Adi Godrej, Chairman, Godrej Group: EVA-ngelist fervour

Since April 2001, all of Adi Godrej's six businesses-Godrej Consumer Products, Godrej Sara Lee, Godrej Foods, Godrej Industries, Godrej Properties, and Godrej Agrovet-are being measured on the basis of EVA generation. The Chairman of the Rs 2,400-crore group of six companies, who now has EVA targets in place till 2004, is pleased as punch with the results. And why not! For the nine months ended December 2001, the six companies that boast a turnover of Rs 2,400 crore posted a 34 per cent growth in sales and an 82 per cent spurt in profits. ''I attribute these good numbers to the EVA project,'' says Godrej.

The top and bottom line numbers may be the most visible indicators of the EVA exercise, but below the surface too there are plenty of other benefits. For one, capital efficiency has improved, with Godrej Consumer Products and Godrej Sara Lee both operating on negative working capital. That means that Godrej's cost of capital decreases, which in turn means that the EVA increases, which also means that overall cash generation in the group improves. "It also leaves us with more funds for capital expenditure and acquisitions," explains Godrej.

The war chest may be ready, but that doesn't mean that Godrej is pulling out all the stops to get into takeover mode. And here too it's EVA that''s helping him. Recently Godrej turned down a couple of acquisitions not only because they had a negative EVA, but turning around those brands to show a positive EVA wouldn't be easy. In fact, Godrej's last two acquisitions -the Ezee brand, and Hindustan Lever's animal feeds business-are both EVA-positive businesses.

One of the most significant aspects of the EVA project is the performance-linked variable remuneration scheme. Simply put, an employee's prospect of a bonus is directly related to his ability to increase EVA, and at senior levels, managers stand to earn more via the variable component than the fixed one.

The challenge now for Godrej is to ensure that EVA creation eventually results in employee interests getting aligned with those of shareholders. ''If we deliver over a period of two to five years, the results will show on the market.'' The targeted market cap for Godrej Consumer Products, for instance, is Rs 600 crore, as against the current figure of Rs 330 crore. The company, which as per plan had to improve EVA by Rs 6 crore this year, is ahead of that target. Now it's for the markets to take note.

-Brian Carvalho

EVA REVIEW TATA CONSULTANCY SERVICES
THE FIRST AMONG EQUALS

S. Ramadorai, CEO, TCS: of values and rewards

One of the first companies in India to look hard at the EVA model was Tata Consultancy Services (TCS), which did so in early 1999. For TCS, which at that time boasted some 15,000 professionals working globally, there were some compelling reasons for doing so. Explains S. Mahalingam, Executive Vice President, TCS, the company's pointman for the EVA exercise: ''We wanted to construct a defined incentive system, which would reward on the basis of profitability. And our individual performance appraisal system had to have a much stronger linkage to value creation. We wanted to focus both on team and individual performance.''

There were other factors that persuaded CEO S. Ramadorai to take the plunge. One major objective was to make each consultancy practice group focus on value-creation and maximising project profitability even as it expended efforts to create competencies for the future. EVA gave TCS a unified framework to identify drivers for value-creation and, more significant, to link the incentive system to the extent of value being created.

The first task was to define clear targets for EVA, not just for revenues or profits. Centres where value was being created had also to be defined, and an EVA target fixed for each of these. Once that was done, the continuous improvement of EVA from one year to the next had to be ensured-at both the corporate level and at the business unit level (there are 100 business units at TCS).

Today, all of TCS' consultancy personnel are covered by EVA. And the results are showing. As Tejpavan Gandhok, Country Manager, Stern Stewart India, points out, benchmarking against the competition when setting growth targets is one of the biggest spinoffs of the EVA exercise. And that's exactly what each practice at TCS has been doing. With employee incentives now being linked to EVA enhancement, much of the new initiatives at TCS today is decentralised. The performance rewards are based not just on individual performances (as was the case earlier). They are doled out keeping in mind the corporate EVA created, the business unit EVA created, and individual performance. ''Value creation has improved,'' stresses Mahalingam.

There is a greater appreciation of, and involvement with, the EVA concept at TCS these days. Verdicts on major capital expenditure invite the curiosity of employees, who are more than interested in knowing the impact the spend will have on income-generation. That's a welcome ripple-effect of the EVA exercise: transparency in management.

-Brian Carvalho

THE METHODOLOGY

The BT-Stern Stewart Economic Value Added (EVA) analysis began with a universe of 800 manufacturing and services companies and 80 companies in the banking and financial (BFs) sector, taken from Centre for Monitoring Indian Economy (CMIE) and filtered by their average market capitalisation. Companies for which complete information was not available for two out of the past five years were excluded.

All information was sourced from CMIE's Prowess database. Data on most credit ratings and spreads came from CRISIL, ICRA, care, and ICICI Securities. The ratings were used to obtain a spread over and above the risk-free rate. For ratings not done by the agencies mentioned above, a proprietary Stern Stewart bond-rating model was used. The following adjustments were made to profit and loss accounts and balance sheets of companies to compute the NOPAT and the economic capital.

RESEARCH & DEVELOPMENT: The after-tax R&D expenditure was included in capital and added back to NOPAT. The amount included in capital was amortised over five years. The adjustment does not apply to the BFs sector.

INTEREST: All interest expenses were added back to profits. The tax-benefits of interest were also removed, and cash operating taxes for the companies adjusted accordingly. This does not apply to the BFs sector.

NON-INTEREST BEARING CURRENT LIABILITIES: NIBCLs were excluded from calculation of capital in non-BFs companies.

CONSTRUCTION IN PROGRESS: Construction in progress was included in capital. It does not apply to the BFs sector.

NON-RECURRING INCOME AND EXPENDITURE: Non-recurring items were excluded from NOPAT, and capitalised after tax. Non-recurring expenditures were taken as additions to capital and non-recurring income as reduction.

ASSET GAIN ADJUSTMENT: Gain or loss from transactions was amortised over three years to spread the returns of an asset over its life. This applies only to the BFs sector.

CASH-OPERATING TAXES: Provision for taxes was restated to reflect taxes paid on operations. The tax-effects of financing and non-recurring items were eliminated.

REVALUATION RESERVE: This was excluded from capital.

The Calculations

NOPAT = (Profits After Tax + Non-Recurring Expenses + R&D Expenditure + Interest Expense + Provision For Taxes) - Non-Recurring Income - R&D Amortisation - Cash Operating Taxes

Cash Operating Taxes = (Provision For Taxes + Tax Benefit Of Non-Recurring Expenses + Tax Benefit Of Interest Expense - Tax On Non-Recurring Income).

Economic Capital = Net Fixed Assets + Investments + Current Assets - NIBCLs + (Miscellaneous Expenditure Not Written Off + Intangible Assets + Cumulative Non-Recurring Losses + Capitalised Expenditure On R&D) - (Revaluation Reserve + Cumulative Non-Recurring Gains)

DEFINITIONS

MARKET VALUE ADDED: MVA is the value added in excess of economic capital employed.

MVA = Market value of the firm - Economic capital. For BFs sector, we calculate the value addition only on the equity capital and hence its MVA = Market value of equity - economic capital.

ECONOMIC VALUE ADDED: EVA is the net operating profit after tax, less the charge on the economic capital employed.

EVA = Net Operating Profits - (Weighted Average Cost of Capital x Total Capital Employed). The economic value added for a BFs company is computed as follows: NOPAT - (Cost of Equity x Equity Capital).

WEIGHTED AVERAGE COST OF CAPITAL (WACC): This gives the return expected by investors, while Cost of Equity gives the expected return for the BFs sector. WACC=Post-tax Cost of debt*(D/MV) + Cost of Preference shares* (P/MV) + Cost of Equity*(E/MV) where, d, p, and e are market values of debt, preferred equity, and equity.

The master ranking of the companies was done on the basis of the MVA. When we analyse MVA and EVA to help a company evaluate performance, further adjustments are made to reduce the impact of market fluctuations and accounting distortions. We also tailor the definition of EVA according to the industry economics. Such refinements are neither relevant nor feasible for this ranking exercise as this is based only on publicly available data.