In The Blue Line Imperative: What Managing for Value Really Means, Kevin Kaiser and S. David Young introduce a concept called ‘blue-line management’, an approach in which all decisions of consequence in an organisation are made with one aim: to create value.
Value creation and the ‘blue line’
It has become a truism in business that if value is to be created, a firm must systematically invest in those projects where the expected value of cash coming in is greater than the cash going out, a difference commonly expressed as Net Present Value (NPV). Projects with a positive NPV are value enhancing, while all other projects are value destroying. These values depend entirely on the cash flows expected from the investment in a probabilistic sense, and not on the cash flow forecasts made by managers. To put it another way, all investments have an intrinsic value that exists independently of management beliefs or assumptions.
The failure of confusing intrinsic value with personal estimates of value leads to the serious error of equating price and value. Price is the outcome of a market mechanism, or negotiation, between two or more parties. For any item, from consumer goods to shares of stock, the buyer in a voluntary exchange assigns a value at least as high as the price paid and the seller assigns it a value no greater than the price paid. The value of any company equals the present value of the expected future free cash flows discounted at the opportunity cost of capital and there is absolutely no reason to assume that the price negotiated between a buyer and a seller of this company’s shares is equal to this value.