CIO — Jim Pecquex doesn’t flinch when he says that his IT organization is truly adding value to the business and is not just a service unit. That attitude isn’t just the product of a practiced poker face. Pecquex (pronounced peck-cue), CIO of The Manitowoc Co., is certain his team contributes demonstrable returns. What has him convinced? All capital IT investments are measured through an Economic Value Added (EVA) analysis.
Manitowoc’s decision in 1992 to make EVA the core of its management practices across the Manitowoc, Wis.-based manufacturer’s food service, crane manufacturing and marine operations acknowledges a simple distinction that economist Alfred Marshall made more than 100 years ago: Standard accounting methods treat capital as if it were available for free. In contrast, an economic profit analysis calculates a business unit’s after-tax cash flow, minus the cost of capital used to generate that cash flow.
EVA, developed by New York City-based consultancy Stern Stewart, is a riff off this distinction. EVA equals the net operating profit minus any applicable capital charges. Net profit after taxes, as defined in accounting terms, considers equity capital as if it were available without cost, since net profit doesn’t account for a charge for equity capital. Yet it isn’t actually free?prevailing interest rates mean it typically costs anywhere between 8 percent and 16 percent to borrow funds for capital spending, depending on the company’s business risk and bond rating. EVA accounts for that charge. Stern Stewart maintains that continuously increasing EVA will ultimately generate higher shareholder value. It’s working for Manitowoc. From 1995 to 2001, the company generated $164 million in economic value for shareholders, which has followed its steadily increasing stock price.
CIOs who subscribe to these arguments and drink the EVA Kool-Aid along with other executives will experience a whole new level of technology investment assessment. Every investment is subject to an internal capital charge up front. That lowers the expected returns and injects some sobriety into investment discussions and decisions, which business unit leaders will appreciate when considering technology acquisitions.
Since EVA calculates a company’s true economic profit, it keeps the CFO happy. According to a recent survey conducted by CFO Research (the research arm of CFO magazine), one in three finance managers uses EVA to help make technology investment decisions. And 15 percent use EVA as their primary finance metric for evaluating IT projects. Shareholders benefit because when executives employ EVA they have a realistic focus on maximizing true shareholder value. EVA is therefore well-suited for attaching a demonstrable financial value to any project or IT investment.
