EVA & Strategy
Stern Stewart, April 2000
ABC, Balanced Scorecard & EVA
Stern Stewart, April 1999
TakeAway Points
“In business circles,the term ‘strategic’ seems
to be a synonym for negative present value”
EVA & Strategy , Stern Stewart, April 2000
“New management techniques are based on
economic theory rather than being tied to
accounting frameworks …”
• “Traditional financial measures confuse
accounting anomalies with the underlying
economics of of business”
• “An accountant measures profit earned,
while an economist looks at what could
have been earned”
EVA & Strategy , Stern Stewart, April 2000
ABC, BSC & EVA, Stern Stewart, April 1999
MVA Components
• Invested capital
– Level
– Velocity
• Current operations value (COV)
– Discounted stream of returns (EVA)
– Especially for mature businesses
• Future growth value (FGV)
– Internal / external
– “In the money” or “out of”
– Real Options
EVA & Strategy , Stern Stewart, April 2000
Capital
• Flexible vs. “rigid” (e.g. plants & equipment)
• Tangible vs. intangible (brands, intellectual
capital, organizational “software”, etc)
• Equity vs. debt (which is self-disciplining)
• Low cost vs. matched to needs
EVA & Strategy , Stern Stewart, April 2000
EVA Objectives
• Decentralize ownership & accountability
• Develop strong “business literacy”
…Get all employees speaking the same language
• Confer economic discipline at all levels
…Act like owners
• Institutionalize a high performance culture
EVA & Strategy , Stern Stewart, April 2000
EVA
• Measuring profits after subtracting the expected
return to shareholders (capital charge)
• “Creating sustainable improvement in EVA is
synonymous with increasing shareholder wealth”
• “Switch from managing earnings to managing value”
• A “management system”, not just a metric …
ABC, BSC & EVA, Stern Stewart, April 1999
EVA: Integrated performance measurement,
management, and reward system
• Planning
• Portfolio management
• Decision-making:
strategic, tactical
• Total compensation
EVA & Strategy , Stern Stewart, April 2000
Increasing EVA
• Improve returns on existing capital
Prices, margins, costs, volume
• Grow profitability
Increased sales, new products, new markets
• Harvest underachieving parts
Curtail investment, rationalize, divest, liquidate
• Optimize cost of capital
EVA & Strategy , Stern Stewart, April 2000
Value Creation Profiles
High
Prospects Superstars
FGV %
of MVA
Benchwarmers
Steady
Veterans
Low
Negative
EVA /Capital
EVA & Strategy , Stern Stewart, April 2000
Positive
Traditional Performance Metrics
Traditional Performance Metrics
• “Too blunt” (vs. sharp focus)
• Numerous & complex … not aligned or integrated
• Not systematically tied to value creation
• Often, represent negotiated settlements prone to
understate and underperform potential
• Not easily “internalized” by employees
• Key: balance accuracy & simplicity … get employees
to think and act like owners
EVA & Strategy , Stern Stewart, April 2000
Dysfunctional Behaviors
Influenced by traditional accounting-based performance measures…
• Rampant short-termism
– EPS focus
– End of month, quarter, year
• Underpricing of capital
– Overinvestment (especially mature businesses)
– Misallocations (feed dogs, starve stars)
– Underachievement (below WACC)
• Excessive vertical integration
– Versus outsourcing, partnerships, alliances
• “Cooked” books
– Acquisition accounting, accruals, transaction timing
EVA & Strategy , Stern Stewart, April 2000
Stock Option Downsides
• “Ownership” is beyond most employees sightlines
• Often fail to provide clear and direct linkage
between actions and results
• Shared risk / return desired in bull markets,
discouraging in bear markets
EVA & Strategy , Stern Stewart, April 2000
Other Performance
Management Methodologies
Activity Based Costing (ABC)
• As product and customer mix become more diverse, the
assignment of overheads becomes grossly misleading,
distorting the cost of individual products and services.
• So, ABC is used to identify all activities, direct and indirect, and
allocate the costs associated with these activities more
precisely.
• May (most) ABC systems only capture P&L costs. Should also
be capturing the cost of capital (e.g. more inventory associated
with a product is an economic cost).
• ABC is most useful for operations with high indirect costs
(overhead), complex transfer pricing issues, and shared
processes or facilities.
ABC, BSC & EVA, Stern Stewart, April 1999
Balanced Scorecard
• Translates vision and strategy into objectives
• Typically, 4 broad categories with 2 to 5 objectives each
• Financial & non-financial objectives
• Lagging (e.g. accounting P&L) and leading indictors
(e.g. customer satisfaction)
• Deployment and Alignment* …
Deployment: consistent from top down (vertical)
Alignment: consistent across functions (horizontal)
• Issue: lacks a single focus of accountability
ABC, BSC & EVA, Stern Stewart, April 1999
* Lecture Notes, K.E. Homa, 2001