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BEST PRACTICES - Value Based Management

Value Based Management (VBM) or Stern Stewart's EVA is used to determine the "real" shareholder value creation (or destruction) contributed by each business unit or division. Rather than simply taking a profit or earnings number, VBM/EVA assigns a capital charge. The intent is to move managers away from fixating on market share or revenue growth and other traditional measures, and instead focus managers on creating shareholder value as the "ultimate" objective. In terms of planning then, the question becomes "How much shareholder value can this division contribute over the planning horizon, and how will it achieve that goal?"

If Implemented Well If Not Implemented Well
Can focus the organization on creating shareholder value, and thereby greatly increase the likelihood of achieving that goal.

Stock analysts generally view the adoption of a VBM/EVA program very positively.

Can create an understanding among all managers of how they contribute to creating shareholder value and focus their efforts accordingly.

Creates one defining, overriding priority - creating shareholder value. All projects, goals and initiatives can be evaluated in this light.

Calculations VBM/EVA can be very complex and difficult to explain to managers. Lack of commitment and buy-in can result.

Without a whole host of supporting factors, below, it's likely to be ignored by the organization and fall into disuse.

Management reporting systems often need considerable reconfiguration in order to report monthly VBM/EVA results.

Business Unit heads often reject allocations, and since allocations are often part of VBM/EVA calculations, bottom line results are frequently contested.

Can this work for my company?
Value Based Management/EVA, in theory, is the best thing that ever happened to shareholders. Why? Because shareholders often underwrite a whole host of money losing propositions - like throwing good money after bad chasing market share. VBM/EVA can change all that by focusing on and reporting on shareholder value creation (it gets very complicated very quickly, but you can think of it as earnings after a capital charge). So rather than focus on revenue growth, or "being #1 in the market", or any one of a number of common goals, VBM/EVA companies will pursue those goals only if they will result in increased shareholder value. In fact, all proposed projects, initiatives and programs are judged by this yardstick. Want to build an on-site daycare center? Fine, as long as you can build a compelling case that it will increase shareholder value (lets say by reducing turnover and recruiting fees).

The problem is that VBM/EVA tends to get stuck at the senior management level. The reason why that's a problem is that it's the decisions that workers make on the front lines every day that really drive shareholder value. Sure, Senior Management can make a "big bang" decision to sell a division or enter into a strategic alliance. But the fact is that line employees and frontline supervisors make dozens of business decisions every day. Whether to throw out or remachine a problem part. How hard to pursue that new prospect. Whether to get maintenance to investigate the funny noise the truck motor is making or just wait till it breaks. Whether the irate customer on the phone is entitled to a refund. Not to mention those little decisions like what hotel to stay in.

If managers don't understand the VBM/EVA measure, or what they do every day that influences it, they'll stop caring about it. They'll do what they need to get by and no more.

That's why the successful implementation of VBM/EVA requires a lot of support; in the form of across the board business literacy, robust management reporting systems, and integration with the compensation and bonus policies.

In light of this, you may want to consider implementing VBM/EVA if your company meets this criteria:

You have a data warehouse, or have implemented an Enterprise Application System (such as SAP or Peoplesoft).
You are prepared to undertake an organization wide business literacy program to teach VBM/EVA.
Your senior management is prepared to make difficult, even unpopular decisions given the shareholder value implications (if not, don't waste you time).
Compensation and bonus polices can be updated to support shareholder value creation goals.