competitive environment, our cost structure,
which is extremely lean, gives us the means to fight
when fighting is what’s required.
Robert Armstrong: Let’s explore that pricing
theme a bit. Nik, how does pricing feed into the
finances of Coca-Cola Enterprises?
Nik Jhangiani: It is a huge element. Fortunately, in
the past couple of years, we’ve benefited from
Nicolas Tissot
Education
Holds an MBA from École des hautes
études commerciales (HEC) and graduated
from École nationale d’administration

Career highlights
Alstom
(2015)
Adviser to the group chairman and CEO
(2010–14)
CFO and executive-committee member
Suez/GDF Suez/ENGIE
(2008–10)
Deputy CEO, global gas and liquefied
natural gas
(2005–08)
CFO and executive-committee
member, Electrabel
(2003–05)
CFO and executive vice president,
Energy International
(1999–2003)
Head of group financial planning and control
French Ministry of Economy, Finance,
and Industry
(1995–99)
Inspecteur des Finances, the senior audit and
consulting body of the ministry
Fast facts
Member of the French-American Foundation
(and former FAF Young Leader) and the Société

d’Economie Politique
Independent director at Euroclear Settlement
of Euronext-zone Securities
the more benign commodities environment. As
recently as four or five years ago, inflation was high,
and we had to find a way to pass that on to our
customers and our consumers. Today, some markets
in Europe are actually facing deflation, and cus-
tomers and consumers are looking at that, too. What
we’re not able to achieve through pricing, we have
to do by reducing costs—finding better ways to be
efficient at what we do.
The answer isn’t always about the absolute price
the market will bear. Sometimes, it’s much
more about what you can do from an overall revenue-
growth perspective. In addition to cutting costs
and increasing prices, how do you get the right mix
of products to generate more transactions?
How might you change your packaging strategy
to increase revenue growth? For example,
would consumers want—and pay a slight premium
for—a smaller or differentiated or more
premium package?
Nicolas Tissot: In heavy industries, the pricing
environment is always driven by the business cycle.
For several years, we’ve been in a crisis that also
has some structural components. So we’ve had to
adapt structurally to the emergence of new

competitors from places with a lower cost base. We
also need to adjust to the interest of our clients
in our services, as well as our technology. The CFO
is instrumental, for example, in launching
performance and restructuring plans, setting up
partnerships, allocating R&D money, and
reorienting manufacturing investment.
On pricing, we need to adapt rapidly or we’ll lose
every sale. At one time, deals targeted a level of
profitability that fully rewarded our investments.
But when there is overcapacity in the market
and when—to break even—competitors fight to
keep factories running, sometimes you end
up settling for the second-best price. At Alstom,
the CFO, who personally approves every
Samih Elhage
Education
Holds a bachelor’s degree in electrical
engineering and in economics from
the University of Ottawa, as well as a master’s
degree in electrical engineering from École
Polytechnique de Montréal
Career highlights
Nokia Networks
(2013–present)
Executive vice president and CFO
(2013–present)
Chief operating officer, Nokia

Solution
s
and Networks
Nortel
(2009–10)
President, carrier voice over Internet Protocol
(VoIP) and applications solutions
(2008)
Vice president and general manager, carrier
VoIP and applications solutions
(2007–08)
Vice president, corporate business operations
Fast facts
Pastimes include world music, traveling,
walking, and golf

17
bid above €50 million, has to take into account
those specific periods and relax the margin
targets appropriately.
Foreign-currency risk
Robert Armstrong: Currency risk has returned
to the corporate world’s attention over the past
year, with the strong dollar and the fluctuations
of other currencies. How do you manage
the risks?
Samih Elhage: I start with how we should achieve
our performance goals and then ask how we cope
with the challenges of all external aspects, including
currency fluctuations. In our business, we depend
mainly on four currencies—the euro, the US dollar,
the Japanese yen, and the Chinese yuan. We
usually get our performance plan approved by the
board in Q4 and make any changes at the beginning
of the year. From there, I ask teams to develop
their performance plans reflecting the impact of

currencies. Their underlying business objec-
tives have to be achieved from an operating-profit
perspective, and that comes down to cash.
If the effect of currency shifts helps the top line,
that’s assumed to be in addition to the team’s
performance goals. If currency shifts affect costs
negatively, the team has to find some way of
compensating for that.
Is that challenging? Absolutely. It adds to the
pressure on teams to meet their goals. Are we mak-
ing progress? Yes, we are. But costs associated
with hedging have to be included in the accounting
statements, and they have cash implications.
Our teams know that they just have to make the
numbers add up.
Nik Jhangiani: The countries in which Coca-Cola
Enterprises operates give us a fairly natural
hedge—because our revenues and a great deal of
our cost base are local. In fact, we produce
90-plus percent of our products within a given
market. It’s difficult and expensive to trans-

port water. Producing locally gives us another
natural hedge.
The issue is more with our commodity exposures,
which could be in different currencies. That’s where
we make sure that we’re covering risk through
transaction exposures, for which we hold teams
accountable—having hedging policies in place
and ensuring that all our transaction exposures are
covered, at least on a rolling 12-month basis
(with lower levels of coverage going out 36 months).
Teams are responsible for making sure that
currency risks are covered through pricing and
cost structures and so on.
Our hedging strategy is very clear. We’re not looking
to beat the market. We are just trying to increase
certainty around our cost structure. We do not hedge
for translational currency conversion or exposure.
When we communicate with the market, we actually
give guidance and provide our performance data
both on a currency-neutral basis and then with the
impact of currencies. The transaction part is built
into the information we provide.

You can’t keep changing what you do in volatile times,
as that volatility will always be out there. At
times, translation or currency conversion works
and has some benefits, and at times it doesn’t.
You have to try to ride through that cycle without
being reactive and changing things, unless you see
something that isn’t working over the long term.
Nicolas Tissot: We see our business as being a
supplier of industrial equipment and associated ser-
vices, not playing games with the fluctuations
of currencies. As soon as an order is firmed up, we
have a full analysis of the currency flows. Then
that exposure is systematically hedged over
the horizon available in the market, with a rolling
foreign-exchange strategy. We have pretty
Profiling the modern CFO: A panel discussion
Why have equity at all? Our philosophy is that
there should be a balance. You should go to the mar-

ket when you must, but you also need a very strong
capital structure to defend the business and to drive
the right investment at the right time.
Nik Jhangiani: We sold the US business back to
the Coca-Cola Company in 2010 and formed the
new Coca-Cola Enterprises. That included much of
the debt we had, as well. We continue to generate
a great deal of free cash flow, but at the same time
we also realized that we were very underleveraged
and didn’t have the most efficient balance sheet.
So we set a leverage target of two and a half to three
times net debt to EBITDA, compared with where
we were before the sale, which was closer to one to
one and a half times net debt to EBITDA. It could
have been lower, but we picked a level that we saw
as the right starting point for the journey we
wanted to make. We would slowly lever up toward
that level, so this wasn’t a big one-shot bang,
and we wanted to make sure we had enough dry
powder for potential activities.
The leveraging up, along with the free cash flow
that we continue to generate and a strong focus on
that cash-conversion rate, gives us a solid pool

of free cash flow. In the absence of M&A, the best
way to use it was to return it to shareholders.
Over the last four years, from the formation of
the new Coca-Cola Enterprises through the
end of 2014, we have returned approximately
$8 billion to shareholders.
significant activity in that respect. To avoid paying
too much in fees to the banks, we use an electronic
platform. The banks own the platform, and it is
competitive for any foreign-exchange trade that we
handle to hedge our exposure.
Capital structure
Robert Armstrong: One of the ironic conse-
quences of the financial crisis is that debt
financing is cheap and easy to get unless you’re
a bank. It’s so cheap, why have any equity at
all? How do you make capital-structure decisions
in this context?
Nicolas Tissot: Regarding debt financing, over the
past few years there have been times when we’ve
needed to think fast, act fast, and be opportunistic.
There are imperfections in the market, and many

of us have seized the opportunities they create. But
at the same time, you always have to keep the
long-term view in mind.
Alstom is in a very cyclical industry, and sometimes
you can lose sight of your position in the cycle.
When things are good, there’s a risk of leveraging
too much; when the hard times come back, you
burn a lot of cash and quickly deteriorate your finan-
cial structure and therefore your rating, which
leaves you little if no access to debt markets.
We manage our financial structure—the structure
of the balance sheet—with that in mind. At the
peak of the cycle, we want to have almost no leverage,
while at the trough we accept more.
Samih Elhage: At Nokia, our capital-structure
decisions are guided by the principle that we should
always do our best to give back to shareholders. In
the past two years, as we purchased Siemens’s share
of Nokia Siemens Networks and sold the device
business to Microsoft, we put in place a program to
improve our capital structure and to return
€5 billion to shareholders over three years.

19
Two-thirds of all executives agree that the best way
for CFOs to ensure their company’s success
would be to spend more time on strategy.1 Indeed, it
is increasingly common for CFOs to be taking
on more strategic decision making. Companies
value the hard data and empirical mind-set
that a finance chief can lend to strategic planning,
especially around forecasting trends, building
strategic capabilities, or managing government and
regulatory relationships.2
Yet as CFOs map out what can be a wide range of
strategic responsibilities, they may encounter
challenges and even turf wars from some traditional
strategy leaders, such as chief strategy officers
(CSOs) and business-unit heads. These seldom
boil over into public view, but we often see signs of

tension where the two roles increasingly overlap.
Such friction is destructive—and a missed oppor-
tunity. Working together, CFOs and CSOs have
the stature to challenge biases and influence how
the top team makes decisions to improve a
company’s performance. In many cases, a CSO may
be better placed to take on certain roles typically
managed by the CFO, such as owning the resource-
allocation map or the M&A process. Many CFOs
are the first among equals on a company’s board of
directors and can assist CSOs with improving
board productivity on strategy. Having explicit con-
versations about expectations and the division
of such roles will improve the dynamics of strategic
Building a better partnership
between finance and strategy
The growing strategic role of CFOs may create tension with top
strategists. That’s a missed opportunity for
teaming up to improve company performance.
Ankur Agrawal, Emma Gibbs, and Jean-Hugues Monier

© Piotr Powietrzynski/Getty Images
Building a better partnership between finance and strategy
decision making—by ensuring a better link between
a company’s capital allocation and its strategic
priorities, by better informing a search for growth,
and by better balancing a company’s strategy for
long-term growth with its short-term strategy for
earnings and investors.
Better linking capital allocation to
strategic priorities
Research by our colleagues finds that, on average,
companies allocate 90 percent or more of their
resources to the same projects and activities year
after year, regardless of changes in the environment
or their strategies.3 Dynamic companies that
reallocate resources more actively deliver better,
less volatile annual returns to shareholders, on
average, than their more dormant counterparts4—

particularly during economic downturns.5
CSOs and CFOs each bring insights to create a better
link between resource allocation and strategy in
the corporate-strategy-development process. This
means, among other things, creating a distinct
corporate- or portfolio-strategy process (rather than
just aggregating business-unit plans); encouraging
more frequent conversations among small groups of
senior leaders on an ongoing basis, rather than
annually or every three to five years; and ensuring
that the corporate-strategy and budgeting pro-
cesses are fully integrated with capital-allocation
processes (including M&A and divestment). This
integrated view of strategic direction and resulting
allocation of corporate resources demands close
collaboration between finance and strategy.
In the case of one North American healthcare
company, the CSO set up a planning council that
included the CFO to discuss strategic issues,
growth opportunities, and funding needs. For each
of the promising opportunities—which carried
the imprimatur of both the CFO and the CSO—the
council appointed a strategic leader. Each leader

was tasked with creating a deliberate dialogue with
existing business leaders and cultivating their
support for more than a dozen related initiatives
well in advance of the annual allocation process. As
a result, the council was able to aggressively
challenge the expenses attributed to running the
business and set aside a defined amount for
growing the business instead. This result clearly
was achieved due to the foresight and trusted
collaboration of the CFO, the CSO, and their teams.
CSOs can also track how critical resources such as
growth investments and talented R&D teams
are used. This allows managers to assess whether
resources are allocated to support strategy—
or whether each year’s capital allocations unduly
influence the next.
Finally, CSOs can pay close attention to the way
strategic decisions are made, for example, by
managing the executive team’s strategic agenda and
prompting debate on competing options and
scenarios to account for inherent sources of bias.
Often this means bringing external data into
the room to help reanchor discussions away from

assumptions based on prior decisions. The CSO
at a consumer-products company, for example,
Working together, CFOs and CSOs have the stature to
challenge biases and influence how the top team makes
decisions to improve a company’s performance.
21Building a better partnership between finance and strategy
used this approach to good effect when managers
found themselves facing a major disruption
in a core market. The CSO shepherded the executive
team through a series of strategic decisions
that allocated resources away from traditional cash
cows. Instead, she shifted attention and resources
into a disruptive technology identified by the
company’s widely accepted strategy review as the
future of the business. To guide the discussion,
she clearly laid out the level of resources needed to
fund the agreed-upon strategy, reminded the
executive team of the rationale for the change of
direction, and carefully positioned each decision
to reduce the likelihood of bias.

Looking outside the company for insights
into growth
CFOs agree that companies need to step up their
game in a wide range of growth-related activi-
ties, particularly driving organic growth, expanding
into new markets, and pursuing M&A. Recent
McKinsey research shows that more than 60 per-
cent of growth comes from riding on favorable
tailwinds—that is, doing business in markets that
are growing well and where companies enjoy
a competitive advantage.6 However, a 2010 survey
found that less than 15 percent of executives
consider such macroeconomic trends when they
develop strategy, and only 5 percent take their
competitors’ strategies into account.7 Moreover,
less than a quarter even look at their own
internal financial projections and portfolio perfor-
mance. Little wonder that companies and their
CFOs struggle to find growth; they’re looking at
a mirror and not a window.
CSOs are well placed to help correct this. Many CSOs
own the organization’s trend-forecasting and
competitor-analysis function. Good trend forecast-

ing involves creating proprietary insight into
trends, discontinuities, and potential shocks to find
growth opportunities and manage business risk.
Similarly, good competitor analysis involves
gathering competitive intelligence, closely tracking
the behavior of competitors, monitoring their
potential responses to a company’s strategic moves,
and evaluating their sources of competitive
advantage. All are necessary to understand how a
company creates value—the foundation of the
strategic decisions that best balance a corporate
portfolio for risk and return. Armed with such
insights, CFOs and CSOs together are better placed
to go beyond a CFO’s traditional strengths in
managing the portfolio, navigating it toward growth
opportunities, setting objectives for organic
growth, and planning a strategy for M&A.
The experience of a CFO and CSO at one industrial
conglomerate is illustrative. The newly appointed
CSO developed a proprietary view of what
contributed to each business’s growth and injected
that insight into corporate-strategy discussions.
Underlying factors included, for example, projec-

tions down to the level of how much new
commercial floor space would be built in Latin
American cities—a central variable in fore-
casting demand for the company’s most advantaged
products, such as electrical wiring. The CFO, in
turn, provided data and analytical rigor in assessing
the business case for each product. In particular,
the CFO created a database that empirically evalu-
ated pricing relative to demand and the number
of competitors in each submarket. With information
at this level of detail, the executive team could
see which businesses in the company’s portfolio
were the best positioned to capture pockets of
growth. Not only were they better able to set targets
for organic growth, which the CFO now uses
to manage performance, but they also used the
information to develop a clear acquisition
and divestment strategy.
Taking a long-term strategic view to
offset short-termism
A key challenge at any company is balancing the long-
term growth strategy against the demands of

increasingly vocal short-term investors. Working
together, a strategist’s deep understanding of
regulation, innovation, and microeconomic
industry trends complements a CFO’s understanding
of cost and revenue, capital allocation, and
stakeholder issues. Together, they can put forth
options that improve both a company’s short-
term earnings and its longer-term growth in a way
that is compelling to management, boards,
and investors.
To facilitate collaboration, one company explicitly
rotates strategy and finance professionals between
the two teams. Formal structures, such as
the strategic-planning team, include people from
both—strategic planning has two from each—so
that they start the budgeting process hand in hand.
That enables both sides to see how resources
align with the long- and short-term strategies as
they make long-term resource allocations,
evaluate make-or-buy decisions, and challenge
the business case.

Working together, finance chiefs and strategy
leaders can complement each other, helping the CEO,
the board, and the rest of the executive team face
the challenges of creating growth over the long term
in the face of so many short-term challenges.
Ankur Agrawal ([email protected])
and Jean-Hugues Monier ([email protected]
McKinsey.com) are principals in McKinsey’s New
York office, and Emma Gibbs ([email protected]
.com) is an associate principal in the London office.
1 Ankur Agrawal, Kaustubh Joshi, and Ishaan Seth, “The
CFO’s
role in the pursuit of growth,” June 2013, mckinsey.com.
2 Michael Birshan, Emma Gibbs, and Kurt Strovink, “What
makes a great chief strategy officer,” Harvard Business Review,
May 14, 2015, hbr.org.
3 Stephen Hall, Dan Lovallo, and Reinier Musters, “How to

put your money where your strategy is,” McKinsey Quarterly,
March 2012, mckinsey.com.
4 Michael Birshan, Marja Engel, and Olivier Sibony, “Avoiding
the
quicksand: Ten techniques for more agile corporate resource
allocation,” McKinsey Quarterly, October 2013, mckinsey.com;
and Stephen Hall and Conor Kehoe, “How quickly should
a new CEO shift corporate resources?,” McKinsey Quarterly,
October 2013, mckinsey.com.
5 Mladen Fruk, Stephen Hall, and Devesh Mittal, “Never let
a good crisis go to waste,” McKinsey Quarterly, October 2013,
mckinsey.com.
6 Mehrdad Baghai, Sven Smit, and S. Patrick Viguerie,
“The granularity of growth,” McKinsey Quarterly, May 2007,
mckinsey.com.
7 “Creating more value with corporate strategy: McKinsey
Global Survey results,” January 2011, mckinsey.com.
23

In McKinsey’s latest survey on M&A practices and
capabilities, most respondents report that their
companies regularly examine the portfolio for new
opportunities—and many do so at least once
a year.1 But if the blistering M&A pace of the past
several years continues, as most respondents
expect, then these responses also suggest that an
annual review of portfolios may not be enough.
As of this writing, the value of M&A in 2015 is on
track to rival last year’s, when deal-value announce-
ments totaled about $3.4 trillion2—levels not
seen since 2008. That level of activity raises the
stakes for companies reexamining their own
business portfolios, as the shifting competitive
landscape creates new opportunities—and
threats. It may also explain why respondents who
perceive their companies to be more successful
at M&A are also significantly more likely to report
looking for opportunities more often. Whether
companies are successful because they look for
opportunities more often or the other way around,
we can’t say. But the correlation, combined

with the fast pace of M&A activity in general, does
suggest that more frequent portfolio reviews
may be better.
These are among the findings of our newest M&A
survey, which asked executives about underlying
trends, what M&A capabilities their companies do
(and don’t) have, and the effectiveness of their
companies’ M&A programs relative to competitors.
Companies that are best at transactions approach M&A
differently—but there’s room for improvement
across the board.
Rebecca Doherty, Spring Liu, and Andy West
© Butch Martin/Getty Images
How M&A practitioners enable their success

Exhibit 1
MoF 2015
M&A capabilities survey
Exhibit 1 of 4
Companies that outperform their peers are more likely to
evaluate strategic options
more than once a year.
1 Respondents who answered “don’t know” are not shown, so
figures may not sum to 100%.
2 Respondents who say the transactions their companies have
completed in the past 5 years have either met or surpassed
targets for both cost and revenue synergies.
completed in the past 5 years have achieved neither their
cost- nor their revenue-synergy targets.
% of respondents1

How frequently does your company evaluate its portfolio of
businesses
to assess each of the following opportunities?
Acquisitions DivestituresJoint ventures or alliances
More than once a year
36
58
34
48
12
26
Once a year or less
63
37
64

42
82
58
High performers,2 n = 464
Low performers,3 n = 302
When we looked at what makes a company good
at M&A, the results indicated that while it’s
important to perform well at every step of the M&A
process, the “high performers” differentiate
themselves from others by evaluating their port-
folios more often, moving faster through their
due-diligence and execution processes, and building
stronger capabilities for integration. According
to the results, though, even the highest-performing
companies could benefit from giving their
M&A teams more effective incentives and from
proactively connecting and building relation-
ships with their potential targets.

Will the pace of M&A continue?
Among respondents whose companies considered
acquisition targets in the past year, just over two-
thirds report completing at least one deal. Of those
that tried but failed to complete an acquisition,
52 percent indicated that their companies engaged
with at least one potential target but, ultimately, did
not close the deal.
Most executives expect the next year to bring as
many or more deals as the past one. It’s too soon to
tell whether market volatility in the late summer
will affect M&A over the longer term, but as of May
2015, two-thirds of respondents expect the pace
of activity over the subsequent 12 months to continue
or increase—and nearly three-quarters expect
these deals will be the same size or larger. Interest-
ingly, those who anticipate a larger number of deals
also expect their value to increase—and those
who expect to do fewer deals expect their value to
decline. Looking further ahead, respondents
expect little change to their companies’ rationales
for deals in the next five years, and the most fre-
quently cited reasons all relate to growth: expanding

offerings, entering new geographies, and acquiring
new assets.
25How M&A practitioners enable their success
More specifically, respondents from high-tech
and telecommunications companies are significantly
more likely than those in every other industry to
expect an increasing number of deals, though they
were not more likely to expect larger ones. Consumer-
company executives tend to expect fewer deals
in the next year than their B2B peers.3
What high performers do differently
To better understand companies’ M&A performance
overall and where the best-performing companies
differentiate themselves most from their peers, we
identified a group of high performers. Respon-
dents in this group characterize their companies’
performance as having met or surpassed targets
for both cost and revenue synergies in their
transactions of the past five years. The low per-
formers, by contrast, are respondents who

report that their companies have achieved neither
the cost- nor the revenue-synergy targets in
their transactions.
The survey results indicate a few areas where the
high performers do things differently. For example,
these respondents are much more likely than
the low performers to report that their companies
evaluate their portfolios for acquisition, joint-
venture, and divestiture opportunities multiple
times per year, as opposed to once every one or two
years. The inverse is also true: low performers are
significantly more likely to say their companies look
for opportunities once a year or less (Exhibit 1).
Notably, the frequency with which companies (both
high and low performers) evaluate their port-
folios for divestiture opportunities is significantly
less than it is for acquisitions or joint ventures.
On average, high- and low-performing companies
tend to move through their due-diligence and
deal-execution processes at about the same speed—
up to a point. However, among companies where
respondents report taking six months or more, the
pattern diverges. More than one-quarter of low-

Exhibit 2
MoF 2015
Exhibit 2 of 4
According to respondents, high performers move faster than low
performers
through deal execution.
Time spent by respondents’ companies on diligence and deal
execution
% of respondents
~2×

30
25
20
15
10
<2 2–3 3–4 4–5 5–6 >6
5
0
Number of months from nondisclosure agreement to binding
offer
Low performers,1
n = 302
High performers,2

n = 464
performer executives say their companies take
longer than six months to move from a nondisclosure
agreement to a binding offer, nearly double the
share of high performers that say they spend the
same amount of time (Exhibit 2).
Finally, the high performers stand apart on the
strength of their integration processes. We asked
executives about their companies’ capabilities
across the four areas of M&A, and those from the
high-performing companies report proficiency
in all four more often than their peers at low-
performing companies do. But their skills are most
differentiated in integration (Exhibit 3). Inter-
estingly, the two integration capabilities with the
largest percentage-point differences between
high and low performers are also the two capabilities

where, overall, respondents report the least
proficiency: effectively managing cultural
differences across organizations and setting
synergy targets.
What all companies could do better
For all their best practices and the strength of their
capabilities, even the high performers have room
to improve. When it comes to incentives, the results
suggest that many companies focus on earn-outs
and retention packages for key talent in acquired
Exhibit 3
MoF 2015
Exhibit 3 of 4
High-performing M&A companies are most differentiated from
low performers
in their integration capabilities.

3 Includes “strongly agree” and “agree” responses.
4 areas of M&A
% of respondents who agree that their
companies have specific capabilities in the
following areas of M&A3
Percentage-point difference
between high-performer and
low-performer responses
Integration
78
44
84
56

67
42
81
58
M&A operating model and organization
Due diligence and deal execution
M&A strategy and deal sourcing
34
28
25
23
High performers,1 n = 464

Low performers,2 n = 302
27How M&A practitioners enable their success
companies—but often overlook their own M&A
teams. Because there are often different owners
throughout a company’s M&A process, it can
be particularly tricky to put proper incentives in
place for each one. So, incentives must balance
the promotion of post-integration success with the
successful execution of an individual’s role.
In practice, few executives report that their com-
panies do this well. Less than half of all respondents
indicate that the incentives of those involved
in a given M&A transaction are closely aligned with
the benefits the company extracts from it. Even
among the high performers, only 57 percent agree
that their companies are getting this right.
For those that balance their incentives well, the
potential for strong overall performance is striking:
93 percent of respondents who strongly agree

that their companies’ incentives are aligned with
their strategic goals are high performers,
versus only 23 percent of respondents who
strongly disagree.
Exhibit 4
High performers,1 n = 464 Low performers,2 n = 302
MoF 2015
Exhibit 4 of 4
When it comes to sourcing M&A targets proactively, companies
get many internal tasks
right but then fall behind on external outreach.

% of respondents who agree or strongly agree
Internal activities External activities
Understands
the attributes
that characterize
a desirable
target
Clearly defines
the roles and
responsibilities
of those
who manage
relationships
with potential
targets
Uses compelling
pitch materials
to support even
very-early-
stage outreach
discussions with

targets
Regularly
conducts “road
shows” or
meetings to
establish
relationships
with the most
attractive
targets
Identifies the
right number
of targets
Assigns the
right people
to develop
targets
Identifies the
right types of
targets

To what extent do you agree that each of the following
statements describes your company’s M&A target sourcing?
68
92
59
91
46
79
53
78
54
74
33

49
32
46
The authors wish to thank Alvaro Aguero and Cristina
Ferrer for their contributions to this article.
Rebecca Doherty ([email protected])
is an associate principal in McKinsey’s San Francisco
office; Spring Liu ([email protected]) is a con-
sultant in the Boston office, where Andy West
([email protected]) is a director.
1 The online survey was in the field from May 19 to May 29,
2015,
and garnered 1,841 responses from C-level and senior

executives representing the full range of regions, industries,
company sizes, and functional specialties. Of these exec-
utives, 85 percent say they are knowledgeable about their
companies’ M&A activity and answered the full survey.
2 According to Dealogic, as of August 11, 2015, the total
announced global deal value surpassed $3 trillion for the year.
3 There were no significant differences in expected size or
frequency of deals across geographies, or by company
ownership or size.
Although the high performers have particularly
strong internal processes to identify potential
targets, they—and their lower-performing peers—
are least effective at connecting and building
relationships with these targets (Exhibit 4). For
example, not even half of respondents at the
high-performing companies (and just under one-
third at the low performers) say their companies
regularly conduct “road shows” or meetings
to establish relationships with the most attractive
companies. Executives at both the high- and
low-performing companies report similar results
for using compelling pitch materials to support

even very-early-stage outreach discussions
with targets.
Looking ahead
ƒ Conduct frequent portfolio reviews. Companies
that systematically evaluate their portfolios
for acquisition, joint-venture, and divestiture
opportunities set themselves up to execute
their corporate strategies more effectively. In
many strategies, the inorganic component
is critical, and getting that piece right begins with
building a sound business case to define which
businesses a company wants—and does not want—
in its portfolio.
ƒ Invest in building M&A capabilities. Companies
that can build capabilities that support inorganic
growth can enjoy a sustainable competitive
advantage. This includes capabilities that are
applicable to the earlier stages of M&A—
such as efficient and effective due diligence and
external outreach as part of proactive sourcing—
as well as the core capabilities required to
integrate a company.

ƒ Pay attention to governance and incentives.
In our experience, many companies will focus on
earn-outs and retention packages for acquired
companies but will overlook ensuring that their
own M&A teams have the right setup, gover-
nance, and incentives. These are the necessary
foundations upon which distinctive M&A
capabilities are built.
Podcasts
Download and listen to these and
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Divestitures: How to invest
for success
When it comes to creating value,

divestitures are critical—but a positive
outcome is not automatic. Some
up-front investment can improve the
odds of success.
Sean O’Connell, Michael Park, and
Jannick Thomsen
Getting a better handle on
currency risk
When exchange rates are volatile, com-
panies rush to stem potential losses.
What risks should they hedge—and how?
Marc Goedhart, Tim Koller, and

Werner Rehm
Overcoming obstacles to effective
scenario planning
Using scenarios to plan for uncertainty
can broaden the mind but can fall
prey to the mind’s inner workings. Here’s
how to get more out of planning efforts.
Drew Erdmann, Bernardo Sichel,
and Luk Yeung
Why capital expenditures need more
CFO attention
Companies in capital-intensive industries
need to get more out of their capital

budgets. CFOs can play a critical role.
Ashish Chandarana, Ryan Davies,
and Niels Phaf
A hidden roadblock to public-
infrastructure projects
Misplaced assumptions that governments
always enjoy a cost-of-capital advantage
over private players can kill projects
on the drawing board. Reexamining the
economics could move more
deals ahead.
Alastair Green, Tim Koller, and

Robert Palter
Maintaining a long-term view
during turnarounds
Changing course demands an intense
focus on short-term performance, but
success needn’t come at the expense of
long-term value.
Kevin Carmody, Ryan Davies, and
Doug Yakola
The real business of business
Shareholder-oriented capitalism is still
the best path to broad economic
prosperity, as long as companies focus

on the long term.
Marc Goedhart, Tim Koller, and
David Wessels
M&A 2014: Return of the big deal
Investors are optimistic about the value
of big deals behind a growing wave
of M&A. What key trends do they need
to understand?
André Annema, Roerich Bansal, and
Andy West
Can we talk? Five tips for
communicating in turnarounds

In tough times, investors scrutinize
every detail. Here’s how to manage
the discussion.
Ryan Davies, Laurent Kinet, and Brian Lo
What’s behind this year’s
buoyant market
Here’s how a tepid economy and
rising interest rates support a strong
stock market.
Ritesh Jain, Bin Jiang, and Tim Koller
Uncovering cash and insights
from working capital
Improving a company’s management of

working capital can generate cash
and improve performance far beyond the
finance department. Here’s how.
Ryan Davies and David Merin
Preparing for bigger, bolder
shareholder activists
Activists are targeting more and bigger
companies. Here’s what attracts
them—and some tips on how to respond
when they show up.
Joseph Cyriac, Ruth De Backer, and
Justin Sanders

Preparing to make big-ticket
investment decisions
When the stakes couldn’t be higher,
the quality of the decision making
can make all the difference. Process
improvements can help.
Michael Birshan, Ishaan Nangia,
and Felix Wenger
Global M&A: Fewer deals,
better quality
In 2013, investors continued to improve
their discipline in creating value.
David Cogman

Goodwill shunting: How to better
manage write-downs
Executives fret that writing down good-
will invites a negative market response.
But that isn’t always so.
Bing Cao, Marc Goedhart, and Tim Koller
Avoiding blind spots in your
next joint venture
Even joint ventures developed using
familiar best practices can fail
without cross-process discipline in
planning and implementation.

John Chao, Eileen Kelly Rinaudo,
and Robert Uhlaner
October 2015
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1
Management’s next frontier:
Making the most of the
ecosystem economy
Jürgen Meffert and Anand Swaminathan
Engaging in digital ecosystems requires a new set of managerial
skills and capabilities. How quickly companies develop them
will
determine if they succeed in the ecosystem economy.
Apple knows how. With its HealthKit open platform, it brings
together participants from across
the world of medicine—physicians, researchers, hospitals,
patients, and developers of healthcare
and fitness apps—to join forces in a digital ecosystem.1 And

Apple is not alone: leading ecosystem
players such as Alibaba, Tencent, and Ping An are already
shaping markets in China. For instance,
89 million customers use Ping An Good Doctor, a platform that
connects doctors and patients for
bookings, online diagnoses, and suggested treatments.2
1 See Jürgen Meffert and Anand Swaminathan, Digital @ Scale:
The playbook you need to transform your company, John Wiley
& Sons, June
2017.
2 See Venkat Atluri, Miklos Dietz, and Nicolaus Henke,
“Competing in a world of sectors without borders,” McKinsey
Quarterly, July 2017.
2 Management’s next frontier: Making the most of the
ecosystem economy
The emergence of ecosystems marks a shift in the landscape as
unexpected alliances are
forged, sector boundaries blur, and long-standing strengths
count for less. It also marks a

shift in how business leaders manage relationships within an
ecosystem.
“Entangling alliances”
Relationships in an ecosystem take many forms. Some are
transactional and informal, like
those based on the application programming interfaces (APIs)
that allow systems to talk to
one another to execute simple tasks.
Other relationships are more formal and complex, with contracts
and service-level
agreements in place to cover governance, escalation paths, and
so on. Some of these
relationships may be with companies that in other respects are
rivals. (See sidebar,
“Coopetition: When competitors collaborate” for another
example.)
These relationships are built on myriad structures, from joint
ventures to mergers, exclusive
and nonexclusive partnerships, and other arrangements. As
businesses scramble to
find the right combination of complementary partners and allies,

many are running into a
thicket of “entangling alliances”—interlocking relationships
that create complex competitive
dynamics and lock players into platforms, technologies, and
systems from which it may be
difficult to extricate themselves. Graphics chipmaker Nvidia,
for example, is working with
eight different automakers to build embeddable computers for
self-driving cars.3
Companies have always forged partnerships and alliances, but
because relationships in
ecosystems are on such a large scale and are evolving so
quickly, traditional management
approaches are no longer fit for purpose. Successful companies
are finding new ways to
choose and manage partners and make deals.
Choosing partners
Any effective ecosystem strategy depends on understanding
where the value is. That
comes from calculating the value of your assets such as
customer relationships and
proprietary data, your existing capabilities, and where market

opportunities are emerging.
Equipped with that baseline, you can evaluate collaboration
opportunities with an eye
to finding capabilities, markets, and technologies that
complement and support your
company’s strategic ambitions.
Any temptation to narrow your search to organizations in your
sector or region should be
resisted. A better approach is to systematically map ecosystem
partners across industries,
3 See Dave Gershgorn and Keith Collins, “The entangling
alliances of the self-driving car world, visualized,” Quartz, July
26, 2017.
3DIGITAL MCKINSEY
Coopetition: When competitors collaborate
Seeing rapid change in the US book market Michael Busch,
CEO of the bookstore

chain Thalia, decided to band together with his competitors
Hugendubel, Weltbild,
Bertelsmann. Having tried to market their own electronic
readers without success, the
the booksellers in this emerging ecosystem needed access to
technology, and so they
brought Deutsche Telekom on board as their technology partner
(see exhibit below).1
1 It’s important to note that Tolino’s success has not benefited
all partners: Weltbild applied for insolvency and Bertelsmann
closed its book clubs in late
2015. On the other hand, several new partners have joined,
including Libri, with its 1,300 stores, and the alliance has also
expanded into Belgium, Italy, the
Netherlands, Austria, and Switzerland.
Web 2017
Tolino
Exhibit 1 of 1
Tolino—Alliance of German book retailers with 1,800 stores
combined and Deutsche Telekom

Large store
network
Established
brands
Existing customer
relationships
Established
technology partner
Experience with hardware and
software development
Profound market
understanding
Tolino alliance:
complete e-reader
offering
e-Reader e-Book
Store

App
Source: mytolino.de/shops
4
The partners knew their alliance had to move quickly, so they
created a small core team
and gave it extensive powers to make decisions and set rules for
working together. The
team decided that meetings would be announced 24 hours in
advance, decisions had to
be made within 30 minutes of the start time, and only CEOs
plus one additional person
per company would attend.1
This new structure allowed the partners to develop the Tolino e-
reader and a supporting
mobile app and to invest in an advertising campaign across all
digital channels.
Launched in 2013, Tolino pulled level with Amazon’s Kindle by
2015, with a market share
in excess of 40 percent.2

2 It’s important to note that Tolino’s success has not benefited
all partners: Weltbild applied for insolvency and Bertelsmann
closed its book clubs in late
2015. On the other hand, several new partners have joined,
including Libri, with its 1,300 stores, and the alliance has also
expanded into Belgium, Italy, the
Netherlands, Austria, and Switzerland.
Management’s next frontier: Making the most of the ecosystem
economy
identify key criteria (such as access to new customers or
capabilities), and consider likely
trade-offs (such as language and market potential). Banks and
retailers can make good
partners, for example, because they often target similar
customer segments but don’t
compete with each other for them.
We suggest companies follow a simple four-step process to
assess potential partners:
1. Evaluate the market in which your potential partner operates
and its level of

competition. The most promising ecosystems involve market
leaders with
complementary skill sets and value propositions.
2. Consider the company’s business model. Is it fit for purpose
and future-proof? What
products and services does the company produce? How nimble,
innovative, and
customer-focused is it? Can it keep pace with you and the
external environment?
3. Weigh the human factor. How strong is the company’s
management team? How
effective are its employees?
4. Look at the culture. How does your potential partner do
business? How does its way of
working fit with your own company’s culture?
5DIGITAL MCKINSEY
Making deals

To be successful, an ecosystem must have a compelling value
proposition that is attractive, open,
and relevant to multiple businesses. Beyond that, however,
forging multiple complex relationships
across an ecosystem requires a substantial investment of energy
and resources. Leading
companies are putting in place industrial negotiating teams that
are similar to central sales
teams in B2B companies but include executives and managers
from corporate development,
management, legal, business development, and technology.
Involving legal specialists in
negotiating teams is particularly important, given the host of
questions raised by working with third
parties—questions about cybersecurity, intellectual property,
data ownership, licensing, privacy,
profit sharing, liability, regulatory compliance, and customer
management. Companies are also
likely to need people with unfamiliar technical skills, such as
full-stack IT architects who can
integrate multiple technologies across infrastructure, apps, and
services.
The main responsibilities of the ecosystem negotiating team are
to continuously review

companies, reach out to prospective partners, and screen likely
candidates for compatibility.
The team should put in place a pipeline to track progress and
hold frequent reviews at specific
milestones to determine whether and how to pursue promising
options and when to drop
unsuccessful efforts. The team also decides on how new
relationships should be structured—
as joint ventures, mergers, or partnerships—depending on
competitive pressures and market
opportunities. Specific leaders will need to lead these ecosystem
deal teams, such as the head-
of-fintech position recently created at Asian bank DBS to lead
fintech engagements locally and
regionally.
New processes and capabilities are needed to enable these teams
to work quickly. Procurement
is often a prime culprit. One unfortunate fintech went out of
business while waiting for a major
bank to complete its 18-month-long procurement process. To
streamline and accelerate the
process, nimbler organizations are adopting new digital-
procurement tools and solutions, such
as workflow tools and supplier collaboration platforms.4

DueDil, a private-company information
platform, has an API that provides company data enabling
clients to automate many aspects of
data sourcing, diligence checks, and credit decisions.
A company that is dealing with hundreds of partners has no time
to customize agreements and
operating processes so it’s important to standardize governance
principles and support them
with service-level agreements (SLAs), technology protocols,
and simple rules. Establishing
realistic (and not too onerous) requirements for software release
cycles, for example, can simplify
development management.
Given the role of APIs as the connective tissue in ecosystems,
we’re seeing some businesses
create API centers of excellence (CoE). These teams oversee
API design and development across
the organization and manage all the APIs in a company’s
catalog to avoid duplication, enable
reuse, and assist with developer access.
4 See Pierre de la Boulaye, Pieter Riedstra, and Peter Spiller,
“Driving superior value through digital procurement,” April

2017, McKinsey.com.
6
Managing partners
Many partnerships underperform because they don’t have the
right management
infrastructure in place. Without it, people can easily get
distracted by issues in their day job,
become overwhelmed, or pass the buck to IT. This state of
affairs can be disastrous for an
ecosystem.
To counter it, companies need to invest in building an
ecosystem relationship-management
(ERM) capability with dedicated staff. At its most basic level,
this means answering emails
promptly and fixing simple problems that partners have. More
sophisticated functions
include resolving more detailed issues or joint development of
new products or services. Part
customer service, part issue resolution, and part account

management, the ERM capability is
crucial to the smooth running of an ecosystem.
Another important function of ERM teams is to track
performance in the ecosystems they
participate in. That requires establishing common standards and
metrics. Common KPIs and
metrics that are agreed to and shared by ecosystem partners can
help track performance and
assess impact, such as traffic or revenue generated, compliance
with budgets, and arrival
at milestones. Companies can guard against cybersecurity
breaches by setting stringent
protocols for encryption and data security for themselves and
their partners. Fraud is another
common problem, and one best tackled through fraud-
identification systems that use
algorithms and machine learning to analyze behavior (such as
speed of response or volume of
correspondence) and predict when an issue may arise.
Developers are among the most important stakeholders in an
ecosystem, so creating the
right conditions for them is crucial. Using open-source
software, for example, makes it easier

for developers to plug into the ecosystem. Developing clear and
user-friendly onboarding
processes is also helpful and should include well-organized
documentation and software-
development kits as well as streamlined reviews and approvals.
The marketplace launched in
2016 by BBVA Compass, a Spanish bank with a growing global
presence, makes it simple for
developers to build apps that interface with its back-end
systems; BBVA channels the energy
and creativity of fintech start-ups while retaining its leadership
position within the ecosystem.5
The best companies go even further and invest in support
channels for developers,
appointing a relationship manager to provide assistance as
needed, from responding to
questions to supporting an entire collaboration. GE holds
regular developer forums to help
peers support one another. Other companies stage one-off
events to provide education,
introduce new features, and strengthen bonds. They also make
developers feel valued by
giving them early access to news and releases.

It’s important to bear in mind that the organization at the center
of an ecosystem must be
prepared to share the surplus. Greed could threaten the whole
ecosystem.
5 See Peter Dahlström, Driek Desmet, and Marc Singer, “The
seven decisions that matter in a digital transformation: A CEO’s
guide to
reinvention,” February 2017, McKinsey.com.
economy
7DIGITAL MCKINSEY
Building ecosystem capabilities
Effective ecosystem management calls for a wide range of
capabilities. We’ve found two steps
particularly critical in developing them:
Invest in tools to scale ecosystem support. Managing
ecosystems requires a balance

between standardization (to prevent a chaotic mess) and
flexibility (to capture opportunities fast).
Standardizing core processes such as pipeline management,
negotiation templates, and software
acceptance guidelines can help accelerate the development of a
successful ecosystem. At the
same time, putting in place tools to track performance in real
time, establishing flexible agreement
structures, and investing in agile processes can give companies
the flexibility they need to adapt
to the changing dynamics of ecosystems.
Tracking KPIs and managing processes across what may be
hundreds of partners in an
ecosystem, however, is a mammoth task. The best companies
are turning to automation for
tracking and issue resolution, escalating to human intervention
for the relatively few cases where
complex judgments are needed.
Build an adaptive and collaborative culture. Embracing
ecosystems requires a shift
towards collaboration. Working with partners or vendors to
develop new initiatives, establishing
frequent communications on progress, and institutionalizing the

use of collaborative tools such
as Slack and video conferencing can can help cement the new
mind-set. One way to help foster
collaboration is to put in place protocols and incentives that
reward players not for their own
performance, but for that of the whole ecosystem. For instance,
in the marketing ecosystem of
agencies and channels, some client organizations are
experimenting with agency payments
based not only on how effectively they deliver their services but
also on their contribution to the
overall success of a given initiative.6
Creating an incubator may be a useful option to foster a
collaborative culture that the rest of the
business might struggle to embrace. These ecosystem incubator
teams can experiment with
advanced techniques, such as using data analytics to uncover
promising opportunities in real
time, bringing in a range of partners to help shape new
offerings, and executing quick-turnaround
experiments to create bottom-line impact.7
Investing in open-IT architecture, APIs, and microservices will
be key to developing a technical

platform capable of supporting the level of flexibility and
agility needed in ecosystems. At the
same time, organization leaders must role-model desired
behavior, such as treating ecosystem
management as a top priority and spending time with external
partners.
6 For more examples of best practices in marketing ecosystems,
see Thomas Bauer, Jason Heller, Jeffrey Jacobs, and Rachael
Schaffner,
“How to get the most from your agency relationships in 2017,”
February 2017, McKinsey.com.
7 See David Edelman, Jason Heller, and Steven Spittaels,
“Making your marketing organization agile: A step-by-step
guide,” November 2016,
McKinsey.com.
8
Who will profit from tomorrow’s self-driving cars, real-time

multichannel financial transactions,
equipment for smart homes and workplaces, and health and
fitness platforms? The answer is
groups of businesses working together in ecosystems—and now
is the time to work out how
to build and manage the partnerships involved.
The authors would like to thank Miklos Dietz and Miklos
Radnai, leaders of McKinsey’s Global Ecosystems
group, for their help with this article. This article draws on our
new book Digital @ Scale: The playbook you
need to transform your company, published by John Wiley &
Sons in June 2017.
Jürgen Meffert is a senior partner in McKinsey’s Düsseldorf
office, and Anand Swaminathan is a senior
partner in the San Francisco office.
economy
9DIGITAL MCKINSEY

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