Value Based Management (VBM) | Shareholders | Firm | Financial Management

In this article we will discuss about:- 1. Meaning of VBM 2. Methods of VBM 3. Benefits and Limitations. 

Meaning of VBM:

VBM is the management approach that ensures corporations are run consistently on value, normally maximizing shareholders value. VBM aims to provide consistency of the firm’s strategy, mission, governance, culture, communication, organization of the corporation, decision processes, reward processes and systems etc. Basically, value of shareholder can be measured in terms of earning after tax (EAT) and return to equity shareholders.

It means that maximization of shareholder value is possible through increase in EAT or decrease in rate of return to equity shareholder. The value maximization process needs increase in sales, decrease in cost and increase in return. Therefore, all levels of operational personnel and executive staff from top to bottom are concerned with VBM improvement.

Methods of VBM:

The important methods in VBM are as discussed below:

a. Marakon Approach:

This method was proposed by Marakon Associates, an international management consultancy firm in 1978. The approach is based on market-to-book ratio. The market value taken in computation of ratio is the long-term equilibrium market value.

b. Alcar Approach:

This method was proposed by LEK/Alcar Consulting group.

Under this approach a business strategy is evaluated by the following steps:

Step 1:

Forecast the operating cash flow stream for the business unit (strategy) over the planning period.

Step 2:

Discount the operating cash flow with weighted average cost of capital.

Step 3:

Estimate residual value of the business unit (strategy) at the end of planning period and fixed its present value.

Step 4:

Determine total shareholder value.

Step 5:

Calculate pre-strategy value.

Step 6:

Determine value created by the strategy.

c. Mckinsey Approach:

This approach was proposed by Mckinsey &Company.

The key steps in the Mckinsey approach to VBM are as follows:

i. Ensure the supremacy of value maximization

ii. Find the value drivers

iii. Establish appropriate managerial process

iv. Implement value based management properly

d. BCG Approach:

The approach was proposed by Boston Consulting Group. Two concepts are at the base of this approach: Total shareholder return and Total business return. For applying these concepts two performance metrics are used: Cash flow return on investment and Cash value added.

e. Economic Value Added Approach:

This approach was proposed by Stern Stewart & Co. The economic value added (EVA) is profit after cost of capital. A positive EVA indicates that a business is not only earning, it is earning enough to satisfy the providers of fund. Therefore, EVA as a performance measure is better than accounting profit.

The EVA sends a clear message to operating managers that further investment can be made only if the cost of capital on further capital can be recovered. EVA concept encourages the projects with shorter payback period rather than projects with long gestation period. The improvement in EVA will lead to improvement in market value added (MVA).

MVA = Present value of EVA

Benefits and Limitations of VBM:

Benefits:

The benefits arise from VBM approaches are as follows:

I. VBM can maximize value creation consistently.

II. It increases corporate transparency and helps organizations to deal with globalized capital market.

III. It aligns the interests of top managers with interests of stakeholders and shareholders.

IV. It facilitate communication with investors, analysts and communication with stakeholders.

V. It provide internal communication with strategy and prevent under valuation of stock.

VI. By giving management a clear priorities, VBM helps to improve decision-making.

VII. VBM facilitates to balance short-term and long-term trade-offs.

VIII. It insists value creating investments and improves planning and budgeting.

IX. VBM sets effective targets for compensation.

X. VBM helps the use of stocks for mergers and acquisitions and also helps to manage increased complexity and risk better.

Limitations:

The VBM concept suffers from the following drawbacks:

i. VBM is a holistic management philosophy, often requiring culture change.

ii. VBM programs are large scale initiatives. To become successful it needs considerable time and resources.

iii. Value creation may sound simpler than corporate strategy but it is actually more or less the same.

iv. VBM requires strong and explicit CEO and executive board support.

v. It necessitates comprehensive training and management consultancy which are quite costly.

vi. The perfect VBM model has not been invented yet.