|Book Review: Value Sweep|
Value Sweep: Mapping Corporate Growth Opportunities
Written by: Martha Amram. Boston, MA: Harvard Business School Press, 2002. 285+xiii pages.
Value Sweep will be helpful to managers responsible for discovering or deciding on the economic value of a new product idea. Watching these managers' struggles and frustrations helped shape Martha Amram's approach to valuation. Her approach is first to benchmark and to compare the value of growth opportunities. The next step looks for “an alignment between private assets laden with growth opportunities and financial market valuations” (p. 12). Finally, the approach replaces complex calculations for such alignment with simple and transparent calculation methods.
Amram states, “This book is written for managers who don't want to be valuation experts. … Readers of this book share a bias toward action; they have jobs that help to nourish and grow new products, new markets, and new companies” (p. viii). “The goal is to integrate the language, image, and process of valuation into everyday business life. Simple spreadsheets—think back-of-the-envelope—are the right level of software for most valuations. … A manager should be able to calculate his or her own answers” (p. 8).
Chapter 1 sets the stage for the balance of the book. It states that most current valuation toolkits fail to value growth satisfactorily. This outcome may be the result of having tools in the kit that don't match the features of the growth opportunity. Or it may be that results of the valuation are complex and easily are misunderstood by decision-makers. The author develops a method to value growth opportunities based on valuation templates. Her intent is to make these templates easy to use, yet rigorous and credible. It is an approach to valuation that leads to the ability to compare, on one map of value, growth opportunities as varied as current product expansion, new products, R&D, licensing, and venture capital.
As outlined in chapter 2, cash-needy growth characterizes most growth opportunities. These opportunities may need years of investment before earning a satisfactory return. Traditional valuation tools, based on near-term cash flow and straight-line extrapolations, break down when applied to such opportunities. Chapter 2 defines two kinds of risks associated with growth opportunities. Private risks are those uncertainties unique to a specific growth opportunity. Market-priced risks reflect uncertainties about the cost of capital in the financial markets. Private risks and market-priced risks require different valuation tools.
After chapters 1 and 2, the author divides the book into four parts. The chapters in part I, “Expanding the Toolkit,” describe specific valuation tools, their strengths, and their weaknesses. The tools are discounted cash flow (DCF), real options, and decision analysis. Some valuation analysts may break down a growth opportunity into a DCF part, a real options part, and a decision-analysis part and may match each part to the proper tool.
While DCF is a workhorse valuation tool, it does not value fast-growing opportunities reliably. It omits contingent decisions about investments; its embedded strategy is “straight ahead.” The real-options valuation tool applies financial option pricing models to real (nonfinancial) assets. In Amram's opinion the real options tool suffers from what she calls the “second date problem.”…“It's great as the subject for a workshop or first project, but real options fails to take off inside the company. There's no second date!” (p. xi).
Decision analysis is, in Amram's opinion, the best tool for showing the value outcomes of private risk. Typically, private risk triggers the most important contingent decisions in a growth opportunity. Amram cautions the reader to be alert to two issues when employing this tool. The first is that new users of decision analysis confuse decisions and outcomes. Decisions are moments of choice; outcomes are uncertain events managers cannot change. The second issue is that managerial apprehensions run high when focused on risky investment decisions. To address these realities, seasoned analysts develop ways for surfacing alternatives and for building consensus.
The first three chapters in part II, “Valuing Growth,” show how to build and to use valuation templates. Examples of templates in this book can be laid out on single spreadsheet screen. They were built employing the toolkit and economic value data from past transactions in the relevant industry or business sector. They are used to help tell the story behind each project, to point out where the risks are, and to state how sustainable growth will be achieved.
The first valuation template built in the book will be of interest to new products management. It deals with valuation of the seven phases of pharmaceutical drug development from Discovery through Launch (p. 87, Table 6-1). Another interesting template is one tailored to quantify the new product expectations of Procter & Gamble (P&G implied in the financial market valuations in January 2000 and March 2001 (p. 207, Table 13-1).
An essential part of each valuation template comes in the last two parts. There the analyst must answer each of the following two statements: (1) The path to sustainable growth is…; and (2) A pessimist would say…? For the P&G template, Amram completed the sustainable growth statement to read, “Companies always have growth premiums that are greater than a valuations model can explain. We just need to put our heads down and execute” (p. 207). Her completed pessimist statement reads, “This is a recipe for disaster. Free cash flow is negative before the costs of new products are added. This picture doesn't add up” (p. 207).
Part III, “Across the Sweep of Value,” applies the toolkit and templates to a selection of growth opportunities facing a business. Amram also addresses the question, “Why do valuation tools fail?” in chapter 12, “Selecting the Investment.” Sometimes it is because the opportunity contains too many assumptions, too many poorly defined parts, and too much risk. However, as seasoned practitioners will testify, much of the time valuation tools fail because underneath a product idea's complexity, there is just not much value; there is no long-term, sustainable competitive advantage.
“Epilogue,” part IV of the book, contains two chapters. The first is about leading growth projects and discusses how to frame growth ideas and how to bring a big-picture perspective to the framing. “Each is a soft issue, yet critically important. For example without that one person or small team, there is no sparkle, no catalyst, and no growth opportunity” (p. 223). The last chapter is a quick review of the book.
Following part IV is an appendix containing several growth lookup tables and tables for estimating volatility. Endnotes with Amram's comments follow a glossary containing a useful vocabulary for growth opportunities. Updates for both the appendix and the glossary are available as downloads at http://www.valuesweep.com.
This book is clear and concise. In each chapter Amram uses the “tell them what you are going to tell them, tell them, and then tell them what you told them” technique of presentation. On my new products bookshelf, only two other books view NPD through a similar economic profit lens though with fewer examples and tools than Amram uses (Doyle, 2000; Moore and Pressemier, 1993). This book joins those two and a book I have used for the past 10 years as references for a value-based management (VBM) approach for day-to-day management that uses the principle “cash flows drive value.” (McTaggart, Kontes, and Mankins, 1994)
Readers of this book will be equipped better to address two critical issues in current new products management. The first issue is how to deal with the ideas and language of VBM, which came into many businesses over the past two decades through initiatives at the executive committee and board level. Some of this emphasis on calculating and maximizing the economic profit of strategic decisions is flowing over into product development and management. Amram's book can help raise practitioners' comfort level with emerging valuation tools and with VBM theory and practice. The second critical issue is to increase the commercial success rate of new product ideas developed and launched and to do it with the same or fewer assets. In development steps downstream from the front end, productivity is high in well-managed firms. Using improved valuation methods to increase productivity in the front-end steps is an arena ripe for exploitation. And, as Amram remarks, “People and financial resources gravitate toward growth opportunities with credible and well-understood value propositions” (p. viii).
Despite clear writing and a practical approach, this book will not be a quick read for practitioners and decision-makers interested in trying out Amram's approach to valuing growth. It is not written either as a textbook or as a reference to be kept over the years. It is however, for the interested reader, a reliable communiqué from the front lines of the growing effort to apply emerging valuation tools to practical applications.