Managing for the Long Term by Maximizing Value, Not Profit
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.
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...