Valuation of Strategies – formal and informal
We know that strategies can be valued based on options analysis, just as options trading markets analyze and determine value. In this way of valuing strategies, having the option of executing or implementing a given strategy has value itself, whether or not the company chooses to act on that specific strategy. Note that to produce this “option value”, the strategy needs to be realistic and something the company could actually put into place (executing the option), with a defined set of steps and costs.
An example to highlight this idea of option value is a simple case of expanding warehouse facilities. Periodically, Acme Widgets surveys available warehouse space that meets its criteria for rail access, loading dock facilities, square footage, environmental conditions and accessibility to the company’s other facilities. While it has not negotiated for any of the potential facilities, it has sufficiently qualified the options (and revisited the options on a recurring basis), such that within roughly 30 days at any time, Acme could substantially expand its warehouse facilities to meet certain triggering conditions. Therefore, the existence of the option itself has value. And in this example, very minimal cost.
A next step on strategy valuation is validating the accountabilities for realizing and claiming the associated value. Quite often, specific functional areas within the business will clamor for individual strategies:
Marketing wants a new, top-tier ad campaign
Operations or manufacturing wants a major retooling, or updated plant & equipment
Sales is advocating a new compensation structure and incentive program
The examples are endless, and vary over time. In most of these cases, the “advocacy” of the particular strategy is absent from a corresponding commitment from the very group advocating it, as to the value creation to be expected, in terms of increased revenues, direct contribution to earnings, and/or reduction in existing expense.
A practical step to solve for this, one rarely taken in more theoretical stagey development, is to make certain to “subscribe” value. This requires formal commitment on the part of functional areas advocating a particular strategy, that indeed the department or function in question will be able to capture the incremental value required if provided with the specific capabilities in question. If value commitments are far less than the incremental value required to make the given strategy a success, then either additional supporting value will have to be sought from elsewhere, or the strategy will have to be reworked or set aside for now.
As a related opportunity for better understanding value in specific strategies, we have found that gathering valuation input from related or even seemingly unrelated functional areas in the organization provides a practical qualification to our value projections. The essential question is: “If you had this capability, what do you think could be done with it?” If the answers contain a whole host of virtuous outcomes but nothing that has an impact on actual expenses, expansion of revenues, or advancement of earnings in some fashion, than we have to question the strategy, even if analytical evaluation shows otherwise.
Part of what we need to accomplish when we seek out practical strategies, is that we are after strategies that can be implemented and owned and become part of the daily operating fabric of the enterprise. In order for this to happen, we simply must have the people who will accomplish the outcome of the strategy prepared to realize a sufficiently compelling value.
Finally, we benefit by having an independent review of strategy proposals. This serves to validate or improve the valuation of each strategy. This valuation should be conducted by an uninvolved party – in most cases the corporate finance function. Taken together with value commitments from the functional areas affected and the value projections from those proposing the strategy, this gives senior management three distinct data points to evaluate each specific major strategy.
