FRESH TAKES ON BIG IDEAS

In the first quarter of this year, I’ll be retiring after a 39-year career in McKinsey’s corporate finance practice. I started working here on January 19, 1987, at a time when what we then called “corporate raiders” were doing hostile takeovers, which raised questions about valuation. McKinsey decided to start a corporate finance practice to help advise clients about these issues. Over the years, the scope of our work has expanded greatly, and we merged our corporate finance and strategy practices to provide a more seamless approach.

When it comes to value creation, the fundamentals have not changed. For the past four decades, when I evaluate a company, I focus on return on capital and revenue growth, because they drive cash flows, which in turn drives valuation. The advantage of this framework—which we didn’t invent, although we codified it—is that it links valuation closely to strategic issues. You can look at revenue growth and ask, “Are we growing faster or slower than our peers?” You can look at return on capital and ask, “Are we earning more than our cost of capital? Are we going up or down? And how does it compare to our peers?” And you can look at both issues and ask, “Focusing on which of these two things would create more value?”

Another thing that hasn’t changed is our advocacy for companies to manage for the long term. Despite our efforts, we still find that many companies are too short-term-oriented, focusing on short-term earnings at the expense of longer-term value creation.

Challenges to these foundational ideas have emerged throughout my career. During the dot-com bubble, I remember people would tell me, “Tim, you’re living in the world of Newtonian finance, and we’re now in the world of quantum finance. The way companies are valued is entirely different now.” However, whenever people forget about the basic rules of return on capital and growth, bad things tend to happen.

There have been a few broad changes since I started here at McKinsey. One is that CFOs used to focus more on accounting and preparing financial statements and less on strategy. Now many companies have done away with the title of chief operating officer, and the CFO has become the number two person. CFOs increasingly advise the CEO on strategic issues, which was not so much the case 39 years ago.

“When I look at a company, I look at return on capital and revenue growth, because they drive cash flows, which in turn drives valuation.”

But the biggest change for us and for my career is that we developed additional materials and approaches to help communicate with companies and convince them of the basic principles. Our book, Valuation: Measuring and managing the value of companies (Wiley, 2025), first published in 1990, has been through eight editions and sold over one million copies. That effort, coupled with ongoing research and client work that has expanded my body of knowledge, has made me more effective at offering counsel as new questions arise and better able to offer tools for clients who are dealing with challenges.

Twenty years or so ago, we found that companies were taking actions that they thought investors wanted them to take but that they didn’t think were right for the company. This led us to develop a service line to help companies better understand who are the long-term investors that truly matter and how to communicate with them.

About 15 years ago, we started really digging into the topic of resource allocation. Companies were not moving resources to the parts of their business with faster growth opportunities and away from legacy businesses with limited opportunities. We developed analytics that illustrated this disconnect between strategy and budgeting. When you put the numbers in front of leaders, it generates robust discussion.

At the same time, we started exploring the topic of cognitive bias in decision-making. I was lucky enough to have dinner once with Daniel Kahneman, who won the Nobel Prize in economics for the work on decision-making biases he did with his partner, Amos Tversky. I asked him, “How do we overcome all these biases?” He answered, “I have no hope that you can change human nature.” But he explained that organizations can overcome them by putting in place the right rules and processes. These insights have informed our work in resource allocation. Strict processes and rules are really the only way to overcome the biases that may lead to improper resource allocation in a company.

There are new business models that didn’t exist 39 years ago, and big companies that didn’t exist before the internet. Technology can help create a lot of value. But many people believe that the first company to get big captures all the value of a new technology, whereas it’s important to remember that winner-take-all companies are fairly rare. In most cases, the benefits of new technology tend to get passed on to the consumer. Consider consumer banking and the advent of the ATM, online banking, and mobile banking. The customer has gained a lot of convenience, but are banks making more money? New technologies quickly become the cost of being in the business at all. That’s another of those eternal truths that’s important to keep in mind, particularly right now.

As I reflect on my 39 years at McKinsey, I’m grateful to have worked with amazing colleagues and clients on fascinating challenges, which has made my work fun. I’ve also been able to continually pursue new topics related to value creation. I couldn’t have done it anywhere else.

—Edited by Katy McLaughlin, executive editor, Southern California

ABOUT THIS AUTHOR

Tim Koller is a partner in McKinsey’s Denver office.