Value Creation

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Value Creation and Business Success
by Paul O'Malley

from The Systems Thinker, Vol. 9, No. 2

Copyright © 1998 Pegasus Communications, Inc. (www.pegasuscom.com). All rights reserved. No part of this article may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying and recording, without written permission from Pegasus Communications, Inc. If you wish to distribute copies of this article, please contact our Permissions Department at 781-398-9700 or permissions@pegasuscom.com.

The most successful organizations understand that the purpose of any business is to create value for customers, employees, and investors, and that the interests of these three groups are inextricably linked. Therefore, sustainable value cannot be created for one group unless it is created for all of them. The first focus should be on creating value for the customer, but this cannot be achieved unless the right employees are selected, developed, and rewarded, and unless investors receive consistently attractive returns.

What do we mean by value creation? For the customer, it entails making products and providing services that customers find consistently useful. In today's economy, such value creation is based typically on product and process innovation and on understanding unique customer needs with ever-increasing speed and precision. But companies can innovate and deliver outstanding service only if they tap the commitment, energy, and imagination of their employees. Value must therefore be created for those employees in order to motivate and enable them. Value for employees includes being treated respectfully and being involved in decision-making. Employees also value meaningful work; excellent compensation opportunities; and continued training and development. Creating value for investors means delivering consistently high returns on their capital. This generally requires both strong revenue growth and attractive profit margins. These, in turn, can be achieved only if a company delivers sustained value for customers.

If the purpose of business is value creation, it follows that the mission of any company should be defined in terms of its primary value-adding activities. Simply put, Honda should think of itself primarily as a maker and marketer of quality automobiles. McDonald's should think of itself as providing meals of consistent quality throughout the world, in a clean, friendly atmosphere, etc.

While this may seem obvious, many managers and strategists behave as though the day-to-day business of a firm is irrelevant. Hence, an oil company might buy a hotel chain, while a national chain of automobile service centers is caught systematically charging customers for unnecessary repairs. What conception of business lies behind these actions? Typically it is a very narrow definition of purpose: "to maximize the wealth of the shareholders," or to achieve a set of short-term financial goals.

Managers are expected to address shareholder wealth, earnings growth, and return on assets, but the most successful firms understand that those measures should not be the primary targets of strategic management. Achieving attractive financial performance is the reward for having aimed at (and hit) the real target; i.e., maximizing the value created for the primary constituents of the firm.

Paradoxically, it is when an organization thinks of itself as a financial engine whose purpose is to generate attractive financial returns that the company is least likely to maximize those returns in the long run. Often, finance people end up shuffling a portfolio of assets in a self-destructive quest for "growth businesses" or "superior returns," with no real understanding of the value-creation dynamics of the businesses they are acquiring and selling. Or, as with the automotive service chain, attempts to profit without delivering superior value end in lost business, long-term customer alienation, and...
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