Overcoming value barriers.

• Author: Mergy, Lee
• Position: Value Creation - Maximizing shareholder value

Too often, companies have long-standing practices or metrics that don't add value -- and sometimes, they help destroy it. A look at several key barriers and how they can be sidestepped.

Every company has its sacred cows, those revered management practices that seem to hang around even as the company itself changes. These long-standing practices might be the way a product is marketed, the way an internal process is run or the habits of one or more influential managers. They might be a strategy that has served the company for years or a core competence that has been a source of enduring competitive advantage. What makes them endure is that they are usually based on accepted management practices that have been handed down from previous management generations. Unfortunately, these practices are not always aligned with the best interests of shareholders.

Maximizing shareholder value requires a reexamination of the company's most cherished business principles. Often, these most cherished ways of doing things are most likely to be at the root of a company's inability to generate higher returns. When companies fail to unburden themselves of pre-existing value-destroying habits -- be they processes, one or more influential managers, "commonly held beliefs" or unproductive customer or supplier relationships -- profitability improvements are unlikely. Without eliminating antiquated ways of doing business, a company can start to look like an archaeological site of management ideas, one generation laid on top of another.

There are five hard-to-identify barriers to value creation that, time and again, prevent companies from growing -- financially, strategically and organizationally -- in ways that maximize shareholder value. Experiences of some clients who have struggled with these barriers will shed light on how organizations have reacted to -- and sometimes overcome -- them.

The Hallowed Metric

Perhaps the most common sacred cow in a large company is the set of financial metrics that management uses to set goals and measure performance. Metrics often take on a life of their own and become set in stone -- be they earnings per share, return on investment or return on assets. When financial metrics become more important than the underlying economics of the business, the company needs to reassess how it measures success.

There are two ways in which these metrics can lead a company astray. First, the metric can exclude important economic facts about the business model. In the case of a telecommunications client, the sales force was compensated based on the size of the revenue stream from the customer contract, and salespeople freely extended credit and payment terms to facilitate and book sales. In many instances, the operating profit margin on these financed deals appeared higher than on those that weren't financed -- leading management to believe that it was pursuing highly profitable growth. However, when the capital costs for these deals were also included in profitability measures (including the risk of customer default), most of these "financed" deals were actually value-destroying. With the right metric, management would have seen the value destruction before the contract was signed and would have avoided the deal (or at least restructured the terms).

The second way that metrics can lead management astray comes when a financial ratio becomes more important than the old "king cash." One current consumer product client has focused on operating profit margin. This company has a strong...