The volatile behaviour of stock markets in April should have dealt a massive blow to the cult of shareholder value - one of the most pervasive notions ever to sweep over the corporate world. Company after company has slowly dedicated itself to the pursuit of SV (as it is also known). But value in the hundreds of billions can be wiped off - and has been - by a few days of trading in the world's stock exchanges.
For companies that are not publicly traded, this collapse, both of prices and the cult, may seem irrelevant. But there's a fundamental issue beneath the froth. What is 'value' in a business, and how is it created? The glib and easy answer, that value rests in the market capitalisation, was never adequate, because the capitalisation number is determined by forces outside management's control. The level of stock markets in general, and price-earnings ratios of individual shares, are not manageable (not by any honest means, that is).
Clever people have devoted a lot of ingenuity to working out theoretical bases for SV. But in the end, it comes down to the share price, which is the product of two variables - the earnings per share (which management can affect, for better or worse) and the PE ratio, which is subject to outside wisdom, unwisdom and whim.
USEFUL MEASURES
To be truly useful, any measurement of management success must be (a) objective (b) directly linked to tactical and strategic efficiency and (c) comparable to similar indices elsewhere. Shareholder value, as exalted in recent years, fails all these tests. That's why some companies have linked bonus payments and share options, not to performance of the stock market as a whole, but to their sector. If the company is performing 'better' than its peers in a deadbeat sector, but SV is still dipping, though, that raises a tough question. Why has management persevered in a business where higher SV is simply not available?
That's much easier said than done. In one famous case, a smoke-stack company named Gould switched out of heavy engineering into electronics only to find that the new sector was slumping while smoke-stack shares were booming. But the fate of Monsanto is even sadder. The company switched from other chemicals into agrochemicals, especially genetically modified foods. For a while, SV soared. The public backlash against GM foods, however, undid all the good work. Monsanto has become a near-pariah, and has now vanished into a merger.
The right way of looking at value has no direct relation to the level of the shares. Imagine (which is, of course, the case for many readers of Thinking Managers) that you are the sole owner of a business. What indicators would you follow to see how well it is doing? They would probably include:
1. Revenues - implemented and invoiced sales
2. Market share - percentage of sales by volume
3. Ratio of costs to revenues = gross margins
4. Change in net worth = total assets less liabilities
5. Trend in economic value added = difference between cost of capital (including equity) and post-tax earnings on the capital
6. Sales per employee
7. Return on equity capital
ECONOMIC VALUE
In most cases, you would expect these indices to increase significantly year by year. You will not find a well-managed company which has a negative Economic Value, or a decrease in net worth. In some circumstances, you are wise to trade revenues for profits. If a Pareto analysis shows (as usual) that 80% of your profits come from 20% of your customers or products, you may well increase the value of the business by cutting out the unproductive four-fifths.
That is precisely what was done by Nypro, the plastics moulding firm beloved by guru Tom Peters. Nypro retained only those customers spending more than £1 million a year: before long, turnover had trebled. However, neither the analysis nor the action taken to reflect the analysis explain Nypro's success. That resulted from the devotion that the management then expended on its remaining customers - locating plants as near to them as possible, and linking computer systems so that Nypro became an intimate part of the customer's business.
That is yet another aspect of true shareholder value: the degree of customers' satisfaction with the company's products and services, expressed above all in the readiness to buy from you again. Do not rely, as most companies do, on statistical, quantitative surveys of workers, customers, other employees, etc. As Thinking Managers has often urged, use qualitative interviews of representative samples if you really want to find out if management is adding genuine value.
One test of value is values - a subject discussed here last month, largely in the context of achieving performance. That is only one side of the coin, though. Other values are the foundation stones of long-term growth and viability. The values that achieve these ends cannot be measured, but they certainly have measurable effects. Do you personally...
• give your subordinates stimulating work?
• respect the needs and values of others?
• give priority to individuals and their needs?
• excel in personal relationships?
• treat colleagues as interesting and valuable people?
• get deeply interested in and excited by your work?
• manage with the full consent of others?
• make all appointments strictly on merit?
• compete primarily to beat your own best standards?
You won't find many people who regard these qualities as anything but highly valuable. On the other hand, you won't find many (maybe any organisations) displaying these features. They come from Charles Handy's description of 'Dionysians' in his stimulating book Gods of Management. The followers of Dionysus, the god of food and wine, do not, according to Handy, fit into organizations at all. They are by nature freelance anarchists.
FREELANCE PHILOSOPHY
The freelance philosophy, though, permeates every modern book on management, every lecture, every top manager's wish-list. It doesn't matter whether you are an autocratic Zeus, an Apollonian 'organisation man', or a task-oriented Athenian. You are still more than likely to want your managers to manage in the Dionysian spirit. But wanting gets you nowhere. How can you make it happen?
Values can be enforced in three ways: the Three Rs - Reward, Repetition, and Removal. General Electric's Jack Welch fits managers into one of of four categories or 'Types'. Type I delivers on performance commitments and shares the company's people-based values (which include Dionysian features). Type II does not meet commitments and does not share the values. Type III managers miss the commitments, but share the values. Type IV delivers on commitments, makes all the numbers, but does not share the values. Each type requires different treatment:
• Type I. Give this person progress and promotion (Reward)
• Type II. Do not keep in the organization (Removal)
• Type III. Give them a second chance, preferably in a different environment (Repetition)
• Type IV. The most difficult to deal with. Despite his or her high performance, they must either change their ways (usually very difficult) or go (Repetition or Removal).
The last treatment may sound harsh. But if you start arguing that the end (the result) justifies the means (tyrannical or bullying behaviour), you can forget about people-based or Dionysian values. In any event, those values themselves dictate that any statement of the principles you expect people to work by should meet these criteria. It...
• has been drawn up with their participation
• has their explicit consent
• is operable and practical
• is revised periodically as necessary
• assumes that people will live the values
• is concise and clear.
Remember, though, that living the values and being Dionysian won't help at all if the organization is doing the wrong thing - no matter whether it's being done in the right or wrong way. Top management earns its rewards and prestige (or should do) by pointing the company in the correct direction - and, even more important, changing direction when that is required: which means before it becomes a dire necessity.
SIGMOID CURVE
Handy admirably illustrates this imperative with the concept of the 'Sigmoid Curve'. This looks like an S lying on its side. The bulge in the curve is the result of anatural human process. In The Empty Raincoat, Handy gives this description: 'We start slowly, experimentally and falteringly, we wax, and then we wane'. The bulge represents the waxing - a point of maximum danger. The organisation is at the height of its powers and achievement. Critics of its methods and strategies are neither welcome nor plausible.
But Handy is absolutely right. You have reached the critical point, somewhat below the absolute crest, where you should be thinking ahead, and acting, in a truly radical manner. If you wait until the Sigmoid Curve has begun to decline, it will be too late. Against a background of falling profits, market value and morale, you can find yourself running hard up a down escalator. Even a successful battle against these odds is most unlikely to restore the old power glory - witness the fate of IBM. To do better, act earlier along the First Curve to generate a Second one, and follow this creed:
• Assume that your strategy will need replacing at least every three years, probably two.
• Work on developing new strategies, no matter how well the old ones are performing.
• Continue to develop the existing business fully, but do not let its development impede the new.
• Entrust the Second Curve planning to younger people.
• Accept that leadership will pass to this younger group as the new strategy takes over.
It takes courage for an older management to accept the whole of this philosophy. There is always the risk, discussed earlier, of heading off in a new direction, only to find that the new one is wrong and the old still had plenty of life ahead. You can best avoid that trap by applying the strategic insight of expert innovators. They concentrate on (a) maintaining leadership in their core businesses (b) diversifying only into areas where they have deep knowledge, and which relate directly to the core activities. They don't head off in the opposite direction. And they base their new strategies on operating practices which are also values.
OPERATIONAL STRENGTHS
Market strength is regularly monitored, with market research statistics and customer surveys supported (as recommended above) by qualitative interviews. Other companies' better performance is used deliberately as a spur to greater achievement. Everybody is set to working on 'stretch' programmes - for themselves and the unit. Constructive criticism is encouraged, no matter who is criticised. High standards are set, and everybody knows them. And success is treated as a springboard for further advance.
These managements also remember Repetition. They never miss out on an opportunity to repeat the values message, both to groups and to individuals. Above all, they know that neither Reward, Repetition, nor Removal will work without personal example from the leader. That is the fourth R: Role Model.
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