Economic surplus

This has implications for model design. A model in which firms maximize a weighted average of profits and sales may provide a more realistic representation of markets than one which purely maximizes profits. The weights on sales and profits would determine how much of the economic surplus is spent on increasing revenues, and how much is retained as profit. 

The model was structured to simulate a single company with an initial market share of 20 percent of a typical product (again, terephthalic acid was used as the illustrative example). This company competed for market share in the troughs and for economic surplus in the peaks. In this way, the dynamics of competitive responses were captured, especially when the company attempted to expand its market share rapidly through aggressive investment. 

Economic surplus (ES) overcomes this limitation by accounting for the cost of capital, and helps focus investments on those opportunities that earn returns above the opportunity cost of capital. 

Moreover, it is a myth that the share market focuses only on short-term earnings. Studies have shown that there is a high correlation between economic surplus and share market valuation (Copeland, Koller, Murrin, 2000). Companies that earn returns less than their cost of capital trade at or below their book value. Companies that earn returns well above their cost of capital trade at many times their book value. In other words, using ES as a measure also aligns the organization with the way investors evaluate their performance. 

Economic surplus (ES) = (return on invested capital (roic) % - weighted average cost of capital (wacc) %) x invested capital (ic)... 

Very few solutions focus on maximizing economic surplus. 

The 80/20 rule is one of the best ways to measure variety. What this rule states is that 20% of causes contribute to 80% of the results. The 20% of the businesses, customers, employees, processes, facilities, and products that contribute to 80% of the revenues, economic surplus, and cash flow represent good variety. The 20% of the business, customers, employees, processes, facilities, products, and suppliers that contribute to 80% of the economic losses and unproductive assets represent bad variety. 

CCR cash contribution ratio DC distribution center DSD direct store delivery ERP enterprise resource planning ES economic surplus GMROI gross margin return on investment... 

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