Value Creation and Business Success Essay Example for Free

Value Creation and Business Success EssayCopyright 1998 Pegasus Communications, Inc. (www. pegasuscom. com). All rights reserved. No disperse of this article may be reproduced or transmitted in any form or by any fashion, electronic or mechanical, including photocopying and recording, without written permission from Pegasus Communications, Inc. If you wish to distribute copies of this article, please contact our Permissions discussion section at 781-398-9700 or emailprotected com. The most successful organizations understand that the purpose of any crinkle is to create valuate for guests, employees, and investors, and that the absorbs of these three groups are inextricably linked. Therefore, sustainable valuate seatnot be created for one group unless it is created for all of them. The origin focus should be on creating rate for the customer, but this cannot be achieved unless the right employees are selected, developed, and rewarded, and unless investors receive sys tematically glossy returns. What do we mean by time time value humans? For the customer, it entails making products and providing operate that customers find systematically useful. In todays economy, such value creation is based typically on product and process intro and on taking into custody unique customer needs with ever-increasing speed and precision.But companies can innovate and try outstanding service only if they tap the commitment, energy, and imagination of their employees. Value must therefore be created for those employees in order to motivate and enable them. Value for employees includes world treated respectfully and being involved in end-making. Employees likewise value meaningful work excellent compensation opportunities and continued training and development. Creating value for investors means delivering arrangedly high returns on their capital.This generally requires both strong r planeue growth and sop upive net income margins. These, in turn, can be achieved only if a company delivers sustained value for customers. If the purpose of melodic line is value creation, it follows that the mission of any company should be defined in terms of its primary value-adding activities. merely put, Honda should suppose of itself primarily as a maker and marketer of quality automobiles. McDonalds should think of itself as providing meals of consistent quality throughout the world, in a clean, fri wipeoutly atmosphere, etc.While this may seem obvious, umpteen passenger cars and strategists behave as though the day-to-day stock of a firm is irrelevant. Hence, an oil company talent buy a hotel chain, while a national chain of automobile service centers is caught systematically charging customers for redundant repairs. What conception of line of descent lies behind these actions? Typically it is a very nail definition of purpose to increase the wealth of the shareholders, or to achieve a set of short-run financial goals.Managers ar e expected to credit shareholder wealth, earnings growth, and return on assets, but the most successful firms understand that those measures should not be the primary targets of strategic management. Achieving attractive financial performance is the reward for having aimed at (and hit) the real target i. e. , maximise the value created for the primary constituents of the firm. Paradoxically, it is when an organization thinks of itself as a financial engine whose purpose is to generate attractive financial returns that the company is least likely to increase those returns in the long run.Often, finance people end up shuffling a portfolio of assets in a self-destructive quest for growth businesses or supreme returns, with no real understanding of the value-creation dynamics of the businesses they are acquiring and selling. Or, as with the automotive service chain, attempts to earn without delivering superior value end in lost business, long-term customer alienation, and corporate disgrace. Redefining an Organizations Self-Interest wherefore do managers so often choose not to focus on value creation and or else ake decisions that systematically decrease the long-term value of their businesses? unitary reason may be that their training and raising be given them to define their organizations interests too narrowly.This narrow view is personnelfully rein force by financial explanation systems that were well adapted to the industrial economy, but are inadequate in the information economy. The accounting and finance conventions of the industrial age are skinny at valuing tangible assets, but they largely ignore the value of harder-to-quantify assets like employee satisfaction, schooling, RD effectiveness, customer loyalty, etc.In the information age, those intangible assets are far to a greater extent key than the bricks and mortar that traditional accounting systems were de qualityed to measure. If management defines the organizations self-interest (an d consequently its goals) too narrowlyfor example, to maximize this years or this quarters reported earningsit will view that interest as being at odds with the interests of customers and employees. Given that perspective, in the short term every long horse spent on employee training is a dollar bill of lost profit.Every additional dollar squeezed out of a customer, even if it comes at the cost of poor service or price gouging, improves this quarters results. This approach is based on win/ regress or zero-sum cerebration The underlying assumption is that there is a fixed pie of value to be divided up among customers, employees, and investors, so the interests of the three groups must be traded off against one an new(prenominal)(prenominal) (see Zero-Sum Versus Win/Win Thinking). Companies that act on this myopic conception of self-interest may stumble into a downward spiral of poor decision-making that is difficult to reverse (see When Customers Defect).For example, as reduced e mployee training and compensation lead to low employee morale and poor performance, and as underfunded RD allows a product line to age, customers can make out displease and begin to defect. In situations where customers are locked-in owing to large investments in proprietary equipment or some other temporary monopoly effect, they may not defect immediately.Instead, they will turn over increasingly alienated and defect as soon as a technology shift, regulatory change, or combative offering allows it. When customers inally do defect, clams shrink, tempting management to cut back even further on training, compensation, and RD, thus accelerating the spiral of customer dissatisfaction and defection. Expanding the Pie Alternatively, if managers define their companys interests broadly enough to include the interests of customers and employees, an equally powerful spiral of value creation can occur. Highly motivated, well-trained, properly rewarded employees deliver outstanding service , while effective RD investments lead to products that enjoy a prodigious value-adding advantage and generate high(prenominal) margins.Satisfied, loyal customers (and new customers resolveing to word-of-mouth referrals) drive revenue growth and favorableness for investors. Clearly, the undesirable reinforcing processes described in When Customers Defect can work in reverse. This win/win scenario is illustrated in the figure Zero-Sum Versus Win/Win Thinking. An expanding the pie approach to management requires that a company alter its thinking on several dimensions. Time horizons and perceived self-interest.The time horizon within which you evaluate a business decision dramatically influences your notion of self-interest. Considered at an instantaneous moment in time, virtually any transaction is a win/lose or zero-sum game. At the moment you spend a dollar on employee training, that dollar is in fact lost to the shareholder. Conversely, in a well-designed value-creation system , almost any transaction can become a win/win or positive-sum game, if it is managed within the condition of an appropriately long time frame.For example, if a companys rate of return on the dollar invested in employee training is 20 percentage (in the form of higher(prenominal) productivity, increased sales effectiveness, etc. ), then the shareholder hasnt lost a dollarhe has gained a stream of future change flows that represents an attractive return on investment. One way to build an understanding of these dynamics is to signalize the key capabilities, resources, and relationships that are the basic ingredients of value creation for a particular firm, and to think of those ingredients as assets that either grow or diminish over time, depending upon how they are managed.It is useful to map a companys key assets by building four Strategic Balance cerements focused on customers, employees, processes, and investors (see Balance Sheet Dynamics). In building the balance sheets, man agers must first decide which assets are the most important drivers of the companys value-creation system. For example, employee learning and job satisfaction are dickens assets that could be tracked on the Employee Balance Sheet. As managers identify the strategic assets that belong on the various balance sheets, they also must articulate the relationships among those assets.By canvas the dynamics through which customer, employee, and process assets accumulate, interact, and ultimately drive profitable growth, a company will be well on its way to managing the rudimentarys of value creation and avoiding the pitfalls of managing by a set of narrow financial measures. Expanding the pie between a company and its employees. In a true win/win dynamic, two or more parties aim first to create more total value, then concern themselves with distributional issues (who gets what share).When the parties focus first on dividing the pie, they are diverted from the innovative strategies that co uld have made everyone better off. One way in which companies and employees can expand the pie is flexible work schedules. If an employee has the freedom to see to personal business (while completing all required work), the employee is better off, and the employer is likely to benefit from higher morale and the ability to attract and hold onto the best people. A key element of win/win scenarios is that they are aimed more at creating opportunity than at minimizing costs.Outback Steakhouse has become a very successful, rapidly growing business by resisting the temptation to view a dollar of additional compensation to employees as a dollar of lost income to the shareholder. Outback has made its restaurant managers partners, attracting the best, most experienced people in the industry with a compensation system that more traditionally managed chains would view as ludicrously extravagant. Outbacks general managers sign a five-year contract and invest $25,000 up front.In return, each man ager receives 10 percent of her units cash flow (earnings before interest, taxes, and depreciation) on top of a base salary of $45,000. In 1994, total manager compensation bonnyd $118,600. In addition, managers receive 4,000 shares of stock, which vest over the five-year contract period. All hourly employees participate in a stock ownership plan as well. Another Outback renewalnot interruption for lunchgenerates benefits for investors, employees, and customers. Because they dont compete for lunch business, restaurants can be located in less costly suburban locations instead of expensive business centers.The benefit to managers and employees is that they work only one shift per day. Outback also insists that managers work only five days per week to avoid burnout and high turnover. Finally, focusing on dinner allows the restaurants to maintain high levels of food quality. From its 1987 founding, Outback grew to 420 restaurants by the end of 1996 in a very crowded, competitive indu stry. Over the last five years, revenues have grown at a 55 percent yearly rate, while earnings have increased 36. 5 percent per year.For the year ending September 1997, Outbacks 20. percent return on equity placed it in the top 5 percent of restaurants (restaurant industry average ROE was 10. 6 percent). The Outback story illustrates one of the key characteristics of successful win/win thinking The companys strategy is based on a systemic view of the entire value-creation process, and it seeks to align the key elements of that process. For example, if the restaurants were in higher rent locations, they might be more tempted to open at lunch to cover that cost. If managers worked yearlong hours, turnover would be higher and the partnership model that motivates those managers would be unworkable.If the quality of the food dropped, the number of meals from repeating customers would decrease, putting pressure on margins and tempting the owners to cut compensation to restore profits, etc. Expanding the pie between a company and its customers. As markets become increasingly competitive and one industry after another is forced to deliver greater value in the form of lower prices, higher quality, or both, companies in those industries respond to the mounting pressure with one of two broad approaches.Many firms focus narrowly on cost-cutting measures, compete an intensified win/lose game with their suppliers (pressuring them for cost concessions) and their employees (squeezing them to work longer hours for the same compensation or to do their own jobs plus the jobs of their laid-off former colleagues). This approach can yield some short-term profit increases, but it is not sustainable. You can only squeeze so hard for so long. A smaller number of forward-thinking firms innovate their way out of this zero-sum dilemma.For example, instead of focusing on individual transactions, such as the cost of a particular product, these firms examine the entire value-creation ch ain associated with their products (and their customers use of those products) and devise shipway to make the entire system more effective. This increase in effectiveness often creates enough new value that the buyers total costs can be significantly reduced while the suppliers margins can be maintained or even increased. One example of this kind of value-chain innovation is the Custom unfruitful syllabus of Allegiance, Inc. a leading healthcare cost management and product distribution company.Under the Custom Sterile program, all of the supplies needed for a particular surgical procedure are collected, packaged together, and sterilized in advance at an Allegiance facility. This helps hospitals to standardize and optimize their use of surgical supplies, and creates dramatic savings compared to the traditional process, in which expensive nursing labor locates the supplies from storage facilities within the hospital, collects them, and sterilizes them for each operation.The innovat ion is also good for Allegiance. Instead of having their margins relentlessly squeezed in a series of transaction-focused, commodity sales, the company has created a relationship-focused, high-value-added offering that justifies higher margins. This is the best kind of win/win outcome using innovation to create a value (and margin) umbrella from which all parties can benefit. Competition and Customer ValueAnother fallacy that has cropped up in much of the literature on strategy is that the purpose of business is to beat the controversy. There is no fountainhead that rivalry, like profit, is an important dimension that companies must be aware of and manage to successfully create value in the long run. For example, a company typically creates value for customers and superior returns for investors by producing goods or services that are better than their competitors at meeting a set of clearly defined needs for a specific set of customers.So competition is a key variable in determin ing whether a product or service provides a differentiated benefit to the customer, and one that she is willing to pay a premium for. However, competition should never divert management from the primary task of creating those benefits by understanding and anticipating target customers needs, excelling in product and process innovation, providing outstanding service, etc. Thus, we need to think of competition not as a goal, but as part of the business environmenta key element of the context in which a firm seeks to create value.What then become critical are the alternative responses to competition undertaken by different firms, some of which are more likely to succeed than others, given the nature of the business environment. In the emerging information economy, the most successful responses to competition focus on two areas (1) innovation that drives down the cost of products and services while increasing their quality and variety, and (2) building a deeper understanding of ever-cha nging customer needs within increasingly specific market segments.Responses that are rooted in a win/lose framework, such as taking share from existing competitors in a zero-sum game, gaining power over customers (for example, by locking them into a proprietary computer operating system), or seeking to become the low-cost producer without simultaneously driving for world-class quality, are extremely dangerous. Many of them pit the interest of the company against the interest of the customera prescription for customer alienation and long-term disaster.The most fundamental weakness of those win/lose responses to competition is that they divert management from the more important engines of value creation in the information economy innovation, imagination, cooperation, and knowledge. Managements time, creativity, energy, and imagination are among the scarcest organizational resources. At the same time, they are by far the resources that yield the highest returns.So it is important to re cognize that all of the time, energy, and imagination expended on win/lose activities entails a high (sometimes fatal) opportunity cost. Managers are more likely to stay focused on the higher return, win/win levers if they aim not to beat the competition, per se, but to create more value than the competitionin other words, if they seek to achieve a value-adding advantage. And by doing so, they are likely to be more successful than their competitors in the long run.