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.
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
Oil Used new planning and Multimillion dollar
production control process to help drive reduction in planning
major change program function through
Prompted an acquisition
Banking Chose growth versus harvest 124% potential value
strategy, even though increase
five-year return on equity
Telecoms Generated ideas for value
* 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
Yet value-based management is not without pitfalls. …