Value Based Management

By M. Isi Eromosele

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 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 multi-business 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.

Not methodology

The focus of VBM should not be on methodology. It should be on the why and how of changing your corporate culture. A value-based manager is as interested in the subtleties of organizational behavior as in using valuation as a performance metric and decision-making tool.

When VBM is working well, an organization’s management processes provide decision makers at all levels with the right information and incentives to make value-creating decisions.

Line managers and supervisors, for instance, can have targets and performance measures that are tailored to their particular circumstances but driven by the overall corporate business strategy.

A production manager might work toward targets for cost per unit, quality, and turnaround time. At the top of the organization, on the other hand, VBM informs the board of directors and corporate center about the value of their strategies and helps them to evaluate mergers, acquisitions and divestitures.

Value-based management can best be understood as a marriage between a value creation mindset and the management processes and systems that are necessary to translate that mindset into action. Taken alone, either element is insufficient. Taken together, they can have a huge and sustained impact on corporate growth.

A value creation mindset means that senior managers are fully aware that their ultimate financial objective is maximizing value; that they have clear rules for deciding when other objectives (such as employment or environmental goals) outweigh this imperative; and that they have a solid analytical understanding of which performance variables drive the value of the company.

They must know, for instance, whether more value is created by increasing revenue growth or by improving margins, and they must ensure that their strategy focuses resources and attention on the right options.

Management processes and systems encourage managers and employees to behave in ways that maximize the value of the organization. Planning, target setting, performance measurement and incentive systems work effectively when the communication that surrounds them is tightly linked to value creation.

The value mindset

The first step in VBM is embracing 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, the most direct measure of value creation. Such targets also need to be translated into shorter-term, more objective financial performance targets.

Companies also need non-financial goals; goals concerning customer satisfaction, product innovation, and employee satisfaction, for example, to inspire and guide the entire organization.

Objectives must also be tailored to the different levels within an organization.

For the head of a business unit, the objective may be explicit value creation measured in financial terms. A functional manager’s goals could be expressed in terms of customer service, market share, product quality or productivity.

A manufacturing manager might focus on cost per unit, cycle time, or defect rate. In product development, the issues might be the time it takes to develop a new product, the number of products developed and their performance compared with the competition.

Even within the realm of financial goals, managers are often confronted with many choices: boosting earnings per share, maximizing the price/earnings ratio or the market-to-book ratio and increasing the return on assets, to name a few. At Oseme Group, we strongly believe that value is the only correct criterion of performance.

M. Isi Eromosele is the President | Chief Executive Officer | Executive Creative Director of Oseme Group - Oseme Creative | Oseme Consulting | Oseme Finance

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