Capital Budgeting Mission of Cer

Capital Budgeting

Mission of CER and capital budgeting process

Stryker has enjoyed a strong run of growth, and has taken advantage of this to gradually de-leverage its balance sheet. As the result of this, the company must use equity in order to finance its new projects. There are few key missions, therefore, related to Stryker's capital expenditure requests. These requests are the formal requests that are the basis of the company's capital allocation process. Because the company avoids taking on new debt, the funds available for expansion are somewhat limited, and this is why there needs to be a system for allocating the available funds.

Another part of the mission for the capital budgeting process is that Stryker has achieved strong growth over the past several years, including double-digit growth for the past seven years and 20% per year average CAGR. Thus, the process is essential to ensuring that the company is able to continue with these growth rates. One thing about having double digit growth every year -- once that is priced into the share price, the market is expecting it. If the company does not deliver, the stock price is going to be hit. Thus, there is significant incentive for the leadership at Stryker to have a robust process for capital expenditure requests that allows the company to maintain its historic growth rates.

The decentralized structure of the company contributes to the design of the CER. Each division is expected to submit plans that have undergone a robust vetting process, and the plans need to be refined. The company's culture encourages generating great ideas, and the result of this is that there is a need to pare back the number of proposals. Further, the proposals were designed around divisional cash flow requirements, which are also consistent with the decentralized structure. Within each division, there are also tradeoffs, between existing businesses and new businesses. Further, the company has in recent years modified the approval process so that large CERs had increased spending authority thresholds.

The superstructure of the CER within Stryker is that once proposals have been accepted at the division level, they are then approved at the group level and finally at the Capital Committee or Board of Directors. This process is time-consuming, but Stryker has been cautious with respect to moving too quickly on ideas, preferring to ensure that the ideas will not reduce the company's growth.

Strengths, Weaknesses and Performance

Evaluating the performance of this CER system cannot be done against a theoretical alternative system. Thus, quantitatively it can only be evaluated in terms of whether or not the corporation's objectives. The system can also be subjected to qualitative analysis to make an intuitive determination of how much it contributes to the company's objectives.

Quantitatively, the system has delivered success. Stryker has been able to maintain a high level of growth over the past seven years. This growth is not only in revenue but in profit as well. Profit is the more likely measure for a company that is using a capital budgeting process that emphasizes positive cash flow. Further, most quantitative systems should factor in the return on investment, or return on equity. The former is probably the best for individual projects, where the latter can be useful for the corporation as a whole. Litzenberger & Joy (1975) argue that ex-post return on investment should exceed a target rate and that managers often equate risk with the risk of not meeting prescribed rate of return targets.

From a qualitative perspective, the system bears some similarities with best practices. Litzenberger and Joy (1975) note that in a decentralized system, quantitative measures are more common for evaluating projects, but they also note that for larger projects there is some degree of centralization. This is the case with Stryker, where the most substantial projects are approved by the Board of Directors.

Ang (1986) notes, however, that there can be agency problems where the interests of the division are misaligned with the interests of the corporation as a whole. A good system for CER, therefore, will incorporate checks into the system, to ensure that projects are aligned. To some extent, alignment at Stryker is generally the responsibility of the Capital Committee. The problem with this system is that the Capital Committee only sees projects that have already been approved by the divisions. This means that there might be some useful projects that are rejected at the division level but that might have been better for the company as a whole than the ones that were submitted to the Capital Committee. Further, there is the possibility that a project at the division level might be a good fit for a different division. There is no process by which communication exists between the different divisions, either in an interdivisional level or via the corporate level.

The lack of coherence between the different initiatives is a significant problem, arguably the most important one with the Stryker system. The company has achieved success with respect to quantitative measures but in qualitative terms there is the risk that its system has undermined the possibility of even greater success, where managers in the company are unaware of the activities in other areas and therefore may inadvertently undermine those areas (Bower & Gilbert, 2007).

Recommendations

The first proposal is that projects should be brought for a summary assessment by the Capital Committee prior to approval at the division level. The CC knows the spending limits for each division, but it is also in a better position to assess whether or not a given project meets the needs of the organization as a whole. The CC can therefore contribute valuable knowledge in determining which projects among mutually exclusive options would not only meet the objectives of the division but of the organization as a whole.