Metrics of ValueReidar Bratvold

Somik Raha

Brushing your teeth and Values

SYSTEMIC VALUE # of times brushed

PRACTICAL VALUE Dental Hygiene

INTRINSIC VALUE Personal well-being

“Everything that can be counted does not necessarily count;

everything that counts cannot necessarily be counted.”

—Einstein

“What can be counted does not really count; What counts cannot really be counted.”

–Jonathan Hall, VP Finance & Strategy, Walmart

“Key Performance Indicators (KPIs) are not measures of SVC … they are measures of

things that drive SVC”

Metrics are not “measures” of value. They are systems that drive action toward value creation.

Our ultimate goal is not valuation but value creation.

Value is created (or destroyed) through our actions (decisions).

The purpose of a metric is to help us rank alternatives, and not to calculate some “true value”

Metrics are ultimately systems we create

Question: Are the metrics we use driving desirable or undesirable action?

GOAL: Capture community wisdom around metrics

Let’s look at some examples

But first, a caveat…

You may or may not agree with the examples

If some of these interest you, you can do a table discussion on it

Christopher Alexander

Using Patterns to capture community wisdom

A book that rocked two worlds

Pattern

“Each pattern describes a problem which occurs over and over again in our environment, and then describes the core of the solution to that problem, in such a way that you can use this solution a million times over, without ever doing it

the same way twice.”

“What is a design pattern?” from Design Patterns: Elements of Reusable Object-Oriented Software by Gamma et al., 1995

Anti-Pattern

An anti-pattern (or antipattern) is a common response to a recurring problem that is usually ineffective and often highly

counterproductive

ANTI-­‐PATTERN  Combined  Risk-­‐Time  Preferences

What:  Capture  risk  and  .me-­‐preference  in  discount  rate  

Descrip:on:  Use  capital  asset  pricing  model  (CAPM)  to  calculate  WACC.  

Reason  this  is  undesirable:  Time  and  risk-­‐preference  get  conflated.  Conversa.ons  around  uncertainty  become  extremely  complicated,  and  are  therefore  avoided.  

Example:  Financial  models  consistently  avoid  conversa.ons  on  uncertainty  by  reliance  on  models  that  automa.cally  calculated  betas  

Related  Pa?ern:  Separated  Preferences

PATTERN  Separated  Risk-­‐Time  Preferences

Problem:  When  risk  and  .me-­‐preference  are  combined  in  the  discount  rate,  conversa.ons  around  uncertainty  become  incredibly  difficult  and  suffer  from  lack  of  clarity.  

Solu:on:  Use  discount  rate  only  to  capture  .me-­‐preference  and  risk-­‐aItude  to  capture  risk-­‐tolerance.  

Reason  this  is  desirable:  Time-­‐preference  is  about  how  much  we  value  future  money  today,  whereas  risk-­‐tolerance  is  about  how  much  uncertainty  we  can  tolerate.  These  are  two  separate  conversa.ons  that  we  know  how  to  conduct  with  clarity.  

Example:  …  

Related  An:-­‐Pa?ern:  Combined  Risk-­‐Time  preferences

ANTI-­‐PATTERN  Discounted  Cashflow  (DCF)  Ranking

What:  Opportuni.es  are  ranked  by  their  DCF  

Reason  this  is  undesirable:  DCF  as  a  sole  metric  of  comparing  two  deals  is  problema.c  as  it  has  no  no.on  of  uncertainty  in  it.  This  oNen  results  in  a  misuse  of  the  discount  rate  to  (ineffec.vely)  incorporate  uncertainty.  

Related  Pa?ern:  PCF  Ranking

PATTERN  Probability-­‐weighted  Cash  Flow  Ranking

Problem:  DCF  does  not  adequately  incorporate  our  thoughts  on  uncertainty.  

Solu:on:  Weight  DCF  with  our  assessments  of  probability  to  produce  a  PCF-­‐ranking.  

Related  An:-­‐pa?ern:  DCF  Ranking But wait - it’s not so simple! Just using PCF is problematic. It needs

to be situated in a context of patterns that clarify preference

metrics.

List metrics that you’ve seen driving counterproductive behavior in a context

METRIC: Discounted Cash Flow CONTEXT: Ranking Business Decisions

DCF as a sole metric of comparing two deals is problematic as it has no notion of uncertainty in it and it is often based on Combined Risk-Time Preferences. This often results in a misuse of the discount rate to (ineffectively) incorporate

risk attitude.

REIDAR + SOMIK

Story

example

Your name(s)

List metrics that you’ve seen driving useful behavior in a context

METRIC: Probability-weighted Discounted Cash Flow

CONTEXT: Ranking Business Decisions

By using Separated Risk-Time Preferences, we are able to drive good conversations around time and risk-preference, while at the same addressing uncertainty in a clear manner.

REIDAR + SOMIK

Story

example

Your name(s)

List metrics that you’ve seen as somewhat neutral (neither helpful nor harmful) in a context

METRIC: CONTEXT:

Story

Your name(s)

example

Please start your reflection writing (5 mins)

METRIC: Discounted Cash Flow CONTEXT: Ranking Business Decisions

DCF as a sole metric of comparing two deals is problematic as it has no notion of uncertainty in it and it is often based on Combined Risk-Time Preferences. This

often results in a misuse of the discount rate to (ineffectively) incorporate risk attitude.

REIDAR + SOMIK

METRIC: Probability-weighted Discounted Cash Flow

CONTEXT: Ranking Business Decisions

By using Separated Risk-Time Preferences, we are able to drive good conversations around time and risk-preference, while at

the same addressing uncertainty in a clear manner.

REIDAR + SOMIK

METRIC: CONTEXT:

Identify contexts of interestArea of Interest Table Leader

Financial Steve BeggAdvertising Elisabeth Browne

Risk Management ChrisOperational Christa

Non-profit Victor Health Kwon Safety George

Personal Elisabeth BrowneCulture Change Jim Driscoll

Environment Laura Rankings Robyn Oil & Gas EricBusiness Carl

Find Your TableTable leaders, take your seats

Table leaders write down in bold on the flipchart the context you are anchoring

Everyone else walk over to the table you want to be a part of.

Only as many participants as there are chairs.

Share your cards and discuss. Make new cards as necessary.

Summarize your Discussion

Metric Discount Rate

Discounted CashFlow …

USEFUL Story of context

Capture Time

Preferences

Input to PCF-Ranking of alternatives

…

NEUTRAL Story of context … … …

COUNTER-PRODUCTIVE

Story of context

Combined Risk-Time

Preferences

DCF-Ranking of

alternatives…

Take 5 mins

Consolidation

Table leaders paste your posters on the wall and consolidate columns across posters - take 5 minutes.

Everyone else - think of other metrics/contexts that have been sparked in your mind from these discussions and

make more cards. Take 5 minutes.

Review

Let’s take 10 minutes to review

What did we learn?

Let’s take 5 minutes to share

Everyone else - walk over and read everyone’s cards. If a context is missing, add your own card to it. Take 10

minutes. e.g. you see a red card, where you think the metric has good uses, please

make your green card and stick it up; and vice-versa

Review stories

Please walk over and read everyone’s cards. If a context is missing, add your own card to it.

e.g. you see a red card, where you think the metric has good uses, please make your green card and stick it up; and vice-versa

Appendix

You can use images to summarize wisdom

Net Cash Flow (NCF)

Ignores time-value of

money

Harder to build on than

NPV

“Cash is king” - planning of cashflow

Discounted Cash Flow

Use

inst

ead

reason this is a pattern

reason this is an anti-pattern

reason this is an anti-pattern

Example: Light on Two Sides of a Room

Possible Patterns and Anti-Patterns on Metrics

You may or may not agree

These are shown as examples

If some of these interest you, you can do a table discussion on it