Making Their Mark by Tad Leahy (Business Finance) www.businessfinancemag.com/
- reprinted with permission from GlobalSkills (Trevor Roberts)
Note: This concept links to issues of organizational alignment and shared missions, visions and values.
True believers in value-based management (VBM) say that employees who understand the impact their jobs have on company performance can turn around an ailing company.
What will managers need to compete successfully in the twenty-first century? In a word: integration. They'll need to bring their company's diverse business units, processes and employees together into a cohesive whole, where all elements work toward the same goal - the creation of value. In other words, managers will need value-based management (VBM). Value-based management says, in a nutshell, the key to increased shareholder value lies in the integration of strategic planning, performance measurement and compensation.
The premise behind VBM is simple: The metrics the company chooses to focus on must reflect and support its strategic goals, and employees' compensation must be tied to how well they achieve those metrics. The more employees succeed in hitting their metric targets, the more they're rewarded, and the more value they create for the organization.
"In the past, companies would put their metrics in place first to test how well they would perform, then after a trial period they'd tie people's compensation to those metrics," says Robert A. Korajczyk, Ph.D., professor of finance and former chair of the department of finance at Northwestern University's Kellog Graduate School of Management, Evanston, Ill. "Now, companies do it all at once, because unless you tie compensation to the metrics right from the start, there's no incentive for people to go along with VBM."
Decision-makers may be tempted to simply identify metrics, tell employees to follow them, pay them to do so, and figure that's all they need to do. But that's not enough. "Educating people on how their jobs influence the organization is just as important as choosing the right metrics," Korajczyk says. "It's also more difficult than determining what metrics to use."
The Importance of Timing Companies that succeed in implementing VBM make people feel like true owners in the business. "It's hard to get people to feel that way unless they really have a stake in the business," says Christopher C. Kenney, vice president of L.E.K. Consulting LLC, a firm in Chicago that specializes in value-based management and growth strategy consulting. "The key success factor here is timing."
Tying people's compensation and incentives to a company's metrics before staff thoroughly understands the importance of following the metrics usually will frustrate employees, says Kenney. They'll end up scratching their heads, not really knowing the reasons why they're supposed to be performing their tasks differently. "On the other hand, waiting too long to tie performance measures to compensation and incentives tends to cause people to drag their feet. [They figure] they're still being evaluated under the old compensation criteria so they don't really have much motivation to change the way they do their jobs," says Kenney. "However, people will adhere to the new set of metrics and perform their jobs in accordance with those metrics if they're certain that the new compensation or incentive system will be in place soon."
When it comes to VBM education, if the explanation is too theoretical, people will lose interest. "You need to show some examples of how VBM worked at other companies, or how applying it within one division of your company has worked so far," says Kenney.
Unless VBM is closely linked to something people can relate to, they're not likely to use it. "VBM, like any new technological initiative you put in place at your company, is like a loaded gun, so you need to be careful about how you put that gun in people's hands," says Dave Sutton, vice president of strategic services at Inforte Corp., Atlanta, an e-business consultant that deals with performance management and change. "Never underestimate the power of the people to break down the new system or initiative."
There are two ways to implement VBM: via pilot study or company-wide roll-out. The latter starts at the corporate level then pushes down into the different business units. If people are skeptical about VBM then a pilot study is preferable.
"Having a successful pilot can overcome people's objections, but that pilot must succeed, so choose a department or business unit where it won't be hard to show some quick results," says Kenney. "If people are on board with the VBM concept, then a companywide roll-out tends to work better."
Providing sufficient education and communication about VBM and then implementing it usually takes about a year, says Kenney. If decision- makers wait too long and tie VBM to next year's compensation program, staff will get tired of hearing about VBM and may lose enthusiasm. However, employees will know the company is serious about VBM if senior management has given it their blessing, which is another critical factor for success.
Prime VBM Candidates Some companies are more likely than others to succeed with value- based management. Capital-intense firms find VBM more attractive than do service-oriented companies because VBM focuses on earning a return on capital. "With service companies, the focus is on people capital," says Samir J. Raza, senior consultant in the corporate finance/executive compensation group at Hewitt Associates, LLC in Lincolnshire, Ill. "VBM may result in major changes within the company, such as downsizing or spinning off a division. So it's not only education that's important. Ongoing communication about your company's VBM initiatives is another key element, so people aren't left in the dark about VBM developments, or why the company is doing what it's doing."
Poor candidates for value-based management include companies with strong earnings and stock prices. Implementing VBM can be difficult because people will continually question the need for such an initiative. Companies that are in bad financial shape and have to turn things around are better candidates.
Having some other business initiatives already in place helps. For example, companies that have implemented activity-based costing/management (ABC/M) have a leg up on value-based management implementation. "ABC/M is a prerequisite to get the full value out of VBM," says Kenney. "You have to walk before you can run. With ABC/M already in place, a company has their data better organized, which will help speed VBM implementation."
Also, companies that have already adopted a major initiative, such ABC/M or the Balanced Scorecard, are more receptive to VBM because they've already successfully navigated the cultural changes that come with such initiatives. Those experiences should give them a better idea of what to expect from a VBM implementation.
Newer companies have an easier time with value-based management than older ones that have outdated, hard-to-remove legacies. "Newer companies are ripe for VBM because they're not displacing anything," says Sutton. "On the other hand, at a steel company, for example, where the basic business model is to keep running at full capacity, it can be more of an uphill battle to get that company thinking beyond that single objective and incorporating a whole new set of metrics."
Interactive Education A prime candidate for VBM was Herman Miller Inc., a designer and manufacturer of office furniture in Zeeland, Mich. For years, the company's stock languished. Then new management came in, led by a new CEO who realized the company's different departments were operating in silos and pulling in different directions. Goals were not aligned. The CEO formulated a set of strategic plans, complete with metrics, and tied those metrics to employees' compensation.
"Other companies have said, `We'll tie managers' year-end bonus to a performance metric like EVA [economic-value added] or CFROI [cash flow return-on-investment] and that will be enough,' but Herman Miller did much more," says Lawrence Serven, principal of The Buttonwood Group LLP, a management consulting firm in Stamford, Conn., and author of "Value Planning" (John Wiley & Sons, 1998). "They based not only compensation but also promotions on managers' EVA performance."
Educating Herman Miller employees about VBM has become an interactive process. "Every month, within each work unit, a non-finance person must present the monthly finance report to their colleagues," says Joe Nowicki, vice president of finance at Herman Miller. "That's when you begin to understand [VBM], when you're teaching it to others within your organization. And these `teachers' include marketing people, engineers, public relations people, human resources personnel - people from all across the company. Our goal is to build a connection between people's daily decisions and the financial performance of the company."
Another advantage of this type of education is that managers train their own staff, as opposed to finance or someone else outside the department leading the training. Marketing people are training marketing people; engineers are training engineers; and so on, "which means there's a greater likelihood of understanding and acceptance when it's coming from those you work with every day" says Serven.
A sweeping change such as value-based management creates multiple challenges. For instance, tying someone's compensation to his or her ability to perform well within a new set of company metrics becomes problematic when that person is an employee of an e-business. "You can't tie the compensation of these people to traditional metrics like EVA or CFROI because building value among these companies usually has little to do with those kinds of measures, and earnings among Internet-based companies are often negative," says Korajczyk.
Perhaps the biggest VBM challenge is the pace of change that companies face. Strategic plans, and the metrics that support them, are being altered quickly these days. That means what you're basing people's compensation on needs to keep changing too. It can be confusing to an employee who's being evaluated on the basis of one set of metrics one month and a different set a month later. The more frequently these changes occur, the harder the VBM nut will be to crack.
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