Council Post: Looking At Strategic Management Through A Financial Model Lens

CEO of Paul M. Wendee & Associates, LLC; Publisher of the Intrinsic Value Wealth Report Newsletter; Founder of the Value Driver Institute.

Defining strategic management has never been easy. I recently confronted this problem again while teaching two courses on strategic management this past summer. I have taught strategic management many times over the years at several universities. It has always been challenging to define and describe strategic management in a teaching environment because there are so many facets to it.

As Robert S. Kaplan and David P. Norton observed having worked with many organizations over the years and in their own attempt to define strategic management, “A generally accepted way to describe strategy did not exist.” They came up with a concept called Strategy Maps to help describe strategy and strategic management. I have been using a related concept: a financial model to explore the shareholder value creation process in order to now explore strategic management. I call my concept the Value Creation Process Chart. This model is based on discounted cash flow analysis.

The first thing one must consider is whether a financial model is appropriate for studying, defining and describing strategy and strategic management. I believe a financial model is appropriate for exploring strategic management, as it is the creation of shareholder value, which is the goal of working with the chart. That is also the goal of any strategic management process. Many other scholars advocate this point as well, including Eugene F. Brigham, Michael C. Ehrhardt and Aswath Damodaran.

Even for those who believe that corporate managers should focus on creating value for all stakeholders — even customers and citizens, not just shareholders — a financial model is still an appropriate model to use. The basic idea behind the Value Creation Process Chart is that managers use management tools to: (1) explore the enterprise’s environment; (2) plan strategy; and (3) solve specific problems or plan to reach specific goals. Accordingly, managers consider the various value drivers that are available to them. Managers then use management tools to help identify and consider the appropriate value drivers to create shareholder value. Management tools are also used to implement the general strategies, the problem-solving strategies and value creation strategies identified in the review of the shareholder value creation process.

This process continues as one “works up the value driver chain.” The shareholder value that has been created by management’s efforts is determined (measured) by taking the free cash flows that are generated by the enterprise and discounting those cash flows at an appropriate discount rate. The result of this calculation is what is known as intrinsic value. Berkshire Hathaway chairman and well-known investor Warren Buffett describes intrinsic value as follows: “Intrinsic value is an all-important concept that offers the only logical approach to evaluating the relative attractiveness of investments and businesses. Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life.”

While the discussion in this article describes the shareholder value creation process, which as mentioned is a financial model concept, it is the essence of strategic management as well. Each of the components that are normally considered in strategic management studies is also incorporated in some way in the value creation process.

The Strategic Planning and Management Flowchart provides a general framework for creating shareholder value, which, as discussed, is the ultimate aim of strategic management. The Value Creation Process Chart is shown as a component of the Strategic Planning and Management Flowchart. Other models such as Competitive Advantage, the Balanced Scorecard and Strategy Maps can also be incorporated into this framework. This general framework can be used by students, entrepreneurs and business executives as a model for strategic management to create shareholder value in their organizations.

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