Value Based Management is an approach to organizational leadership which says that organizations should define what they consider value to be, then focus on maximizing it. It’s usually defined as shareholder value.Summary by The World of Work Project
Value Based Management
Value Based Management is a strategic, organizational approach that focuses on maximizing value, which is often taken to be long-term shareholder value.
The core tenant of the approach is that organizations should maximize the value of their discounted future cash flows. This means adopting a longer term horizon than many organizations do and not simply focusing on profitability. In order to create value, organizations need to ensure they only invest in projects and products that provide a return on capital greater than the organization’s cost of capital.
By doing this, they can ensure that they will generate a positive return on capital, and in doing so ensure they can return dividends to investors. Of course, a by product of this strategic approach is that organizations create an incentive to redirect benefits or returns to shareholders from other stakeholders. Over the past half century this has manifest itself through things like the stagnation of working wages, the degrading of the environment and the erosion in supplier stability and fair treatment.
The Three Pillars of Value Based Management
For value based management to be effective, organizations need to become proficient in three core competencies.
An organization’s strategy should be focused on creating value. Decision making processes should focus on the long-term value added by activities (typically measured by discounted cash flows), and investment appraisals should consider the organization’s cost of capital. Decisions should be made to maximize value returned on capital. In some instances this focus leads to the reallocation of benefits from a wider stakeholder pool to shareholders.
The organization should be managed to maximize value. The organizational culture and mindset should enable value maximization, governance structures should support value creation and tracking, leadership should focus on and communicate the value creation imperative and the organization should be changed to support it.
Value must be defined and measured effectively at multiple levels if it is to be maximized. Value is usually taken to be shareholder value, but some organizations may define a different stakeholder value to maximize. Whatever definition of value the organization is focusing on needs to be clearly defined and a strategy to measure it must exist.
Culture and mindset are very important for Values Based Management. While embedding processes and governance approaches is a requirement, an organization’s ability to maximize value lie in the minutia of its culture, values and ways of working.
The required culture for successful use of Values Based Management is a values based mindset at all levels of the organization. As with all cultures this is partially achieved through vision and mission statement, effective leadership role-modelling and communication, and partly achieved through the setting of targets and objectives and their alignment to reward and recognition processes.
Targets and objectives are key to Values Based Management. Each part of the organization needs to have specific value based objectives that are measurable and which it can influence. Objectives must be appropriate for the level of the organization that they’re being applied to and they must form the basis of the performance management process.
The World of Work Project View
Value Based Management really came to prominence in the second half of the 20th century. It’s now a very common way of running organizations, particularly larger one. Its focus on value, often reflected in share-price, makes it the de-facto way that most listed entities manage themselves. Many un-listed organizations also operate in this fashion, particularly any organizations looking to float or sell themselves.
The model talks about the importance of maximizing value, and literature explains that this is about more than short-term profitability. While this is true, it’s often hard for organizations to find the space to really focus on their long term value as many are slaves to capricious markets and the need to post managed, level, quarterly results in line with expectations. What this means is that many organizations end up struggling to balance the some-what conflicting requirements of short and long term shareholder value maximization.
We are pleased to see reference in some instances to the fact that value doesn’t always need to be reflected as return to shareholders. Unfortunately, we think that until very recently, most organizations focused almost exclusively on shareholder value maximization.
We know that in some instances certain organizations will look to maximize value as defined by stakeholder benefit, whatever form that will happen to take. In the UK charitable organizations often use a “value for money” framework to assess and evidence the effectiveness of their programs of work at achieving their underlying purpose.
Overall we think that focusing on long-term value (of whatever definition) is an objective that most organizations should try to focus on. That said, we think that maximizing only shareholder value is a bad thing. We think that this approach has lead to negative outcomes in the world. Instead, we think that organizations should work towards creating long term value for a mix of their stakeholders.
Sources and further reading
Where possible we always recommend that people read up on the original sources of information and ideas.
There, as ever, is a lot of original work behind this post. The concept of value based management may have originated with Peter Drucker, was certainly progressed by Alfred Rappaport, but wasn’t really named until Jim McTaggart used the term in his 1994 book: “The Value Imperative“.
McTaggart, James M, Michael C Mankins, and Peter W Kontes. The Value Imperative : Managing for Superior Shareholder Returns. New York (N.Y.): Free press, 1994.
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