directors report and accounts 2006 - Our strategy

 
 

 Our strategy

Our vision is to achieve leadership of the global tobacco industry, through strategies for creating shareholder value based on Growth, Productivity, Responsibility and a Winning Organisation.

We define leadership in both a quantitative and qualitative sense. Quantitatively, we seek volume leadership among our international competitors. Qualitatively, we aim to lead our industry as the preferred partner of key stakeholders and in demonstrating responsibility.

Diagram 1: Group strategy

Growth

We aim to grow our revenues and profits and to grow our share of the global market. We have two routes to do this: organic growth and mergers and acquisitions. Organic growth means increasing our market share in existing markets and through entering new markets.

To achieve organic growth, we focus on key market segments that offer the best long term prospects, including Premium and International Brands. We also aim to optimise the performance of our Global Drive Brands and to exploit opportunities for profitable volume growth in the Value-for-Money and Low Price segments. We see innovative products that offer consumers meaningful, value-added differentiation as key to organic growth. We aim to continue sustaining or developing strong positions in our largest and most profitable markets.

Strategically important and financially attractive mergers and acquisitions may also provide us with growth opportunities.

Productivity

Our approach to productivity concentrates on smart cost management, marketing efficiency and capital effectiveness; deploying our global resources more effectively to increase profits and generate funds to reinvest in our business. This includes ensuring that we use our marketing resources and capabilities in the most efficient way, reducing unnecessary complexity and using our cash and other assets effectively. We are saving money by turning a multinational business operating in over 180 markets into an integrated global enterprise that can really take advantage of its scale.

Greater integration across our supply chain is helping us to reduce costs, increase speed to market and improve effectiveness. We are also reducing our overheads and indirect costs (anything we spend money on other than leaf, wrapping materials, cigarette making machinery and labour costs).

Responsibility

Because we manage a product that poses real risks to health, we strongly believe that our business must demonstrate responsibility in everything it does. We aim to balance our commercial objectives with stakeholders’ changing expectations of a modern tobacco business. Our Business Principles and our Standards of Business Conduct set out what we require of our companies and employees in terms of responsible corporate behaviour and personal integrity.

We support tobacco regulation that balances the preferences of consumers with the interests of society, establishes an open-minded approach to harm reduction as a policy, and enables our businesses to continue to compete and prosper.

Harm reduction is an important element of our strategy. For more about our approach, see the Harm reduction section of Responsibility.

Winning organisation

To achieve our vision of industry leadership, we recognise that we must continue to have the right people and the right working environment. We aim to develop leaders at all levels, to foster a confident culture that embraces change and innovation, to attract and retain talented people and to ensure continuous improvement throughout the Group.
Net revenue growth
Global Drive Brand volumeShare of global volume amongst key players
Organic operating profit growth
Cash flow
Earnings per share

Our Key Performance Indicators

Measuring our performance
We have a wide range of measures and indicators by which the Board assesses performance compared to the Group’s strategy.

The Group’s goal to create shareholder value through the strategies of Growth, Productivity, Responsibility and Winning Organisation is best measured by the main financial drivers of the business. To ensure management’s focus is aligned with the interests of our shareholders, these measures form the basis upon which the levels of incentives for the global organisation are decided. They are described below as our seven Key Performance Indicators (KPIs). Some of these KPIs are used to set the targets for the Group’s performance over three years and some are focused on the short term. These KPIs were chosen as they are mainly based on published results or can be calculated from them. They are therefore reliable and are not based on subjective measures or interpretations.

A number of other Business Measures, financial and non-financial, are monitored and assessed on a frequent basis to ensure that all the Group’s strategies are delivered. Although all these are not included in management’s incentives, we believe that these Business Measures are all contributing to the success of the Group, particularly over the longer term.

We have therefore included, in this Review, some additional Business Measures relating to the Responsibility and Winning Organisation elements of our strategy. Our progress under Productivity is, of course, covered by the information we already publish about the Supply Chain and Overheads and Indirects programmes.

These measures and the performance relating to them, are discussed in Productivity, Responsibility and Winning Organisation.

The Remuneration Committee sets targets at different levels, based on the Group budget approved by the Board in December. The KPIs used in 2006 have been retained for 2007.

Measuring short term performance

See chart 1 Net revenue growth
Net revenue for 2006 grew by 5 per cent. The long term goal is to grow net revenue, on average, by 3-3.5 per cent per annum.

The net revenue figure is calculated as the revenue of the Group after the deduction of any duties, excise and other taxes, as published in the Group Income Statement.

Click here to view the Net revenue growth data

See chart 2Global Drive Brand volume
A key strength of the Group is its diversified Global Drive Brands (GDBs) portfolio. The growth of the four GDBs Dunhill, Kent, Lucky Strike and Pall Mall is therefore a key driver of the Group strategy and is measured as one of the KPIs.

In 2006, GDB overall volume grew by 17 per cent to 146 billion compared to 9 per cent growth in 2005. Our target is to achieve high single figure growth.

GDB volumes are calculated as the total volumes of the four brands sold by our subsidiaries.

More information about the GDBs and their individual performances, is provided in this Review in Growth.

Click here to view the Global Drive Brand volume data

See chart 3Share of global volume amongst key players
The long term goal is to become the leading international tobacco company and British American Tobacco is currently second.

In 2006, our share of global volumes amongst key players grew by 0.2 per cent. Share of global volume is calculated as the volumes sold by Group subsidiaries as a percentage of the volumes sold by all international players, namely Philip Morris International, Japan Tobacco, Imperial Group, Gallaher and Altadis. The information used to complete this calculation is based on publicly available information and internal company analysis.

In our endeavour to grow global volumes, we assess all available acquisition opportunities on a frequent basis, but will only make a move when it is both financially and strategically attractive.

Click here to view the Share of global volume amongst key players data

See chart 4Organic operating profit growth
The Group’s long term aim is to grow organic underlying operating profit by 6 per cent per annum, on average. For 2006, it was 7 per cent and for 2005, it was 9 per cent.

Organic profit used in this assessment is the operating profit of the Group’s subsidiaries, excluding any exceptional items – the items shown as memorandum information on the Group Income Statement.

Click here to view the Organic operating profit growth data

See chart 5Cash flow
The Group’s free cash flow in 2006 was £1,541 million, marginally below 2005.

Free cash flow is defined as net cash from operating activities (including dividends from associates, restructuring costs and taxation) less net interest, net capital expenditure and dividends to minorities – the change in free cash flow is described in Cash flow.

The purpose of this measure is to ensure that the Group generates sufficient cash to fund its operations, pay dividends to its shareholders, operate the share buy-back programme and undertake other investment opportunities that may arise.

Click here to view the Cash flow data

Measuring long term performance

See chart 6Earnings per share
Adjusted diluted earnings per share (Adjusted EPS) grew at an average of 12.4 per cent per annum since the beginning of 2004. This compared favourably to the long term goal of growing at the rate of high single figures per annum, on average, over the medium to long term. Adjusted EPS grew 10 per cent in 2006 (2005: 17 per cent).

Adjusted diluted EPS is the best measure to assess the underlying performance of the business, as it excludes all significant distortions (one-off and exceptional items that occur) but includes the potentially dilutive effect of employee share schemes. The detail of the calculation and the adjustments made, are explained in note 7 to the accounts included in the Annual Report and Accounts. This calculation removes the impact of the exceptional items shown as memorandum information on the Group Income Statement. These items are the restructuring costs and impairment of a business, offset by gains on disposal of brands. In addition, the calculation also adjusts for certain distortions in net finance costs arising under IFRS.

Click here to view the Earnings per share data

See chart 7Total Shareholder Return
The Group’s strategy is focused on increasing shareholder value which is measured using Total Shareholder Return (TSR), compared to the FTSE 100 Index and also to the Fast Moving Consumer Goods (FMCG) peer group. The Group has achieved a top quartile performance in both these categories since 1999. The goal is to be in the top quartile of each of the two comparator groups over a three year average.

Over the past five years, the Group has delivered an average TSR of 26 per cent compared to 7 per cent for the FTSE 100 Index (See Summary remuneration report for performance graph).

TSR performance combines both the share price and dividend performance of the Company during the performance period, as set against the two comparator groups. The FMCG comparator group is reviewed annually to ensure that it remains both relevant and representative and to, as far as possible, reflect the Company’s financial and business trading environment.

TSR is measured according to the return index calculated by Datastream, on the basis of all companies’ dividends being reinvested in the shares of the companies. The return is the percentage increase in each company’s index over a three year period. The measures and the outcome for the current and previous years are explained in the Summary Remuneration Report, where the Group’s employee share schemes are described.

Total shareholder return (annual %) - FMCG group
Total shareholder return (annual %) - FTSE 100