The first thing Jim Rutledge did when he became CFO of Baldwin Technology Co. in January 2000 was throw out the performance measurement system.
Not that he was shunning the idea of measuring performance. Far from it. The problem was the confusion that surrounded the economic profit program that Baldwin had designed with the help of a consultant, Vanguard Partners. “There was a lot of mysticism around that,” says Rutledge of the value-based program that had been the guiding light for Baldwin’s financial management for three years. Employees had “no crisp understanding” of how their behavior affected the $200 million printing equipment, controls, and accessories maker’s “economic profit”– generally defined as the net operating profit after tax of a company’s businesses, reduced by subtracting a charge for the cost of capital. In particular, Baldwin executives had to make adjustments for such items as transfer pricing to calculate the numbers used to determine, for instance, the size of their incentive compensation.
Adding to its value-metrics problems, returns at the Shelton, Connecticut, company became uneven–whether measured by earnings per share or economic profit–thus slashing the bonus potential. And the difficulties brought on operational changes, including a revamp of product lines and a move toward globalization, along with downsizings and divestitures, that made keeping track of the shareholder-value calculations all the more burdensome. In short, says Rutledge, “Moving all the way to an economic profit model was too much.”
In jettisoning its program, Baldwin was hardly alone. Indeed, between 40 and 50 percent of all companies trying value-based metrics abandon them between the third and fifth year of implementation, according to Jim Knight, a partner at SCA Consulting LLC, which helps companies structure value-based metrics. Among other companies dropping their economic-profit approach, or subordinating it to more-traditional metrics such as earnings or return on capital employed, have been AT&T, J.C. Penney, Tenet Healthcare, and Armstrong Holdings. Some of these used a form of Economic Value Added (EVA), the program trademarked by Stern Stewart & Co., the leader in the economic- profit consulting field.
Many decisions to discontinue value-based measurements are made because plans are “incorrectly designed to begin with, and don’t reflect the business strategy of the companies,” suggests Knight. Stern Stewart, which has emphasized the training of rank-and-file employees recently, says that only about 5 percent of its 200 full-fledged clients have actually discontinued EVA. It acknowledges, though, that a number of companies adopting value-based systems may keep them in name only after failing to implement programs properly–for example, by choosing not to tie compensation to the metrics.
No matter what the exact size of the exodus from shareholder-value metrics–or the reasons for it–questions remain: Does using economic profit help a company deliver on its performance promises over the long term, or does it harvest the low-hanging fruit of cost reductions for more of a one-time boost? Is the bloom off the value-metrics rose when bonuses evaporate? And how can a company boost shareholder value year after year?