EVA, short for Economic Value Added, is a financial performance metric developed by the New York-based consulting firm Stern Stewart & Company. In simple terms, EVA is the true measure of the value created by a firm, calculated by taking into account the economic profits generated by the firm and the cost of the resources used to achieve these profits. Arithmetically, EVA is calculated by subtracting the cost of capital from a firm’s net operating profit after tax (NOPAT).

The EVA framework provides a comprehensive and integrated approach to value-based management. Further, when integrated with the variable compensation philosophy of a firm, the EVA framework provides an excellent tool to focus the entire management team’s attention and energy to creating superior operational efficiencies and improving upon the same each year.

EVA was implemented at Godrej Industries and its associate companies in four phases from October 2000 to July 2001. All the major businesses were covered: Godrej Agrovet Ltd. (agribusiness), Godrej Consumer Products Ltd. (FMCG: soaps and personal products), Godrej Industries Ltd. (oleo-chemicals), Godrej Properties & Investments Ltd. (property development), Godrej Sara Lee Ltd. (FMCG: household insecticides), and the newly acquired Gold Mohur Foods & Feeds Ltd. (agribusiness).

In the past (1996-2001), performance-linked bonuses at the Group were a step function in which exceedingly superior performance went unrewarded and poor performance went un-penalised. Along with the EVA framework, Godrej Industries and its associated companies implemented the EVA-linked incentive plan. "Performance-Linked Variable Remu-neration" (PLVR) is our EVA-linked incentive plan. It has no caps, no floors, and a deferred bonus "bank" to encourage long-term thinking and owner-like behaviour.

Under the PLVR plan, achieving target performance yields the target bonus while exceeding the target bonus leads to additional rewards without any limit to the upside. Similarly, falling short of the target bonus leads to an erosion of the bonus earned. Further, each year, a part of the bonus earned by the employee is retained in a notional "bonus bank". Every subsequent year’s bonus paid out comprises in part the bonus earned in that year and in part a portion of the bank. Thus, the "notional bank" serves to smoothen out fluctuations in bonus payments which might otherwise occur due to business cycles.

As with any change process, obtaining the buy-in of key managers and employees was important. Initially there was scepticism about the "bonus banking" concept and the longer-horizon stretch targets. Relentless communication and demonstrable results were the key to ensuring that the concept of EVA was imbibed at all levels of the organisations.

Following EVA implementation, our operating performance has improved significantly. Between the years 2001 and 2004, Return on Capital Employment has improved by 8 percentage points, Sales have grown by 15 per cent per annum, and PBT has grown by 42 per cent per annum.

All the businesses improved their performance, many of them well ahead of the stretched targets. In 2002, three of the five businesses achieved their respective EVA improvement targets. In 2003, four out of six achieved their targets - and all had positive EVA improvements.

To summarise, Godrej Industries Ltd. and its associate companies have been very successful in improving their operating performance substantially by implementing the EVA framework. I am certain that many other companies can and will benefit in the near future by using the same principle as a management tool.