Managers' responsibility to shareholders is paramount
William H. Schumann, III
FMC Technologies Inc.
Houston
Corporate managers are stewards of shareholder capital. Their jobs are to invest their shareholders' capital at acceptable rates of return to create value for those shareholders. Corporate managers' ability to generate value is based on how much return they can create with their investments and how much money they can invest at those rates of return.
High returns on capital in limited situations are not as valuable as high returns on capital in situations where more capital can be invested. High returns on capital coupled with the ability to grow the amount of capital invested are the best indicator of growth in shareholder value.
In today's business world, competition is intense. Technology is changing rapidly. Communication allows small businesses to access world markets, both for sales and for sourcing of raw materials or services. Products and services are offered in bundled or unbundled packages. All of these factors put pressure on returns on capital.
Competitive advantage traditionally created through technology, service, distribution systems or even industry structure is harder to maintain. High returns in this environment indicate that a company has a truly protected position. Conversely, low returns indicate a weak competitive position or one that can easily change from a profitable business to a losing business.
Additionally, a factor that is often overlooked in this current environment of low interest rates is that investing in low return businesses ultimately slows the growth of a company as capital constraints come into play. The low returns in Enron's businesses and the need for capital were factors that drove that company to create some of the off-balance sheet structures that ultimately forced Enron into bankruptcy.
Most companies have some product lines or businesses that create high returns and constitute the basis of a company. The growth profiles of these businesses and what companies do with their other businesses and excess capital ultimately determine the total returns of the company. These businesses use technology, manufacturing, sourcing, customer service and distribution systems to create an environment in which they generate more profit with less capital than their competitors. They may not have the highest margins on sales or capital turnover, but the combination of profitability and capital results in a high return on the capital necessary to generate the profits.
At FMC Technologies, we are fortunate to have a number of these types of businesses. Our subsea production systems, fluid control and citrus businesses all possess these high return characteristics.
Most businesses do not create high returns. Our free market economy dictates that capital is deployed to areas of high return. Capital flows to areas of high return and lowers the returns until they become too low. Then capital exits, allowing returns to rise back to acceptable levels. Evidentially, only very protected businesses with significant advantages can sustain high returns. Managing businesses in this environment requires a disciplined focus on the details of those businesses. A relentless focus on costs and capital is required.
At FMC Technologies, we are proud of our focus on the details of our businesses. We manage capital as well as any company. We continually focus on working capital in all of our businesses. We consistently try to reduce costs through improved processes, sourcing, and technology. The result is that we manage competitive businesses in a way that allows us to produce acceptable returns in those businesses.
Additionally, we tie managers' compensation to a measure, similar to Economic Value Added (EVA), that we believe is very close to shareholder creation. We call it net contribution and define it as the after-tax profits in a business or product line less a charge for the capital required. It captures both high returns and the amount of capital that is deployed at those high returns. We have used it for many years and have educated managers throughout the organization on its merit. The results speak for themselves. We have combined our protected, high-return businesses with investments in well-managed, competitive businesses that have acceptable returns.
As a result, FMC Technologies has returns on capital that are among the highest of any industrial or oilfield service company (see Figure 2). Since our IPO in June of 2001, we have also produced returns for shareholders consistent with our improving returns. These returns have been in excess of what both the S&P 500 and OSX index have produced.
At FMC Technologies, we believe relentless attention to the management of capital is essential to the continuing health of our company. We also believe that adherence to our strict capital management discipline, with the objective of optimizing returns, is the most effective way for us to be good stewards of our shareholders' capital.
The author
William H. Schumann, III is senior vice president, CFO, and treasurer, of FMC Technologies Inc. He joined FMC in 1981 and has served the company in a variety of capacities, including director of pension investments, director of risk management, and director of investor relations and pension investments. He was appointed treasurer of FMC in 1987 and served as executive director of corporate development from 1991 to 1993, when he joined the company's Agricultural Products Group as director of North American Operations. He has been a vice president of FMC since 1995. Before joining FMC, Schumann served as financing planning manager for Sunkist Growers Inc., and prior to that he was a program management analyst with Hughes Helicopter. He has a BS degree in systems engineering from the University of California at Los Angeles and an MS degree in management from the University of Southern California.