March 2003 | R Radhakrishnan
Over time the Tata group has imbibed revolutionary technologies, new business models, innovative human resource strategies, and better accounting methods to build a dynamic conglomerate
But it has not been smooth sailing for the group. One of the main problems it faced was the issue of how to measure the performance of its 80 companies spread over seven sectors. The performance-review systems at the centre and at individual companies needed to focus on creating value for shareholder. "We were getting a lot of numbers (with the frameworks we were using), but traditional performance-measurement metrics do not capture shareholder wealth creation explicitly," says Koushik Chatterjee, general manager, corporate finance, in the Group Executive Office, and facilitator of the group-wide EVA implementation programme.
Enter economic value added, or EVA. Pioneered by Stern Stewart and Co, a US-based management consultancy firm, EVA defined as return on invested capital (ROIC) minus an appropriate charge for the cost of capital invested in an enterprise is a financial performance measure that captures the economic value added of an enterprise.
Although the concept is easy to grasp, the implementation of EVA is a different matter. It forces people to think differently. "It is all about change management and getting a much sharper focus," says Tej Pavan Gandhok, country manager for India at Stern Stewart. "In a conventional profit and loss-based setup, people juggle with revenues and costs; in an EVA setup, they have to juggle the balance sheet, available resources, and long- and short-term considerations." A tall but necessary order.
Tata Sons, the group holding company, decided to retain Stern Stewart to develop and implement an EVA-based performance-management system. Before getting on with it, though, the firm had to overcome some reservations. The first criticism was that EVA with its emphasis on return on investment (ROI) as a measure of performance restricts growth. "People were used to and comfortable with the ROI kind of framework; to bring in another metric was difficult initially," says Mr Chatterjee. "They thought EVA would restrict further capital growth in the company."
Secure the future
EVA tackles this problem by focusing on incremental value creation. Mr Chatterjee adds, "Many people tend to use EVA as a stock measure instead of as a flow measure across the plan period. Value creation is not so much about being EVA-negative or EVA-positive. Companies need to chart out the EVA-improvement trajectory for the forecast period and rigorously follow the target. That is the key to sustainable value creation." Suppose we target Rs100 crore of value increase every year and we pursue it rigorously, at the end of five years the absolute value will increase by Rs500 crore. But if we target a jump from 5 per cent to +1 per cent of EVA at one go, without carefully understanding what is needed to make that happen, in most cases it is not going to work.
But wouldn't this exacerbate shareholder anxiety? The answer is no. "Shareholders look at the value-creating trends of a company," asserts Mr Chatterjee. "As long as the company orients itself to the right strategy and delivers incremental value on a year-on-year basis, the shareholder is most likely to be content with the company's performance in the long term."
EVA recognises that in capital-intensive industries returns cannot be expected in a short time. The initial EVA-negative years will be built into the EVA capital budgeting framework, as is the year in which the company is scheduled to go EVA-positive. If the company fails to achieve the desired level of performance, as forecasted in the capital-approval process, it will be an accountability issue.
The analysis done for some Tata companies where EVA was being implemented showed that the future growth value of the company would be positive, although the current operational value was not so high. This means that the capital markets place a premium on the company because they are confident it will come up with strategies to propel itself to a higher value creation level. "That is the biggest challenge that lies ahead for all of us," says Mr Chatterjee.
One of the most contentious issues in EVA is the weighted-average cost of capital (WACC) and its change every year due to changes in the financial markets. The WACC was calculated for each of the companies undertaking the project. The WACC will be reviewed after every two or three years unless there is a significant change in the underlying assumptions.
Uniformity and customisation
Initially, the group finance team at Tata Sons and Stern Stewart worked out a customised framework for the group. "We decided on uniformity in measurement, management and rollout of the programme across all companies currently implementing EVA, as well as those that will in the future," says Mr Chatterjee. It was also decided to have a knowledge repository on EVA implementation in each company. Uniformity in capital budgeting and investing processes would also be ensured across the group. In the new structure, all constituent units would make capital investments according to the common framework, and Tata Sons would recommend an update of the process periodically. However, the insistence on uniformity does not ignore the quirks of particular industries. "The EVA measurement template will be largely consistent across the group. However, peculiarities within an industry will be suitably factored in the adjustments. We are fully aware of the fact that the characteristics of the hotel industry are quite different from those of the steel or automobile industry."
The apex body responsible for EVA implementation is the group steering committee, which comprises senior members from the group management. The committee, which meets every month, has an oversight function of implementing the project as per plan, and providing guidance to the working team on various contentious issues. Each company also has a steering committee which monitors project implementation at the company level.
Implementation comprises three primary modules, with a training calendar across all modules. The first one is the value diagnostic module that reviews whether the various processes are oriented towards value creation. This model involves interviews and interactions with people in the organisation. It has already been implemented in companies such as Tata Steel and Tata Tea, and is underway in Indian Hotels Company and Tata Engineering.
The second module is the value-based audit, which is carried out at the group finance level before being rolled out as a process in the companies. This module essentially comprises two parts: value-based goal setting and the investment-management process.
Value-based goal setting provides the framework to measure the gap between the fair value of the enterprise and the projected business plan of a company. This framework can help the company's management evolve its own options to bridge the performance gap and to increase the net present value (NPV) of the company. Options to increase the value can range from cost reduction, improvement in operating efficiency and rationalisation of business portfolio, to the acquisition of businesses to grow inorganically. The framework is capable of panning out a year-by-year gap in NPV, based on the business plan.
The investment-management process in the EVA framework will provide robustness to the capital-allocation decision and foster accountability for capital invested in the business. "Once the above processes are rolled out to the group companies, the senior management will be able to improve their quality of decision making by using these sophisticated analytical tools," says Mr Chatterjee.
The third module is measurement and management, the core of the EVA framework. During this phase, the measurement framework and the EVA drivers analyses is taken down to the business unit level of the company. The operating managers of the company get involved in cascading EVA consciousness across the organisation. The company starts inculcating value creation as a "way of life" across the decision-making process in the company.
Delegation of responsibility is an important aspect of EVA. As Mr Gandhok puts it, managers should be empowered to make economically optimising decisions, and to face the consequences of those decisions. The top management should encourage this empowerment.
However, the degree of decentralisation depends on the frequency of decisions of strategic import taking place at the lower levels. "In an organisation like Indian Hotels, where strategic decisions are made deeper down the organisation, it makes sense to cascade [decision making] all the way down," Mr Gandhok points out. "In an organisation like Tata Steel, where strategic decisions are not often made at the lower levels, it is not necessary to cascade."
The Tata group is decentralising with gusto. Training programmes are underway for school managers. The training has already started paying off. In Tata Tea, for example, managers are using EVA to decide on the optimal pruning pattern for winter months. It is expected that the companies undertaking the project will be able to take the EVA framework down to its desired level by the end of project implementation in May 2003.
The group's commitment to empower is appreciated by Mr Gandhok, who finds the top management amenable to the idea of delegating responsibility. He contrasts this with the strict demarcation between the decision makers and the executors that exists in most Indian enterprises today, a trend that is responsible for making these companies less global than their American counterparts.
While implementing EVA, it is easy to overlook stakeholders and the board of directors, which is responsible for improving the alignment of stakeholders and management. Mr Gandhok underscores this angle. "It is very important that the board reviews the choices the senior management is making for the firm, and monitors the performance of the top management." EVA can achieve this. It can give board members a record of the top teams performance.
The greatest benefit of EVA will be an improvement in the quality of decision making. "Once EVA becomes a way of life in the organisation, there will be an improvement in the quality of decision making within the company, which has to, sooner or later, translate into improved EVA," says Tata Tea's managing director Homi Khusrokhan. EVA improvement will be the natural corollary to better decision making.
Other articles on EVA:
||TCS: Double clicking EVA|
||Tata Steel: Rolling Out EVA|
||Tata Tea: EVA in a teacup|