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At its heart, value-based management seems a no-brainer—especially for the company with a crippled share price. First, adopt an economic profit metric as a key measure of performance. Then, tie compensation to targets in the metric. Problem is, real-world experience with VBM has brought largely lackluster results. The issue: Executing a VBM plan is anything but simple.
In this Harvard Business Review excerpt, the authors present two of six necessary keys for VBM to take root in a company: explicit commitment to value and intensive training. The other keys are building ownership, empowering business units, broad process reforms, and creating a virtuous circle.
An Explicit Commitment to Value.
Whatever its annual report may say, a company rarely embarks on a VBM program with a single-minded focus on shareholder value. Typically, there are many other, often conflicting, corporate goals. The most common contending objective, we've found, is the desire to become bigger. Managers are often conditioned to think big—to strive to go global, for instance, or to be the number one company in their market—regardless of the consequences for value. Cadbury Schweppes is a case in point. Through the 1980s and early 1990s, its expressed ambition was to catch up to Coke and Pepsi while driving toward "a million tons of sugar consumption" in its confectionery business. Throughout the period, even though Cadbury was one of the most admired companies in Britain, its share price obstinately lagged behind the competition's.
The first challenge in implementing VBM, therefore, is usually to jolt the company out of its preexisting mind-set. To do that, the CEOs of the most successful VBM practitioners have nearly always kicked off their programs by making public an explicit commitment to shareholder value. Soon after he had been appointed CEO in 1996, Cadbury's John Sunderland called a meeting with institutional investors at which he committed Cadbury to doubling its share price every five years (later shortened to four). An explicit commitment like that can serve two purposes. First, it communicates to the outside world that the company recognizes the need to break with a prevailing culture. Given his own adherence to volume-oriented goals when he was the leader of one of Cadbury's business units, Sunderland's action marked just such a shift. Second, some CEOs use the announcement as a way to energize internal constituencies. In Cadbury's case, Sunderland felt that he needed to create a sense of urgency among employees, many of whom were too comfortable with the company's paternalistic environment.
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| Effective VBM-training programs can—and probably should—lead to a shakeout among senior managers. | |
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| —Haspeslagh, Noda, and Boulos |
Explicit commitments to value like Cadbury's are a strong predictor of success in a VBM implementation: Companies that made them were more than twice as likely as companies that didn't to report that VBM was highly effective in improving their share price performance relative to that of their peer group (see the exhibit "The Impact of Commitment"). The majority of VBM companies in our survey, however, seemed to shy away from making explicit commitments to shareholder value: 36% of participants described their commitment as implicit, expressed indirectly through their actions and decisions. A further 16% sought to cater to a variety of stakeholders—shareholders being only one of those. Perhaps predictably, attitudes toward shareholder value in our survey seemed to depend on cultural factors. European and Asian companies were much less likely to make an explicit commitment. Indeed, in some countries, the very term "shareholder value" is considered politically incorrect. Such cultural differences can pose a problem for multinationals. Asked why he was explicit about shareholder value in managing his U.S.-listed affiliate yet low-key about it in the French parent company, the CEO of one multinational responded: "I drive differently in the U.S. than I do in France. I also don't manage in the same way." Although this CEO was convinced of the merits of espousing shareholder value openly, his French board members (mostly CEOs of other French companies) feared that an explicit commitment in France would antagonize France's government and unions.
Intensive Training.
As Sunderland puts it, "Managing for value is 20% about the numbers and 80% about the people…because people create value." Getting VBM right demands that everyone in the company be convinced that managing for value is the right thing to do. Accordingly, our research shows successful VBM companies invest a great deal of time, effort, and money in training large numbers of their employees. As the exhibit "The Impact of Training" shows, 62% of the successful VBM companies in our survey report training more than 75% of their managers in VBM concepts, whereas only 27% of the unsuccessful companies trained that great a proportion of their management staffs. Let's look at what those training programs involve.
Covering All the Bases.
Dow Chemical retrained 75% of its nearly 40,000 employees, starting with the senior executives and then cascading down to the shop floor. Every business unit team received about a day and a half of training in the basics: how to calculate the economic profit metric, how to develop key value drivers for a given value center or smaller organizational unit, and how to interpret the results. Additional sessions lasting another three days followed, geared toward specialized functions. Marketing staff, for instance, focused on supply, demand, and pricing analysis, as well as on how to link that analysis to economic profit concepts. The finance staff focused on computer modeling, cost structure analysis, and benchmarking. Dow then went on to train virtually all its remaining employees in the basic concepts of economic profit and value creation "right down to the forklift operator," as one senior Dow executive puts it.
Before implementing VBM, the executive says, fewer than 5% of its people—including those in the executive suite—could have given adequate definitions of economic profit and cost of capital. Afterwards, he says, more than 75% of Dow's employees could do so—and they also knew what the implications were for Dow's success.
Most of the training was designed and led by Dow company officials—insiders who understood their company's sensitivities. External consultants were engaged only to provide senior-level training and teaching materials. In general, relying on line managers as instructors helps make the VBM concepts credible, especially on the shop floor, where employees tend to be suspicious of consultants and even of in-house HR professionals.
Shaking Out the Team.
Effective VBM-training programs can—and probably should—lead to a shakeout among senior managers. Like Dow, Cadbury believed that training should trickle down from the top. Its training therefore began with an exhaustive evaluation of the capabilities of Cadbury's top 150 managers, conducted through interviews with external human resource consultants. This resulted in the creation of personal development plans for each manager focused on eight attributes, which Cadbury refers to as "leadership imperatives." These are: accountability, aggressiveness, adaptability, and assertiveness, as well as the ability to motivate, to be forward thinking, to be mature, and to be international in their outlook. In developing their personal plans, managers had to answer questions such as: Which managerial qualities do I need to hone to deliver value? Where in the organization can I best do that? Cadbury was intent on having a cadre of managers who were totally committed to VBM and had the necessary leadership skills to implement it: As a result of this exercise, 50% of the 150 top managers left the company or were assigned to new positions.
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How <I>Not</I> to Do VBM
A well-known global company participating in our survey is an excellent study in how not to implement VBM. Although it proclaimed that value creation was its raison d'être, the company did little beyond adopting an economic profit metric as a performance measure.
For a start, the link between employee bonuses and shareholder value was tenuous. Although a proportion of the bonus was tied to the share price performance of the company and to the economic profit targets of its businesses, several other factors also played a part in determining its size. As a result, employees could game the system by focusing on whatever measures they favored. Training was also skimpy: Less than 10% of all employees and less than 25% of managers were trained in VBM concepts.
More seriously, however, the company failed to make significant changes in its processes. Budgeting and strategic-planning systems remained separate from each other. The company continued to fund individual projects coming up through the system, basing funding decisions largely on the reputation of sponsoring managers and on the perceived fit of a project with the CEO's vision. And for good measure, senior management interfered frequently in the resource allocation process, suggesting that politicking and gaming were rife.
As one might expect, this company reported in our survey that it took no important actions based on VBM and that, far from having a positive impact on employees' behavior, its VBM program actually had a negative effect. Eventually, the company abandoned its VBM program, declaring the experiment a failure.
