What Is Value Based Management (VBM)?
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.
Value Based Management (VBM) is the management philosophy and approach that enables and supports maximum value creation in organizations, typically the maximization of shareholder value.
The value creation process requires an understanding of the attractiveness of the market or industry where one competes, coupled with one’s competitive position relative to other players. Once this understanding is established and is linked with key value chain drivers for cash flow and profitability, competitive strategy can be established or modified to maximize future returns.
What Does Value-Based Management Mean?
The concept of value-based management (VBM) has developed over the last 20 years. It started with the development of performance metrics and has gradually matured into a whole management system based on the creation of value. A number of well-known companies, among them Coca Cola, Cadbury and Du Pont, have apparently achieved good results by implementing VBM into their organizations. Proponents of VBM maintain that companies which have taken it on board perform better, but nothing is said about causality, i.e. do they take on VBM because they are successful, or are they successful because they take on VBM?
Inherent in the VBM concept is the thesis that value-based management leads to a management style which guarantees that companies and organizations will base their activities on the creation of value.
There are three important building blocks for value-based management:
- The creation of value, meaning that there is a focus on increasing, or creating maximum value.
- Managing for value – including shared values, corporate culture, external relations, organization and, not least, management style.
- Measuring the creation of value: finding effective indicators for progress.
Value-based management has the ambition of creating a coherent system consisting of:
- Corporate mission – business philosophy and business model.
- Strategy – guidelines for achieving goals.
- Corporate government as an expression of owners’ ambitions and orientation.
- Corporate culture.
- Internal communication.
- Decision processes and systems.
- Performance management.
- Reward systems.
According to its adherents, the success of VBM depends on a company’s aims, corporate mission and values. Goals can either be financial in the form of shareholder value or be oriented to a broader spectrum of stakeholders. Many people believe that in the last decade VBM has been too focused on short-term shareholder value to the detriment of both other stakeholders and the long-term perspective.
Value-based management is essentially an approach wrapped around an attitude. It does not really possess a systematic methodology. According to its proponents, success in the use of VBM depends on how well it has been integrated into the corporate culture, while reports would suggest that it is the converse, i.e. how well the corporate culture has been integrated into the creation of value in the organization.
VBM is all about organizing the company’s main processes (performance measurement, strategic planning, budgeting, training and communication) on the basis of value creation. This approach is necessary to create a culture in which individuals and groups at all levels make decisions that are oriented to creating value for shareholders who make profits to compensate them for their financial contribution, and the risks they take by investing in the first place.
In short, we could say that VBM deliberately factors in a calculation for the use of capital with all decision-making in order to be sure that value is created. There are three questions that we should be asking ourselves within the framework of VBM:
- How much do I need to invest in this project?
- What profit can I expect from the project?
- Is this profit sufficient to compensate for my risk?
Value-based management developed, as part of a trend where there was a deviation from traditional accounting figures, to include what were called value-based metrics representing profitability. This approach has been developed in a similar way to EVA (Economic Value Added) which came to include not only capital expenditure activated in the balance sheet but also the cost of generating profit.
What are the Operational Factors Which Typically Drive Value?
Increasing value involves managing those factors in a business that influence value. We term these factors value drivers. For example, increasing operating margins without affecting sales volumes will increase value, so operating margins is a value driver. There are seven value drivers that apply in all organizations and we call these generic value drivers. They are:
- Value and price, (the revenue drivers, where volume is derived either from growth in the market or growth in market share).
- Operating margins
- Tax ( using different tax jurisdictions to advantage )
- Fixed assets
- Working capital
- Cost of capital
- The length of time a company maintains a competitive advantage against competitors.
Doing things differently in a business will usually affect more than one value driver. For example, a price increase might affect volume and working capital and maybe fixed assets as well. Management must assess the relationship between value drivers, which will be different for different businesses. It’s possible to model the effect on value of changes to the value drivers, and thereby help identify the best courses of action to increase corporate value.
What are the Benefits of Value Based Management?
- Can maximize value creation consistently.
- It increases corporate transparency.
- It helps organizations to deal with globalized and deregulated capital markets.
- Aligns the interests of (top) managers with the interests of shareholders and stakeholders.
- Facilitates communication with investors, analysts and communication with stakeholders.
- Improves internal communication about the strategy.
- Prevents undervaluation of the stock.
- It sets clear management priorities.
- Facilitates to improve decision making.
- It helps to balance short-term, middle-term and long-term trade-offs.
- Encourages value-creating investments.
- Improves the allocation of resources.
- Streamlines planning and budgeting.
- It sets effective targets for compensation.
- Facilitates the use of stocks for mergers or acquisitions.
- Prevents takeovers.
- It helps to better manage increased complexity and greater uncertainty and risk.
How Can VBM be Embedded in a Company’s Capabilities and Culture?
VBM must be embedded into the normal ways of the business. Above all this is a cultural issue in which two factors are critically important. The first is performance measurement and associated reward mechanisms, and the second is education and communication. The purpose of performance measurement is to focus managers on achieving business objectives. The old adage “what gets measured, gets done” means that the wrong measures are certain to get the wrong things done.
Establishing and communicating the link between increasing SVA (Shareholder Value Added) and the remuneration received by individuals – or preferably, teams – ensures that people will be keen to know how they can positively influence value. Systems of incentive and reward have a powerful effect on collective and individual behaviours. For example, a sales force targeted and rewarded on revenue alone will inevitably have scant regard for profitability, or departmental measures of cost control may restrain expenditure at the expense of process effectiveness and customer service.
Value-Based Management provides a common goal and framework for an organisation’s performance measurement system. It requires a total process perspective, and therefore ensures as far as possible that people and departments have compatible goals, and that co-operation and teamwork are built into the structure of performance measurement and reward.