Operating Contribution


Definition

The Operating Contribution is the sum or the average of the Operating Ranks of a) several financial metrics of a company or a portfolio or b) one financial metric of several companies observed across several time periods.

Typically a graph as shown below is conceived as Operating Contribution.

Description

The Operating Contribution is a selection of Operating Ranks where 50 percentile ranks are deducted thereof. The conversion of the Operating Rank into the Operating Contribution is done by deducting 50 percentile ranks from the Operating Rank. I.e. only that fraction is left of the Operating Rank that is above (positive Operating Contribution) or below (negative Operating Contribution) the median.

The graph thus emerges from the middle, the 50th percentile rank, to above and below in each case by plus and minus 50 percentile ranks. For simplified interpretation and with regard to the consistency with the Operating Rank the vertical axis (y-axis) is being labeled in analogy to the Operating Rank (thus from 0 to 100 percentile ranks).

The sum of the ranks of the company or the portfolio is shown with orange dots that are connected with an orange line. This relates to the total performance of the individual contributions.

For consolidated Operating Contributions, it is admissible to use averages or sums of Operating Ranks.

Like the Operating Radar, the Operating Contribution combines data from numerous Operating Ranks to show value contribution per financial metric. Growth rates, margins, and turns are displayed together in like terms: each as a percentile rank within its peer universe. Operating Contribution is shown in two different ways:




First Application

The first application of the Operating Contribution demonstrates which key metrics (value drivers) accounted for which contribution across the time horizon. In this manner, one can assess the extent that financial metrics such as revenues, by cost management (margins), or by capital efficiency (capital turns) contribute to changes in value.

If the analysis is conducted with average Operating Ranks, the same conclusion can be asserted for an entire portfolio. For example, the research company Obermatt supports Private Equity Firms in the assessment of portfolio companies by identifying from where thus from which value driver the contributions are made.

In the example above, the revenue contribution to the portfolio is always positive. The Operating Contribution from cost management has been positive until 2006 (except for 2003) and then was negative in 2007 and 2008. The contribution from capital utilization (blue) was always negative. This does not have to be a bad thing per se, as long as it is in line with company strategy. A growing company, for example, can follow the strategy to invest more than the market and thus show a negative performance in capital efficiency over a certain time period.

The Operating Contribution can also be combined with statements about the source of value from changes in market valuation (such as P/E Ratio, Market-to-Book Ratio, etc.).




Second Application

In a second application, one can assess which of several companies accounted for which key metric contribution (value driver). If, for example, the goal is to assess which company contributed which share to growth, the Operating Rank for sales growth can be shown for each company under investigation.

The graph above shows the value contribution of cost management across a number of companies. Company A and Company B showed positive value contributions across all time periods. The other companies showed mostly negative performance. Only Company C was able to show a positive value contribution in 2008. Based on the data, the overall portfolio performance was negative in 2006 and 2007.

With the Operating Contribution, one can identify the contribution towards value growth of each company in a portfolio. This is primarily used by investors which also pursue operative management in the portfolio companies. Obermatt maintains these analyses for strategic investors to identify early warning signals or value gaps in portfolios.

Examples

The financial research company Obermatt AG (about) provides indexing performance analysis such as the Operating Contribution to clients. Request a quote for your company by contacting Obermatt AG (contact).

If you are writing a dissertation or master thesis on this topic, Obermatt AG (career) supports you.