What Is Value-Based Management?

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. …