EVA as Fact, Not Fiction

An employee of a health care company in the South was inspired enough to write an e-mail in response to my last column introducing economic value added (EVA) as a potentially powerful approach to IT financial measurement and management . His e-mail included this passage:

"In your recent management article in the Sept. 2 Computerworld, you used the term 'quantifiable benefits.' That's the rub with EVA, some activities don't produce quantifiable benefits; they are just good business. An example would be hiring a security guard to protect a warehouse full of stuff. If you don't hire the guard, somebody will steal stuff from the warehouse, resulting in a loss, but I would challenge anyone without Stephen King's talent for writing fiction to actually put a number on the benefit of hiring the guard.

"The problem is really not so much that you can't put a number on it, but that you can put any number on it. . . . Simply put, the use of EVA encourages managers to make up numbers."

The writer's first observation is well considered. Not every investment requires a business case justification. Just as important as the security guard in the warehouse is a company's need for a solid network; IT managers shouldn't need to prove this.

The last sentence of this reader's polemic is the reason I am returning to EVA. In theory, the EVA approach to capital investment decision-making might motivate IT managers to exaggerate their preinvestment assessments. When a cost of capital charge is assessed against an IT project's estimated ROI, the total return is lowered; an ROI of 50% before EVA is 38% after the company's 12% cost of capital is charged. Thirty-eight percent might be a respectable return, but perhaps not respectable enough when an IT project is competing against others for scarce resources.

A structural feature of EVA, however, discourages a manager's inclination to juice the assessment numbers to win project approval. A cornerstone of EVA is a bonus compensation regime under which every penny of pay beyond a manager's base salary is at risk depending on yearly EVA outcomes. If EVA is negative for the company in one year, no bonus. If EVA scales the baseline target, managers and employees receive bonuses. If EVA is significantly higher than the base, the company will pay several multiples of the bonus. Recipients of EVA bonuses will attest to the fact that nothing focuses the mind like pain - or money. In many, but not all, companies, EVA bonuses flow right down from managers to workers on the shop floor.

Companies such as The Manitowoc Co., Boise Cascade and Briggs & Stratton have undergone observable cultural change as EVA companies. IT managers there truly think differently in that they no longer regard company funds as other people's money. Their business units are charged the cost of capital as well as the capital required for the project, and their personal compensation is on the line because of it. They tend to think more like owners than employees.

Typically, a company calculates the EVA of every IT project but scores the entire IT organization as a whole at year's end. Is IT's EVA positive for the year? More important, has IT's EVA improved from the previous year? Philosophically, the EVA dollar amount for an individual project or even a company in a given period is less important than the idea that EVA will increase year to year.

Also implicitly radical about EVA-driven IT investment is the demand that the IT project is measured along the established financial metrics rendered in the business case; compensation practices require postinvestment measurement in order to calculate EVA for every year in the life of the project. How many IT organizations in this country have embedded a systematic, rigorous postinvestment measurement program to compare technology project financial returns against plan? How many fingers did you use to do the count? Two? Three?

Under EVA, IT investment decisions are infused with a level of clarity and, perhaps more important, accountability that might not otherwise exist. We should be shocked if a company that embarks on the EVA way allows IT managers to juice their numbers in order to win project approval or to report EVA higher than is actually the case - as the reader claims. If this kind of fiscal jury-rigging is happening, it's doubtful that the company is truly EVA-inspired in the first place.

John Berry is an IT management consultant and analyst in Bend, Ore. He's currently writing a book about the measurement of intangible assets. Contact him at vision@according2jb.com.


Copyright © 2002 IDG Communications, Inc.

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