Capital Investment at Stryker The investment process began in Stryker's decentralized divisions, where marketing, production, and technology specialists proposed projects within their own division for the upcoming year, in accordance with multi-year strategic plans. Generally, proposals were discussed, vetted and prioritized within the division as part of the process of developing division operating plans and budgets. Curt Hartman, President of Global Instruments, commented (in early 2007) on the relationship between the operating budget and the capital budgets: \"I already know my 2008 numbers for revenue, operating profit, all the way down to free cash ow. The corporation is going to have a plan to grow adjusted net income by at least 20% and I know what that means for me R&D hits operating profit,- capital spending hits free cash ow, and so forth. It all has to fit.\" Generally, the plans presented by divisions to corporate had already been refined by analysis, negotiations, and assessments of tradeoffs within the division. These plans contained goals for revenue, operating prot and cash ow that the divisions felt were both deliverable and consistent with global corporate targets. Total divisional capital spending had to be trimmed to meet cash ow targets. Hartman observed, \"Everyone has a wish list [for spending items]. If we roll up everyone's wish list, it's too big by a factor of three. So I have to push back. And we go back and forth until we gure out what works.\" The capital budget also reected tradeoffs between spending on existing businesses and new initiatives. The split within Global Instruments, for example, had recently been This document is authorized for use only by EUROPEAN COLLEGE-EC BUSINESS S SA in 2019. For the exclusive use of E. S.A., 208-046 Stryker Corporation: Capital Budgeting about 25-35% percent for existing businesses and the remainder for new initiatives. Spending proposals originated with sales and marketing executives, who were listening to customers and watching competitors; with in-house technology experts, mostly engineers; and with business development executives, who studied markets, went to medical conventions and trade shows, and worked with outside experts and consultants. Authority to approve capital spending resided at the division level, the group level, with the Capital Committee, or with the Board of Directors, depending on the purpose and the amount of funds involved. Only the Board could authorize expenditures over $10 million. The Capital Committee had to approve operational projects involving more than $2.5 million, as well as all acquisitions, joint ventures, equity investments, and licensing, development or distribution agreements in excess of $1 million. The Committee likewise reviewed all subsequent changes in cost or scope for projects it had previously approved. Below the Capital Committee, spending authority varied within different groups and across divisions but had to conform to corporate guidelines. The greatest strengths of the CERs system all relate back to accountability and consistency. For example, with the new capital budgeting process management is able to better control what projects are and are not approved for funding. This eliminated potential losses that might have occurred if an unsound project was given the green light. The CERs also provide a more detailed look at the financials of each proposed project, including the NPV, IRR, and payback period. This, along with an examination of the risks, leads to educated decision making on the part of the management. Finally, the proposal process has now been standardized, such that every proposed project from every department now follows the same layout. This allows for better inter department communication, a smoother workflow, and the comparison between projects. The weaknesses of the CERs system have more to do with bureaucracy and a negative effect on the corporate culture of Stryker. Firstly, now that the proposal process was more included the identification of key team members and the time each would devote to implementation. This section also diScussed milestones, Such as revenue, operating profit, capacity utilization, costs savings targets, and dates by which such milestones would be met. The second section of an Operational CER presented the financial plans and analyses that Supported the economic justification presented in the first section. It also included sensitivity analyses of the key risk factors Set forth in the rst Section. M&A CERS contained the same two sections, business and nancial, but generally had a broader scope. Section I covered the business proposition and included: 0 Situation analysis. This consisted of a review of the macroeconomic context, the market situation, and background information on the target. 0 Strategic rationale for the proposed transaction. This linked the transaction to specic Stryker goals and the corporate strategic plan, and articulated the justication for the deal. 0 Transaction as proposed. This was essentially a term sheet - a comprehensive summary of key terms of the transaction. It set forth, among other details, all parties to the deal, ownership interests, the legal form of the deal, the types and amounts of consideration to be paid/ received by all parties, representations and warranties, fees and expenses, etc. 0 Overview of Base Case operating plans. The operating plan for the target business or assets was a set of ve-year (longer if necessary) operating forecasts based on explicitly-identified value drivers. The plan enumerated and supported all key market and operating assumptions. It projected the financial performance of the business under the Base Case plan and summarized key financial performance measures: NPV, payback period, and IR. Finally, the Base Case plan also included a management plan: key people and their qualications and key management structures and timelines. 0 Risk factors. This consisted of a summary and description of key risks that could affect performance. CERs were to consider risks in twelve specific areas (such as pricing risk, competitive reactions, regulatory approvals, technological obsolescence, overruns, currency and exchange risks, etc.). 0 Project timeline. This set forth key project milestones and expected completion dates. It covered all steps in accomplishing the transaction from negotiations through closing and management transition. Section II of an M&A CER covered the Same financial analyses as for an Operational CER and some additional topics as well. In addition to a detailed financial model of the Base Case operating projections, the CER had to present nancial analyses of \"Best Case" and "Worst Case" scenarios for the propOSed transaction. These Scenarios were to reect Salient combinations of the key risk factors identied in Section I of the CER. It was expected that these alternative scenarios would be materially different from the Base Case. Section II also prepared a summary table of key operating and financial performance indicators for years 0-5 for all scenarios. Exhibit 5 summarizes essential elements of both types of CER. The Approval Process The approval process for large CERs had been modied in recent years to increase the spending authority thresholds at the Division and Group levels, institute more formal, standardized procedures, and require more rigorous analysis and documentation. The standard CER forms were also redesigned and came into usage along with the modified procedures in 2005. Partly as a result of the changes, the number of CERs requiring centralized approval fell from about 300 per year to about 30 per year. As part of the change, a Capital Committee was constituted and formally charged with reviewing and approving large CERs. Members of the Capital Committee included Stryker's CEO, CFO, Treasurer, Controller, General Counsel, VPs for Tax and Business Development, and the Director of IT. To receive spending authorization, a large project had to be approved by both the CEO and a majority of the other Capital Committee members. Each CER had a designated sponsor who served as liaison between the proposing division and the Capital Committee. Operational CERs were sponsored by the Controller. M&A CERs were sponsored by the VP for Business Development. CERs for IT systems were sponsored by the Director of IT. The sponsor had several tasks to perform. The first part of the job was to assist the division in preparation of the CER and supporting documentation to ensure that it met Stryker standards for quality and completeness. Second, the sponsor coordinated the submission of the completed CER to ensure that Committee members all received complete information Third, the sponsor served as an interface between Committee members and the division regarding requests for additional information and conditions to be met for approval. Internal guidelines specified a timetable for submission, review, and disposition of CERs. These were intended to ensure that adequate time was allowed to review spending requests and to minimize the need for "emergency" approvals. In general, the guidelines provided for a minimum of two weeks between the time a division notified the appropriate sponsor of its intent to submit a CER and the formal consideration by the Capital Committee of the CER. About a week was devoted to a review process between the division and the sponsor, and another week set aside for review of the submission by individual Committee members, who could request additional information. The System in Practice: 2007 In early 2007 participants in the new process were still getting used to it. Some of the goals for the revised system were being met: more data, more depth, more analyses, more standardization and rigor. But there were complaints as well. The stipulated timetable for CER submission and review was not always met. Committee members complained about CERs not being submitted on time. Divisions complained about the Committee not being available as such when needed. Indeed, the Committee did not hold regular meetings as a group, but operated more as a \"virtual" committee with members contacting one another as needed. The requirements for standardization and extensive documentation struck some managers as unnecessarily bureaucratic for proposals that were \"no-brainers\" and clearly assured of approval. Indeed, \"The vast majority gets approved,\" controller Jim Praeger observed, \"but recently a few CERs have not been approved.\" Finally, the heavy corporate involvement in the process clashed somewhat with Stryker's decentralized organization and entrepreneurial culture. One division executive said simply, \"It's painful.\" Capital Expenditure Requests: CERs Part of Stryker's capital allocation process was structured around formal requests for authority to spend funds referred to as Capital Expenditure Requests ("CERs"). Nominally, CERs were forms that had to be filled out before authority to spend could be obtained. More broadly, they embodied a proposal and approval process that was utilized throughout the entire corporation. Internal guidelines split proposals into two broad categories: Operational and M&A. The former included proposals involving buildings, equipment, IT systems, and so forth for Stryker's existing businesses. The latter included not only mergers and acquisitions, but also licensing and distribution agreements, joint ventures, equity investments, and development agreements negotiated with outside parties. For both types of CER a \"project" was defined to include all parts of multi-phase undertakings and all later-phase expenditures had to be included in descriptive materials and analyses. All CERs, whether Operational or M&A, were comprised of two main sections: one setting forth the business proposition and another summarizing pertinent financial analyses. In addition, submissions often included extensive background and supporting documentation. For a large acquisition, for example, the CER and its accompanying support would be voluminous. For Operational CERs, the first section addressed the following prescribed topics: I Project background, key facts and descriptions, and strategic rationale. This part would also review, for example, key industry or competitive trends, salient market facts, the role of the project in the division's annual and strategic plans, and so forth. 0 Economic justication and key risk factors. This part of the CER showed that the project's returns on a discounted cash flow basis would exceed Stryker's normal 15% hurdle rate (which could be higher for riskier projects). In many CERs NPV calculations were performed on the basis of five to seven years of cash flows and without a terminal value. Calculations of IRR and payback period also were required; these likewise were often computed without a terminal value. Finally, this part of the CER set forth the project's anticipated ongoing cash flow and earnings effects on Stryker as a whole, and described specific risks that could affect the project's ability to deliver the projected economic results. 0 HR implementation plan and key milestones. This part set forth the human resource requirements of the project and described the plan for meeting these needs. Descriptions