EVA Finance Management at GPCL

EVA Finance Management at Godrej EVA Finance Management at Godrej Consumer Product LTDConsumer Product LTD

Presentation by,Presentation by,Ms. Pramita AMs. Pramita AMs. Suvarna G Ms. Suvarna G Ms. Kajal CMs. Kajal C

Topics to be coveredTopics to be covered Company History of GodrejCompany History of Godrej Winds of Change at GodrejWinds of Change at Godrej Moving towards EVA Moving towards EVA Training for EVA at GodrejTraining for EVA at Godrej EVA Calculations and AdjustmentsEVA Calculations and Adjustments EVA Incentive programEVA Incentive program Initial experience with EVAInitial experience with EVA ConclusionConclusion

Company HistoryCompany History Started in 1897 as a Started in 1897 as a locks manufacturing companylocks manufacturing company, the Godrej Group is today one , the Godrej Group is today one

of the most accomplished and diversified business houses in India. of the most accomplished and diversified business houses in India.

In 1930, Godrej became the In 1930, Godrej became the first company in the worldfirst company in the world to develop the technology to develop the technology to to manufacture soap with vegetable oilsmanufacture soap with vegetable oils; that spirit of innovation has continued ; that spirit of innovation has continued throughout the organization's history. throughout the organization's history.

Today Godrej is a Today Godrej is a leading manufacturer of goods and provider of servicesleading manufacturer of goods and provider of services in a in a multitude of categories: home appliances, consumer durables, consumer products, multitude of categories: home appliances, consumer durables, consumer products, industrial products, and agricultural products to name a fewindustrial products, and agricultural products to name a few

GCPL came into existenceGCPL came into existence after the de-merger of the consumer products division of after the de-merger of the consumer products division of the erstwhile Godrej Soaps Limited (GSL) on April 01, 2001. the erstwhile Godrej Soaps Limited (GSL) on April 01, 2001.

With annual sales in excess of $1 billion, a workforce of approximately 18,000, and With annual sales in excess of $1 billion, a workforce of approximately 18,000, and a strong diversified portfolio, Godrej has proven its ability to a strong diversified portfolio, Godrej has proven its ability to deliver strong deliver strong financial performancefinancial performance. .

The group has more recently The group has more recently entered the real estate and information technology entered the real estate and information technology sectorssectors, and management views these as avenues for enormous growth., and management views these as avenues for enormous growth.

2001-02 to2001-02 to2008-092008-09

ContinuingContinuingStrong Domestic Strong Domestic

PresencePresence

Company HistoryCompany History

April 2008April 2008Expanding presence in S AfricaExpanding presence in S Africa

Acquisition of Kinky Group Acquisition of Kinky Group ((Proprietary) Ltd) Ltd

2005-062005-06Entry intoEntry intothe UKthe UKKey line Key line BrandsBrandsLimitedLimited

Company HistoryCompany History

Operations…..Operations….. Manufacturing facilities both in India and abroadManufacturing facilities both in India and abroad

• • Malanpur (M.P.) Malanpur (M.P.) – 45,000 tonnes of soap– 45,000 tonnes of soap• • Guwahati (Assam) Guwahati (Assam) – hair colourants and toiletries– hair colourants and toiletries• • Baddi (H.P.)Baddi (H.P.) – 30,000 tonnes of soap– 30,000 tonnes of soap• • Katha (H.P.)Katha (H.P.) – 45,000 tonnes of soap– 45,000 tonnes of soap• • Sikkim Sikkim – hair colourants and toiletries– hair colourants and toiletries• • South Africa South Africa

– – Rapidol Rapidol – range of hair colour products– range of hair colour products– – Kinky Kinky – diversified hair products – diversified hair products

portfolioportfolio

Rs 110 crore investment towards capacity expansions over FY07 & Rs 110 crore investment towards capacity expansions over FY07 & FY08FY08• • New Katha plant operational from December 2006New Katha plant operational from December 2006• • New Sikkim plant operational from March 2007New Sikkim plant operational from March 2007• • Capacity expansion of the Malanpur plant. Operational from May 2008Capacity expansion of the Malanpur plant. Operational from May 2008

Winds of ChangeWinds of Change

MNC’s entering in Indian FMCG Market ncreased MNC’s entering in Indian FMCG Market ncreased competitioncompetition

Managers walked out with JV partnersManagers walked out with JV partners Lack of talented peopleLack of talented people Needed to attract & retain good peopleNeeded to attract & retain good people Young people where Underutilized & uninvolved in Young people where Underutilized & uninvolved in

Strategic decisionsStrategic decisions A Clear Communication Gap between Management & A Clear Communication Gap between Management &

EmployeesEmployees

Moving towards EVAMoving towards EVA

Announcing the implementation of the EVA (economic Announcing the implementation of the EVA (economic value added)-based performance management system in value added)-based performance management system in 2001, Mr. Adi Godrej, chairman of the Godrej Group, 2001, Mr. Adi Godrej, chairman of the Godrej Group, said, said,

“ “Implementing the EVA framework is a key business Implementing the EVA framework is a key business performance initiative in support of our efforts to evolve as a performance initiative in support of our efforts to evolve as a world-class organization and enhance shareholder value.”world-class organization and enhance shareholder value.”

"Our main objective behind implementing EVA is to be driven, "Our main objective behind implementing EVA is to be driven, measured and rewarded by our ability to create sustainable measured and rewarded by our ability to create sustainable shareholder value."shareholder value."

BOOH Factor in the implementation of EVA BOOH Factor in the implementation of EVA at Godrejat Godrej

BBuild uild Invest as long as returns exceed Invest as long as returns exceed the cost of capitalthe cost of capital

OOptimiseptimise Reduce cost of capital by Reduce cost of capital by optimizing capital structureoptimizing capital structure

OOperateperate Improve the return on existing Improve the return on existing capitalcapital

HHarvestarvest Divest capital when the returns Divest capital when the returns fail to achieve the cost of capital fail to achieve the cost of capital

Training programme for employees was conducted by consultants Training programme for employees was conducted by consultants from Stern Stewart & Company. Stern Stewart worked closely from Stern Stewart & Company. Stern Stewart worked closely with three key teams at Godrej:with three key teams at Godrej:

• A steering committeeA steering committee — — comprising the top management, including Mr. A B comprising the top management, including Mr. A B Godrej and Mr. N B Godrej as well as the business unit heads / directors — to make Godrej and Mr. N B Godrej as well as the business unit heads / directors — to make key policy decisions.key policy decisions.

• An implementation teamAn implementation team — — comprising Mr. C K Vaidya, executive director comprising Mr. C K Vaidya, executive director (corporate personnel), Godrej Industries Limited, Mr. S S Sapre, vice president (corporate personnel), Godrej Industries Limited, Mr. S S Sapre, vice president (finance), Godrej Consumer Products Limited, and Dr S S Sindhu, general manager (finance), Godrej Consumer Products Limited, and Dr S S Sindhu, general manager (personnel), Godrej Agrovet Limited — to monitor overall project progress, ensure (personnel), Godrej Agrovet Limited — to monitor overall project progress, ensure organization-wide coordination across the various business units and functions and organization-wide coordination across the various business units and functions and achieve full knowledge transfer.achieve full knowledge transfer.

• Cross-functional working teamsCross-functional working teams — — which were formed at each SBU, to which were formed at each SBU, to ensure that the outcome of the project was tailored to meet specific business ensure that the outcome of the project was tailored to meet specific business requirements.requirements.

TRAINING FOR EVA AT GODREJTRAINING FOR EVA AT GODREJ

The project involved four overlapping phases:The project involved four overlapping phases:

• Performance measurement: Performance measurement: Tailoring the EVA definition for Tailoring the EVA definition for each Godrej business to ensure a simple yet robust financial each Godrej business to ensure a simple yet robust financial performance measure. performance measure.

• Management processes: Management processes: Integrating value-based thinking Integrating value-based thinking into the various management processes, and developing the relevant into the various management processes, and developing the relevant tools and framework to guide management in its strategic, operating tools and framework to guide management in its strategic, operating and financing decisions to improve business EVA. and financing decisions to improve business EVA.

• Motivation: Motivation: ‘Performance-linked variable remuneration' (PLVR) ‘Performance-linked variable remuneration' (PLVR) scheme has been designed to reward management teams for scheme has been designed to reward management teams for improving their businesses' improving their businesses'

• Training and communication: Training and communication: An extensive training An extensive training

programme has been undertaken for various managerial and officer levels.programme has been undertaken for various managerial and officer levels.

EVA Implementation Time Line DiagramEVA Implementation Time Line Diagram

Framework provided for value-based managementFramework provided for value-based management

What is EVA (Economic Value Added)?What is EVA (Economic Value Added)?

EVA EVA is a measure of financial performance based on the is a measure of financial performance based on the context that all capital has a cost and that earning more context that all capital has a cost and that earning more than the cost of capital creates value for shareholders.than the cost of capital creates value for shareholders.

Registered trademark of Stern Stewart & co. Of New York Registered trademark of Stern Stewart & co. Of New York city (USA)city (USA)

Concept was popular after stern stewart & co. Marketed Concept was popular after stern stewart & co. Marketed it.it.

EVA is the Operating Profit after tax less charge for the EVA is the Operating Profit after tax less charge for the Capital used in the Business.Capital used in the Business.

EVA = NOPAT – (WACC * Net Assets) EVA = NOPAT – (WACC * Net Assets)

COMPONENTS OF EVA:COMPONENTS OF EVA:

UNDERSTANDING EVA AND ITS UNDERSTANDING EVA AND ITS COMPONENTSCOMPONENTS

NOPATNOPAT• (Profit after Tax + Non-Recurring Expenses + Revenue Expenditure on (Profit after Tax + Non-Recurring Expenses + Revenue Expenditure on

R&D + Interest Expenses + Provision for Taxes) – (Non Recurring Income R&D + Interest Expenses + Provision for Taxes) – (Non Recurring Income + R&D Amortization + cash operating Taxes)+ R&D Amortization + cash operating Taxes)

• Cash operating Taxes (Provision for Taxes + Tax benefit of non recurring Cash operating Taxes (Provision for Taxes + Tax benefit of non recurring expenses + Tax benefit of interest expenses - Tax on non-recurring expenses + Tax benefit of interest expenses - Tax on non-recurring Income)Income)

Capital EmployedCapital Employed• Net Fixed Assets + Investment +Current Assets – (NIBCLs + Miscellaneous Net Fixed Assets + Investment +Current Assets – (NIBCLs + Miscellaneous

Expenditure not written off + Intangible Assets + Cumulative Non-Expenditure not written off + Intangible Assets + Cumulative Non-Recurring Losses + Capital Expenditure on R&D) – Revaluation reserve – Recurring Losses + Capital Expenditure on R&D) – Revaluation reserve – Cumulative Non-Recurring Gains.Cumulative Non-Recurring Gains.

WACCWACC• (weight of equity Capital+ free reserve) + (weight of long-term Debt)(weight of equity Capital+ free reserve) + (weight of long-term Debt)

Technical Adjustments to ROI & EVA Technical Adjustments to ROI & EVA A survey made by Dodd & Johns identified significant inconsistencies in the A survey made by Dodd & Johns identified significant inconsistencies in the

measurement of EVA. Although a consistent philosophy has been applied, measurement of EVA. Although a consistent philosophy has been applied, none of the companies measure EVA the same way.none of the companies measure EVA the same way.

Many adjustments have to be made in order to calculate EVA. Alone NOPAT Many adjustments have to be made in order to calculate EVA. Alone NOPAT requires as many as 120 to 164 adjustments to financial statements compiled requires as many as 120 to 164 adjustments to financial statements compiled in accordance with GAAP.in accordance with GAAP.

According to Stern Stewart adjustment should be based on the following According to Stern Stewart adjustment should be based on the following criteria:criteria:

Materiality: Adjustment should make a material difference in EVAMateriality: Adjustment should make a material difference in EVA Manageability: Adjustment should impact future decisionManageability: Adjustment should impact future decision Definitiveness: Adjustment should be definitive & objectively Definitiveness: Adjustment should be definitive & objectively

determineddetermined Simplicity: adjustment should not be too complexSimplicity: adjustment should not be too complex

Due to the measurement differences, EVA is a limited tool that cannot be Due to the measurement differences, EVA is a limited tool that cannot be used for competitive analysis.used for competitive analysis.

What Does EVA Show?What Does EVA Show?

+Ve+Ve The Company has Managed to The Company has Managed to create Shareholder Valuecreate Shareholder Value

ZeroZero This should be treated as the This should be treated as the Shareholders have earned a return Shareholders have earned a return that compensates the riskthat compensates the risk

-Ve-Ve The Company has destroyed the The Company has destroyed the Shareholder Value.Shareholder Value.

Usage of EVAUsage of EVA

Bonus to employeeBonus to employee Extra remuneration to managementExtra remuneration to management Incentive dividend to preference shareholdersIncentive dividend to preference shareholders Bonus shares to equity shareholdersBonus shares to equity shareholders Setting organization goalSetting organization goal Performance measurementPerformance measurement Motivation of managerMotivation of manager Corporate valuationCorporate valuation Communication with shareholder & InvestorCommunication with shareholder & Investor

Initial experience with EVAInitial experience with EVA

A few weeks after the EVA announcement, Adi declared the half yearly A few weeks after the EVA announcement, Adi declared the half yearly financial results of GCPL for the period ended September 30, 2001. financial results of GCPL for the period ended September 30, 2001.

The revenues had grown by 19% to Rs 2.529 bn as against the growth of The revenues had grown by 19% to Rs 2.529 bn as against the growth of 15% in the corresponding period in 2000. 15% in the corresponding period in 2000.

GCPL reported an EVA of Rs. 0.137 bn for the six months ended GCPL reported an EVA of Rs. 0.137 bn for the six months ended September 30, 2001. September 30, 2001.

On June 18, 2001, GCPL was listed on the BSE quoting at Rs 48.50 while On June 18, 2001, GCPL was listed on the BSE quoting at Rs 48.50 while GIL traded at Rs 16. By August 2002, the share price of GCPL rose to Rs. GIL traded at Rs 16. By August 2002, the share price of GCPL rose to Rs. 120 while that of GIL remained stagnant at Rs. 20120 while that of GIL remained stagnant at Rs. 20

EVA Incentive programEVA Incentive programFeatures :Features :

Bonuses are linked to changes in EVA and not to absolute EVA Bonuses are linked to changes in EVA and not to absolute EVA or Profit Before Tax (PBT). or Profit Before Tax (PBT).

Bonuses paid out are budgeted for before EVA targets are Bonuses paid out are budgeted for before EVA targets are met. met.

No caps and no floors in pay-off profile. No caps and no floors in pay-off profile. Multi-year targets, de-linked from annual budgets. Multi-year targets, de-linked from annual budgets. Bonus “bank”. Bonus “bank”. EVA drivers and individual performance factored in bonus EVA drivers and individual performance factored in bonus

distribution to the team.distribution to the team.    

Bonuses for meeting EVA expectations

Unlimited upside potential, but with corresponding downside risk

• Bonuses are “decoupled” from budgets

• Bonus banking system

BENEFITS :BENEFITS :

Reinforces continuous improvement focus. Reinforces continuous improvement focus. Greater focus on tax and balance sheet impact. Greater focus on tax and balance sheet impact. Cost of the scheme is funded through business performance, Cost of the scheme is funded through business performance,

therefore very shareholder friendly.therefore very shareholder friendly. Avoids the kinks in the pay-off profile that can encourage Avoids the kinks in the pay-off profile that can encourage

undesirable behavior. undesirable behavior. More productive budgeting process and more stretch More productive budgeting process and more stretch

thinking.thinking. Encourages longer-term focus.Encourages longer-term focus. Smoothens impact of business cycles.Smoothens impact of business cycles. Helps retain top performers. Helps retain top performers. Mix of team and individual rewards.Mix of team and individual rewards.

Present SituationPresent Situation

CRITICISMCRITICISM EVA is based on past accounting performance derived from financial EVA is based on past accounting performance derived from financial

statements. Accounting based measures like EVA may not be able to statements. Accounting based measures like EVA may not be able to measure value creation. Overemphasis on EVA may leads to its measure value creation. Overemphasis on EVA may leads to its manipulationmanipulation

On the basis of survey made by Chen and others, it is found that On the basis of survey made by Chen and others, it is found that market may place higher reliance on audited accounting earnings market may place higher reliance on audited accounting earnings than the unaudited EVA metric.than the unaudited EVA metric.

EVA can be biased against low return start-up investments and can EVA can be biased against low return start-up investments and can favour business with heavily depreciated assets as a result of the favour business with heavily depreciated assets as a result of the adjustments made to compute EVA. EVA approach can penalize adjustments made to compute EVA. EVA approach can penalize companies that invest in assets with long term returns.companies that invest in assets with long term returns.

EVA overemphasized the need to generate immediate results, EVA overemphasized the need to generate immediate results, therefore it creates a disincentive for the managers to invest in therefore it creates a disincentive for the managers to invest in innovative product or process technologies.innovative product or process technologies.

CONCLUSIONCONCLUSIONSo to conclude on this case study, So to conclude on this case study,

Co was able Co was able to enhance shareholder value & thereby rise in Profitability of to enhance shareholder value & thereby rise in Profitability of the co.the co.

EVA is a accounting based measure of Operating performance which is the EVA is a accounting based measure of Operating performance which is the difference between accounting earnings and suitable adjustment and the difference between accounting earnings and suitable adjustment and the cost of capital used to generate these earnings.cost of capital used to generate these earnings.

The objective of co to make all employees think like owners by an open-The objective of co to make all employees think like owners by an open-ended variable remuneration scheme.ended variable remuneration scheme.

EVA implementation helped Godrej group in segregating the entire EVA implementation helped Godrej group in segregating the entire business into several units to see them creating EVA or not.business into several units to see them creating EVA or not.

EVA was the main financial parameter to measure co performance. Used EVA was the main financial parameter to measure co performance. Used in all capital expenditure decisions including acquisitions.in all capital expenditure decisions including acquisitions.

Thank You !!!!Thank You !!!!