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How changing the way we measure value helps companies focus on the long-term

Photographic portrait of Hywel Ball
Hywel Ball

EY UK Chair and UK&I Managing Partner, Ernst & Young LLP

8 minute read 28 Feb 2020
Related topics
Long term value

Organizations that effectively anchor their approach to long-term value are best positioned to benefit from the value they create.

Imagine being in an industry that has no choice but to transform itself or be transformed. It may be quicker to list industries that don’t face this choice.

Virtually all companies are being buffeted by changing market conditions and technological disruption; new regulations and shifting consumer tastes. Amid this volatility, it’s no wonder shareholders increasingly want to know how businesses plan to thrive in the long-term in an everchanging world.

Yet that’s not the only demand on leaders. We increasingly want authenticity from the organizations we work for, buy from, and invest in. We need to know what companies stand for, and why.

This pressure has only increased as technology empowers more stakeholders to speak up and influence markets. In particular, the millennial generation representing around a quarter of the world’s population is responsible for bringing a greater focus on purpose, both as consumers and employees¹ and Gen Z is further amplifying those demands.

So, where do leaders and organizations begin? As one of management’s most influential thinkers, Peter Drucker believed that if you can’t measure it, you can’t improve it. A company’s purpose and long-term strategy should reinforce each other, but that requires a clearly articulated purpose and a long-term strategy founded on strong metrics. It’s a four-step process:

  1. Understanding the context in which your business operates
  2. Identifying stakeholders and understanding what they value
  3. Gaining a clear sense of your organization’s strategic capabilities
  4. Developing metrics to evaluate long-term value creation

Get these right, and your organization has a chance to unite purpose with long-term strategy.

Understanding the value of purpose

 

Energy companies are battling public concern over climate change. Tech companies are judged on whether big data and social media positively contribute to society. Pharmaceutical companies face growing calls to justify their use of patents, and to make lifesaving medications more affordable and accessible. Across all industries, leaders today face pressure from consumers, regulators, and investors alike.

 

When it comes to responding, we often hear similar questions. Who are our most critical stakeholders? What’s our purpose? How is it fulfilling stakeholders’ needs? What outcomes and investments will create the greatest value for them, and how do we articulate and measure that? And, importantly, if we create, articulate, and implement a long-term strategy aligned with our purpose, what will investors think? 

 

To that last point, there’s a very public, broad shift of capital toward organizations with a clear long-term strategy anchored by a purpose that is authentic and well-communicated. In the United States, the Business Roundtable last August issued a much-heralded statement signed by 181 CEOs recognizing the need for companies to act “for the benefit of all stakeholders – customers, employees, suppliers, communities, and shareholders.”

 

The problem? While stakeholders increasingly agree organizations thrive when they create a broad spectrum of long-term value – financial, human, consumer, and societal – no one is sure how to measure value beyond dollars alone. In the absence of metrics that clearly articulate the value of a company’s long-term investments, it’s hard to blame investors for continuing to make decisions based on established, short-term metrics and reporting.

 

Yet that hurts companies and investors alike. With 48% of global enterprise value represented by intangibles2, it’s little wonder only 25% of investors believe current financial reporting clearly conveys how a company can create future value through its investments.

The shift toward purpose
CEOs recognizing the need for companies to act “for the benefit of all stakeholders – customers, employees, suppliers, communities, and shareholders."

Valuing purpose-driven strategy

In 2017, a group of business leaders together representing $30 trillion of assets under management—including the EY organization—launched the Embankment Project for Inclusive Capitalism (EPIC) (pdf). The goal was to identify consistent, widely accepted metrics to measure the impact of an effective strategy around today’s key drivers of long-term value – consumer, financial, human, and societal.

 

For example, measuring how well a company is creating human value could be done by looking at how talent is deployed using metrics such as workforce costs; workforce composition and diversity; training, learning, and development; and engagement and well-being.

 

The EPIC project did not propose a “one-size-fits-all” solution. It recognized a company’s metrics should measure the areas of value creation most relevant to its purpose and strategic goals, and tested a long-term value framework to identify specific, outcome-based metrics based on a company’s strategy, context, purpose, stakeholders, and strategic capabilities.

 

That way, companies would have a process to identify the most important metrics to report – and investors a way to know that the metrics had been rigorously selected for their relevance to a company’s situation.

 

It was a timely contribution that advanced the debate on long-term value. With a concrete way to measure how specific factors create value for a wide range of stakeholders, it’s easier for businesses and investors to align on the best path forward.

 

That, in turn, makes it easier for organizations to bring their purpose to life, and then execute it with a credible, measurable strategy to maximize the most long-term value.

 

So, how do you measure long-term value being delivered to stakeholders? Through four key steps:

Investment in intangibles
of investors believe current financial reporting clearly conveys how a company can create future value through its investments.

1. Establish the business context

Leaders need to examine the purpose that drives how the business creates value for stakeholders, and the big-picture trends impacting its business model. Is the company in an industry being disrupted by a major new technology? Are Millennials a growing part of its consumer base, demanding it positively contribute to society? Understanding these big-picture trends is vital to an effective strategy.

Once you’ve systematically established the organization’s purpose and the trends affecting its operations, there’s one final piece of context: governance, or the mechanisms the company has in place to implement a strategy. What’s the leadership structure and process?  What are the incentives within the company to drive action?

Establishing the business context is about answering the why (the purpose), the what (the trends shaping the company’s business environment), and the how (the governance structures for implementing strategies) underpinning the organization’s long-term strategy. These three factors are critical, and identifying metrics to drive that requires companies answer a fundamental question: why does our company exist?

2. Assess stakeholder outcomes

After establishing the context, you then need to identify the company’s main stakeholders – both inside and outside the organization – and the value they get from the work your company does.

Maybe Millennials are a key consumer base. Maybe your organization’s appeal centers around a specific societal mission. Maybe it depends on delivering constant technological innovation to the market.

In the case of an energy company, maybe it needs to deliver affordable, reliable services to its customers, while decarbonizing the business as much as possible to fight climate change and benefit society.

All of these factors point to critical stakeholders for your company – and suggest the types of value the company will need to create. Whatever the case, it is crucial to identify the ways in which your company is uniquely positioned to add value to the lives of all stakeholders.

3. Identify strategic capabilities

Once you know the company’s context and its stakeholders, you need a clear sense of the capabilities that can be deployed to advance a strategy that serves those stakeholders. What levers create or protect long-term value? What resources does the company need?

Answering these questions is critical to prioritizing the long-term investments and related metrics that matter most to a company’s future. The best strategies approach a transformation challenge from every angle. It’s not acceptable to focus on one stakeholder group at the total expense of another.

For instance, a company seeking to create greater human value may already have a particular personal development program for employees. That’s a value lever it should include in its strategy – coupled with the specific resources and investments needed to ensure that lever produces the value the strategy calls for.

Or take an automobile company whose stakeholders want to minimize impact on the environment while still producing high-performance cars. In that case, key value levers may be the programs the company has in place for research and development – or the training it offers employees to cultivate new skills that will help the company adapt and innovate.

Companies today are the world’s most powerful engines for growth and
prosperity – and the world is better off when business behaves in ways that
create long-term value for all stakeholders.

4. Develop metrics to evaluate long-term value creation

The final step in measuring the success of a strategy based on creating long-term value is to select metrics closely based on your company’s goals, identified stakeholder outcomes and strategic capabilities. The EPIC project report outlines five qualifying criteria and seven guiding principles for selecting and developing metrics, including being comparable, empirically tested, accurate and credible.

Having the right metrics is essential to gaining support for your company’s long-term strategy. The metrics are what make this strategy credible – they provide the means to measure and demonstrate the value of long-term investments to investors and other stakeholders, and help gain their support if the metrics are trustworthy and robust.

Stakeholders need information giving them faith, for example, that an oil and gas company’s technology roadmap for decarbonization will actually be worth the long-term investment.

This is another place where the use of broader, non-financial metrics allows companies to measure and report progress against goals and the potential to create even more value.

A purpose beyond profit

We live in a world of constant disruption, shifting toward a form of capitalism aimed at creating value for a wide range of stakeholders. In this world, companies are expected to be financially successful in the long-term – but they’re expected to simultaneously contribute to solving the problems facing people and our planet.

They are, in other words, being judged by both their value in the stock market and their value to society.

This is a good development. Companies are the world’s most powerful engines for growth and prosperity – and the world is better off when business behaves in ways that create long-term value for all stakeholders.

We today have the tools to turn that incredible potential for good into real action. If we can accurately and effectively measure the creation of long-term value, we can turn rhetoric into reality.


The Embankment Project for Inclusive Capitalism (EPIC)
Get in touch with us to request a copy of the EPIC report.
 
 

Summary

Today, organizations are challenged by as there is a broad shift of capital toward organizations with a clear long-term strategy anchored by an authentic purpose. The key is to turn long-term value from being rhetoric into reality. 

About this article

Photographic portrait of Hywel Ball
Hywel Ball
EY UK Chair and UK&I Managing Partner, Ernst & Young LLP
UK Chair and UK&I Managing Partner. Leading our 17,000 people in the UK. FTSE 100 audit partner. Father of three and Welsh rugby fan.
Related topics
Long term value

EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients.