For a long time, value creation in the financial services industry was often viewed as the result of topping the competition in organisational efficiency and functional excellence.
Better operations, better distribution networks and better service all were seen as main factors in improving market share, creating value for customers and, therefore, creating shareholder value.
But, as argued in the 2000 paper Creating Value in Financial Services, customers do not care about functional excellence, nor do they care about whether an organisation has unique resources to take advantage of scale or networks. Customers care about whether the product or service is of utility to them and (in some cases) to the wider society.
This recognition has led to a renaissance in organisational strategies focusing on anticipating, understanding and responding to the needs of customers and developing long-term relationships with them.
Value creation is not only an outcome but also a process. In the case the paper presents, this process involves generating strategies, services, systems and measures of success focused on customer value. However, the International Integrated Reporting Council, in the context of its integrated reporting framework, defines this process more generally.
“Value is created through an organisation’s business model,” the IIRC states, “which takes inputs from the capitals and transforms them through business activities and interactions to produce outputs and outcomes that, over the short, medium and long term, create or destroy value for the organisation, its stakeholders, society and the environment.”
This definition breaks apart the historically narrow focus on value creation as the sole preserve of shareholders and, more recently, customers. So for whom should value be created and how can we measure it?
Organisations have a wide range of interactions within the regulatory, societal and environmental contexts in which they operate.
Value for whom?
This promotes relationships between the organisation and its shareholders, consumers, employees, regulators and other stakeholders. The long-accepted dichotomy between creating value for shareholders and creating value for stakeholders was discussed in Michael E. Porter and Mark R. Kramer’s 2011 work, “Creating “shared value”.
That article’s central premise is that the competitiveness of a company and the health of the communities around it are mutually dependent. Making a similar point was professor in management practice at Harvard Business School Robert Eccles, in an article published by the MIT Sloan Management Review titled “Why boards must look beyond shareholders”. He notes that corporations have two basic aims: to survive and to thrive. He argues that the outcome of a company’s activities, not shareholder value, should be its objective.
With this in mind, at the Thinking Ahead Institute, we propose a balanced approach to better understanding for whom value is being created and, equally, for whom it is being eroded.
First, we define four key terms:
- Owner value proposition (OVP): this is well represented by traditional reporting (balance sheet, profit-and-loss accounts) and is the value produced for the owner.
- Stakeholder value proposition (SVP): value created for the society and environment in which an organisation operates. This is usually outlined to varying degrees in corporate social responsibility (CSR) reports.
- Client value proposition (CVP): policies and actions that deliver value to clients in services and products.
- Employee value proposition (EVP): policies and actions that attract, retain and develop employees and teams.
Metrics for the value an organisation creates need to take into consideration all four areas.
This requires organisations to use new measurement techniques that move beyond long-standing accounting and CSR reports. Traditionally, EVP and CVP have not been measured. At the institute, we have created a toolkit to help organisations assess these. There is no strong CVP without a strong EVP, so these should be considered equally in an organisation’s mission and strategy.
In 1997, author John Elkington coined the phrase ‘triple bottom line’ to argue that corporations should focus not only on the economic value they add, but also on the environmental and social value they add (and destroy).
Companies are increasingly seen as needing a social licence to operate, the deterioration of which is linked to tangible reductions in shareholder value and, in turn, portfolio return.
Understanding companies’ creation of value and its impact is at the heart of modern initiatives such as the IIRC framework. It encourages companies to think about value creation and destruction through the lens of multiple capitals over multiple time horizons.
The Global Reporting Initiative’s (GRI) Sustainability Reporting Standards leadership on non-financial disclosures does provide an industry-trusted framework to enable organisations to report publicly on their economic, environmental and social impacts; however, we believe there is more work to be done to understand how we can better measure value creation of companies – the balanced framework proposed above provides a first step towards this.
Marisa Hall is senior investment consultant in the Thinking Ahead Group, an independent research team at Willis Towers Watson and executive to the Thinking Ahead Institute.