The eva challenge

Economic Value Added (EVA) is a crucial metric for assessing a business's true economic profit. It offers a more nuanced understanding of profitability by considering the cost of all capital used in generating profit, including equity capital and debt. This makes EVA a comprehensive measure that reflects a company's real profitability better than traditional metrics. The significance of EVA lies in its ability to determine whether a business is creating or eroding wealth, considering the potential returns shareholders could have achieved by investing in other ventures with similar risk profiles. As companies increase their EVA, they are likely to see a corresponding rise in their market value, highlighting the direct link between EVA growth and shareholder wealth.

One key advantage of EVA is its alignment of the interests of shareholders, who aim to create wealth, with those of business managers, who strive to utilize the company's assets most productively. Its simplicity and clarity make it accessible to individuals without a deep financial background, serving as a singular financial measure that can replace various other metrics such as market share, revenue growth, and budget comparisons. This singular focus on enhancing a firm's EVA prompts a unified direction for strategic and operational decisions across all levels of the organization, from the enterprise as a whole to individual product lines.

Moreover, EVA encourages financial discipline by compelling businesses to scrutinize how capital is deployed. Projects that yield a negative EVA are less likely to be pursued, ensuring that only value-adding initiatives receive investment. This metric also addresses and simplifies the complexity of accounting adjustments, offering investors a clearer picture of a company's financial health. Furthermore, EVA can underpin incentive compensation schemes that align managers' efforts with shareholder interests, fostering a culture of entrepreneurship and ownership that drives innovation.

Economic Value Added (EVA) is not a one-size-fits-all solution that can be simply plugged into any organization expecting instant results. It requires a thoughtful and tailored approach to implementation. EVA is ineffective if it's used as a band-aid for a fundamentally flawed business strategy or for products that lack market appeal. A company must have a solid business strategy and organizational structure in place for EVA to truly enhance performance.

EVA is particularly useful in assessing the value creation potential of acquisitions or strategic alliances. It can help determine the financial, managerial, and operational synergies that may arise from such business moves. Financial synergies might include portfolio management or restructuring with hands-on management expertise. Managerial synergies could involve the introduction of more effective business systems, while operational synergies may stem from improved technology or the spreading of fixed costs across a larger product line.

The concept of strategy as relationship management is central to EVA. Different types of companies—cost leaders, product leaders, and best-total-solution providers—each have unique relationships with their stakeholders. EVA can pinpoint where value is being created or lost within these relationships.

For EVA to be more than an academic exercise, it must be integrated into management decisions. It should guide all decisions, whether they concern capital outlays, acquisitions, or divestitures, with the aim of growing EVA. Managers in EVA-focused companies understand that value can be increased by running the income statement more efficiently, investing additional capital where returns exceed costs, or releasing capital from operations through asset sales or improved capital turnover. EVA encourages managers to actively pursue these strategies, and when understood by all employees, it becomes a powerful tool for enhancing employee involvement and ownership thinking.

Briggs & Stratton Corporation, established in 1908 and recognized as the world's largest producer of air-cooled, gasoline engines, faced significant challenges in the mid to late 1980s. The company was grappling with a shift in retail sales patterns and increased competition from foreign manufacturers with lower labor costs. These challenges led to a loss of over $20 million in 1989, prompting a comprehensive strategic and organizational overhaul. The adoption of an Economic Value Added (EVA) program in 1990 marked a turning point for Briggs & Stratton.

The EVA program's implementation was a strategic move to refocus the company's direction. A company memo from 1989 highlighted the need to concentrate on specific market segments where Briggs & Stratton could leverage its strengths and establish a competitive edge. The company restructured into seven autonomous operating divisions, each with control over operational matters and capital expenditures. EVA became the lens through which all financial decisions were viewed, from divestitures to new factories and strategic alliances. Additionally, an EVA-based managerial incentive program was introduced across the corporation.

The results of these strategic shifts were remarkable. Briggs & Stratton's share price soared from $10.25 per share in 1990 to over $70.00 per share by May 1999. The company moved from a negative EVA of $62 million in 1989 to a positive EVA since 1993, achieving an EVA of $50.9 million in 1999. The return on capital also improved significantly, reaching 12.9 percent. To further clarify the value creation process, Briggs & Stratton developed a holistic model encompassing the company's key relationships with customers, suppliers, the community, and employees. However, recognizing that many employees found the model complex, it was broken down into three basic categories: product development, operations and support, and human resources. This simplification aimed to make the EVA concept more accessible and understandable to all employees.