What Is Value-Based Management?

Article excerpt

An excerpt from Valuation: Measuring and Managing the Value of Companies, Second Edition

RECENT YEARS HAVE SEEN a plethora of new management approaches for improving organizational performance: total quality management, fiat organizations, empowerment, continuous improvement, reengineering, kaizen, team building, and so on. Many have succeeded -- but quite a few have failed. Often the cause of failure was performance targets that were unclear or not properly aligned with the ultimate goal of creating value. Value-based management (VBM) tackles this problem head on. It provides a precise and unambiguous metric -- value -- upon which an entire organization can be built.

The thinking behind VBM is simple. The value of a company is determined by its discounted future cash flows. Value is created only when companies invest capital at returns that exceed the cost of that capital. VBM extends these concepts by focusing on how companies use them to make both major strategic and everyday operating decisions. Properly executed, it is an approach to management that aligns a company's overall aspirations, analytical techniques, and management processes to focus management decision making on the key drivers of value.

Principles

VBM is very different from 1960s-style planning systems. It is not a staff-driven exercise. It focuses on better decision making at all levels in an organization. It recognizes that top-down command-and-control structures cannot work well, especially in large multibusiness corporations. Instead, it calls on managers to use value-based performance metrics for making better decisions. It entails managing the balance sheet as well as the income statement, and balancing long- and short-term perspectives.

When VBM is implemented well, it brings tremendous benefit. It is like restructuring to achieve maximum value on a continuing basis. It works. It has high impact, often realized in improved economic performance, as illustrated in Exhibit 1.

Examples of VBM's impact

Business          Change in behavior                   Impact

Retail            Shifted from broad national          30-40% increase in
household         growth program to focus on           potential value
goods             building regional scale first

Insurance         Repositioned product                 25% increase in
                  portfolio to emphasize               potential value
                  products most likely to
                  create value

Oil               Used new planning and                Multimillion dollar
production        control process to help drive        reduction in planning
                  major change program                 function through
                                                       streamlining

                                                       Prompted an acquisition

                                                       Exposed nonperforming
                                                       managers

Banking           Chose growth versus harvest          124% potential value
                  strategy, even though                increase
                  five-year return on equity
                  very similar

Telecoms          Generated ideas for value
                  creation

                  * New service                        240% potential value
                                                       increase in one unit

                  * Premium pricing                    246% potential value
                                                       increase in one unit

                  Around 40% of planned                NA
                  development projects in one
                  business unit discontinued

                  Salesforce expansion plans           NA
                  completely revised after
                  discovering how much value
                  they would destroy

Pitfalls

Yet value-based management is not without pitfalls. …