Stryker: Net Present Value and Capital Budgeting Process

1. What are the missions of CERs and the capital budgeting process at Stryker?

Mission: Standardize and formalize the capital budgeting process. The CERs and capital budgeting process were implemented so that a more formal process of requesting capital expenditure and approving them would be applied. All this was put in place to support cash flow targets and maintain Stryker’s 20% growth benchmark.

To what extent have they been shaped by elements of corporate finance theory?

They are heavily influenced by corporate finance theory All submissions are required to show the net present value (NPV), internal rate of return (IRR) and payback period. They need to highlight the project’s anticipated outgoing cash flow and earnings effects on the company and describe specific risks that could affect the projects abitily to deliver projects economic results. Specifically for mergers the CER would include financial analyses of “Best Case” and “Worst Case” scenarios which would include income and cash flow figures.

To what extent are they shaped by Stryker’s particular industry, history, and culture?

These factors play a role in shaping the CERs and capital budgeting: Industry: With a growth in the medical industry and an aging baby boomer population Stryker would naturally see a growth. However to continue to achieve this growth a steady or increased rate they would need to establish a method (in this case CERs and capital budgeting process) to make the best financially decisions and keep the company moving on its current growth path.

History: Their business history shows that in the 1970s when John Brown took over a CEO and set ambitious growth targets that were met through invention, of their corporate slogan “20% growth forever!” That trend continued over the following decades and to maintain that growth Stryker will need to continue to review and strategically plan their investments.

Culture: The company was very accustomed to proposing many investment projects and getting them approved (prior to establishing the CERs about 300 requests were submitted per year). By implementing the more standardized processes Stryker was able to funnel these requests down to about 30 per year and see each project under the same view as each project is now submitted under the same requirements.

2. What are the primary strengths and weaknesses of the current system? How should the performance of such a system be evaluated? Strengths: With the current capital budgeting process in place there is greater control (by higher management) of the proposed investments and therefore potential cost savings on unnecessary projects that might have been put into action in the past. The CERs provides a more rigorous review of the financials, economic justifications (NPV, IRR, and Payback period), and risk factors, to make for more educated decisions on the types of projects/investments to move forward with. They now have standardized documentation on every project that is proposed so they can compare and review if similar opportunities arise.

Weaknesses: With more control being placed with upper management, employees feel less responsible and less motivated to succeed with these projects. They now have less ownership. Projects that we dubbed “no brainers” have to go through the same scrutiny and this takes time from both employees and the Capital Committee members. Time to get projects going was extended as now there was a two week timeframe for submission and approval and in some cases longer if the virtual committee was unable to agree with the allotted time. It affected the old entrepreneurial culture of Stryker Corporation.

Evaluation of System: Revenue Growth- Since the main mission of the company has been to maintain or increase the 20% growth each year you can look at how well this process aligns to maintain that mission. Research and Development expenses. To sustain the growth it is the capital committees responsibility to ensure the company continues to invest in R&D. Looking at the Exhibit 1 the summary of the operating and financial data for Stryker you can see from 2005 to 2006, when the CREs and capital budgeting process were put into place, that there were significant increases in RD&E expenditures and purchased in process R&D.

3. Given Stryker’s strategy and its long--‐run goals, what modifications to the current system— analytical, organizational, and/or procedural—would you recommend? Develop some specific proposals and explain how they address specific problems.

Procedural Modifications and Recommendations: The CER system was developed to outline specific requirements of a project and create rigorous documentation of the projects. As well, the process was put into place to enable a more structured review of these proposals between employees and management. The implemented a two week review timeframe to receive and review the documentation. These processes while good had several flaws: The committee was not holding regular meetings and as a consequence “submission and review” process was not being completed on time. As they were meeting virtually this did not facilitate good conversation/discussion on the proposals. For insignificant “no brainer” projects there was excess documentation, decreasing efficiency and productivity.

To improve the efficiency of how the Capital Committee reviews and approves proposals they need to establish a scheduled face-to-face session (perhaps on a weekly basis) to receive and review all CERs. This will give further structure for divisions to prepare their proposals and a more formal atmosphere to review and discuss them. As well, in case of an emergency CER that need immediate attention there wouldn’t be a backlog.

As, well a “CER light” should be established for the “no brainer” projects that would not require the rigor of some of the other proposals. This will allow the Capital Committee to still receive pertinent information about the project/investment but not to the extent required by the current CER.

Organizational Modifications and Recommendations: With the implementation of the CER process there was a shift to heavy corporate involvements in the process which clashed with the existing decentralized organization and entrepreneurial culture that employees had been used to. This shift changes the responsibility and ownership that these employees have with these projects and that passion the company had to growth may start to diminish without employees feeling they have a role.

To improve employee satisfaction there needs to be some way for employees to have a voice with the committee or be acknowledged for the proposals they are working on. Incentive programs, such as bonuses or possible promotions for proposals that prove to be successful, could be established. As well, employees could play a bigger role in presenting and “selling” the proposal to the committee.