More than a decade ago, Georgia-Pacific Co., in Atlanta, signed up with Stern Stewart & Co. and began measuring financial performance with Economic Value Added. It started making incentive payments to managers based on the EVA numbers. Then, before any thought could be given to extending the program to the rest of the workforce, dissatisfied executives pulled the plug.
Today, it’s a part of Georgia-Pacific lore why the $13 billion maker of pulp, paper, and building products dropped EVA about a year after introducing it. Most managers, says Suzanne McFadden, senior director, corporate planning and development, didn’t understand how the new measure was calculated. More important, they couldn’t figure out themselves how to use EVA as a guide to affect corporate financial results, let alone how to explain it to the rank and file. A diagram of the EVA calculation presented in a one-hour training session looked, adds one consultant, like the wiring pattern for a Boeing 747.
Given all the good press EVA has received, companies might not be blamed for getting the impression that rolling out EVA is as easy as making microwave popcorn. But, in reality, there are many ways to stumble in adopting value-based metrics, whether the Stern Stewart version or other such programs, and in using them to drive corporate planning, budgeting, control, and compensation systems.
Sometimes, the company’s approach to economic profit–essentially, a measurement that subtracts the cost of all capital invested in an enterprise from aftertax net operating earnings–is just designed improperly.
John Donovan, global director of value-based management at Deloitte Consulting, tells of one distribution company that created an economic-profit plan and bonus system, but failed to provide a way to parcel out incentives over time to reward longer-term gains in shareholder value. That damaging short-term emphasis led company managers to fatten their bonus checks by halting investment in new growth, embittering top management so much that it eventually stopped using value-based numbers entirely.
Many corporations say other problems involve the complexity of the new metrics. For some managements, that complexity leads to trouble integrating the economic-profit approach into their enterprise resource planning systems– something that vendors are only now addressing with new software products.
Training the Trainers
Perhaps the greatest challenge, though, is how to popularize the EVA concept within the ranks so that workers and their front-line managers will find it a useful tool. “They need to know what the actionable things are that they can do” to change EVA, says Justin Pettit, a partner at Stern Stewart. Managers help by drawing examples of decision-making within the basic operating levels of the company, but those managers must also learn what kinds of lessons appeal most to their subordinates.
“There’s a lot of behavioral science” in getting the EVA calculation right and making it meaningful to the workforce, comments Pettit. And some behaviors are simply hard to predict.
In fact, according to companies that claim to have had success with EVA, it works well only if the metrics are explained clearly and reinforced frequently among all employees. Often, of course, workers haven’t a clue what terms like “economic profit” mean. “You can’t make it a black box,” says David Young, a professor of accounting at INSEAD, a business school in Fontainebleau, France, who is writing a book on EVA.
Herman Miller Inc., the $1.7 billion Zeeland, Michigan, maker of office furniture, may hold the speed record for an EVA rollout, boasts chief financial officer Brian Walker. But the company gave equal attention to achieving a high level of comprehension among all of its employees when it installed EVA throughout its 7,900-person organization in several stages during 1996. The roll-out strategy, says Walker, was to instruct its own managers–250 of them–first, and put them in charge of the broader training effort. Stern Stewart helped with the high- level instruction, he says, and “really pushed us and made us embrace this whole train-the-trainer approach.”
That tack forced the team leaders, generally not finance people, to study EVA as intensely as teachers expecting a tough class of students. “One of the keys was having nonfinancial people deliver the concepts,” Walker says. Because the trainers were familiar to their teams, the trainees felt comfortable peppering them with questions. “Everybody assumes [the supervisor] is fair game,” he says.
The trainers, who had to teach a two-hour course on “EVA 101” followed six months later by the more-advanced EVA 201, approached the assignment with a certain amount of dread. “The anxiety level went up threefold,” says Dave Guy, vice president, finance. But because the EVA message was delivered from the top down in a cascading succession of trainings, from executive to supervisor to team member, Guy believes a more-substantial knowledge of how the metric works took hold at Herman Miller.
Workers now have precise information on just how to boost their EVA numbers, according to Chris Sanford, an office-panel assembler working in the Zeeland plant. Each dollar saved from replacing a glass-fiber product with a new honeycomb filler, for example, contributes 60 cents to EVA, as does each dollar saved by replacing the wood sheathing on the top of the panel with a cheaper material based on a wood-dust product.
In the past, Sanford says, employees groaned when engineers intervened at the plant level to suggest operational improvements, and worker output tended to slow down at least temporarily in response. Now, when an engineer arrives, employees say, “How can I help you?” according to Sanford. Help, that is, to improve EVA.
“We have everyone buying into this system,” Sanford says. “This drives our bonus. If we’re not participating, we’re not helping ourselves out.”
In fiscal 1998, which ended May 30, they helped themselves out to an extraordinary degree, earning incentives totaling 23.1 percent of their pay because of improvements in the EVA number. That’s up from 14.9 percent in 1996, the last full year of the former non-EVA bonus plan. The year before it installed the incentives, the company had negative EVA of $13.4 million, and a small net profit of $4.4 million.
EVA has shot up steadily since fiscal 1996, when it was $10.3 million, through last year, when it surged past $78.4 million. Net income also has been up each year, but on a slightly less spectacular curve.
One Standard Fits All
One of the longest track records for achieving positive EVA belongs to Briggs & Stratton Corp., the $1.3 billion Milwaukee-based maker of small engines. President John Shiely credits information systems that properly calculate and track measures for individual units, and a tenacious drive to extend compensation based on economic profit down through every level of the enterprise. In more than a decade of using EVA, the company has gone from granting 100 top executives incentives, to paying EVA bonuses to all salaried employees, to giving some type of value-based compensation to all hourly workers.
Spreading the economic-profit approach didn’t come easy. “It replaced a profit-sharing plan we had in place,” says Shiely, “and the preference for most union bargaining groups is for less incentive compensation and more fixed-incentive compensation.” A major EVA selling point for hourly Briggs & Stratton workers: the company’s argument that “it’s the same standard used to compensate the chief executive officer, basically,” Shiely says, noting that “that establishes credibility.” The plan for hourly workers includes some slight modifications requested by the union, he says.
Briggs & Stratton has done plenty of training, much of it by internal consultants. It first gave the EVA classes to 1,100 salaried people in 1994, then added thousands more workers on the front lines. Today, it gives two- to four-hour classroom sessions to all 7,800 employees.
Briggs trainers start by explaining to all employees the company’s strategy for competing in the small-engine manufacturing business. Next, they teach everyone how to calculate EVA and how to boost it in their own work groups. Newsletters and an intranet site reinforce the training by providing a forum for workers to ask questions and by enabling them to simulate potential EVA-increasing moves.
Finding EVA’s Drivers
Shiely, who since 1990 has personally developed material for many training sessions, notes that one of the goals is to show employees precisely what levers must be pulled to boost EVA. “They have to understand what behavior drives value in their organization,” he says, whether that means selling underutilized machines, outsourcing parts production, or collecting receivables more quickly.
To help workers understand the links better, Briggs & Stratton managers identify their own operations’ EVA drivers. At the Ravenna, Michigan, cast-iron foundry, for example, the four major drivers are molding efficiency, uptime, scrap rework, and attendance.
Ed Bednar, vice president and general manager responsible for the Ravenna plant until 1997, and now vice president of the utility engine division, says he focused on the four drivers as he pointed out to workers where the foundry was running well and where it needed improvement. Workers caught on quickly, he notes, especially because EVA triggered bonus payouts of up to 12 percent of their salaries.
In one case, two machine maintenance workers located a jamming problem that involved a magnetic separation device that lifted castings from a conveyor belt as they made their way from the foundry to a cleaning area. The workers suggested bypassing the separator completely through a new conveyor system–not only to eliminate the jamming, but to allow the sale of the separator, reducing capital employed by getting the equipment off the company’s books.
Whether for production-line workers or managers, says Bednar, the EVA emphasis “has forced us to continuously evaluate the investments that we’re making in our business, making sure we’re spending money in the right places.”
Briggs & Stratton has beaten its cost of capital routinely in recent years, but last year it scored more than a threefold jump in EVA. During the same period, net income rose a more-modest 15 percent.
Complicate It, And Lose Them
At Georgia-Pacific, which dropped EVA years ago, the early trial with economic profit wasn’t for naught. In fact, the company reintroduced EVA in 1995. This time, the company understood that support from chairman and CEO A.D. “Pete” Correll, and the linking of performance to pay–necessary though these are–wouldn’t be enough to make the metric work.
Executives had to work harder to bring understanding of EVA down to workers on the factory floor. “The further you complicate it, the more you’re going to lose people,” says senior director Suzanne McFadden, who, along with CFO John McGovern, served as architect of the current program.
Managers kept the calculation simple and understandable, and talked up EVA in every newsletter and company event. The mantra was, “train, train, train.”
Georgia-Pacific hired Stephen Timme and Christine Williams-Timme, financial educators at FinListics Solutions Inc., in Dunwoody, Georgia, to instruct more than 1,500 people in 14 divisions, including 25 mills, in EVA concepts. The two trainers dedicated themselves to finding ways to keep the measurement game interesting to nonfinance people–a task that is increasingly on the front burner at companies trying to install EVA.
Georgia-Pacific and other building-products manufacturers have suffered since the glory days of the mid-1990s, when prices soared and mills ran at near capacity. The company produced a slight negative EVA in 1996 and 1997, and didn’t publish aggregate economic-profit figures last year, noting that it had split in two and issued shares in separately traded Georgia-Pacific Group and The Timber Co. entities.
But in several divisions at Georgia-Pacific, this second incarnation of EVA has made a substantial difference, leading employees, for example, to propose various cost-saving measures that benefited both the “traditional” bottom line and the EVA numbers that help determine their bonuses. Still, progress in building worker understanding has been somewhat uneven. While manufacturing groups with profit-and-loss responsibility put together EVA numbers fairly easily, support groups often have had to invent ways to calculate a plausible EVA for their operations.
Failing the Laugh Test
Susan Moore, the vice president for environmental affairs, says it took two years, for example, to figure out how to submit defensible numbers for her department to Correll. The first year, the 60 people in her group calculated EVA from both ongoing and proposed projects. They came up with an EVA figure of $550 million– which was essentially an aggregation of all cost savings.
The number, Moore notes ruefully, “did not pass the laugh test.” The EVA figure was a whopping 50 percent of the whole corporation’s net income that year, a preposterous sum for a single staff department. Perhaps, suggested the chief executive sarcastically, Georgia-Pacific should change its entire business to environmental affairs. Moore and her people went back to the drawing board and reworked their assumptions, calculating EVA as a negotiated share of gains from environmental efforts in collaboration with the company’s mills. The unrelenting focus on EVA, Moore says, has brought the group around to a new understanding: A staff group can quantify the business value of its services.
Despite the negative EVA results, progress is being made on the value-based front, says Moore. “We are thinking more clearly, and we are prioritizing our projects,” she says, adding that the review of EVA numbers allows employees to “better appreciate the economics of what they do.”
An example is in the use of consultants for certain work–such as the writing of complex permits–that could be done in-house with a better EVA return. After taking that action in 1996, the company brought $600,000 of consulting work back in-house, twice its goal for the year. Last year, it replaced $800,000 of the outside consulting work.
One EVA-inspired engineer in Moore’s department, seeking to cut expenses for waste disposal, developed a new process to dry plant waste and burn it. The process required no capital; it saved $120,000. Far from getting a chuckle from Correll, this time the engineer got a letter of praise–and a bigger bonus.
Bill Birchard, a CFO contributing editor, is co-author of the recently published book Counting What Counts (Perseus Books).
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AN ASSIST FROM SOFTWARE?
Some products may help bring economic profit to the troops.
What financial manager wouldn’t want to show front-line supervisors a list of activities that create or destroy value? Or link shop-floor workers’ results directly to the bonus system? Or give team leaders computer tools for simulating potential value-boosting process changes?
But despite the flood of accounting software, companies using Economic Value Added (EVA) or other economic-profit measurement systems generally haven’t gotten much help from off-the-shelf applications providing these capabilities.
With the potential market so large, vendors are certainly working on it. But they are largely playing catch-up. Lawson Software says it has shipped a “strategic ledger,” yielding some shop-floor-level economic-profit data already. SAP says it has begun shipping SAP Strategic Enterprise Management software (SEM), which offers some economic-profit capabilities systemwide. PeopleSoft plans to ship a “workbench” for its Enterprise Performance Management software in December. And Oracle Corp. is looking to early 2000 for the first shipment of a module for its SEM software.
Why the slow entry to market? Calculating EVA properly on old software and databases is no cinch. Rather than simply extracting information from the general ledger, software programs must massage the data to calculate net operating profit after tax, or NOPAT, and make at least a half-dozen adjustments that can include the capitalizing of research and development. Arriving at the appropriate cost of capital, after figuring out the amount of capital employed, may be equally tricky.
“None [of the vendors] is yet providing an effective way to provide the EVA data,” says Al Ehrbar, senior vice president at Stern Stewart & Co., which markets the Economic Value Added version of economic profit. He maintains that the vendors are having trouble translating operating numbers into company-specific definitions of NOPAT and applying the appropriate capital charge, for one thing. Still, a number of vendors are angling to negotiate deals with Stern Stewart to be providers of EVA-related products, he says.
The problem of finding the right ways to generate accurate figures for a company has many solutions. These include manipulating the general ledger, drawing from activity-based-costing calculations, converting to cash-basis accounting, or creating a separate “shadow” ledger of economic-profit data. Lawson, for example, takes the shadow approach. Lawson clients get two clean sets of data, one for traditional reporting that regulators require, and one for management accounting.
If the “vaporware” of more-advanced solutions can turn into software, some firms think they may be able to give new power to the front lines. Team leaders in manufacturing would compare online the economic profit or cost of longer production runs and carrying extra inventory. Salespeople would calculate, by customer, the economic cost of discounts and generous sales terms. And product managers would tally the economic profit of each product.–B.B.