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Making Value Happen
Most publicly traded companies today have a stated aim of creating value for their shareholders.
The question for many managers is not ''Why should we create value?" but "How can we create value?" This question translates into issues in a number of areas, such as:
• How can we set targets that reinforce our overall goal of creating shareholder value?
• How can we align our management processes with the goal of value creation?
• How should we structure our incentive programs?
• How can we promote a value emphasis throughout our corporate culture?
Various approaches have been proposed for companies to carry out value-based management. Some are strictly metrics focused; others take a wide scope, including strategic, financial, and organizational issues. Some promise almost immediate impact, while others ask managers to commit to multiyear improvement programs. Some are highly data- and systems-intensive, almost reminiscent of planning programs of the 1960s, whereas others try to get by with a minimum of paperwork.
Regardless of the approach, not all companies have had success with such programs. We looked at the total returns to shareholders of a sample of companies that announced they would undertake value-based management. Only one-third outperformed their sector index by more than 5 percent
Special thanks to Susan Nolen who co-wrote this chapter. Material in this chapter draws upon the work of McKinsey's working group on "Making Value Happen," including Petri Allas, Steve Bear, Richard Benson-Armer, Parke Boneysteele, Richard Dobbs, John Hall, Johanne Lavoie, Susan Nolen, Neville Salkeld, Bas van der Brugge, and Kristina Wollschlaeger. The "Performance Ethic" initiative headed by Warren Strickland has also provided considerable insight.
following the announcement; this pattern was consistent over 3-, 5-, and 10-year intervals. Our hypothesis is that in many companies, value-based management is taken up as a one-time project and not translated into long-term changes, with the effect that results are limited.
The central issue isn't whether companies have a special program called value-based management; rather, value results from a set of interrelated activities that most companies already have in place. The point is to what extent these activities are done in ways that lead to value creation, and to what extent values and behaviors that promote value creation are a part of ''how we do things around here." This chapter describes what a company that actively manages for value would look and feel like, as well as how a company interested in achieving a high level of performance can get started.
The prerequisite for making value happen is that a company's actions build on a foundation of value thinking. Value thinking in turn has two dimensions—value metrics and value mindset.
The central question of value metrics is whether management really understands how companies create value and how the stock market values companies. Does management balance long- and short-term results, or focus on short-term results only? Is the opportunity cost of capital included in the measurement? Are the metrics based on economic results or on accounting results? Chapters 3 and 4 detailed an economics-based view of value creation metrics.
Value mindset refers to how much management cares about shareholder value creation. This mindset expresses itself in several crucial areas of the CEO's thinking and behavior. One aspect is whether the CEO truly seeks to create as much shareholder value as possible, as opposed to creating as much as is needed to quiet restive shareholders. Another aspect is whether the CEO sees managing for shareholder value as a way of life or just as a short-term project. Sir Brian Pitman, chairman of Lloyds TSB Group, introduced the target of doubling the bank's share price every three years in the 1980s, and was quoted in 1998 as saying, "We are willing to go on changing in order to double the value of the company—to stretch ourselves beyond the things that we are doing at the moment."1
Finally, the value-driven CEO is willing to make unpopular decisions if these are the choices that will maximize shareholder value in the long run. Pfizer, for example, was strongly criticized by analysts in the late 1980s for its high level of research and development spending. When this R&D spending translated into blockbuster drug sales in the 1990s, the market rewarded Pfizer's patience with one of the highest valuations of any pharmaceutical company. In almost all companies that have successfully done
1 A. Morgan and P. Bose, "Banking on Shareholder Value: An Interview with Sir Brian Pitman, Chairman of Lloyds TSB," McKinsey Quarterly, vol. 2 (1998), pp. 96-105.
value-based management, the CEO's commitment to shareholder value is a crucial first element.
Building on the foundation of value thinking, there are six areas where a company must act to reinforce a shareholder value focus, as presented in Exhibit 6.1: