Shareholder Value Creation
Date: Monday , May 05, 2008
To deliver real value to the business, C-level executives must make all investment decisions with the company's long-term goals in mind.
CIOs and CFOs may not always see eye-to-eye, but one topic is very dear to the hearts of both, and that's value. CIOs' aim is to create value through the efforts of their IT organization and the systems and technology the organization implements; CFOs seek to guarantee that the value is delivered enterprise wide. Unfortunately, value is one of those terms that everyone loves to throw into a conversation as evidence of the importance of his or her efforts, often without a clear, consistent meaning. The picture gets even murkier when you take into account all the metrics and methods out there that claim to capture this mysterious thing we call value: the ROI, net present value, the Balanced Scorecard, and the like as well as external indicators such as the stock price, market capitalization amongst others, all of which lead to a confusing mess.
How should value be defined? It all comes down to whether you've increased the wealth of the organization's shareholders. If you have, you've succeeded in creating value; if you haven't, you haven't created value; the bottom-line shareholder value is what it's all about.
What It Is, and Isn't
In simplistic terms, every for-profit organization's goal is to create consistent, profitable growth for the company and a return to the investors that is consistently above what they could earn somewhere else at a similar amount of risk. When you improve the return on investment, you're creating shareholder value. It is critical to remember that all investments an organization makes should create shareholder value; if they don't, then the money is better spent elsewhere.
The executive management's job is to find the right businesses, strategies, and investments that consistently grow the company's profitability over time. Conceptually this is not difficult to grasp, but there are several factors that make achieving that goal absolutely unclear.
First, there is no single metric you can use at an operational level to measure shareholder value. It is a high-level, multifaceted and long-term concept, and there is no single number you can use to guide your decision-making. The best way to measure shareholder value is to break it down into a series of smaller-scale metrics that, put together in the right proportions, demonstrate shareholder value. Those smaller metrics are the ones you see being used in varying combinations in an organization's day-to-day operations things such as net income, earnings per share, and others.
A company can track its day-to-day process and operational metrics to demonstrate that it is achieving its short-term goals, which in aggregate help support its long-term plans for delivering shareholder value. A critical point to remember is that those metrics are directly linked only to the short-term objectives; doing well on them individually shows nothing per se about whether the company is creating shareholder value or not.
That is where trouble arises often, such as what we saw during the dotcom frenzy when everyone assumed that high stock prices meant a company was delivering real value. Enron and WorldCom also appeared going great, based on stock price, and were thought to be growing, but in reality those were empty measures that didn't reflect the real shareholder value.
The bottom line: shareholder value is a long-term notion that's very complex to compute. Short-term indicators such as revenue, stock price, and growth don't necessarily stand to show anything about shareholder value, especially when you look at each of them in isolation.
IT projects, like those from anywhere else in the organization, need to support the company's long-term goals. Sometimes you can use short-term objectives to evaluate whether to approve a project, but they must always be in line with your long-term goals. As you're weighing a number of potential investment alternatives, the trick is to remember that achieving short-term goals is not the whole story support of long-term goals is much more important. The C level executives must understand the company's strategy and long-term goals, and be able to prioritize projects accordingly.
In general, IT projects should support some combination of four short-term goals: reducing cost, boosting productivity, improving efficiency, and increasing customer satisfaction. Very likely, you will find yourself with several potential projects that all promise benefits in one or more of those areas. To decide among them, prioritize on the basis of your understanding of how well each project supports the long-term goals of the organization and how well each will ultimately affect the shareholder value.
I once witnessed a situation in which this was not done well. In my previous consulting assignment with a leading safety restraint manufacturer in the U.S., our C level executives were evaluating an MRP investment for our inflator operations business unit versus the homegrown solution. The project made great sense for the business unit but what the decision makers didn't know was that the company was planning to scale down the size and eventually wind up the operations. So they approved the project, spent the money, and the business unit was shut down a year later. (Sadly it was moved to Eastern Europe & China.)
From the above scenario it is clearly evident and, as is true in so many such situations, that never would have happened if there had been perfect sharing of information among business units and department executives. But it's a perfect example of why IT decision makers need to stay informed about their company's long-term plans. Having a real understanding of expected returns is also crucial when it comes to the point of making decisions. Some companies publish guidelines, such as rules for the minimum expected risk-adjusted returns that will help IT decision makers understand how the company wants to balance risk and payoff in the long run in order to deliver shareholder value. Beyond a certain amount, the growth may not be worth what it costs to create it, meaning it is not worth the effort actually spent to create shareholder value.
Bottom-line shareholder value should be the guiding light for all investment decisions in any organization.
The author is a Senior Project Manager at Axentis Software