Economic value added (EVA) systems and the balanced scorecard (BSC) have generated a tremendous interest in corporate America recently as approaches to performance management. Implementation of these methodologies has not proven to be easy. This paper introduces the analytical hierarchy process and shows how this methodology addresses the limitations ore VA and BSC by integrating them into one comprehensive system. A case study is used to illustrate this methodology.
Managing for value has become the mantra of today's executives as the reality of today's competitive environments force businesses to focus on improving profitability. Firms, both large and small, are implementing value-based measures using measures such as Economic Value Added (EVA). All too often, however, these initiatives are interpreted merely as an advance in metrics and measurement and not a tool for strategy development. This narrow interpretation and use suggests little fundamental change in the behavior of the many people responsible for the decisions and actions that create long-term value and has brought only mediocre results to some firms. To improve the implementation of value based management (VBM), firms need to move beyond narrow metrics to the utilization of EVA as a strategic decision tool. It must be linked to broad process reforms including the identification of value drivers, the integration of budgeting with strategic planning, and development of a comprehensive performance measurement system. This is the objective of our paper.
We focus on the development of a complementary system of managerial metrics linking the EVA system to the Balanced Scorecard (BSC) using analytical hierarchy processing (AHP). The importance of managing for value is discussed and potential limitations identified. The Balanced Scorecard as a vehicle for identifying value drivers and drilling down into the operations of the firm is presented. Then, these two complementary frameworks are combined, using the AHP methodology, to develop a comprehensive measurement system for assessing the overall performance of the organization. A case study is used to illustrate this methodology.
Economic Value Added
A paramount objective of management should be the creation of value for the firm. Thus, it is essential in strategic planning to manage the firm's resources with an objective of increasing the firm's market value (Hawawini and Viallet 2002: Eccles and Pyburn 1992). From an EVA perspective, the ultimate success of a firm is not measured only by its capacity to grow its sales, produce profits, or generate cash from its operations, but whether the firm's activities are creating value for its owners (Ehrbar 1998). According to economic theory, a firm is creating value if the net present value of all its investments is positive. Quite simply, EVA is a measure that enables managers to see whether they are earning an appropriate return on the capital under their control. It is a measure of profit less the cost of capital employed (EVA calculations are provided in Exhibit 1) and is the one measure that properly accounts for all the complex trade-offs, often between the income statement and balance sheet, in creating value (Pettit 2000).
The EVA metric is not only a measure of financial performance but should serve as the centerpiece of a strategy development and implementation process. Putting value based management into practice, however, has been found to be more complicated than some of its proponents suggest. Haspeslagh, Nada and Boulos (2001) found a number of characteristics associated with the successful implementation of value based management (VBM). Successful VBM companies keep the technical accounting aspects of EVA simple, making very few changes to their accounting practices. They invest time and effort in identifying and assessing the operational factors, or value drivers, that have the greatest influence on the creation of economic profit. …