Value Creation Requires a New Reporting System

by Jay Deragon on 11/11/2013

-intangible tangibleThe game of business in the 21st century is no longer won by the financial reports after the game. That was the game of the 20th century. The game has changed and what drives business success today is value creation in the minds and hearts of stakeholders.  The problem is most businesses are not equipped to measure what drives value creation for their stakeholders.

According to Larry Ackerman, the father of identity based management, “The most powerful cultures spring naturally from the identity of the organization – the value-creating core of the enterprise.”  There is a direct link between “value-creating” cultures and organizational success.  Great Place to Work has studied the link between value creating cultures and performance for 25 years and publishes their annual “Best Companies to Work For Reports” Analysts show that the financial performance of publicly traded companies on our 100 Best Company List consistently outperform major stock indices by 300% and have half the voluntary turnover rates of their competitors.

So How Do You Measure Value Creation?

Culture is an intangible asset of strategic significance. Mary Adams, CEO of Smarter Companies and author of Intangible Capital says that culture is an element of the organizations strategic capital. Strategic capital includes how an organization combines its resources to solve problems and give purpose. It may also include the business model and other strategically relevant elements of the organization.  Every organization has five key assets that are constantly interacting internally and externally together as a system. These assets include:

  1. Human Capital
  2. Structural Capital
  3. Relationship Capital
  4. Strategic Capital
  5. Tangible Capital.

It is the interactions of these five assets that create or diminish an organizations ability to create value. Yet our accounting systems only measure 20%, the tangible assets, while the 80% go unmeasured and unreported. Care to guess were most of the value creation comes from?  If you guessed the 80% you are right.  Ironically 80% of the value in the S&P 500 Index is attributed to the intangibles.

In a recent article in The Guardian Allen White states: The backward-looking and myopic focus of financial reporting provides inadequate insight into the mind, business model and strategy of the organization. It fails to capture long-term opportunities and risks in a world in which knowledge, technology and supply chains are increasingly borderless. Further, financial reporting’s short-term focus and omission of intangible assets that underlie some 75% of market value beg for remedy.

As integrated reporting emerges in the coming years, integrated ratings will benefit from a new generation of information ready to populate a new generation of ratings methodologies.

This evolution cannot materialize too soon. A transformation of ratings can play a vital role in creating the “new operating system” for capitalism that Peter Bakker, president of the World Business Council on Sustainable Development, advocates:

“The mistake currently lies in only expecting (and managing) a return on financial capital. Capitalism requires a new operating system and needs to be rebooted so that we expect and manage the return on financial, natural and social capital. … Business as usual is not an option for a future-proofed economy in which nine billion people live well with the limits of the planet by mid-century.”

Companies, investors and society at large stand to benefit from such a sea change. It is a future the ratings community should not only anticipate, but champion as well.

The future is here. Organizations can indeed identify, visualize and measure the intangibles that drive value creation. Instead of accounting it is called icounting meaning accounting for your intangible capital. You can see the icounting tools here. Welcome to the value creation measures of the 21st century.

{ 16 comments }

E.Ted Prince November 20, 2013 at 9:27 am

My book “The Three Financial Styles of very Successful Leaders” (McGraw-Hill, 2006) shows how we can measure the behavioral propensity to create capital and specifically invokes the concept of value creation as part of its model. I think it fits in beautifully with what I am reading here.
See the book at Amazon on http://www.amazon.com/Three-Financial-Styles-Successful-Leaders/dp/0071769943/ref=sr_1_1?s=books&ie=UTF8&qid=1384961222&sr=1-1&keywords=prince+3+financial+styles

Mike Mellor November 19, 2013 at 1:55 pm

The stock markets have an infallible method of measuring value creation. It’s called the stock price.

Larry Ackerman November 14, 2013 at 10:08 am

Thank you, Jay, for quoting me in your article, which I love. While I’m not a finance guy, I think I can help further sharpen this conversation – dare I say movement? – by offering a few timely distinctions based on my work over the past 30 years.

Distinction #1 – Value creation is different from wealth creation. Indeed, the former drives the latter. This is a precise cause-and-effect relationship, where wealth is about money, reputation, loyalty, etc.. and value is about (see Distinction #2)

Distinction #2 – “Value” is the unique, or proprietary, contribution a company is capable of making in the marketplace or, in fact, the world. I say “capable’ because most organizations are unaware of what their value-creating potential is and, thus, cannot strive to realize it. That’s bad news but also good news; it means companies have extraordinary potential for profitable, purposeful growth, once they understand how they really create value.

Should anyone be interested in learning more about the dynamics of value creation, based on my experience, let me suggest you read Identity Is Destiny: Leadership and the Roots of Value Creation. Here’s a link to the book site: http://www.identityisdestiny.com.

Looking forward to more about this fundamental, but misunderstood, topic.

Jay Deragon November 14, 2013 at 11:53 am

Larry

Thanks for your comments and input on this important subject. Appreciate your contributions and I’ll be sure to read your book and likely to both learn and share the insights gained. Would love to do a Google Hangout discussion with you.

E.Ted Prince November 14, 2013 at 12:20 pm

Larry makes a good distinction between value and wealth creation. I think we also need to add a further term and distinction which is also important, namely capital creation. Value to capital to wealth creation.

Larry Ackerman November 14, 2013 at 5:43 pm

I love the reference to capital creation, which is a core need. In Identity Is Destiny – Chapter 6 – I offer a model called the Value Circle. The model states that 1) employees create value, per my definition; 2) customers purchase, or don’t purchase, that value, producing revenues and profits, and 3) investors put, or don’t put more capital into the company, depending on their assessment of value-created earnings. My model is predicated on the unassailable economic interdependence of employees, customers and investors. FYI, any company that tries to get from employees who create value to investors who finance value typically falter. You can’t get from point A to point C without going through point B.

Larry Ackerman November 14, 2013 at 5:45 pm

Hey Jay,
Let’s do it. Set up a googledocs space. I’d love that.
Larry

Becky Roberts November 13, 2013 at 1:33 pm

The balanced scorecard addresses just this issue. Balanced Scorecard is a strategic management framework that includes goal setting and measurement of four perspectives that can be loosely aligned to the 5 asset categories addressed in the article:
Financial — that covers the Tangible Capital category
Customer — that can be broadly defined and corresponds to Relationship Capital
Internal Business Process — which addresses strategic processes, so it aligns somewhat to Strategic Capital
Learing and Growth — which includes Human Capital and Structural Capital

While this is grossly oversimplified, balanced scorecard is a good place to start!

E.Ted Prince November 14, 2013 at 12:24 pm

I think the BSC is a great approach. But it does not show how behavior links to BSC metrics; that is a major weakness. E.g. what precise behaviors lead to the business outcomes which result in the various BSC metrics? That is one of the major focuses of our company’s programs and research.

Becky Roberts November 15, 2013 at 10:51 am

BSC in general, and strategy mapping in particular, can be a great tool to both clarify and communicate the linkages between behavior, investments and activity and business outcomes. And, part of the power of having a balanced set of metrics is that you include leading indicators as well as outcome measures, so you have the data to make management decisions and mid-course adjustments that can impact outcomes.

E.Ted Prince November 13, 2013 at 8:44 am

The financial statements of most corporations are very misleading since they essentially show the state of the company a couple of years back from a value creation perspective. EVA tries to solve this problem but it still uses the concepts of traditional accounting and finance. Ultimately it is behavior that creates value and capital generation and value creation is an outcome of behavior. That means you have to measure behavior scientifically and link it directly to financial outcomes that link directly to standard financial statements. Behavioral finance is moving in this direction but it isn’t there yet. My company is conducting research in this area and has developed psychometric assessments that directly link behavior to measurable financial outcomes, including valuation. So far I think we are the only people doing this. See http://www.perthleadership.org

James Thomas Horn November 13, 2013 at 5:35 am

Duplicate comment detected; it looks as though you’ve already said that! I did but couldn’t complete it because my computer shut down and restarted to update itself and wiped off everything I had been saying. I apologize for your inconvenience. Heaven help computer updating in the middle of trying to communicate with the world. I am sure you wouldn’t be too happy either if the same thing happened to you then you received a “DUPLICATE” message.
Please be understanding. Thank You, Jim Horn

James Thomas Horn November 13, 2013 at 5:28 am

Heavens. My computer just updated and wiped out everything that I (just) had written. I put JUST in parenthesis because I am no supposed to be using it along with really, very, perhaps and others including amazing. So how do I get all of this across to the President of the Board here at RiverSea Plantation in Bolivia, NC. He is old-fashioned and lacks an open mind and is afraid of invading other people’s privacy. He won’t let us run a computerized survey even though such a function exists on our website. He won’t let us ask questions about the characteristics of home and property owners for fear of committing a privacy violation. Defense mechanisms are
running rampant in our current society. He may have our best interests in mind but they appear to be somewhere in the back of his mind waiting for an opportunity to come out. So how should we apply what you just said to open the eyes and mind of our current President? Sincerely, Jim Horn

Paul November 12, 2013 at 5:28 am

I completely agree its about time.

Anna Mialet November 12, 2013 at 4:12 am

I would like to receive a copy of the document

Rory Manchee November 11, 2013 at 11:47 pm

I think Integrated Reporting will herald some interesting changes in the way stakeholders assess companies – and even better if it provides a framework for measuring value creation. However, a lot of this is simply a new label, or only a slightly different means of measuring performance. We’ve had triple bottom line reporting, balanced score cards and other fads. Picking up the comment about ratings, a number of ratings bodies have tried to promote different measures for CSR, governance and other non-financial factors – but could not get traction because banks and other sources of capital were seemingly unwilling to embrace non-financial indicators of a company’s health and performance…

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