by Raghavan Rajaji

CXO PERSPECTIVES – Lessons in Shareholder Value

Jun 01, 20027 mins
IT Leadership

CIOS AND CFOS MAY NOT ALWAYS SEE EYE-TO-EYE, but one topic is dear to the hearts of both, and that’s value. CIOs aim to create value through the efforts of their IT organization and the systems and technology the organization implements; CFOs seek to guarantee that value is delivered enterprisewide. Unfortunately, value is one of those terms that everyone loves to throw into a conversation as evidence of the importance of their efforts, often without a clear, consistent meaning. The picture gets even murkier when you take into account all the metrics and methods out there that claim to capture this mysterious thing we call value: ROI, net present value, the Balanced Scorecard and the like, as well as external indicators such as the stock price. It can be a confusing mess.

How should value be defined? It all comes down to whether you’ve increased the wealth of the organization’s shareholders. If you have, you’ve succeeded in creating value; if you haven’t increased that wealth, you haven’t created value. Shareholder value is what it’s all about.

What It Is?and Isn’t

In simplistic terms, every for-profit organization’s goal is to create consistent, profitable growth for the company and a return to the investor that is consistently above what he could earn somewhere else at a similar risk. When you improve that return on investment, you’re creating shareholder value. It is critical to remember that all investments an organization makes should create shareholder value; if they don’t, then the money is better spent elsewhere.

Management’s job is to find the right businesses, strategies and investments that consistently grow the company’s profitably over time. Conceptually this is not difficult to grasp, but there are several factors that make achieving that goal decidedly unclear.

First, there is no single metric you can use on an operational level to measure shareholder value. It is a high-level, multifaceted and long-term concept, and there is no single number you can use to guide decision making. The best way to measure shareholder value is to break it down into a series of smaller-scale metrics that, put together in the right proportions, demonstrate shareholder value. Those smaller metrics are the ones you see being used in varying combinations in an organization’s day-to-day operations?things such as net income, earnings per share and so on.

A company can track its day-to-day process and operational metrics to demonstrate that it is achieving its short-term goals, which, by design and in aggregate, help support its long-term plans for delivering shareholder value. A critical point to remember, though, is that those metrics are directly linked only to the short-term objectives; doing well on them individually says nothing per se about whether the company is creating shareholder value.

That is often where trouble arises, such as what we saw during the dotcom frenzy, when everyone assumed that high stock prices meant a company was delivering real value. Enron also looked great based on stock price and appeared to be growing, but in reality those were empty measures that didn’t reflect shareholder value.

The bottom line: Shareholder value is a long-term notion that’s very complex to compute. Short-term indicators such as revenue, stock price and growth don’t necessarily say anything about shareholder value, especially when you look at them in isolation.

Why IT Matters

IT projects, like those from anywhere else in the organization, need to support the company’s long-term goals. Sometimes you can use short-term objectives to evaluate whether to approve a project, but they must always be in line with your long-term goals. As you’re weighing a number of potential investment alternatives, the trick is to remember that achieving short-term goals is not the whole story?support of long-term goals is much more important. The CIO must understand the company’s strategy and long-term goals, and be able to prioritize projects accordingly.

In general, IT projects should support some combination of four short-term goals: reducing cost, boosting productivity, improving efficiency and increasing customer satisfaction. Very likely, you will find yourself with several potential projects that all promise benefits in one or more of those areas. To decide among them, prioritize based on your understanding of how well each supports the long-term goals of the organization and how well each will ultimately affect shareholder value.

I once witnessed a situation in which that was not done well. The company’s IT department was evaluating an ERP investment for one of its divisions. The project made great sense for the division, but what the decision makers didn’t know was that the company was planning to shut down that division. So they approved the project, spent the money, and the division was shut down a year later.

As is true in so many situations, that never would have happened if there had been perfect sharing of information among divisions and department executives. But it’s a great example of why CIOs need to stay informed about their company’s long-term plans. Having a real understanding of expected returns is also critical. Some companies publish guidelines, such as rules for the minimum expected risk-adjusted returns, that can help CIOs understand how the company wants to balance risk and payoff in the long run in order to deliver shareholder value. When I worked at Occidental Petroleum, we had a matrix of minimum rates of returns broken down by project type and?because we were multinational?by country. It’s also important to consider how much it costs to create any increment of growth. Beyond a certain amount, the growth may not be worth what it costs to create it?it may not, in fact, create shareholder value.

The bottom line here is alignment. Any given project may create incremental return, but it may not be enough to support the company’s long-term goals for creating shareholder value. That’s where the CIO’s understanding is critical.

How to Embrace It

To make shareholder value your guiding light in all investment decisions, make sure you do the following.

Remember that operational metrics support only short-term goals directly. Favorable measurements don’t necessarily mean you’re creating shareholder value.

Understand the organization’s long-term objectives. In some organizations, CIOs are not necessarily informed about long-term goals. If that’s the case at your company, it’s up to you to get proactive. The information won’t come to you?you need to go out and get it. Build relationships with influential senior executives; develop the connections throughout the organization you need to stay informed.

Align the goals of the IT department with those of the organization. If you’re rowing in different directions, you won’t get anywhere. Enough said.

Really understand the concept of ROI, including adjustments for acceptable risk, and know your organization’s minimum expectations.

Evaluate every IT investment with a long-term perspective. Ask how the project will support long-term objectives, and assess the incremental return. If it falls below your company’s cutoff, don’t even put it on the list.

Those are the dos. In this way, a CIO who really understands shareholder value can go beyond evaluating proposed projects to being the one who proactively identifies high-priority needs that haven’t already been brought to the table. That’s how a CIO becomes CEO.

The main caution I’ll end with is to make sure you don’t get seduced by IT for its own sake. During the past 18 months or so, an incredible number of companies have written off huge expenditures?in the $100 million range?in software and consulting for large, integrated systems. These systems were viewed by many as the solution to every company’s problems and adopted without a real understanding of the costs, risks and returns. In the end, they didn’t just fail to create shareholder value?they destroyed it. By asking the right questions, CIOs can prevent that from happening again.