Oh, it’s such a confusing world. Your main competitor has been stealing a march on your firm by using some new-fangled technique which tells management whether a business operation is creating economic value. No external factors have changed and yet their share price is buoyant while your own is in the doldrums. Better look into this thing.
Then it gets really confusing. Everyone starts talking about Stern Stewart, McKinsey, Rappaport, value added tools, value based management, discounted cashflows and the like.
Each consultancy firm tells you that its measure of – and technique for achieving – economic value is the best method. Why do these management techniques have to be so complicated? you ask.
Only it’s not that complex, and it’s certainly not new-fangled. It just hasn’t swept the corporate globe – yet. The concept of managing according to the creation of economic value dates back to the late 1960s in the US. And it’s been knocking around internationally in various guises for at least 15 years. ‘I’m constantly surprised that value based management hasn’t been taken up more readily in the UK and continental Europe,’ says Alan Clark, principal consultant at KPMG Management Consulting in London.
Clark should know about the adoption of managing for value techniques in Europe.
KPMG has just published a survey of European industry’s attitudes to value based management (VBM) which reveals a large gap between awareness and implementation of the concept. In short, a significant majority are aware of VBM, but only a minority claim to use it for management purposes at any level. Of those, a miserable 8 per cent of the 500 or so companies which responded to the survey were deemed to be ‘real’ users of VBM – that is, using it for key business decisions at all levels within the company.
But why should companies switch to directly managing for value? Can’t anyone be happy with traditional means of measuring corporate objectives? Anyway don’t the markets still judge companies’ performance using EPS and profits?
No. Not according to Clark and other preachers of the value added gospel. ‘My perception is that the institutions use cashflow based techniques to evaluate companies,’ says Clark. ‘However, managements still believe they use short-term EPS measurements.’
And as accounting data is by its nature a historical record possibly subject to manipulation to create profits, it’s not the best way to evaluate a company. ‘It’s more difficult to manipulate cashflow,’ adds Clark. ‘Managements and shareholders should be interested in cash and future cashflows as that determines dividends. That’s what this technique focuses on.’
That’s certainly not what a majority of the respondents in the survey were focusing on. Nearly 60 per cent said that they would keep a business running even if it destroyed value – producing a smaller return on capital than its cost. Clark acknowledges that this may be justified in certain circumstances – it’s difficult to apply VBM to start-ups or new business projects from their inception, for instance. But more often managements use invalid arguments to defend continuation; or are just plain unaware of the value destruction.
Okay. If managing according to value creation really is such a great tool, why aren’t more companies adopting it as the very be-all and end-all of their existence? ‘It’s a relatively complex concept which must get a chief executive’s approval,’ says Clark.
‘There are many who are sceptical of new tools and techniques as they come and go. But this is something that will stick around.’ Clark points out that those companies in Europe which have adopted VBM or the like, such as Boots and Lloyds, have gone the whole hog and are now strong believers.
It’s the same in the US. Once converted, forever smitten. Coca-Cola and AT&T were happy to shout about their new found faith in Fortune magazine back in 1993. Under the banner headline The Real Key to Creating Wealth, starry-eyed executives detailed their conversion to Stern Stewart’s Economic Value Added (EVA) model.
‘Every corporate executive in the US says they are managing for shareholder value,’ says Al Ehrbar, senior vice president at New York-based Stern Stewart, which is widely credited with initiating the managing for value shebang. ‘But only a small proportion of companies are actually doing it.’
Stern Stewart is currently traversing the globe with its corporate problem solving kit and has made notable inroads into the South African and New Zealand markets. And Ehrbar says it doesn’t matter if companies are reluctant to view shareholder value as their primary goal.
Managing according to the dictates of EVA will still lead to the creation of more jobs, better products and all round stakeholder satisfaction.
Sounds marvellous, doesn’t it? All corporate prayers answered. The only problem is finding a suitable consultant to advise on which management consultant has the ultimate value creation method.
It’s such a confusing world.
