Value-based Business Methodologies
I. Value-Based Financial Management Methodology
To provide a return on investment (ROI) to stockholders, management has to continually increase the value of the business, through producing significant profitable annual sales growth, which generates a sufficient level of free cash flow.
Although, profitability is the necessary condition of a business or product, it is not sufficient, because, contrary to conventional business wisdom, profits are not cash. The necessary and sufficient condition of a successful business or product is free cash flow, which is the real measure of generated economic value.
In addition, the free cash flow has to be at a sufficient minimum level to cover the weighted average cost of capital, the risk adjusted cost of capital or the opportunity cost of capital. In other words, before a company can generate a satisfactory level of free cash flow to increase the value of the business, the company has to invest capital and achieve a ROI greater than the cost of the capital itself.
Hence, looking upon a business as a collection of investment projects, for example, investments in new or existing products, new manufacturing equipment, sales programs, information technology software and systems, etc., the goal has to be to have every investment project generate or save a significant level of free cash flow, and thereby, achieve a sufficient ROI. Accordingly, every investment project can, and has to be measured on a free cash flow basis.
To accomplish the above, companies have to measure the correct financial value “drivers,” with the correct “tools.” In addition, the companies have to use the same “tools” to measure all the various types of investment projects, as well as, measuring the business as a whole, and utilize the identical “tools” employed by professional investors, to assist them in making their investment decisions vis-à-vis the company.
Consequently, companies cannot use standard accounting methods to measure ROI, like return on equity (ROE) or return on assets (ROA), which measure substandard value producing activities. Additionally, ROE and ROA cannot be used to measure all the various types of investment projects, and professional investors cannot use them to make successful equity and/or debt investment decisions.
II. Value-Based Product Marketing and Development Methodology
Optimize products and prices between buyers, competitors, and internal financial requirements, using an externally driven development process, that is:
- identify the buyers' problems, needs, and/or the benefits required by the buyers;
- determine the value to be delivered to the buyers, with emphasis on incremental value delivered via competitive advantages;
- set prices based on the value delivered, pricing segments analysis, pricing leverage analysis, pricing strategy and/or the marketing strategy; and
- determine the product development investment and manufacturing costs that can be justified.
Identify the business value creating market segments, and the product line development sequencing, through the development of a strategic product marketing plan, that identifies the market segments, price segments, optimum prices, product configurations, product development investments, manufacturing costs, targeted marketing and sales programs, and unique positioning of products.
Identify the value delivered to the buyers through price segments identification, pricing leverage analysis, competitive value analysis, and classifying features and benefits based on the value they deliver to the buyers, that is, required, persuasive, and preemptive features and benefits, and detrimental, dissuasive, and preemptively dissuasive features.
You need to know:
- how to identify the value producing market segments for a product,
- how to quickly evaluate new product or business opportunities, before performing a detailed evaluation, and
- why you should, and how to calculate the free cash flow, and the return on investment (ROI) generated from a new or existing product investment, a marketing or sales program, an information technology system or a