is the Relative Value of Growth? Description
The Relative Value of Growth framework (RVG) from Nathaniel J. Mass
is a technique that can be used for comparing how growth- and margin improvement
effect shareholder value. The relative value of growth expresses the value
of an extra percentage point of growth as a multiple of the value of a percentage
point increase in a company's operating profit margin. If the multiple is
higher, the growth will be more valuable to a company.
An RVG of 3, for example, means that a firm would generate three times
as much shareholder value by adding 1% of growth, than it would add by increasing
operating profit by 1%.
Mass claims that the shareholder value creation potential of growth strategies
often outweighs by a factor that of Cost Cutting strategies. In his article
in HBR of April 2005, Mass concludes furthermore that growth is often far
more valuable than managers think, especially when considering long-term.
Calculation of the Relative Value of Growth. Formula
RVG is calculated by dividing the value of 1% revenue growth by the value
of 1% margin improvement (see fig).
Usage the Relative Value of Growth model. Applications
- Making investing decisions.
- Corporate Strategy formulation.
- Business Strategy formulation.
- Establishing a long-term focus.
- Show the potential of growth as a source of value.
- Understanding shareholders expectations.
- Performance Management.
- Executive Compensation.
Strengths of the Relative Value of Growth framework. Benefits
- Ease of use and simplicity.
- Find right balance between growth and margin improvement at corporate
- Find right balance between growth and margin improvement at SBU level.
- Establishing a long-term focus.
- Helps to show the potential of growth as a source of value.
- Provide managers with an understanding what shareholders expect of them.
- Maybe used in the future for Performance Management and Executive Compensation.
Limitations of the Relative Value of Growth method. Disadvantages
- Margin calculation is EBIT based / Operating Profit based: limited reliability.
Relatively easy to manipulate.
- Technically flawed and not very precise:
- DCF model does not distinguish short-term and long-term.
- Cost of capital and growth-return prospects are taken at corporate
- No distinction is made between acquisition-driven growth and organic
- RVG is a relative measure: does not show the actual amount of the contribution
of growth and margin improvement.
- RVG helps shifting the investment focus to the long term. However
it does not prevent a short-term view by analysts or by investors.
- Intangibles valuation?
Assumptions of the Relative Value of Growth model. Conditions
- A simplified numeric approach can help to make the right strategic choices
and investment decisions
- The limited reliability of the Relative Value of Growth formula is not
a major problem.
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Compare with Mass's Relative Value of Growth:
PEG Ratio |
Economic Value Added |
Market Value Added |
Discounted Cash Flow |
Return on Investment |
Growth Phases |
BCG Matrix |
Product Life Cycle |
Product/Market Grid |
Profit Pools |
framework | Rule
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