Value Based Management: How Companies Create Value Beyond Short-Term Profit

Value Based Management (VBM) is a management philosophy that states management should foremost consider the interests of shareholders in its business actions. This framework encompasses the processes for creating, managing, and measuring value.

It is important to note VBM differs from a profit-focused way of managing business. Specifically, VBM means that the decisions that you make today are not simply driven by short-term profit. Instead, we consider the longer-term effects that the decisions will have on organizational sustainability and profitability, reflected in future cash flows.

VBM asks people within a company to think like owners and to make decisions that will ultimately benefit the owners. Managers and executives must constantly look for investment and growth opportunities that will create value—and use the company’s capital in ways that ensure long-term, sustainable success.

The Definition of Value

First, let’s define what “value” means to us within the context of Value Based Management. In VBM, the value of a company is determined by its discounted cash flows (DCF). In other words, value is created only when companies invest capital at returns that exceed the cost of that capital. We employ DCF, because it is the only metric that takes a long-term view, while still focusing on the balance sheet.

VBM can best be seen as a combination between a Value Creation Mindset and the Management Processes and Systems that are necessary to translate that mindset into action. Let’s take a deeper look into each of these 2 components.

Value Creation Mindset

First, we must adopt the Value Creation Mindset. This means we need to embrace value maximization as the ultimate financial objective for a company. Traditional financial performance measures, such as earnings or earnings growth, are not always good proxies for Value Creation. To focus more directly on creating value, companies should set goals in terms of discounted cash flow value. These targets also need to be translated into shorter-term, more objective financial performance targets

To determine where we create value, we need to uncover our Value Drivers. A Value Driver is any variable that affects the value of our organization. These are often best visualized and captured using a tree structure, where we see how Value Drivers at varying levels are derived. See the example below.

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When developing our Value Drivers, we should follow these 3 guiding principles:

1. Value Drivers need to be organized, so that managers can identify which have the greatest impact on value and assign responsibility for them to individuals who can help the organization meet its targets.

   
   

2. Value Drivers must be defined at a level of detail consistent with the decision variables that are directly under the control of line management.

   
   

3. Generic value drivers (e.g. sales growth, operating margins, and capital turns) might apply to most business units. However, these lack specificity and cannot be used well at the grass roots level.

   
   

Management Processes & Systems

Adopting a Value Based Mindset and finding the Value Drivers only gets you halfway there. Managers must also establish processes and systems that bring this mindset to life in the daily activities of the organization.

The 4 essential management processes to consider, in sequence:

1. Strategy Development - First, our company or business unit develops a strategy to maximize value.  (See our Strategy Development Stream.)

   
   

2. Target Setting - Next, we must translate this strategy into short- and long-term performance targets. These are defined in terms of our key Value Drivers.

   
   

3. Action Plans and Budgets - We then develop action plans and budgets to define the steps that will be taken over the next year to achieve these targets.

   
   

4. Performance Management - Lastly, we need to institute performance measurement and incentive systems in place to monitor performance against targets and to encourage employees to meet their goals.  (See our Performance Management Stream.)

These four processes are linked across the company at the corporate, business-unit, and functional levels.

Interested in gaining a better understanding on how to implement VBM?  Take a look at our framework on Value Based Management.

This framework is part of the Value Creation Stream (https://flevy.com/browse/stream/value-creation).

Since the early 1990s, organizations have relied on VBM and other Value Creation frameworks to analyze and drive business performance and shareholder value. After all, maximizing shareholder value is the #1 priority for any publicly-owned company—and a top priority for most others.  Over the years, Value Creation Thinking has evolved from VBM to more inclusive models.

Our Value Creation Stream provides you access to established best practices to help you stay ahead of the curve and meet your business objectives. This allows you to follow the same methodologies used by Fortune 100 companies and global consulting firms with their clients.

FlevyPro Streams gives you unlimited access to specific topics (e.g. Strategy Development, Digital Transformation, Leadership Development). Peruse our available Streams here: https://flevy.com/pro/streams

Hope you found the info in this email interesting and helpful.  Please feel free to forward this to any colleges and friends who may find this useful.  Thanks.

David Tang / flevy.com Corporate Strategy

Email: dave@flevy.com

Mobile: +1-323-387-3876

LinkedIn: www.linkedin.com/in/davetang4

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