This article discusses how to determine which investment option provides the greatest advantage when investment alternatives need to be measured using differing value frameworks?
The locality of the investment often contributes to the criteria by which the investment is measured.
Market conditions in India will impact decisions to invest there, which will be different from market conditions in other countries, such as the U.S.A. or Australia.
Thus, choosing between investments in different markets can be problematic.
Very similarly, investments made in one business unit may be measured differently from investments made in others and investments to support one product suite may also be very different from others.
Until now and under these circumstances the judgement that one is more advantageous than another has relied on specialist opinion admittedly, supported by limited analyses, even though the usage of opinion can introduce significant risk.
What if you could eliminate the risk by analysing your potential investments against the hierarchy of value measures appropriate for each investment but have a common way of measuring which was most advantageous?
The Concept of Relative Business Value
To determine if one alternative is of higher value Kepa Software uses a measure called Total Relative Business Value (RBV) to rank each investment opportunity because business decisions are about choosing the most beneficial solution but always having rational alternatives (Plans b,c,d, etc.).
Conceptually then, to develop a Relative Business Value measure we would need to apply all of the value measures appropriate for each investment and calculate some sort of universal numerical equivalent that equals the relative contribution of that investment to each and all value measures. Then we would need some way of equating Relative Business Value measures made under differing value models.
Historical approaches to investment decision-making principally tested the financial aspects of potential investments, focusing on benefit-cost ratios and other business ratios to determine investment feasibility, and whether selected investments can generate incremental value. This approach generally, but unfortunately, ignored other tangible and intangible characteristics that today collectively constitute “business value”. Such considerations may include safety and risk but increasingly there will be considerations of societal, ecological and reputational impacts.
So we need to have a method of comparing tangible and intangible to determine the optimal set of investments
Multi-criteria Decision Making (MCDM)
Multi-criteria decision making (MCDM) utilises the science of Multi-criteria Decision Analysis (MCDA) to provide a structured approach to making decisions through semi-quantitative analysis to determine the potential contribution to the business (or Relative Business Value). Similar to financial benefit analysis (FBA), otherwise known as Cost Benefit Analysis (CBA), MCDM adds a range of non-financial criteria to the mix in allowing more balanced and customer-focused investments to support the achievement of outcomes and objectives. The Asset Management Peak Council of Australia publication entitled “Asset Management through a Sustainability Lens” recommends a combination of CBA and MCDA.
However, the application of pure MCDM techniques will not allow the direct comparison of results achieved under differing value measure regimes. To do so would require the extension of Multi-criteria Decision Analysis (MCDA) techniques to ensure the equivalence of Relative Business Value scores in these conditions.
With that extension it should not matter what hierarchy of value measures is used to determine Relative Business Value, the relativity of the number will hold so that options considered using differing criteria hierarchies, as would occur when considering investments in differing markets or countries, can be compared – The higher the number, the greater potential contribution to value generation for the business.
The calculation of RBV in this manner would be an extension of the work of Thomas Saaty (Analytic Hierarchy Process, 1978,1980) and Louis Thurstone (Pairwise Comparison, 1927), which has been tested globally for over forty years.
Provided that a reasonable level of care is taken to analyse the investment opportunity for bias (intended or unintended), provided the value measures are reasonable and the processes and people used to develop any assessments of value and suitability are reasonable, decisions made using an extended MCDM RBV calculation will be defendable and could be substantiated to any stakeholder group as rational and robust.
What Does RBV Measure?
The simple answer is that what RBV measures depends on what you want it to measure. Most commercial organisations will usually look for RBV to measure strategic alignment, however increasingly complex business decisions must be measured against a range of value criteria. Please look at the following table for a few examples:
Using APO, value models can be merged, re-structured, and re-calibrated to generate new, more encompassing value models. For example, the United Nations Sustainable development Goals could be merged with a Cost Benefit Analysis, and perhaps also the European Standard for GHG emissions reporting to derive an appropriate (perhaps draft) value model for test market differences, or compare strategic approaches, or to fulfil reporting requirements.
But, in the end, any RBV score developed using an extended RBV calculation, regardless of which value model is applied to the investment opportunity can be directly compared to any other investment opportunity to which another value model has been applied.
This means that it is now possible to support decisions to invest in one market, or business, or product suite, for example, over another by using APO to provide the analyses.
Want to get a broader view of your potential corporate investments? Pick up the phone and talk to the experts at Kepa Software.
