ATOM AND EVA
Implementing EVA may not be rocket science, but doing it yourself can be tricky.
By Elizabeth Fry

It may not have been the reception G. Bennett Stewart III had been hoping for. At a recent CFO Asia/Economist Conferences roundtable in Bangkok, the founding partner of US consultancy Stern Stewart spoke about Economic Value Added (EVA), the financial metric and management tool that he pioneered. After his speech, Stewart fielded questions from the audience. The attendees, mostly finance managers, seemed a bit riled up, peppering Stewart with questions about the validity of Economic Value Added and Stern Stewart's claim as the keeper of the EVA flame. Later, several finance managers privately questioned the need to hire a consultant when implementing Economic Value Added. Said one finance director at a top-tier Asian company: "These EVA consultants are going to have a tough time here."

The response at the conference was not surprising. While EVA has gained great currency with managers at corporations in the US and Europe, the financial metric has yet to truly catch on in Asia. Many finance managers - anesthetized by years of double-digit corporate growth and huge run ups in share prices - remain oblivious to EVA's central tenet, that capital has a cost. Others question how well a consultant can know their business, particularly in the Asian market, where shareholder value is practically a foreign concept. Still others, intrigued by EVA's capital consciousness - but put off by the capital charges of EVA consultants - have decided to implement the metric on their own.

And in truth, the argument for adopting EVA is pretty compelling. At its heart, Economic Value Added is simple stuff. A company does not return value to shareholders, according to the EVA gospel, unless that company ekes out a profit that exceeds the cost of the capital it takes to run the business. That concept is then turned into a powerful management tool by linking EVA to the compensation packages of managers and workers. EVA backers like to refer to Economic Value Added as "the codification of common sense."

That, of course, has some finance managers in Asia wondering why they should pay consultants for common sense. But management consultants point out that there can be a severe penalty for going solo when adopting EVA. The argument has merit. A solid, well thought-out EVA program has proved to be the engine of recovery for many companies around the world. Consultants like Boston Consulting Group, Ernst & Young, KPMG and Stern Stewart bring a wealth of implementation experience to the table, along with the kind of EVA know-how that most finance managers simply do not possess. By not relying on these specialists, a company could miss a vital component when launching an EVA program and, therefore, not get the full benefit of an EVA implementation.

Those benefits can be substantial. In the ideal, EVA galvanizes managers and workers by introducing a sense of accountability for their actions and, simultaneously, handing them a greater stake in the company's performance. If they help the company increase EVA, they reap full reward. What's more, a fully functioning EVA program can have enormous advantages for CFOs at cash-strapped companies. In Asia, banks tend to offer better terms on debt to companies that demonstrate strong capital management. And EVA's principles of sound capital management have made EVA companies a magnet for value-minded, long-term investors - a sought-after constituency by most Asian companies.

Some Do, Some Don't

Not surprisingly, Stewart warns against companies designing and implementing an EVA program without outside help. To Stewart, a do-it-your-self (DIY) EVA program resembles those airplane kits sold to hobbyists, the ones promising: "Build an airplane in your spare time!" Building the plane is one thing, Stewart argues, flying safely in it is another. While he says companies might achieve some initial benefits from a DIY EVA program, he insists that he has never seen a single in-house implementation that has achieved the focus necessary for EVA to work. Further, Stewart doubts that it's possible to actually change the behavior of managers without bringing in EVA specialists.

And make no mistake, Stewart has his supporters in the region. Singapore Technologies, Singapore Ports and the Manila-based Jolly Bee Foods are all Stern Stewart clients. So, too, is Monsanto Asia Pacific, a division of the US-based life sciences specialist. Robert Paley, the company's Singapore-based CFO, concedes that businesses can get some EVA-type benefits if they simply start charging managers a financing cost for capital employed and paying bonuses based on that calculation. But Paley insists that to get the full benefits of EVA, a company should hire a consultancy. "When the Stern Stewart team comes in they really turn over all the rocks, and there are some things that will come out that companies will never discover on their own," he says. "There may be some business drivers that are influencing the overall result that wouldn't be taken into account with a DIY implementation."

Others aren't so sure. Michael Healy, finance director at First Pacific Company, has discussed a full EVA implementation with a consultancy. So far, he has not been won over. "We're not sure we would get value for money," Healy explains. The First Pac finance director feels the Hong Kong-based conglomerate is achieving its strategic objectives with its own version of EVA. To measure performance, Healy says First Pac uses a mix of financial metrics, including cash flow return over the cost of capital. The acquisitive company's hurdle rate, which includes cost of capital valuations, is 18 percent. The company relied on that model when it recently acquired sizeable stakes in both Indonesian noodle-maker IndoFood and the Philippine Long Distance Telephone Company.

Citic Pacific's Robert Adams also believes that EVA is the right way to judge a company's economic well-being. But the Citic Pacific finance chief is convinced that companies can make progress on their own - as long as senior management buys into the program. "I think we, like many companies, are educated enough to come up with our own model," argues Adams.

Nevertheless, observers note that Citic Pacific - a division of China International Trust and Investment - invests in many projects that won't generate cash on an ongoing basis for some years. A company with a DIY EVA program might become wed to a system that hinders managers' ability to measure and define investment opportunities under these circumstances - a complex problem that EVA consultants have tackled and resolved. Not all CFOs may be able to navigate that minefield. And Adams concedes that, with or without consultants, EVA requires a real corporate commitment to get the full results. "You want intelligent workers and you want them involved, including the salespeople, the procurement director, everybody."

That's not always easy. But David Buckle, CFO at Hindustan Lever, the Mumbai-based subsidiary of Unilever, the Anglo-Dutch maker of food and home care products, says it can be done. While Unilever has created its own value-based management system - called trading contribution measure (TCM) - Buckle says implementing this EVA lookalike was not overly difficult. The key, he says, was getting everyone - from the board to managers and employees - to wholeheartedly embrace the new metric. That task, Buckle argues, falls on the shoulders of senior management, rather than consultants. "There are a number of consultants who can offer value-based management systems, but you still have to get people to understand the concept and think it through," he says. "People have to be taken through what EVA means for decision-making."

Take investments in new business categories. Typically, new business categories are real cash burners, often sucking down capital for years before eventually throwing off profits. EVA offers a method for evaluating such capital expenditures, but it is a very different approach than that offered by earnings-per-share, the most commonly used performance measurement in the world. On sizeable capital-intensive investments, a change in EVA could take years to register. Generating positive EVA, well ... employees could grow old waiting for that. As Buckle implies, it's an enormous leap of faith for managers to hitch their wagon to a new way of thinking - years before they might see any real results. Even then, he points out, EVA may not be the only lens necessary to get a true picture of the value of these investments. "You have to apply judgment," he says. "You have to understand what EVA is telling you and, equally what it is not telling you, about the management of your business."

Gaming the System

While it can be difficult to convince employees of the merits of EVA, it's not difficult to convince shareholders. With an EVA-linked compensation plan, managers must take on both the upside and the downside risk of a business - just like shareholders. This, in turn, makes owners out of managers, and probably explains why the share price of most EVA companies outperforms those of many non-EVA companies.

In fact, DIY implementations often fail to link EVA with compensation. Instead, companies reward managers who make budget or meet operational goals. Stewart argues that such set ups encourage managers to meet expectations - but never surpass them. Research and de-velopment is the perfect example. Rather than treating it as an expense, EVA capitalizes it, with the cost spread out over future years. This is important, Stewart notes, because it allows managers to step up the investment while still holding them accountable for generating long term results. He makes a good point. Managers working solely to meet budget may miss out on money-making opportunities since they have exactly zero latitude to increase their budgets.

Conversely, Stewart warns that managers at many DIY EVA companies quickly learn how to game the bonus system. One way they do this is by increasing their company or division's EVA by reducing the amount of capital they employ. The danger here is that managers avoid the investments that provide long-term corporate growth. Says Stewart: "We have developed a carefully calibrated formula that gives managers a predetermined fixed percent share interest in the current and cumulative increase in EVA," says Stewart. "Thus, managers with a penchant for gaming the system can't manipulate a short-term EVA gain by reducing their capital." Moreover, Stewart claims that companies with DIY plans that lack a purely EVA-based com-pensation scheme won't get the full EVA wallop - they might get 30 percent of the total benefits. Why? "Because you have complicated your system," he says. "Now you're paying for certain other targets, and tradeoffs are simply measured on how they are weighted in bonus plans, rather than them being truly economic."

But Healy doesn't see it that way. First Pacific's managers are rewarded for meeting specific targets that help the company achieve larger strategic goals. Those goals, he says, change. By Healy's lights, that doesn't mean First Pac is juggling too many balls or rewarding the wrong behavior. Last year's emphasis was on cash generation, he notes. The emphasizing seems to have worked, too. First Pac closed its fiscal year with about US$272 million in cash on its books. While that was down about 13 percent from 1997, analysts note the company maintained this fairly strong cash position while managing to retire a whopping US$1.6 billion in debt. Most of the deleveraging came from over US$2.7 billion in asset sales. That's one way to generate cash.

Even Monsanto's Paley is not convinced that a company's entire compensation package should be based on a single metric. "You need balance in the overall goal setting for individuals. It just can't only be EVA," Paley says. "You have to have goals for such things as people development, business positioning, new product intro-duction, and so on." Although Monsanto is a Stern Stewart client, company managers don't rely solely on EVA to shape their decisions. Senior executives also look at return on investment, discounted cash flow, net income and cash flow return on investment when assessing the com-pany's financial per-formance. "There is room for all," Paley says.

Buckle agrees. At Hindustan Lever, senior management is compensated on trading contribution and cash flow measures. But the performance yardsticks for other employees depend on the function they perform. Senior marketing is rated and compensated on meeting market share targets. The company's technology director, on the other hand, is rewarded on achieving health or environmental targets.

Very Sensitive

Such a hybrid of EVA may play the best in Asia. Even then, finance managers at many local companies point out that EVA consultants could have a tough time getting in the door at family-owned and -managed operations. Even publicly traded local companies could be a tough sell. George Chang, the deputy chief executive at Hong Kong-based Dah Chong Hong, says he hasn't adopted a full-scale EVA system because of cultural concerns. "In a Chinese company," Chang explains, "people are very sensitive about compensation." Although Chang likes the EVA concept - he is moving towards a return-on-capital approach to measuring performance - he is not certain that transposing a US-based system onto a Chinese company will work. He also thinks that, although managers at many local operations generally shy away from bringing a stranger into the house, these managers also lack the expertise to reengineer the finance department on their own.

But Jameson Bryan, a partner at Ernst & Young's Hong Kong office, disagrees. While Asian companies have an enormous need for EVA and its cost-of-capital consciousness, Bryan says he is not so sure these companies need help with implementation. "Chinese companies are different," he notes. "Consultants are wrong in thinking they are the only ones who can drive the commitment from the top needed to make these methods work." According to Bryan, if owner-managers decide to make changes in their decision-making methods and compensation systems, the changes get made. Adds Bryan: "If their management team is skilled enough, then it can create something that will work for them."

Nevertheless, some EVA consultants see Asia as their next great market, and are expanding their operations in the region. But some observers say these consultants need to temper their gung-ho, US-bred approach when working in Asia. Somehow, EVA advisors must be able to convince local corporates that they need to change their long-standing methods of doing business - without actually disparaging those long-standing methods. Even then, some CFOs aren't convinced that an EVA revolution is headed to Asia any time soon. "EVA is not going to take over here as it has in the US," says Monsanto's Paley. "In the US, it has become a tribal language."

Elizabeth Fry is a contributor at CFO Asia.