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The value-based management approach

Companies around the world are managed in various ways. Some are focussed on maximising sales whilst others believe that diversification is the way to success.

Whatever approach is used, the ultimate aim for shareholder-owned businesses is to make money.

This may be placed in context by the individual company&#39s desire to maximise profit whilst living within its own beliefs or values.

For example, a car company may take the view that it does not like a profit-at-all-costs approach. It may prefer to restrict its activities to selling cars whose emissions fall below a particular level.

This may damage its sales and profit but it may also make the company more comfortable in its operation. On the other hand, it may attract customers who agree with the company&#39s stance in relation to the environment.

One highly respected method of operating a business is value-based management. Rather than driving their decisions based on the sales to be generated, businesses who operate under a VBM approach use the value to be obtained.

For example, Company A, which uses a VBM approach, might choose not to enter or develop a stake in a large market because it does not believe that there is value to be generated.

Company B, by contrast, might see the potentially high sales, albeit it at a small margin, as justification for entering the same market.

In the case of financial services, examples of areas where major decisions have been required are stakeholder pensions and Cat-standard Isas. The volumes of either product are potentially huge but margins are low.

In these cases, how would we define value? The initial consideration is financial. On the basis of expected market size, market share, average contributions etc. would a particular venture make money?

Most businesses will test a number of different possible participation strategies in an attempt to determine the highest value generating option for it.

For example, three options which might be considered for selling Isas could be tracker fund Cat-standard Isas only, active management non-Cat-standard or full market participation. Whatever options are considered they would always be tested against not participating at all.

Financial services is a long-term business and therefore the value assessment will take account of income and costs which may arise many years from launch of the venture.

Indeed, a consideration will be the period which will elapse until the venture is profitable and the capital required to support it until that time.

This illustrates one reason for choosing a financially strong provider – the ability to invest and develop where less well funded companies may not be able to participate.

A further consideration will be the risks inherent in adopting (or not adopting!) the proposed option. For example, two proposed activities may have best estimates for the value to be produced of £10m and £8m respectively.

The £10m option may appear to be the more attractive but it may, for example, rely on success through a distribution channel where success has previously been limited. The £8m option may be more secure by utilising a distribution channel where the provider has a track record of success.

Ultimately, all businesses have big decisions to take from time to time. Value-based management can provide a tool for companies to compare different options within one proposal or to compare different proposals.

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