554  Strategic Management: Analytics and CFO. The strategic projects are then included alongside the business unit tranches in the overall ranking. This approach ensures that critical strategic projects are highlighted for discussion and funding at the level of the com- pany’s executive leadership, rather than by business unit management. Applying Value Drivers to Monitor Performance Analyzing business units and projects at a fine-grained level while allocating investment opportunities across the entire enterprise unveils the promise of managing strategically. In many companies, communication between man- agement layers revolves entirely around missing or hitting profit targets for divisions, business units, and other groups. Strategic management, done well, helps an organization’s various layers communicate frankly and effectively. Managers gain leeway to manage while assuring their bosses that agreed- upon levels of performance will be achieved. They can also carefully disaggre- gate such targets to business segments that can be individually monitored and managed. Attention shifts to the long-term, value-creating potential behind short-term profit targets and the adjustments needed to achieve long-term performance goals. To plan and monitor progress, it is critical to understand what drives long- term performance. Think of a patient visiting the doctor. The patient may be feeling fine, in the sense of meeting requirements for weight, strength, and energy. But if the patient’s cholesterol is above the target level that medical science has established as safe, the patient may need to take corrective action now to prevent future heart disease. Similarly, if a company shows strong growth and return on invested capital (ROIC), it still needs to know whether that performance is sustainable. Comparing readings of company health indi- cators against meaningful targets can tell us whether a company has achieved impressive past financial results at a cost to its long-term health, perhaps crippling its ability to create value in the future. Companies should look be- yond the usual health indicators for business performance to also assess their health on environmental, social, and governance criteria, as these measures are sometimes even more important for sustaining value creation over the long term (see Chapter 6). To see the difference between companies’ recorded performance and their long-term health, consider the pharmaceutical industry. In the year after the patent on a drug expires, sales of that drug for the patent owner often de- cline by 50 to 75 percent or more, as producers of generics lower prices and steal market share. Investors know that future profits will suffer when a major product will be going off patent in a couple of years with no replacement on the horizon. In such a case, the company could have strong current per- formance but a poor performance outlook reflected in a low market value, Applying Value Drivers to Monitor Performance  555 because market values reflect long-term health, not just short-term profits. Or consider retail chains that sometimes maintain apparently impressive margins by scrimping on store refurbishment and brand building, to the detriment of their future competitive strength. To effectively manage short-term and long-term performance, companies should identify and understand the underlying value drivers of their busi- nesses. Based on these insights, they should develop a coherent set of action- able metrics that are tailored to their business and set appropriate targets against which to monitor results. Identifying Value Drivers We can gain insight into a company’s health by examining what drives long- term growth and ROIC, the key drivers of value creation. A systematic method for analytically and visually linking a business’s unique value drivers to finan- cial metrics and shareholder value is the value driver tree. It breaks down each element of financial performance into value drivers. The value driver tree in Exhibit 29.4 illustrates the basic kinds of value drivers. The left side of the exhibit shows the financial drivers of intrinsic value: revenue growth and ROIC.9 Proceeding to the right, the exhibit calls out short-term value drivers, followed by medium- and long-term value driv- ers. The choice of a particular value driver, along with metrics and targets for testing and strengthening each one, should vary from company to company, reflecting each company’s different sectors and aspirations. Companies should choose their own set of value drivers and metrics, under the generic headings set out here, and tailor their choice to their industry and strategy. Such tailoring is critical for setting the right strategic priorities. For example, product innovation may be important to companies in one industry, while for companies in another, tight cost control and customer service may matter more. For companies in electric power generation, the growth of gen- eration from renewable resources may well be critical over the next decade. The way executives set priorities for value drivers should reflect these differ- ences. Similarly, an individual company will have different value drivers at different points in its life cycle. Every company will need to develop its own appropriate value drivers and metrics. The generic categories of short-, medium-, and long-term drivers presented in Exhibit 29.4 offer a practical starting point for analysis. Using them will ensure that a company systematically explores all the important drivers. 9 Cost of capital is also a driver of company value, but it is largely determined by the company’s indus- try sector and is difficult for management to influence.