The History of Value Based Management

Value Based Management History

The history and development of Value Based Management (VBM) and the growth of internal and external corporate complexity over time are highly interrelated (figure). This is only logical if one realizes that VBM is basically a philosophy enabling and supporting maximum value creation in organizations.

Before the industrial revolution, companies were relatively small and their internal complexity was low. Also the external environment of companies was relatively stable and clear. Value creation was relatively straightforward, simple and obvious. There was no need for VBM.

Implicit Value Management (±1800-1890)

The earliest forms of implicit "VBM" date back to the end of the 18th century, when, by mechanizing and by the industrial revolution, it becomes possible to achieve economies of scale through investing in machines and hiring production workers. The dislocation of facilities is making direct supervision harder, and insight in the efficiency and productivity of the production process becomes more important. Efficiency and productivity methods are being developed. During the 19th century, these methods are gradually improved, using improved transportation and communication mechanisms that become available. These systems are aimed at promoting and evaluating the efficiency and productivity of decentralized production processes and not yet on measuring and managing value creation as such.

Explicit Value (Based) Management (±1890-2000)

At the end of the 19th century, Alfred Marshall sees profit as the residual income accruing to a firm's owner, a return to the investment of his own capital and to the pains he suffers in exercising his 'business power' in planning, supervision and control. Frederick Taylor (1911) and Harrington Emerson develop Scientific Management (using detailed physical manufacturing standards, enabling a simple translation to financial standards).

Corporations become more complex, because they now have a diversified product assortment and often have several types of company activities instead of just one. Allocation of assets over the various activities and, as a result, better information on these activities becomes more important. Management Accounting introduces Return on Investment (ROI), at first only at top management level for allocating resources and judging performance.

In 1938, Grant makes some references to using the time value of money for deciding about investment projects. In 1954 Dean publishes an article in the HBR about using Discounted Cash Flow (DCF) practically for valuing investment proposals and other decisions. Later, also methods are introduced such as residual income, responsibility accounting and transfer pricing.

Professional investing. In 1964, Sharpe introduces the Capital Asset Pricing Model (CAPM) and in 1973 Black and Scholes introduce their formula for calculating the value of financial options.

In 1964 Peter Drucker writes "Managing for Results" and in 1986, Alfred Rappaport writes his ground-braking book "Creating Shareholder Value". In 1994 Jim McTaggart uses the term "value based management" in his book The Value Imperative : Managing for Superior Shareholder Returns. From now on, thinking in financial/shareholder value terms is firmly rooted in business and corporate Strategy. MVA, TSR, EVA, and CFROI are developed in order to determine the value of corporations and investments.

The world of Corporate Finance is also rapidly professionalizing, also leading to increased attention for managing value creation in Mergers and Acquisitions. Leveraged buy-outs became very popular in the 1980s, as public debt markets grew rapidly and opened up to borrowers that would not previously have been able to raise loans worth millions of dollars to pursue what was often an unwilling target. This presented a major stimulus for managers that ran their companies in ways that mainly served their own private interests (improved authority, control and compensation), often at the expense of the companies’ owners, shareholders, and long-term strength to change their behavior.

From the eighties Activity Based Costing (ABC) and similar concepts (Activity Based Management, Transaction-Based Costing) are developed, enabling more precise and more future-oriented measurement of profitability and economic value by products, channels, markets, processes and organizations.

Risk Management methods such as RAROC (1970) are becoming more popular in the nineties, combining risk management and economic profit valuation for allocating capital in financial institutions.

Following the birth of the WWW in 1994, many new strategic information / knowledge related opportunities and technologies arise, simultaneously increasing the complexity of the internal and external environment of modern corporations. A spectacular value increase of intellectual capital in corporations is the consequence. New intangible asset valuation models arrive, such as the Skandia Navigator. Change Management is developing as a way to deal with increasing discomfort levels in ever faster changing companies.

In 1998 Luehrman transfers the formula for determining the value of options into dealing with uncertainty over time in strategic decision making (Real Options). Scenario Planning and Game Theory are also developing to deal with strategic complexity and agility.

The Balanced Scorecard model (published by Kaplan and Norton in 1992) becomes most popular, enabling organizations to translate a company's vision and strategy into implementation, working from both the financial perspective as well as the customer, business process, and learning and growth perspective.

New Technologies such as Business Performance Management, Business Intelligence and Business Simulation are arriving to support the ever more complex decision making and management processes in corporations. Many companies struggle with the large-scale implementation of these technologies.

Holistic Value Based Management (2000-now)

At the beginning of the third millennium, what appears to have been the Internet bubble bursts, and in 2001 the Enron accounting crisis hits the media, followed by several more corporate scandals throughout the world.

Accountants, stock analysts, top management, business schools, media, shareholders and investors are all blamed.

Among the most prominent ideas to prevent further disasters in the future are:

Strict accounting practices and rules,
Improved corporate governance,
Separation of analysts from other banking activities,
More attention for business ethics and corporate social responsibility,
Rules for executive remuneration,
Protection of shareholders interests,
Attention for stakeholders interests,
A long term view towards value creation,

Despite their good intentions, many of these ideas also further increase the complexity of both the internal and external environment of corporations, causing renewed interest to holistic Value Based Management in corporations to support and ensure their core value creation processes.