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The hunt for creating value

What does value creation signify, and how should it be pursued?In business, one thing we can easily agree on is the importance of creating and delivering value

Salvatore Cantale & Jean-Louis Barsoux (The Jakarta Post)
Sat, May 10, 2014

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The hunt for creating value

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hat does value creation signify, and how should it be pursued?

In business, one thing we can easily agree on is the importance of creating and delivering value. Unfortunately, there is far less agreement on what is meant by value or how to promote it.

Two factors are responsible for much of the confusion: first, the multiple perspectives on value; and second, the failure to distinguish value indicators from value drivers.

Views on Value


When people from different business functions discuss value, the likelihood is that they are talking about different things and focusing on different constituencies. Finance people tend to focus on creating value in the form of returns for shareholders. Marketing people concentrate on creating value for customers through differentiation. And strategy people are mostly concerned with the network of alliance partners, suppliers and distributors from whom they must secure critical resources, as well as a fair share of the value created.

Part of the confusion stems from the tendency to conflate value creation and value capture. In broad terms, the value created establishes the size of the pie, while the value captured represents the share of the pie. Creating value is not helpful to the firm unless it can also capture significant parts of this value. For example, EMI was responsible for inventing the CT scanner. But the firm'€™s inability to profit from this breakthrough led to its takeover '€“ even as the inventors themselves were being awarded the Nobel Prize in medicine. Other companies, notably General Electric, Siemens, Toshiba, Philips and Hitachi, went on to capture most of the revenues. This represents a classic failure to capture value created '€“ or what is sometimes called '€œvalue slippage'€.

Value creation is also confused with profit '€“ yet they are only loosely connected. Take the case of Twitter. Founded in 2006, the micro blogging site has grown exponentially, focusing on increasing its community of users rather than on revenues. While it boasts 218 million users and just raised over US$14bn in its recent IPO, it has yet to turn a profit. It is highly valued, in spite of its past losses, because of its potential to enjoy huge positive cash flows in the future '€“ once it can come up with a more effective revenue generating model.

Having recognized areas of confusion regarding the meaning of value creation, companies can turn their attention to driving it, which raises another set of challenges.

Misleading indicators


To create value companies need to be able to measure it. But the metrics they use can actually interfere with value creation. For example, if they start measuring time-to-market, they may be inclined to look for safer projects, those that can be taken from start to finish quickly and predictably, meaning projects that are not very stretching or that create much value.

Companies often mistake value indicators for value drivers. Value creation depends on value drivers '€“ things like brand reputation, attention to customers and proprietary technology. Then there are the metrics we use to gauge progress, which are the indicators. So, for the three drivers just mentioned, it could be brand awareness levels, customer satisfaction scores and patent awards. But after a while, employees start focusing on and trying to influence the indicators and tend to lose sight of the drivers. So companies have to be careful not to put invalid indicators between executives and value creation.

The problem is exacerbated when companies link the indicators to incentives. When people are paid according to these metrics, they realize that it is in their best interest to deliver on the metric, even if that does little to create value, and possibly destroys it. A classic example is the use of the '€œaverage handling time'€ indicator when assessing rep performance in contact centers '€“ based on the belief that customers are happier if they spend less time on the phone.

This does not imply we should get rid of indicators. Metrics help companies assess if they are making headway, but they must remember that their primary function is to promote organizational learning and improvement. Once attached to incentives, metrics can easily become distorted and drive the wrong kind of behaviors. Periodically, the indicators need to be revisited to make sure that they are truly aligned to value creation and learning.

In a general sense, effective indicators should be more aligned with how customers measure value. For example, in business schools this would mean a shift from '€œhappy sheets'€ to evaluate executive education programs to measuring customer relevant outcomes '€“ such as post-program changes in executive behavior or performance. In a difficult economy, companies really need to understand their drivers of value.

Salvatore Cantale is professor of finance at IMD, where he teaches on the following programs: Orchestrating Winning Performance (OWP), Building on Talent (BOT), Executive MBA (EMBA) and Strategic Finance (SF).

Jean-Louis Barsoux is a senior research fellow at IMD.

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