How Should We Measure Value?

There are several approaches to answering this question. One methodology that speaks in "CEO language" is the economic value added (EVA) and market value added (MVA) procedures developed and popularized by the financial consulting firm, Stern Stewart & Company. In simple terms, this methodology requires an analysis of the firm's cost of capital for any new investment (e.g., business line, acquisition, assets) and the true economic gain (in the case of EVA) or the gain in stock market capitalization (MVA) attributable to that investment. Today, MVA is the preferred model if the company's valuation can be measured reliably. Prudent investments have a MVA that is greater than the cost of capital that the firm must expend to make that investment.

One of the difficulties of applying MVA to this field is that project management does not always directly and exclusively contribute to a company's market capitalization (as in the case of companies like Hewlett-Packard). Also, MVA is a very meticulous procedure, where capital costs must be amortized and pooled costs distributed to the appropriate business unit or project.

Benefit/Cost (B/C) analysis is another methodology that has been used for project management investment analysis in the past (Knutson 1999). However, it is largely discounted these days because of conceptual flaws. For instance, when comparing multiple projects, there is ambiguity over whether to select the project with a superior B/C ratio or perhaps another project with a greater B/C difference. Another problem is that B/C comparisons must be discounted for the time value of money, and it is easy to hide the discounting factor. Finally, B/C analysis has acquired a stigma because it has occasionally been used to improperly legitimize the quantification of qualitative factors (Riggs 1984).

Others have suggested balancing tangible and intangible metrics to appraise project management value (Crawford and Pennypacker 2000). They contend that a mix of financial and non-financial measures allow companies to track the metrics that matter most to themselves. Unfortunately, from the standpoint of shareholders, allowing managers to pick metrics that best suit them, particularly non-financial, may be the equivalent of allowing "the fox to watch the henhouse." Organizations must exercise caution when measuring value with non-financial measures. The use of non-financial measures can be disadvantageous because multiple measurements can be time consuming and the cost of measurement greater than the benefits. Bureaucratic measurement policy may degenerate into practices that add little value to the bottom line resulting in "paralysis by analysis." Additionally, unlike accounting measures, non-financial metrics have no common denominator, and thus comparisons between other companies (and even different business units within one company) may be arbitrary. This, in turn, will lead to a lack of statistical reliability. Lastly, while financial measures alone may not paint a complete picture of management performance, a scorecard system with an overabundance of measures can dilute the effects of the measurement process (Ittner 2000).

Crawford and Pennypacker also fail to explain how balanced measures are linked to shareholder value. Combining tangible and intangible measures only works if its implementation moves beyond an ad-hoc collection of financial and non-financial measures (Ampuero 1998). The purpose of a scorecard is to map an organization's overall strategy, comparing individual units on equal footing where financial measures alone may not tell the entire story. However, the strategy must be implemented with a cause-and-effect model that links measures to shareholder value, through a vehicle such as ROI or EVA. In other words, it is not productive to simply measure metrics regarding customer satisfaction, employee satisfaction, quality, EVA, and so forth, but to join each metric in a causal financial relationship that determines how shareholder value is being created or destroyed, a point overlooked in recent applications of balanced measures to management (Kaplan 1996; Kenney).

Lastly, by using non-financial measures to determine value, organizations run the additional risk of reporting values that seem fuzzy to institutional lenders, analysts, and shareholders. Accurate financial reporting is crucial for companies because their cost of capital is tightly linked to the quality of their measurement—the better and more trustworthy the measurement of value, the lower the cost of capital for that organization because of reduced risk to investors. Banks and investors may experience difficulty determining the cost of capital for organizations that use non-financial measures to determine value, but the aforementioned stakeholders can easily grasp rational measures of value such as the ROI. If organizations as a whole use financial measures to report the value of the corporation, then project management should follow suit (Tarsala 2001; Larcker 1999).