The consultant looked at the confused faces all around him, especially the concerned look on the chief executive officer’s face, and slowly began his address:
“I know that all of you are wondering what really happened here. Should the value of the firm have gone up by more than $20 million because of all the equity created here? Or is it that the net value created is just $20 million and there is actually less credit to go around than is being claimed? You would perhaps also wonder about where the credit really belongs if the second scenario is indeed true. In reality, where did we really create the equity? All of these are fair questions, and I will try to answer them as best as I can.
“Let me begin with the bad news. The total equity created is actually only $20 million. Because all of us were connected with this value creation, each one of us unknowingly claimed all of it. That led to double counting, triple counting, and so on and gave the impression that value was created independently in each domain and should be added up. But, realistically speaking, we collectively created that value and should not each claim full credit for it.
“Naturally, the next question is to whom the credit belongs. In order to answer this question, we should ask ourselves whether we made the decision that led to value creation or if we were beneficiaries of someone else’s decision. From my vantage point, there are two critical decisions here. The first is the marketing vice president’s decision to change the packaging of the flagship brand. The change in the brand’s fortune is directly linked to this decision. To that extent, the packaging decision holds equity to the tune of $20 million. The fact that customers are now more valuable is a consequence of this decision and not an independent event. Similarly, the fact that the brand is more valuable today is also a consequence of the same decision. In other words, both customer equity and brand equity were beneficiaries of the decision to change packaging. The true residence of equity is in the packaging decision. Therefore, the credit for value creation should go to the new vice president of marketing.
“However, there is one caveat, and this brings me to the second critical decision. I would be sympathetic to a claim from the vice president of human resources that the decision to change the packaging design was a consequence of her decision to alter the hiring policy and recruit from outside the industry. In other words, the equity really resides in her hiring decision, not in the packaging decision made by the newly hired vice president of marketing. There is some truth to that. However, another way to look at this issue is to state that the new hiring policy possibly increased the likelihood of good decisions. However, the vice president of human resources did not make the specific decision that led to value creation. In other words, her decision neither directly changed the stream of future cash flows for the company by enhancing revenues or reducing costs, nor reduced the size of the assets deployed by the company. To that extent, the equity resides primarily in the packaging decision. However, because the change in the hiring policy increased the odds of a good, value-enhancing decision, such as the actual packaging decision, perhaps some credit can be transferred to human resources. Over time, if we see a consistent linkage between the change in hiring policy and value creation, we will acknowledge hiring as a strategic fulcrum and transfer decision equity accordingly. In any event, the equity resides in one or perhaps two decisions, and the remaining entities are merely its beneficiaries.
“Finally, from a learning perspective, we discovered that product packaging is one of the key strategic fulcrums of our business. More importantly, we learned how to connect decisions to their ultimate outcomes and did not get mired in trying to improve the value of an intermediate metric. We also learned the cross-functional underpinnings of the effects of good decisions. To that extent, whether accidentally or deliberately, we took a first step toward becoming more integrated on the one hand and paradigm free on the other. That is not to say that we are now heading toward chaos just because we are beginning to abandon our long-standing mental models. On the contrary, we just discovered perhaps our first strategic fulcrum from perhaps our first strategic flowprint. If we continue down this path of verification-based management, we will ultimately build our own repository of actions that work and discover strategic fulcrums that matter in our business. This new knowledge base will be data driven, verification based, and unique to our company. We can slowly begin to leverage this accumulated knowledge to speed up our decision making, learn to discard weak options, and quickly converge on strong actions that are likely to work. In other words, we will ultimately build value for this firm by successively taking actions that have high decision equity.”