Chapter10 Cfg

Chapter 10- Value Based Management Chapter 10- Value Based Management ...............................................................................1 Value Based Management................................................................................................2 10.1 What is VBM?.........................................................................................................2 10.2 VBM implementation steps.....................................................................................3 10 Step approach..........................................................................................................3 10.3 The VBM approach (example)................................................................................4 10.4 The strategic perspective and scenario thinking....................................................4 Scenario thinking.........................................................................................................5 10.5 Key Issues to consider in implementing VBM........................................................6 Phase 1.........................................................................................................................6 Phase 2.........................................................................................................................6 Phase 3.........................................................................................................................7 Phase 4.........................................................................................................................7 Balanced Scorecard (BS).............................................................................................8 Business Excellence Model (BEM)...........................................................................11 10.6 Implementing VBM- The Evidence.......................................................................12 Key features of successful implementation ..............................................................12 Key implementation issues........................................................................................13 Observations on successful implementation of VBM...............................................14 10.7 What can VBM facilitate?.....................................................................................15 10.8 Changing role of finance.......................................................................................16 10.8 The ascendancy of the general financial manager.................................................17

Value Based Management 10.1 What is VBM? An approach used for the management of a business that differs from traditional approaches to managing a business linked with DCF. DCF principles are used to develop a value based strategy from which value based plans are developed and implemented as VBM. Value creation can benefit all stakeholders and shareholders- how do you created value for them over the lifetime of the business? VBM is often adopted by businesses due to some external threat e.g. acquisition or where a conglomerate is worth less than the sum of its parts indicating a demerger may be needed for management to focus on value creation within its separate parts. Another reason is related to Lloyd’s Bank who adopted VBM in the UK. For more on VBM at Lloyd’s refer pp 301 text. The key point of VBM is that the focusing on shareholder value gives clear discipline. The goal is to analyze every strategic decision in terms of its impact in shareholder’s wealth and also to focus upon shareholder value to evaluate acquisitions, divestments, capital investment projects and assess alt strategies. VBM helps manage companies better from a strategic and financial perspective but implementation is a challenge. The different approaches and implementation of VBM can be seen in terms of companies that:-

Have adopted various value analytical techniques but not managerial implications of the approach.

-

Have

embraced

principles

of

VBM

and

embarked

on

implementation -

Have not experimented at all 2

-

Claim to be value oriented companies but their actions do not support the claims.

10.2 VBM implementation steps The steps can be summarized as follows: 1.

What is the managerial interpretation of the current value in the market?

2.

What is influencing it- i.e. what are the key value drivers?

3.

What are the apparent managerial actions for improvement and what is their impact?

One then needs to consider:-

What is the CAP? How do you know?

-

What is the coc?

-

How should the TV be estimated?

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Which measures of values should be used?

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What framework should be used to guide managerial and employee actions?

10 Step approach The overall framework for VBM can be viewed in terms of the following steps:1.

What is the managerial interpretation of your current value in the market?

2.

What are the key value drivers?

3.

What are the apparent managerial actions for improvement and their impacts?

4.

In view of 3, what should be the new vision?

5.

What is the value of the new vision?

3

6.

How does the vision translate into customer, shareholder and other relevant perspectives for the org?

7.

How does the vision look in terms of the divisions/ business units?

8.

What is the divisional value?

9.

What are the key divisional value drivers?

10.

What do these divisional value drivers look like in terms if the micro drivers and KPIs?

The 10 steps above capture the sequence of events to be followed. The first 5 challenge the current vision, value and potential for improvement for the whole business. In terms of implementation, Balance Scorecard and Business Excellence Model are invaluable but they need to be related to a vision that is clearly articulated and related specifically to financial performance. Successful implementation would require change to be driven down the business across divisions. The advantage of using the 10 step approach is that it related specifically about value and performance in financial terms at the overall business and business unit levels.

10.3 The VBM approach (example) Refer to pp 303 to understand application- Asia Hotels Ltd case study given as example.

10.4 The strategic perspective and scenario thinking VBM should also be viewed from a strategic perspective. Therefore, scenario thinking is particularly important. Issues to consider include:-

What are the business’ prospects according to your scenario?

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What is driving the prospects?

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What are the values of these prospects?

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Do these prospects make sense?

-

What should be the business response?

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Scenario thinking Scenarios start from the premise that there is more than one future and recognize that there is more than one future and requires the consideration of major forces and trends driving valuation, their relationships and critical uncertainties. Refer text pp 305 for Shell e.g. The value of performing scenario thinking is the insights discovered in the process of investigating the nature and existence of the opportunities available to management. Scenario thinking avoids the shortcomings of traditional approaches to analysis where assumptions are based on the present situation with little attention to the external environment. Linking ST with free cash flow and strategic value calculations provides a distinctive way of grasping key questions about the future of the business. In terms of CAP, it focuses thought about when conditions signaling the end of CAP might occur i.e. a return greater than the coc cannot be achieved. Scenarios helps managers recognize the external environment of the business over which it has no control but to which they might respond in a timely manner. It encourages thinking through various diverse speculations and structuring them in pathways that are relevant to the business. ST helps managers to anticipate and adjust for the potential impact on the value drivers of change in the environment; develop a comprehensive set of assumptions about what the future might be and how it will affect industry profitability and the company’s performance. There should be at least 2 equally credible scenarios posed against each other. Working out of different potential values for a business gives more flexibility, realistic relevance and ‘navigational’ value to the analysis of strategic value. Sharp and sensitive mental preparation by advance calculation of the value impact of alternative scenarios allows faster responses to be made. Working out the CAP and present value of different scenarios enables managers to make 2 important gains in their strategic thinking. -

Strategic value outputs from the inputs of their preferred plans depends on assumptions which could be clarified and critically evaluated by comparisons 5

made with the assumptions of credible alternative scenarios. Managers have to focus on the quality of the assumptions re ext environment before relying on the figures generated by the Shareholder Value model. -

Considering present value and CAP implications should sharpen managers’ sense of range of options they could have in driving forward their business in a particular direction.

-

Each scenario helps clarify the dominant strategic challenges associated with it and the similarities and differences between the required responses.

10.5 Key Issues to consider in implementing VBM Key phases are:1.

Introduction of concepts and gaining of corporate commitment

2.

Establishment of policies and procedures

3.

Integration of concepts into practices

4.

Development and refinement of the approach

Phase 1 This will take a minimum of 6 months involving: -

Presentation to senior corporate and divisional management of the concepts and their benefits

-

Discussing key concerns and issues

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Obtaining commitment of the MD and other key management

Phase 2 This will require considerable time and effort which depends on the size of the org but on average 6 months is manageable. Involves: -

Formulation of a ‘task force’ drawn from senior central management and divisions. 6

-

Identification of specific obstacles and issues e.g. relating the approach to corporate financial management and reporting culture.

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Determination of app divisional coc, TV frameworks and planning periods

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Development of app applications at corporate and divisional level

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Development of application guidelines

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Identification of education requirements of employees who will perform or need to understand the approach.

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Development of educational programmes.

Phase 3 This is the longest and most critical part of the implementation process. 9 months is rough guideline. It involves the development of a framework that makes explicit recognition of the need to ensure a strong customer focus. Aspirations of a strong customer focus can be thwarted w/o the recognitions that it may have broader organizational ramifications. Customer orientation can be attempted using either balanced scorecard or business excellence model. Other initiatives include: -

Incorporation of the approach into performance measurement via financial and non financial performance measures

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Delivery of education programmes and how it links to current practice

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Use of the approach for evaluating capital expenditure plans etc

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Provision of expert assistance when needed.

Phase 4 Involves: -

refinement of the approach and performance measurement

-

linking of the approach to incentive compensation schemes

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development of the approach for investor communication

The above are fairly consistent from org to org.

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Balanced Scorecard (BS) The needs of both customers and shareholders need to be satisfied at the same time. Businesses need to be able to respond to customer requirements with their internal delivery mechanisms and to update and change them as necessary. To be successful, companies need a broad set of performance indicators that are appropriate and relevant rather than just financial indicators therefore the use of the BS. This approach includes some financial measures complemented by operational measures e.g. customer satisfaction, internal process measurement and the org innovations and improvement to activities. These require operational measures of strategy and represent the drivers for future financial performance.

The BS allows managers to look at the business from 4 imp perspectives: -

How do customers see us (customer perspective) ** particularly important. meeting customers requirements has implications for the orgs delivery mechanisms and the internal business perspective focuses on the processes and actions that need to be undertaken w/in the org. the measures will have an impact upon customer satisfaction.

-

What must we excel at? (internal perspective)

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-

Can we continue to improve and create value? (innovation and learning perspective)- focuses on change. It has to be recognized that targets have to keep changing and need to be redefined. This perspective focuses on challenges and measures them in terms of innovation, improvements and learning.

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How do we look at our shareholders? (financial perspective)- relates to shareholders. KPI include profitability, liquidity and value creation.

The BS is invaluable for linking the vision with the managerial action needed to bring about improvement. The BS offers the potential to align the business goals throughout the whole org. The mechanism to make this possible are the org’s key management processes e.g. business planning, budgeting, performance reporting and incentivisation.

When used in this way, the BS becomes part of a businesses VBM system for understanding the dynamics of value creation.

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In the fig above, there are 4 key processes to a typical VBM which are part of a self reinforcing circle: 1.

Strategy Development:

concerned with articulating the org’s vision and

expressing it in terms of specific strategic goals needed to be achieved from the s/holder, customer, employee and innovation perspective. The BS can be used to translate the vision into tangible goals. 2.

Business planning is about how the strategy should be specifically carried out .e.g. activities, actions and programs to be undertaken to achieve the strategic goals.

3.

Monitoring and reporting is about measuring the org’s performance in executing the strategy- how well did the org do what it said that it would do?

4.

The incentivisation and reward stage concerns rewarding people for the attainment of the strategic goals- the BS is a mechanism for communicating how successful (or not ) the org was and capturing the key lesson that the business has learned or should learn to achieve its vision.

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The implementation has been shown to have 2 benefits: -

it brings together in a single management report the company’s competitive agenda

-

helps prevent decisions that are not in the interest of the whole org even though they might benefit one aspect of the business. the BS helps managers see whether improvements in one area may be achieved only at the expense of another area.

Business Excellence Model (BEM) Many orgs that have adopted the principles of value focus on the BEM.

A standard European model has been developed to measure an org’s ‘level’ of excellence. The BEM is based on the principle that in order to succeed there are a number of key enablers that an org/team should concentrate its efforts and it should measure its success through a no of key results areas. The key enablers are: -

How well the org is led

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How well its people are managed

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How far its policies and strategy are developed and implemented by leaders and people

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How well it manages its resources and develops and manages its processes

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The key result areas are: -

How far it satisfies its customers

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How well motivated and committed its workforce is

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How the local and national community outside the org view its activities – contribution to society

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key business results- profits, ROCE, SE and achieving targets.

10.6 Implementing VBM- The Evidence Below is recent research into the factors for successful implementation, their implication and observations.

Key features of successful implementation •

Value creation is key objective and NOT a management objective

•

Top management commitment to s/holder value approach is essential

•

process needs to be championed at CEO level, with delegation for implementation

•

Importance of communicating the concepts of DCF based rather than accounting view of future performance to senior management is essential

•

Process of developing awareness is vital followed by formal education for business/unit heads- for an understanding of the concept within the company.

•

The process of strategic planning is critical in implementing. The preparation of realistic strategic reviews by business units with alt strategies evaluated using shareholder value concepts are a primary planning tool. The corporate centre is essential is challenging and coordinating this process.

•

Development if VB framework and management needs to be supported by the strategic planning process. Step by step approach to integrating with the financial reporting systems is recommended. To fully align VBM and financial reporting systems will require lots of effort.

•

Commitment of management to the process is critical for success.

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Key implementation issues Timescale/Speed:

Takes longer than anticipated. There has to be preparedness and

planning to overcome resistance to the changed requirements. Speed in being able to create value is seen as crucial. Management processes will need to be improved and external consultants can be used to speed up change. The role of the champion: Success requires a champion who wants s/holder value to be the way the company is measured and wants to take the lead. There is a considerable resource requirement to provide an effective leader who may be tied up with implementation for years. Management must plan for the resource and ensure continuity and succession in the key role. Role of the Corporate Centre (CC): CC becomes a primary resource in terms of education and training in the application of the concepts. There has to be good linkage between those in the CC, who are familiar with VB concepts, and those out in the business units, at operational level, at the customer face. CC plays an in role in implementation. Level of cascading throughout the company: When the concept has been “bough into” by senior management, next is cascading the concept in value development of value creating strategies/processes undertaken with the business heads. The primary objective of VB system is to link the firm’s strategies and management performance evaluation to the creation of s/holder value. Those cascading the information have to portray the concepts in practical ways rather than complicated theories. Implementation process at corporate level will differ from implementation in lower levels. Most orgs used the approach at corporate level, where the need to understand which parts of the business deliver value and which use excessive capital without much returns is vital. Cost of capital: Estimating and understanding the coc is a fundamental issue in s/holder value. it is difficult to estimate the coc for each business unit. Often, the total company 13

coc is used and applied to each of the business units- this is inaccurate. The coc should be understood below management level via commutation and education. W/o adequate assessment of coc, it is not possible to determine how much or whether value has been created or destroyed. Change from established financial/management reporting system: Moves towards DCF based management reporting system is essential. Systems need to be adapted to incorporate more fluidly operational value drivers to ensure that management and measurement are aligned operationally. The ongoing nature approach: Most companies’ intention is that it will be managed and governed to maximise value for its s/holders and stakeholders for the long term. The objective is that the ROI exceeds the COC. Implementation does not have a finite end- its ongoing via continual feedback, review and drive/momentum of top management to sustain the approach.

Observations on successful implementation of VBM In order to achieve value creation, it is a vital requirement that the company direct the value creation process. It requires accepting long term responsibility for maintaining and retaining the processes necessary to ensure that ROI exceeds COC and provides the direction for it. The direction process has to be ongoing and will influence the whole org and all functions of the company. Below is a list of the skills suggested for value direction- (for full list refer text pp321) o development of applied corporate finance o value metrics o strategic planning o internal audit o education and training o value performance management o IT

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value direction means ensuring that the necessary links are in place between building budgets and targets in physical value terms and enabling their transfer to financial data at higher levels so that everyone can get on with managing the business in meaningful terms for creating value.

10.7 What can VBM facilitate? 

Strategic and financial planning at corporate and business levels



Corporate investment decisions



Evaluation of revenue expenditure programmes



Corporate finance decisions with respect to dividend policy, investor relations, treasury management and financial decisions



Performing targeting, measurement and reward systems

CSF for successful implementation of VBM: o Visible commitment from top management o Set ambition to create value for s/holders alongside other corporate values so that former is not the sole objective o Inclusion of planning, control and reward systems o Education in cash based financial tools and strategic analysis tools o Willingness to explore areas where value creation is weak o Early handover of management from ext consultant to company’s management o Clear roll out plan for whole org from outset o Management of expectations- realize lags can occur btw investing in change and reaping rewards DON’T’S: o Avoid degeneration into a number crunching exercise

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o Avoid manipulating TV figures of business strategies which need to be tested against ext assumptions o Do not apply VBM exclusively to just one area of management process o Avoid being “bull headed”- compromise to make headway- e.g. defer reward system changes KEY BENEFITS: o Development of a common framework for integrating long range strategic plans, acquisitions, short term budgets and capital programmes etc o Reward systems that align behavior and motivation o Realisation that a trade off exists between large investment and revenue projects o Performance measurement has a more outward focus relative to competitors and market conditions.

10.8 Changing role of finance For successful businesses embarking on shareholder value initiative, there are 3 crucial issues to address: 1. Strategy implementation: ensure that the agreed strategy is proceeding according to plan. Financial managers have to keep the entire company under review; milestones and responsibilities are clear and everyone is aware of what they have to do 2. Strategic change: financial managers and their information systems have to respond to present day pressures 3. Strategic flexibility: finance has to be ready to respond quickly to opportunities which arise. Finance is now regarded as an asset for driving business competitiveness and effectiveness. The modern finance function will need to focus on implementing global 16

integration strategies, deploying cutting edge technology and working to upgrade quality of people and processes. Finance function has to manage value created from: -

an internal perspective- managing for value

-

an external perspective- M&A

Analytical tools to manage value from an internal perspective Finance has to provide better information for better business decisions. The challenge is to implement world class financial and business analysis tools e.g. dashboard form which to monitor performance to operate a proactive business model.

Analytical tools to manage value from an external perspective M&A now happen across all sectors of industry. New players in the M&A market, like PE structures can pose a threat to the most secure firm in its current form. Private equity (PE) can be applied to companies at all stages of development from start ups to mature established companies with a stock market listing. PE is invested in exchange for a stake in the company and, as s/holders, the investor’s returns are dependant on the growth and profitability of the business. The speed at which M&A deals are completed has also accelerated. With the changes in M&A, both the enabling and the tracking of the value creation process frequently rest in the hands of the CFO. CFO plays an imp role from strategic planning to opp identification and education and initial evaluation to execution and integration. The CFO must lay the foundation for increased efficiency and productivity which will underpin value creation.

10.8 The ascendancy of the general financial manager General information re financial specialist – refer pp325. Not highly relevant

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