A key value driver (KVD) is any variable that drives value for shareholders. But few firms can identify their KVDs and thus use them for forecasting and improvement. Identifying your KVDs requires a deep understanding of your business and much trial and error. Often, value drivers are combinations of variables. Alfred Rappaport, the founding father of value-based management, believes that most businesses can focus on just three to five indicators and capture an important part of their value-creation potential.

Note: I suggest you check out one of Rappaport’s articles, “Ten Ways to Create Shareholder Value,” HBR, September 2006, by clicking here.

Here is what Jeremy Hope and Steve Player recommend.

Action to Avoid

o Stop basing key decisions and improvement initiatives on earnings rather than free cash flow.

[Remember: Companies create value by generating future cash flows at rates of greater return than the cost of capital. The combination of revenue growth and return on invested capital (ROIC) drives value creation.]

Actions to Take

1. Teach managers the importance of free cash flow.
2. Make strategic decisions that maximize expected value, even at the expense of lowering near-term earnings.
3. Educate managers in value driver analysis.
4. Identify and eliminate key drivers that [begin italics] destroy [end italics] value.

Hope and Player: “Managing earnings is an obsession with many CEOs who are continuously under the spotlight of the investment community. They constantly tamper with the business by raising or cutting discretionary expenditures, such as R&D, marketing, and improvement initiatives, to meet investors’ expectations. The fixation with meeting budgets and managing earnings makes its difficult to focus on KVDs. Maximizing free cash flows is the name of the game.”

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For a thorough discussion of key value drivers and 39 other major business topics, I highly recommend their Beyond Performance Measurement: Why, When, and How to use 40 Tools and Best practices for Superior Business Performance, published by Harvard Review Press (February, 2012).

SUPPLEMENTARY READINGS

Saving Capitalism From Short-Termism: How to Build Long-Term Value and Take Back Our Financial Future
Alfred Rappaport

Understanding Michael Porter: The Essential Guide to Competition and Strategy
Joan Magretta

Good Strategy Bad Strategy: The Difference and Why It Matters
Richard Rumelt

Value Drivers: The Manager’s Guide for Driving Corporate Value Creation
Mark C. Scott