Value Based Management

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James A Knight McGraw Hill 1997 0786311339 Alistair Schofield, Managing Director, Extensor Limited

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I was recently doing some research into “value based management” and came across this book on the shelf in my office. It had been given to me by the author in the late 90’s when I attended a presentation he gave and, like so many books that I have not purchased for a specific reason, it unfortunately remained unread until now. I say ‘unfortunately’ as it proved to be quite an illuminating read.

Unlike most of the other books I came across while researching the subject, this book steered clear of the analytical constructs of shareholder returns, operating performance and economic profit and instead focused on the ways in which long-term shareholder value is actually created through practical examples and case studies.

I have a high degree of empathy with this approach as I have all too often seen companies expend inordinate amounts of effort trying to measure ‘value’, when what is lacking is an understanding of how value is created. For example, I once asked a senior team in an insurance company what the impact on profitability would be if persistency (the average lifespan of a policy) were increased. They had no idea. When they actually did the research, they found that a 1% increase in persistency would add roughly £10m per annum to the bottom line! However, knowing that was just the start. The next step would have been to understand how they could influence persistency, to share an understanding with all staff as to which of their actions could influence persistency and to empower them to take those actions whenever the opportunity arose.

The book is organised in four main sections. The early chapters look at the concepts underlying the definition of value and explain why managers should focus on value rather than on more short-term goals. Knight goes on to ask the question, why is it that since value management is the single reason why businesses exist, value management is not always understood?

The answer, it seems, lies in the plethora of other targets that businesses create for their managers. For example, the ‘strategic plan’ may emphasis one goal or objective while the budgeting process emphasises another and the management incentive scheme yet another.

To address this Knight lays out a simple formulae for success:

1. Capture the business strategy in the performance measures.
2. Pay management for value-creating performance.
3. Focus managers on business strategy.

This sounds simple enough but, as Knight’s research showed, very few companies even manage the first objective and instead have performance measures based on earnings per share and other similarly single-period financial measures.

As Knight says “Excellent companies don’t just measure results, they look beyond the results to the key drivers of their strategy and then include these drivers in the performance measures they use to measure how well they are doing against their strategic objectives.”

To assist in this process the second part of the book looks at the concepts and definitions underlying value-based decision making, the ingredients necessary to achieve a value-managed organisation and explains the relationship between value-based decision making and strategy execution.

The third part of the book looks at the issues involved in implementing value management within an organisation while the last part of the book rounds off the discussion by looking at key lessons and ideas critical to success.

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