Value-Based Management

Managing for the Long Term by Maximizing Value, Not Profit

VBM can create long-term value for your organization.

The first decade of the 21st century saw two economic downturns, and quite a few corporate failures. This has caused corporate leaders to examine how to guide their organizations through these times effectively, so that they continue to be successful.

But what does "success" really mean? Does it mean high profits, or high dividends for shareholders? Or does it mean being more efficient, building for the future, and operating with a structure that will survive the difficult times?

If your success strategy is primarily based on profit, it probably won't provide enough incentives to consider the long-term impacts of your decisions.

For example, you could increase your prices to increase profits, or you could choose to cut costs dramatically, and increase your quarterly earnings to satisfy your investors. However, this approach is likely to affect your market share, and your ability to compete in the long term. It may also have an impact on quality, and affect your ability to attract and retain talent.

Everyone wants to operate profitably and efficiently, with cost-effective teams, projects, and organizations. You don't want to ignore your short-term goals, but sacrificing long-term profitability for short-term profits isn't a sustainable strategy. Ultimately, you want to build and maximize your ability to be profitable in the long term. One way of doing this is to use Value-Based Management (VBM).

In this article, we'll look at the ideas behind VBM, and highlight strategies that you can apply to boost the overall value of your organization. We'll also identify the drawbacks to VBM, and look at situations where VBM may not be suitable.

Note:
This article focuses on applying Value-Based Management in an organizational context. But you can also apply the ideas behind it to a department or small team, if this fits with your organization's overall objectives.

Principles of Value-Based Management

In a Value-Based Management (VBM) approach, your overall goal is to maximize the value of your organization. This means that the decisions that you make today are not simply driven by short-term profit. Rather, you 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 success.

A fundamental principle of VBM is the belief that future cash flow and growth are the source of a company's value. Looking at accounting-based measures - like quarterly earnings, earnings per share, and the price/earnings ratio - is not how advocates of VBM make decisions. This may be difficult, particularly when there's significant pressure from short-term investors.

VBM is both a philosophy and a methodology. It recognizes that the decisions that you make on a daily basis all contribute to the value of the organization. Therefore, VBM must be pushed throughout the organization; not just in the boardroom. People at all levels must participate in driving this overall value.

Weaknesses of VBM

Although a VBM approach can boost the value of your organization, it's important to remember that it's not suitable for all situations. This is because it adopts a longer term perspective, where you must rely on forecasts, projections, and assumptions about what will (and will not) contribute to the value of the organization.

For example, while you may be sure that an upgrade to your software systems to improve efficiency will create value, it's much harder to predict the effects of a new technology that disrupts your services, yet has the potential to increase market share significantly. Using VBM as your only criteria may cause you to discount projects and strategies that have a highly uncertain outcome, but could make a large contribution to long-term growth and sustainability. This may make it unsuitable for early stage technology ventures, for example.

Also, VBM may not be suitable in companies that are well established and that have successfully used a particular business model for a long time. For instance, commodity-based companies, such as those in the steel and lumber industries that have stable markets and reasonably stable stock prices, may find that implementing VBM is actually more disruptive than any potential gains. So, in creating new organizational value, you also have to make sure that the projects that you take on as part of the VBM process don't detract from the value of the work that you already do.

A VBM focused approach may also cause you to lose sight of social or non-financial measures of corporate success. Being a good corporate citizen can be a factor that adds significant value. Costly projects that reduce the impact on the environment may not appear to add shareholder value in the strictest of terms. However, when you analyze these projects with a broader view of social value, they can actually contribute to long-term, sustainable value. Likewise, decisions that put shareholder needs above those of other stakeholders like employees and customers, can quickly backfire in some industries.

It is important therefore, to use an approach like VBM with a scope and perspective that matches your organization's overall mission and goals.

Note:
Jack Welch, a strong advocate of maximizing the value of an organization, was notoriously quoted in a 2009 interview as saying, "On the face of it, shareholder value is the dumbest idea in the world." However, what wasn't included in the sensationalized headlines was that Welch went on to say, "Shareholder value is a result, not a strategy..."

Welch's point was that you can't tell people that your strategy is to maximize organizational value. He doesn't feel that is a tangible outcome that energizes or motivates people. What he does believe is that to provide value, you must implement successful strategies, and VBM can be a part of that implementation.

To read more about this, see this follow-up interview with Business Week.

Implementing Value-Based Management

There's no one set of steps for introducing VBM to your organization. As we said, it's a mindset and a method. As such, you'll need a formal change program to implement it, and this will drive an organizational journey that starts and ends with a commitment to creating value.

However, to launch and sustain this journey, there are four key stages for success:

... for the complete article:

Mind Tools Club members, click here.

Join the Mind Tools Club to finish this article AND get 1,000 more resources

Join now for just $1, first month

"When I started using Mind Tools, I was not in a supervisory position. Now I am. Along with that came a 12% increase in salary." – Pat Degan, Houston, USA

Add this article to My Learning Plan