Rijksuniversiteit Groningen
“Why organizations fail to
succeed in implementing
value-based management”
Master Thesis
Jolanda Schoenmaker
Master of Science in Business Administration
Organizational & Management Control
Name: Jolanda Schoenmaker Address: Rooseveltlaan 103-1 1079 AH Amsterdam Student number: 1465252 Telephone number: 0612299602 E-mail: jolandaschoenmaker@gmail.com Supervisor: Dr. W. Westerman
Second corrector: Dr. P.C.M. Claes
Abstract
The aim of this master thesis is to determine why organizations fail in successfully implementing value-based management. Hurdles encountered during this implementation are found by doing six case studies. A comparison is made between the hurdles available in literature and hurdles mentioned by practitioners. New hurdles for failure are explored. Moreover, not all hurdles described in literature are found relevant by practitioners. The wide range of hurdles found in this research is useful for practitioners, like managers and consultants, and for academics, focusing on value-based management and change management.
Preface
I want to express my gratitude to Conrad Roelen and Timo Mulder, ABN AMRO, for their continuously motivating and stimulating. They assisted me in the start with helping to find the right angle on my thesis subject and motivated me to stay working during World Soccer Championship and sunny days.
In addition, I am grateful for the support and time of the interviewees of ABN AMRO, SiTel Semi Conductors, Royal Haskoning, Steps Ahead, Value Drivers and PricewaterhouseCoopers.
Moreover, I want to thank my supervisor Wim Westerman for supporting and assisting me during writing master thesis. Thanks for the social talks and making all the meetings enjoyable.
Without the support of my family, friends, colleagues and Paul Claes finishing this master thesis would not have been possible. Special thanks the proofreaders Barbara, Emilie, Lisette and Richard who were so kind to read and correct on parts of my thesis.
Table of contents Abstract ... 2 Preface ... 3 Table of contents ... 4 1. Research design ... 6 1.1 Research Introduction ... 6
1.2 Problems encountered in practice ... 7
1.3 Main Concepts ... 8 1.4 Research Outline ... 9 1.4.1. Problem Formulation ... 9 1.4.2. Research Objective ... 9 1.4.3. Research Questions ... 9 1.4.4. Research Preconditions ... 10 1.5. Research Methodology... 10 1.5.1. Method of research ... 10
1.5.2. Data and sample collection ... 11
1.6. Thesis Outline ... 11
2. Theoretical Framework ... 13
2.1. What is value-based management? ... 13
2.2. Why focus on value-based management? ... 15
2.3. Implementing value-based management ... 16
2.4. Why value-based management fails ... 24
2.5. Recap ... 25
3. In Practice ... 27
3.1 Doing the interviews ... 27
4.2. Differences and Similarities between Interviewees ... 47
4.2.1. Similar opinions ... 48
4.2.2. Different opinions ... 51
4.3. Recap ... 55
5. Conclusion, limitations and further research ... 57
5.1. Conclusion ... 57
5.2. Limitations... 58
5.3. Further Research ... 59
6. References ... 60
Appendix 1. Interview with Dhr. R.W.J. Groenink ... 63
Appendix 2. Explorative interviews with specialists and consultants ... 66
Appendix 3. Case study protocol and questionnaire ... 69
Appendix 4. Devised Interviews ... 74
SiTel Semiconductor... 75
ABN AMRO ... 82
Royal Haskoning... 89
Steps Ahead ...100
Value Drivers Corporate Finance ...111
1. Research design
This thesis concerns the results of the research about hurdles encountered while implementing value-based management. The research design contains a number of components. First of all, an introduction about the topic will be given. Secondly, explorative interview results provide some first hurdles encountered in practice. Moreover, the main concepts are described. Furthermore, the research objective, main and sub questions and other research related topics are addressed.
1.1 Research Introduction
Creating shareholder value was one of the biggest management mantras of the 1990‟s. This hype led to the development of “an extensive set of tools for determining which parts of the business add to or subtract from shareholder value” (Slater and Olson, 1996, p. 48). With a focus on financial gain for shareholders, many organizations implemented different value-based analysis tools and tried to incorporate value-based management within their firms. Unfortunately, many organizations found value-based management practices difficult to implement and use. Therefore they discarded the use of and focus on value-based management after a few years. Various Dutch organizations tried to implement value-based management within the structure of the organization. Examples of these are Heijmans, Schiphol and ABN AMRO. Dhr. R.W.J. Groenink, the initiator within ABN AMRO for implementing value-based management, stated: “Managing for
value has been extremely important to make people more aware that you have to make a return on capital in order to survive and that the business needs to maintain a certain level of economic capital in order to run the business as well as for creating future opportunities.” (Appendix 1).
1.2 Problems encountered in practice
Short explorative interviews with several practitioners such as managers and consultants have revealed new hurdles that are not mentioned in the literature. These insights will be used later in the research during several case studies. Below, a summary of the hurdles mentioned by the practitioners is given. A full description of interviews results can be found in appendix 2.
Pijlhove Consultancy, Dhr Heimerikx
In literature the frequently mentioned cultural change, necessary for putting value-based management into practice is “hard to grasp, elusive and difficult to measure”. It is hard to pinpoint necessary changes and to influence employees‟ motivation. Another hurdle is that most of the value-based initiatives find their background in Financial Departments; resulting in a too high reliance on financial measurement and not selecting suitable project leaders. Also the „Calvinistic‟ attitude in the Dutch organizations is said to be an obstacle as well. A literal quote: “Value-based management and Calvinism is not a suitable match”.
Royal Haskoning, Jan-Dirk Schepers
The cost of capital requires investments to deliver higher returns on projects in comparison with the originally used cost of debt, leading to a higher rejection rate of projects. The higher rejection rate results in a decrease in workload within the organization, possibly causing a crush in motivation and creating resistance by (project) managers and employees. The value-driver identification by a value-tree is a complex, time consuming and therefore costly activity, especially since the value drivers of today may not be the value drivers of tomorrow.
Henk Vrielink, HV B.V. (independent consultant)
daily operations that block the attendance possibilities for employees. Also, after attending training and courses, organizations are sometimes too rigid or not open to new ideas.
Dhr. R.W.J. Groenink, Former CEO ABN AMRO
On a strategic level it is very hard to decide and to communicate on which value creation aspect the organization should focus. Besides shareholder value, an organization can focus on sustainability, customer satisfaction and much more. Furthermore, making operational value drivers for lower levels in the value tree can be challenging. Making a value-tree is easier said than done, especially because people, team, and subunits performance are reviewed by these measures and these measures are linked to bonus and incentive systems.
Figure 1 summarizes the hurdles mentioned during explorative interviews.
Dimensions Aspects Initiative background Dutch Culture Workload - Projects Value-tree Organization development Education Staff Value Focus
Achievable Expectations and Goals Hurdles from
practitioners
Figure 1 Hurdles mentioned by practitioners during explorative interviews
1.3 Main Concepts
that first reaction it could be concluded that the aspects, mentioned by the practitioners, are more important than the dimensions mentioned in literature.
In the centre of attention are control aspects which play a role in the success or failure of the implementation process. Financial factors and value measuring metrics will not be discussed in this thesis.
1.4 Research Outline
The following section contains the problem statement and the research methodology used. The problem statement describes the aim of the research. It consists of the next elements: the research objective, the research questions and the preconditions under which the research is carried out (De Leeuw, 2005).
1.4.1. Problem Formulation
In the introduction of the research theme, it has been mentioned that value-based management would be suitable for focusing on improving shareholders‟ value. In practice, value-based management initiatives do not deliver the results and yields it is said to be able to provide. Therefore, it is interesting to look for the hurdles that organizations encounter during the implementation process.
1.4.2. Research Objective
The following research objective can be derived from the problem formulation and research theme: “Determine why organizations fail to succeed in implementing
value-based management.”
1.4.3. Research Questions
The research question can be derived from the problem formulation and research objective and is the main question in this thesis. The research question of this thesis is: “What hurdles make organizations not succeed in implementing value-based
management?”
SQ1 How can value-based management be defined, and what are the distinctive characteristics of value-based management?
The objective of this SQ is to discuss the value-based management definition, and to explain the unique characteristics of the VBM. Clarity on the value-based management definition supports the literature review.
SQ2 What aspects can be found in the literature related to the implementation of value based management?
The goal of this SQ is to map the aspects discussed in academic literature.
SQ3 What hurdles do managers and consultants in practice encounter during the implementation process?
Through empirical research, by interviewing managers and consultants, an overview of hurdles endured in practice will be made.
SQ4 Are the hurdles as mentioned in practice similar to those found in the literature?
This sub-question can also be seen as the conclusion in which a comparison will be made to check the similarities and differences of hurdles discussed in previous sections.
1.4.4. Research Preconditions
The research has to be carried out under several specific preconditions:
1. The subject of this thesis must be related to concepts relevant for the master Organizational & Management Control.
2. Accomplishing this master thesis is worth 20 European Credits. 3. This research is carried out from March 2010 until August 2010.
quantitative method, as well as literature research and empirical research respectively. This research can both be seen as a descriptive study, when analyzing implementing different kind of value-based practices and a causal study, when explaining why it is difficult for organizations to implement value-based practices (Cooper and Schindler, 2003).
1.5.2. Data and sample collection
The main question is formulated as follows: “What hurdles make organizations not
succeed in implementing value-based management?” Answers have been derived from
qualitative (secondary) data, namely literature from academic journals as well as from articles published in financial management newsletters. The literature search has been carried out by doing a desk research at ABN AMRO N.V. A desk research is a study whereby the researcher uses qualitative (secondary) data produced by others, or whereby the researcher tries to come to new insights by evaluation of existing literature. The literature study is supported by a case study with managers or consulting organizations who have worked with the value-based management implementation. The hurdles found in literature have been reviewed with a case study. New and additional reasons and obstacles have been found as well. The goal of the literature search is to get a clear view of what to discuss during the case studies. A case study is a research by which the researcher tries to get a deep and overall insight in one object or process (Bloomberg et al, 2008). Eisenhardt (1989) describes a case study research as a method by which a collection of in depth interviews leads to general statements. Case studies suit an explorative research goal in which practical related insights can be used to describe an overall occurring phenomenon. To find deeper insights and hurdles in the implementation process six cases have been selected. The number of cases that can be investigated is limited; therefore a diverse choice of organizations has been picked.
1.6. Thesis Outline
2. Theoretical Framework
The following section discussed the first sub question and will therefore concentrate on the definition of value-based management. Reasons for using value-based management will be addressed in the second section. In the third section aspects influencing the implementation of value-based management given in the literature are discussed.
2.1. What is value-based management?
Within value-based management the focus should be on three different key components namely creating value within the organization, measuring value by the management and
managing value at all levels of the organization. All pieces of this puzzle need to be in
place to create a successful value-based management implementation and practice within the organization. These components are generally understood and often mentioned in literature. A frequently forgotten aspect of value-based management is that value creation is not focused on short time profits, but on a long term value creation. A reason for several CEO‟s and management teams to implement value-based management is to improve mid term and long term future value.
Improving the value of the firm can be done by improving economic profit which refers in this context to covering all costs, including all costs of capital, both debt and equity. This is in contrast with accounting profit which only takes into account the interest costs (cost of debt). Focusing on economic profit, in stead of accounting profit, is one of VBM characteristics frequently mentioned by authors like Rappaport (1986), Copeland et al. (2000) and many others. As Wenner and LeBer (1989, p.54) state it “economic profit helps you understand which businesses are contributing value and which issues and uncertainties are most important”. For the management this provides useful tools in setting priorities and helping to decide how to act upon risks and decisive choices.
write that managers can use value-based management to assess the added value prospects of new strategies, business initiatives or new lines of business.
Claes (2008) stresses the importance of the variables used in a value creation calculation and not the importance of the outcome itself. The variables are linked to organizational activities and can be expressed in financial and non-financial terms for all levels in the organization. These financial and non financial drivers are called the key value drivers which reoccur in the wide accepted definition of value-based management by Copeland et al. (2000). Copeland et al. (2000) state value-based management is a management approach whereby the company‟s overall aspirations, management processes and analytical techniques are aligned to help the company maximize its value by focusing management decision-making on the key value drivers.
Claes (2008), Koller (1994) and Rappaport (1986) mention also this third characteristic; value-based management is built around value drivers. Koller (1994, p.91) states the following: “An important part of VBM is a deep understanding of the performance variables that will actually create the value of the business – the key value drivers. Such an understanding is essential because an organization cannot act directly on value. It has to act on things it can influence – customer satisfaction, cost, capital expenditures, and so on. Moreover, it is through these drivers of value that senior management learns to understand the rest of the organization and to establish a dialogue about what it expects to be accomplished”. A manager can make value drivers more explicit by the use of a value tree or a balanced scorecard.
Claes (2008) enumerates all generally shared characteristics of value-based management: 1. Value-based management takes all costs of capital into account.
2. Value-based management is a managerial approach. 3. Value-based management is built around value drivers.
2.2. Why focus on value-based management?
Organizations are set-up to deliver certain values. The primary objective for profit organizations is to maximize owner or shareholder value (Merchant & Van der Stede, 2007).
Wenner and LeBer (1989, p.65) complement this by saying that “what really matters is long-term cash generation”. Long-term cash generation is what drives a long-term improving performance for the shareholders. Value-based management is a management control systems that supports managers in managing the value creating process. Maximizing the value of the firm is subject to some constraints, such as an adequate concern for customers, employees and other stakeholders and compliance with laws. Besides this, an organization should set clear targets and align these with the organizational goals to increase firm value (Wenner and LeBer, 1989).
Listed-firms, family-owned firms and state-owned enterprises try to maximize the owner‟s capital for several reasons. An external factor is the capital market pushing to improve the credit rating or share value, but also shareholders requirements provide reasons to focus more on VBM. Internal factors to focus more on maximizing value are creating more entrepreneurship, having a control language, valuating investment options and the knowledge to managers that using capital has a cost (Koller, 1994; Claes, 2008). Also future takeovers, buyouts, disinvestments or selling the whole organization cause to focus on maximizing the future value and create value reports. Haspeslagh et al. (2001) bring the argument to the table that many organizations hoped that the development of new measures of economic profit would improve and sharpen organizational performance in a capital-intensive and highly competitive market-place. They found that implementers tried to solve resource allocation issues with value-based management. Another issue is that implementers could not determine where value is destroyed or created in their company and were hoping that the capital charge in value-based management metrics could help in solving this problem.
Dobbs (2005) writes about research done by McKinsey's corporate-performance center. This research has demonstrated that the companies that created the most shareholder value over the past 15 years also created the most employment and invested the most in R&D. The conclusion is drawn that more created shareholders‟ value leads to an organization who serves all its stakeholders better. Due to a focus on long term health, the organization improves performance over time. The following components improve corporate heath and therefore secure value creation: maintaining assets, improved strategies, innovating products and services, reputation improvement and contract high-performing employees. So, when focusing on shareholder‟s value it does not have to result in neglecting other stakeholders.
Koller (2010) writes in a recent paper that economic crises are a result of investors, companies and governments who have forgotten how investments create value or how value creation can be measured. Therefore an advocacy of relearning value creating and measuring occurs, especially since relearning could help in creating a secure economy and defend ourselves against a future crisis.
2.3. Implementing value-based management
alternatives and trade-offs, and helps to improve the sharpening management ability to set goals and targets.
Markus and Pfeffer (1983) find that power structures, organizational paradigms and politics must be taken into account. Changing power structures will cause resistance from those people who feel a loss in power or influence. Simons‟ (1990, p. 128) research indicates that “Management control systems are not only important for strategy implementation, but also for strategy formulation”. So, the alignment between the strategy and a management control systems is necessary for a successful execution, as they mutually reinforce each other.
Strategy and competitive advantage are related subjects. Koller (2010) states that an organization needs to have a well-defined competitive advantage in order to be able to sustain strong growth and deliver high return on the invested capital. Not having a competitive advantage will negatively influence future cash flows, which are the base of an organization‟s value.
Bannister and Jesuthasan (1997) claim that because organizations are not ready to manage within the value-based context, the value-based management approach fails. Living and breathing value-based management is necessary to achieve positive results. They also suggest that a critical first step in considering using value-based management is an organizational audit to assess the readiness. A “Preliminary Readiness Assessment” will be looking into four areas: culture, performance measurement (PM), financial
information systems and incentive design, resulting in a solid, multi-dimensional
assessment. This assessment tells the organization about its ability to adopt value-based management today and what it needs to change or do to become a successful user. It helps to design the organization of tomorrow.
With the four dimensions, used in the „preliminary readiness assessment‟ of Bannister and Jesuthasan (1997), various hurdles can be encountered during the implementation process. To create a logical overview of hurdles encountered, the hurdles to be discussed will be linked to the four dimensions. The discussed hurdles within these four dimensions will be converted into an overview used as a foundation for the case interviews.
Dimensions Aspects
Money Patience Effort General
Culture
A value-based program is only successful when introducing radical and fundamental changes into a culture within the organization. As counts for many new theories and approaches, within value-based management cultural resistance to change is a main hurdle for failure. Bear et al. (2000) comment that the CEO, the management team and the entire organization must have a value mindset and having a supportive culture is a first necessary first step. Knight (1998) mentions multiple implementation traps. The first trap is a lack in true commitment, mostly due to a lacking commitment of senior management. Senior management should take value-based management into account when making important strategic moves for a company. If the senior management does not use the value-based management in strategic decision-making, why should the organization use value-based management in other situations and decisions anyway then? In addition, Claes (2008) and Haspeslagh et al. (2001) state that value-based management can only work successfully if the decision making process is decentralized. In addition empowerment of employees is necessary. The first step in the audit suggested by Bannister and Jesuthasan (1997) is to evaluate whether the organizational culture is conducive to decentralize the decision making. Bannister and Jesuthasan (1997, p.12) say that an “effective way to do this is to conduct focus groups with key employees to assess their perceptions, expectations, capabilities and attitudes”. This is useful for pinpointing gaps and discrepancies between the current and the required culture to support a value-based framework. This information is plotted into a matrix which helps a company to identify how to focus their attention and how to allocate their resources needed for change (figure 3).
Culture Gap Analysis Matrix
High discrepancy and High Importance
Research and recommend new action
High discrepancy and Low Importance
Reallocate resources to areas of higher need
High
Both Bear et al. (2000) and Haspeslagh et al. (2001) found that all of the successful leaders make value happen by focusing on and showing an explicit commitment for creating shareholder value in the whole organization. This includes changes into the organization structure, processes and its culture. Haspeslagh (2001) found that these changes where supported (at successful organizations) by training programs for their employees, but, Bear et al. (2000) do not notice training as a significant role in the implementation process succeeding.
To form an embracing culture, managers use belief systems already for several years. Belief systems communicate core values. Simons (1995) states that belief systems help managers to articulate the organizations direction and values which need to be embraced by the employees. This can be done with inspiring statements, missions, credos and values. Simons (1995, p. 83) states: “belief systems can also inspire employees to create new opportunities: they can motivate individuals to search for new ways of creating value”. It is a way to show employees how they can add value and make a significant contribution.
Figure 4 recaps the culture related aspects mentioned in this section. These aspects influence the success of the implementation.
Dimensions Aspects
Open to change Leadership support
Decentralized organizational structure Belief systems
Culture
Figure 4 Culture related aspects influencing the implementation Performance Measurement
After cultural hurdles are solved or not found to be present at all, the following step for the organization is to focus on performance measurement. This is related to the second characteristic of value-based management namely measuring.
Merchant and Van der Stede (2007) comment that measurement systems should have a high degree of accountability and controllably factor; this is not the case with a total shareholder return measurement system. However, companies do need a performance measure that strongly correlates to total shareholders return. Copeland et al. (2000), Claes (2008) and others suggest measures like economic spread, cash flow return on investment and economic value added. However as is shown by Claes (2008), there is no single, appropriate measure.
All in all, Bannister and Jesuthasan (1997, p. 13) advocate the following: “prospective value-based management users should conduct a rigorous, objective analysis to identify measures that are externally relevant, internally credible and present minimal administrative complexity”. This can be started with a benchmarking analysis that helps pinpointing the value drivers of shareholder value in a particular industry and consists of three different components (Bannister and Jesuthasan, 1997).
The first component is the shareholder value driver analysis which correlates financial measures with market valuation measures. Having the right performance measure shapes the way the company is managed in relation with internal planning and incentive use. The second component is a relative performance measurement analysis; this provides the management with information about how the company‟s performance stacks up against its competitors and gives insights into the strengths, weaknesses and areas for improvement. Finally, an intrinsic value analysis helps understanding the underlying assumptions of the organizations stock price. With this exercise, an organization can estimate the value of its strategic plan and measure the created or destroyed incremental value (Bannister and Jesuthasan, 1997). Looking at these different components the organization will have a better understanding of the different aspects which influence performance.
able to understand how performance and value creation is measured, and therefore measures should not be too complex (Knight, 1998).
Slater and Olson (1996, p. 50) found in their research that “many highly successful firms set stretch targets – extremely ambitious goals that artificially stimulate and encourage the development of new ways to accomplish a task”. So, new goals and targets used for evaluating employees need to be at least achievable. An artificial goal which is too stretched can result in burnout and reduced moral. “It is essential that employees be given the information and training necessary to try to achieve the goal (p. 50)”.
As with all management control systems, performance targets and strategies must be consistently aligned throughout the whole organization if it is to achieve its value creation targets (Koller, 1994).
Aspects mentioned in the latter section are recapped in figure 5.
Dimensions Aspects
Linked to Total Shareholder Return Control and Accountability Factor Different measures
Complexity Measurement Benchmarking Analysis Performance
Measurement
Figure 5 Performance measurement related aspects influencing the implementation of VBM initiatives
Information and control systems
Collecting and delivering meaningful data about the performance measurement chosen systems should be the next organization‟s point to focus on. The first aspects are general requirements which should be in place in every (result) control system and are therefore not really specific for value-based management (Merchant and van der Stede (2007). Bannister and Jesuthasan (1997, p. 14) state the following: “financial performance depends heavily on whether its decision makers receive sufficiently timely feedback on the results of their actions to make adjustment that will improve performance.” To enable this, comprehensive financial data is required, particularly focused on the division level, where most of firms‟ value is created. Another requirement is that data should be available for the right people, which should be able to process the data properly.
performance accountabilities, ensures communication and integration up, down and across all levels.
„Over focusing on the measuring of value‟ is mentioned by Knight (1998) as another hurdle for a successful implementation. The organization should acknowledge the fact that no measure will be completely accurate or appropriate in every case. The designing period for a fine-tuned calculation can be too long for a company, as the environment can change in such a way that the measure is already outdated or the business is deteriorated. Managers should keep in mind that value management is about improving decision making and not about counting every penny. It is not about the measure, but about the information which the management can use from that measure.
Another trap which is encountered frequently, stated by Knight (1998) is that not everyone within the organization „speaks finance‟, so understanding the phenomenon will be a difficult task. Different departments need different measures; one measure will not provide the necessary information for everyone. Therefore the organization should not rely on one single measure, calculation, or value, as a basis for decision-making.
Claes (2008), Bear et al.(2000), Copeland et al. (2000) and Cooper et al. (2001) all state that economic measures provide more management insights than accounting based measures, especially because the cash flows used in economic measures is what drives the future share price performance. Successful companies use a range of economic measures because no single economic measure can fit all management requirements. These measures alone are not enough; they must be embodied and consistently applied in a value-focused and well-designed performance management process.
Figure 6 summarizes aspects related to information and control systems which influence the implementation of value-based management.
Dimensions Aspects
Availability relevant data Accessibility for the right people Linked to Value Drivers
Jesuthasan (1997) suggest that an organization assesses its findings against a range of incentive plan designs from others organizations to determine whether it needs to adopt a new plan or it can modify its current one.
Both Bear et al. (2000) and Haspeslagh et al (2001) mention the positive relation of value-based management and a successful implementation due to linked incentive systems with value-based management performance measures. The linked incentive systems create an „ownership‟ or „controllability feeling‟ with the employees in both the company and the program. Bear et al. (2000) and Haspeslagh et al. (2001) mention the organizational willingness to make changes that allow employees to make value-creating decisions individually. This way, an employee is able to control value creation.
Biddle et al. (1999, p. 76-79) found evidence which suggests that “adopting residual income-based incentives tend to improve operating efficiency by increasing asset turnover, disposing selected assets and reducing new investment and reduce more shares” and they also measured an increasing residual income.
Slater and Olson (1996, p.48) add an extra reasoning for implementing a linked incentive system. The value creation within an organization is “the result of the actions of individuals and groups throughout the firm. This value for the firm, but also for the customer, should therefore also be shared by all”.
Knight (1998) does not agree with the positive influence of incentive systems. He states that using compensation to fasten the implementation may be dynamite that can blow up the VBM program, as it not creates focus on the ills within in the organization and will not automatically lead to ownership of the employees.
Extracting the main aspects related to incentive systems leads to figure 7:
Dimensions Aspects
Linked to performance measures Linked to value drivers
Control and Accountability Factor Incentive Plans
Figure 7 Incentive plans related aspects influencing the implementation of VBM initiatives
Execution
program is not investigated in this thesis. But, it is useful to know the first steps necessary for executing value-based management. One should understand that for a successful execution multiple hurdles need to be encountered too.
Maximizing value starts with the development of a strategy for an organization or business unit, followed by translating the strategy into performance targets. These performance targets should be defined in the key value drivers (which can be found by making a value-tree). These targets guide employees in their tasks and create controllability and accountability for the short and long-term. The third step is making
action plans and budgets to decide necessary steps in the next years to achieve the goals.
Finally, to monitor performance against targets or competitors and to encourage employees to meet their goals, the organization puts a performance measurement and
incentive system into place (Knight, 1998).
Tillema (2005) found a primarily focus on implementation-related factors in the academic literature. She suggests that a successful execution of management accounting systems may also be related to the environmental contingencies and general characteristics of the organization. Relating this to value-based management, organizations should consider the appropriateness of the system in their own circumstances. The information provided by the management accounting system should also be taken into account; if this does not suits the goal of the instrument the chance of success will be small.
One of the reasons why Ittner and Larcker (2001) are focused on value-based management is that it represents contingency theories of managerial accounting system design. When these contingency ideas are incorporated properly into a value-based management initiative it would be possible to successfully implement and execute a new management accounting system that takes into account organizational aspects.
2.4. Why value-based management fails
the implementation process can be seen as the general reasons why implementation fails to be successful.
Organizations must try to meet or comply with all mentioned aspects. The aspects which influence the implementation are given in figure 8. The literature does not describe problems endured while trying to cope with these aspects. For example, the literature states that „organizations and employees should be open to change‟. „Not being open for change‟ could therefore be labelled as a hurdle. However literature lacks in unfolding which hurdles are encountered in making organizations and employees open to change. Putting the recaps of the dimensions of Bannister and Jesuthasan (1997) together with the general dimension and hurdles mentioned by practitioners creates the overview with 6 dimensions. Figure 8 is used to investigate hurdles encountered by case organizations.
2.5. Recap
In the literature slightly different definitions of value-based management can be found. Researchers focus on different components of value-based management: creating value,
measuring value and managing for value. Including the characteristics of value-based
management into one definition gives the following: “Value-based management is a managerial approach to create value by investing in projects exceeding the cost of capital and by managing key value drivers” (Claes, 2008).
A wide range of arguments can be found for focusing on value-based management. Value-based management supports directors and employees in managing the value creating process. It creates more entrepreneurship, it shapes one control language, it helps to valuate investment options and to maximize organizations‟ selling prices and furthermore it stimulates performance improvement. Some organizations use value-based management to solve resource allocation issues or to create a coherent portfolio of projects aligned with strategic plans. It also supports long-term thinking and decision-making.
3. In Practice
This chapter focuses on organizations to examine hurdles encountered in practice, required for answering the third sub question: „What hurdles do managers and
consultants in practice endure during the implementation process? Firstly some overall
description is given about the interview set-up. This will be followed by six sections summarizing the results of the interviews. Finally, these six interviews will be summarized in a recap section.
3.1 Doing the interviews
The relevant hurdles for practitioners have been derived from interviews. The main findings mentioned by managers or consultants are given in a summarized description per organization. The full description of the interviews, however, can be found in the appendices.
The interviews start with an open question where the manager or consultant explains the implementation process issues. He is able to mention the hurdles the organization comes across in practice. These hurdles can be new or are related to aspects mentioned in literature. The managers and consultants are not “helped” by providing them with the aspects related to a dimension mentioned in literature. If aspects of the several dimensions are not mentioned, these aspects could be less or not relevant for the organization. When the interviewees have given their view on the value-based management implementation issues, the interview continues with discussing the six dimensions.
Concept Variable Dimensions Aspects Money Patience Effort Open to change Leadership support
Decentralized organizational structure Belief systems
Availability relevant data Accessibility for the right people Linked to Value Drivers
Communication Purposes
Monitoring and Decision-making Tool Economic Focused
Broad and Understandable Linked to Total Shareholder Return Control and Accountability Factor Different measures
Complexity Measurement Benchmarking Analysis
Linked to performance measures Linked to value drivers
Control and Accountability Factor Initiative background Dutch Culture Workload - Projects Value-tree Organization development Education Staff Value Focus
Achievable Expectations and Goals Hurdles endured during the implementation of value-based management Pre-implementation Phase
Not in the scope of
this thesis Not in the scope of this thesis
Execution Phase Not in the scope of
this thesis Not in the scope of this thesis Implementation Phase General Culture Information and control system Performance Measurement Incentive Plans Hurdles from practitioners
Figure 8 Aspects discussed in the literature and mentioned by practitioners
The case study protocol is enclosed in appendix 3. It shows the research question, the goal of the interview and the questionnaires (in Dutch).
The (sub) questions and dimensions were based on the literature research and on explorative interviews. None of these interviewees are represented in the cases covered in this master thesis.
focused on value creation while developing new chips since its start up. Since SiTel started focusing on value creation by monitoring on R&D straight from the beginning, no implementation hurdles were discussed. Useful insights, however, were obtained in how an organization could design its organization to succeed in VBM practices. For that reason SiTel is not excluded from this thesis. ABN AMRO failed in implementing value-based management and Royal Haskoning is in the process of implementing value-value-based management. After the organization interviews, the descriptions of the interviews with the consultants are given. Steps Ahead is discussed first, followed by Value Drivers and finishing PricewaterhouseCoopers (PwC).
Not all organizations came up with hurdles in all dimensions. For that reason, no hurdles are mentioned related to dimensions in which they encounter no obstacles. Interviewees were free to emphasize topics which they found most important. Sometimes, these results in a wide range of hurdles mentioned that were related to one of the four dimensions, leaving others a bit less discussed. Based on this, one can conclude that these broadly discussed dimensions are found more important than others.
3.2. SiTel Semiconductor
SiTel started to focus on value creation from the very moment the organization was set up. With a group of experts out of the chip industry the new organization was designed to focus on its main value driver, namely R&D. For SiTel defining the value driver was not a difficult task. New projects are evaluated by their financial contribution and during the progress of the projects this is monitored on a frequent basis. Project managers, the board of directors and employees all are able to access the relevant data. Accurate and useful (financial) data is stored in the information system. Financial information is communicated monthly throughout the whole organization. In doing so, everyone is up-to-date, knows the progress towards the goal of maximizing value, how value can be improved or what the reasons for underperformance are. Financial information is made understandable for everyone.
Employees are only able to influence the smart goals by their own performance. The bonus is not directly linked to reaching or not reaching the goals, but an increase in salary is. The height of the salary influences the size of the bonus. The two performance measurements which are used during an evaluation have a low complexity. The employees‟ individual performance is not benchmarked, but the performance on an organizational level is benchmarked with the main competitors. Especially the amount of money spent on R&D is a key figure which is used.
The way SiTel designed its incentive system does not correspond fully with how the literature suggests it should be done. According to the interviewee “the incentive system is
a key success factor within their organization”. The system in place seems to work very
efficient and creates the desired behavior, resulting in the number one position of SiTel in the market. However, the control and accountability factor towards a bonus is very low. There is no direct link with the performance of the individual employee, but there is one with the performance of the whole organization. In addition, the value drivers are also linked to the bonuses, but the secondary performance goals of employees are not linked to a bonus system. Linking value created and the bonus is done by giving employees a share of the EBIT.
It is noted that “having a culture is not necessary” because of the formalized processes and codes of conducts. Looking deeper, however, shows a culture with open communication. There is a “change it, love it, leave it” mentality, whereby complaining is not appreciated. Belief systems are strongly presented in the organization and everyone carries the same values to make value creation possible. Openness and leadership support towards change is an irrelevant topic since no changes have occurred, but the organization as a whole can be described as open and the distance between the board of directors and employees is relative small, as the atmosphere of the interview showed.
Because no hurdles where found in managerial practices and processes, SiTel will not be used for further analysis. Organizations could use SiTels way of managing the organization as an example.
3.3. ABN AMRO
Value-based Management within ABN AMRO can not be classified as a success. The concept has never been never fully accepted throughout the organization by all its employees. Although the employees of ABN AMRO are not resistant to change, they were and are opponents of focusing primarily on improving shareholders value, especially since they felt that it was at the expense of the customers. The biggest hurdle during the implementation of value-based management was that the organization and consultants focused too much on to technocratic aspects of the value-based management. The emotional, unconscious motivations and beliefs are of intense importance. These “meta level” aspects should deserve at least the same amount of attention as „technocratic‟ aspects, perhaps even more than that.
Chairman Dhr. R.W.J. Groenink supported value-based management practices the most, but support and commitment gradually decreased towards the lower levels of the organization. Employees working with clients did not accept VBM at all. The centralized organizational structure did not have any influence on the implementation process. The top management changed the belief system by changing the mission statement into a profit oriented credo. This was not in accordance with the stakeholders‟ principle which was rooted within the beliefs of the employees. Shareholder value creation got a primary role in the new mission statement and credo of the organization. This change was never fully accepted by the employees.
The information and control systems were left relatively unchanged; however the usage of the systems was changed significantly. Relevant data was already available, but used to monitor performance more closely. From now on, information was used for communication with employees and this communication created more commitment and pro-active attitudes. Reports changed from providing solely accounting based information toward more economic based information. In the lower levels, there was relatively more focus on non-financial measures and a link was made to operational value drivers. This change led to a more active and broader usage of data.
parameters would benefit the objectivity of the assessment. Some managers felt that this new assessment showed a lack of confidence in the ability of managers to make good assessments themselves. The new systems still incorporated some imperfections; some performance measures stimulated short term opportunistic behavior and unwanted situations (e.g. product push). Employees knew on which measures they are judged and a large part of the measures could be influenced. Economic profit could not be controlled by the individual employee; most of the non-financial performance measurements had a higher controllability factor.
The bonuses of employees were linked to their activities via the PPP which were defined by the managers. The PPP system determined if the employee would be granted a bonus. The link between the bonus system and the created value within the organization was made by using Economic Profit as a measure. Customer satisfaction and risk management, however, were also aspects included in the assessment. The controllability on the level of the bonus was medium. The derived goals can be influenced by employees. Bonuses or punishments did not have any positive or negative influences on the success of the implementation process. A great different amount of courses and trainings where provided to let employees become familiar with value-based management practices. Still, the value-based concept was not accepted within ABN AMRO, especially not at the „lower‟ regions of the organization, due to the mismatch in values.
New hurdles*
Culture • Leadership support gradually decreased Emotions • Technical aspects get main focus • Lack of support by managers not outspoken
• New belief systems not accepted • Support can be fake or acted
• Lack of support not acknowledged Communication • No chance to phrase doubt and resistance • Laying decisions down on employees
Value Focus • Value focus of the top-management not supported downwards • Partially change towards economic-based data
Involvement • Not involving employees or managers during implementation Education Staff • Lack of training to employees
• Product push not adding to long-term value creation • Opportunistic behavior still incorporated
• Objectivity of measures questionable
• Stakeholders not included • No influence on the success or failure of the implementation
• Intrinsic drivers and motivation more important than bonuses
Hurdles related to Literature
Recap Hurdles at ABN AMRO
External Stakeholders
* either not mentioned by practitioners or did not receive a significant emphasis in literature
• Emotion, urge, (personal) values, desires and intrinsic drivers left out Incentive System Information and control system Performance Measurement
• Measuring employees by a predetermined plan was felt like a
lack of confidence in the capabilities of managers Product Development
3.4 Royal Haskoning
The term „value creation‟ is experienced quite differently at Royal Haskoning than in other organizations. This is due to its legal structure; it is a foundation. It exists to fulfill its purpose of serving the community, its employees and to realize good projects, not to make high profit margins. A cultural change is necessary to create the awareness that projects need to be at least self-sufficient and have a positive result (this differs from a real return on the invested capital). This cultural change is considered the biggest hurdle. The organization is not open for this change although the CEO clearly motivates and supports it. But even the management council is not fully convinced yet. The organization is relatively decentralized; with 11 divisions all having their own decision authorities. The mission statement has changed over the years. The four strategic programs „continuity, independence, returns improvement and value improvement in business processes‟ are new (Source: annual report, p. 20). After a year, the support and acceptance towards those „values‟ can be felt significantly, perhaps resulting in more openness towards value creation. Changing an organizational culture is underestimated in difficulty. It is a slow, heavy process in which a lot of resistance must be conquered. Expanding and strengthening the finance department was one of the first steps in doing so.
system. A different trap concerns financial information: not all managers understand the provided data (some are engineers and without financial education).
The performance measurement of employees is in no way linked to the created value, value drivers or financial measures. Instead, it is fully qualitative and focuses on employees‟ competences and behavior. Employees are in control to influence their score on assessment and the accountability factor is also high. Quantitative measures like profit and loss statements are used when evaluating the performance of whole advice groups. There are no formal benchmark analyses in place due to confidentiality of information, but the group‟s net profit is compared with competitors.
Changing the bonus system to create incentives does not work for Royal Haskoning. 95% of the employees are not driven by money but by passion and finishing nice projects. There are no implementation plans on the shelves to change the present system. There is only a small part of flexible salary (bonus); this is not linked to individual, but to the performance of the whole organization. The control and accountability factor is, therefore, very low. Just like the performance measurements, a bonus is also not linked to a value driver.
New hurdles*
Culture • Creating receptiveness slowly process Patience • Attitude of employees difficult to change
• Non-financial values in belief system remain important • Managers must put long-term effort in creating awareness Education Staff
• High amount of training necessary
• Top-management support is influenced by knowledge • Commercial awareness creation only possible by education • Resistant towards an expansion of finance departments Value Focus • Long history of focusing on non-financial values
• Difficulty in subtracting data quickly and easy • Employees do not want to make improve profits • Monitoring considered time consuming and difficult • Value creation stays a side issue
• Limitations in ERP system, adjustments or renewal is costly
• Financial data frequently not understood Emotions • Employees do not want to higher profits • Slow switch incorporating data in decision-making
Communication
• Benchmarking difficult due to confidentiality of information
• Changing incentive system will not have an impact
Recap Hurdles at Royal Haskoning
Information and control system
Performance Measurement
• Implementing VBM and creating awareness is a very slow process
• Only a small percentage of employees committed towards change
• No full top management support, division heads going their 'own course'
• Resistance towards new way of reporting by employees who need to change their routines.
Hurdles related to Literature
• Employees unconscious incompetent leading to no receptiveness towards changes in IS
• Gained knowledge is not always used by managers or employees
• No predefined plan to create change due to a lack of commitment in top management
Incentive System
* either not mentioned by practitioners or did not receive a significant emphasis in literature
3.5. Steps Ahead
The consultants of Steps Ahead notice that a lot of organizations do not focus on value creation. Organizations start to focus on value creation and relevant tools when it is almost too late. Even though value-based management consultancy services can be delivered by Steps Ahead in every situation, there are no organizations that contact Steps Ahead without being forced by stakeholders e.g. bank. Intuition is used during day-to-day activities, strategic thinking is not practiced. Employees are frequently not open to changes, which results in no turnaround being undertaken. Change creates insecurity and puts employees out of their comfort zone. Implementing value-bases management and focusing on value creation will have the support of many directors, especially when it benefits them directly. Lack of time and training for the management and employees are reasons why „value creation‟ practices are not implemented successfully. In a centralized organization, like a SME, the implementation is the easiest. A cultural change is necessary, but since „culture‟ is hard to grasp and difficult to amend, the focus generally lays on financial information tools. In organizations helped by Steps Ahead a change of belief systems is not necessary.
no idea where an organization is heading for and what could be expected. Organizations should analyze different scenarios to determine risks and the impact of certain strategic decisions. The biggest obstacle in focusing on value creation is getting a perfect financial information system in place and using it efficiently. Creating a system which quickly and understandably delivers the right information to the right people and links information of value drivers to the value creation is an important hurdle. Without this, no one is able to monitor properly and to make the right decisions. The financial information needs to shift from accounting based towards economics based information. A hurdle significantly linked to this is education. Education of the bookkeepers, controllers, managers and directors of the organization is frequently below par. Replacing employees by higher educated or more experienced employees is necessary.
Measuring performance more accurately can be done by making adjustments or implementing a new ERP system. Buying such a system is expensive and the integration is time-consuming. In situations of near bankruptcy, organizations do not have money available for a new system or to make adjustments. In those situations, it is suggested to start with data gathering and making analyses in Excel. Changing the bonus structure and linking this to performance measurement is only used in specific departments like sales, but not in the whole organization. A bonus should only be linked to value creating measure like paid net profit margin.
New hurdles*
Culture • Employees feel insecure and out of their comfort zone Education Staff • Lack of leaderships support due to lack of knowledge
• Cultural change difficult to grasp • Terminology too holistic and too complex
• Directors and managers stay managing on intuition
• Lack of financial information • Training must be given • Making good forecasts considered difficult
• Outdated software Patience • Implementation not fulfilled due to lack of time
• Difficulty in embedding and effective usage
• Troubles in delivering the right data to the right people Value Focus • No clear future goal or strategy is followed • Transforming information out of data found complicated • Day-to-day practices remain top-of-mind • Linking information to value drivers
• Monitoring not possible on data or information delivered Involvement
• Create time to focus on value creation
• Cost of capital not understood or used • Operation department must be involved
• Particularization of the smallest identification of value • Monitoring not results in pro-active acting
• Purchase of new system or making adjustment too costly • Consulting good consultants is too expensive • Developing and imbedding considered time-consuming • Acquiring an interim manager can be too expensive • No in-house knowledge to create a good working PM system
Performance Measurement
• Active attitude of bookkeepers not appreciated by top management
External Stakeholders
* either not mentioned by practitioners or did not receive a significant emphasis in literature
• No external pressure or motivation from stakeholders leads to a lack of focus
• Organizations outgrow present employees' capabilities and knowledge
Recap Hurdles given by Steps Ahead Hurdles related to Literature
Incentive System
• Education, competences and experience employees below par concerning financial data and information systems
• Linking bonuses to wrong drivers or performance measurements
• Organization outgrows knowledge bookkeepers and controllers
Information and control system
3.6. Value Drivers Corporate Finance
Value Drivers Corporate Finance provides consultancy services on and related to VBM. Terminology like VBM is not used by clients, but the number of entrepreneurs starting to focus on value creation is increasing. Most organizations‟ need for advice is triggered by an event; it never comes out of the blue. This leads to a more open and receptive stance towards change in the organization. Leadership support depends on the level of knowledge and education in the organization. Without a certain amount of knowledge of the terminology, models, underlying ideas and definitions, no support will be given. Management teams are surprised with insights and information about risks, financial ratio‟s and value drivers and their influence on the value of the organization. The organizational structure most suitable for value-based management is a decentralized one, which is said to be best to achieve results. Belief systems are considered „unnecessary‟ for a successful implementation. The biggest cultural obstacle is making people „aware of the necessity and commitment‟ to the new goals and ways of working.
historical numbers and figures and are not familiar with value-based management ideas and monitoring value creation. There is a „knowledge-gap‟ between professions. Another issue is the particularization of incoming and outgoing cash flows towards the smallest identification of value that is necessary for the preferred calculations. A side effect can be that some organizations produce too much unused information; overkill is created. In most situations some training is necessary to understand the „new‟ data. A big switch to more economic based information, instead of accounting based information, is visible when implementing value-based management.
The use of performance measurements is not done efficiently enough. Organizations undermine the effects of a suitable performance measurement. More changes and quicker changes should be made. Most performance measurements are not adequately linked to the value creation. Organizations could benefit by focusing more on this topic, especially since it is essential for a successful implementation. Official benchmarking mechanisms are not used that often. This can be due to the difficulty of obtaining, formalizing and comparing information of competitors on KPI‟s and (non)-financial measures. Emotional resistance, complexity and costs are the main reasons of problems concerning performance measurements, resulting in declining or moving adjustments in the performance measurement to a later stadium.
New hurdles*
Culture • Special occasions create openness towards change Patience • Significant high underestimation of impacts (and costs) • Underestimation of the time horizon
• Long-term commitment decreases • Belief system not necessary to change, no impact
• Creating awareness and commitment easier said than done Value Tree • Developing value tree considered difficult • Lack of entrepreneurial behavior
• Decentralization stimulates should cooperative working Involvement • Operational departments necessary for full embedding • Lower level management and work floor not involved
Education Staff • Full understanding of the concept will dampen resistance • Knowledge gap at the IS developers • Not enough training is given
• Particularization of the smallest identification of value • KPI's and value drivers unknown
• Too much unused information will be created
Workload • Firing colleagues increases resistance • Underestimated effects of changes, not used optimally
• More and quicker changes should be implemented • Goals too high
• Not optimally linked to value drivers • Necessary work and effort underestimated Money • Costs are underestimated
• Changes/renewal frequently moved to later stadium • Linking to TSR is expensive and inaccurate
• Determining non financial measures considered difficult • Not (appropriately) linked to value drivers and PM • Reluctant to put 'stick' component into the incentive system
• Stays linked to organizational wide performance Information and
control system
Performance Measurement
• IS only functions properly if culture, business processes and strategy is aligned
• Determination of needed information and KPI's is considered difficult
Incentive System
Achievable expectations • Benchmarking problematic due to lack of information about
related KPI's of competitors
• Developing model with high control and accountability factors considered difficult.
Recap Hurdles given by Value Drivers Hurdles related to Literature
• Top-management support depends on their knowledge and education
* either not mentioned by practitioners or did not receive a significant emphasis in literature
• Models are kept simple so, the power and influence of entrepreneurs or directors are not limited
• Most managers are generalists, value-based management requires specific knowledge
• No room is given to create ownership for employees in changes and improvement processes
3.7. PwC
The interviewee is working as an actuary at PwC where he is involved in advising insurance organizations during the implementation of „Solvency 2‟. Solvency 2‟ can be considered the „Basel-II‟ for insurance companies, obliging insurance companies to incorporate risk management into their organization. In the interviewees‟ perception, risk
management is interchangeable with value management, because “taking risks and
revenue together leads to value”.
When an organization wants to implement value and risk management they should make a gap-analysis. In this analysis, the present organization is compared with the future organization, leading to a determination of which aspects, tools and conditions need to change. The analysis must focus on the models, monitoring and reporting systems, IT structures, corporate governance, data warehousing and the culture.
