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Implementation of EVA at Godrej

Godrej Consumer Products Limited was formed as a result of the de-merger of Godrej Soaps
Limited. A major player in the FMCG market with leadership in the personal, hair- care, fabric and
household segments, it had over 950 employees with manufacturing facilities in Malanpur (MP)
and Silvassa and Guwahati. The product range included Colorsoft liquid hair colour and Godrej
liquid and Powder hair dyes, the Fairglow brand, India's first Fairness soap, the Liquid Detergent
brand EZEE etc.
In the initial year of operations of Godrej Consumer Products Limited (GCPL), the sales of GCPL
brands increased by 9% from Rs. 406.6 crore in FY 2000-01 (as part of the Consumer Products
Division of erstwhile Godrej Soaps Limited) to Rs. 442.9 crore in 2001-02.
Executive Director and President, Hoshedar K Press said, GCPL has seen tough competition in
all its segments from global majors with deep pockets and the ability to withstand losses.
However, our vision is to create a world class FMCG company, which will create value for
customers and shareholders."

It hadn't been always so rosy for Godrej. There was a time when the company was struggling to
keep pace with the changes of liberalization and the challenges of competition. To enumerate the
concerns:
* Post the dissolution of Godrej's JV with P&G in 1996, there was a lot of introspection, which led
to the realisation that there was a need to change dramatically to achieve progress. Not only did a
lot of managers walk out along with JV partners, the group did not attract enough talented people
with the advent of MNCs in India.
* In 2000-01, an appraisal was conducted of all employees in which Adi Godrej, Chairman and
Managing Director of GCPL, also participated. A deadpan Godrej commented, "My evaluation
said that I'm too autocratic and not a good listener. People also felt that I do not encourage
teamwork."
* The internal surveys on HRD climate and employee satisfaction reflected that young people in
the organisation felt underutilised, and uninvolved in strategic decision-making.
* Under the existing multi-step variable bonus plan, three levels of targets were outlined. A
salesperson who had reached level I would never aspire to do more unless he was sure to touch
level II, because he would not get any additional bonus for being midway. It would be more
beneficial for him to report it in the next financial years' sales. The company's figures suffered as
a result of such groupthink.

There was clearly gap in communication between the management and the employees.
Something needed to be done to ensure that the company was on track. A measure was needed
that would align the interests of the employee, the company and the shareholder, explained SS
Sapre, VP Finance and Company Secretary.
DECISION TO INTRODUCE EVA
Continuous discussions among the management let to the conclusion that a system of internal
corporate governance was needed which guides all managers and employees and motivates
them to work for the best interests of the company. Meanwhile, the concept of EVA was catching
on (refer exhibit 1.1 for a primer on EVA). Several Indian companies including TCS and Dr.
Reddy's laboratories had adopted it (Exhibit 1.2). A leading consultant was called to make a
presentation on the EVA option for Godrej. This is what the management learned:
* EVA implementation would improve overall capital efficiency and ensure that the company was
moving forward in the right direction. It also integrated financial measurement with business
imperatives in a comprehensible form.
* The key factor was that employees would begin to think like owners. They would also start

worrying about where the capital is employed and what returns are being generated from it, rather
than sticking to just their own pay cheques and promotions. This mindset was crucial for the
success of the company.
* EVA eliminated the problem of multi-step targets outlined earlier because it is a graph where
incentives are plotted against the EVA earned and so every employee gets rewarded for the
amount of work put in by him.
* EVA would make it possible to have bonus plans with no upside limits. Bonuses, whether
meager or lavish, are earned by beating annually negotiated budgets. Under the old system,
a manager's greatest incentive is to negotiate an easily achievable budget-and, because the
bonus is capped, not to exceed it by too much for fear of raising expectations or damaging his or
her credibility. EVA bonus targets, in contrast, would be automatically reset each year by formula.
If EVA shot up, for example, the following year's bonus would be based on improvement above
the new, higher level of EVA.
* Over the years, financial analysts have found conventional accounting to be misleading, under
which most companies appear profitable while many in fact are not. As Peter Drucker put the
matter in a Harvard Business Review article, Until a business returns a profit that is greater than
its cost of capital, it operates at a loss. Never mind that it pays taxes as if it had a genuine profit.
The enterprise still returns less to the economy than it devours in resource. Until then it does not
create wealth; it destroys it." EVA is an excellent indicator of wealth creation.

EXHIBIT 1.1
EVA = [NOPAT/CAPITAL - COST OF CAPITAL ] x CAPITAL
In the EVA system, there are four ways to increase value
1. Operate: Improve the return earned on existing capital
2. Build: Invest as long as returns exceed cost of capital
3. Harvest: Divest capital when returns fail to achieve cost of capital
4. Optimise: Reduce cost of capital by optimizing capital structure.
EXHIBIT 1.2
COMPANY

THE USAGE OF EVA

INFOSYS

Here EVA is used as a tool to tell its clients that the value delivered by
Infosys is greater than what the client pays for.
As a signaling device to tell its employees that capital is important.

MARICO
DR. REDDY'S
LABORATORIES
TCS

As a qualifying criterion to grant rewards such a variable pay, stock


options and performance bonuses.
Here EVA is linked to compensation and has been implemented in great
detail.a

Cash flow and the cost of capital employed to generate that flow have become the key
determinants of business performance, with earnings per share increasingly a misleading
target for strategy and investment. When a firm switches from FIFO (first in, first out) to
LIFO (last in, first out), its cost of goods assumes the price of the most recent purchases
of materials in inventory. This typically reduces its profits because the older purchases

cost less than the more recent ones. Yet the firm's stock price will rise, even though its
reported profits drop, because it pays less in taxes, thus increasing its after-tax cash flow.
The money spent to acquire the goods in inventory is exactly the same regardless of
which method is used, but LIFO increases economic value-added. This is where you
realize where the true impact of EVA lies.
Press informed, The only other alternative to EVA that came up during the management
discussions was Employee Stock Option or ESOP. He added, However, we had been
tracking FMCG companies abroad, who followed the ESOP pattern and found that the
share market fluctuations had practically wiped out the value of the shares held by the
employees. We had to choose an option which was more related to employee
performance and lesser to the fluctuations of the market." (refer exhibit 1.3) After much
debate and contemplation, the management decided to go ahead with EVA. Godrej
Consumer Products Limited (GCPL) implemented EVA in the financial year 2001-02.

EXHIBIT 1.3
ESOPS

EVA Incentive PLAN

These are prone to the vagaries of


the market sentiments

The EVA bonuses are tied to fundamental operating


performance, which can be linked to employee
performance.

They reflect the performance of the


listed entity alone and not the
performance of sub-units of the
business.

Group EVA results can be compared to that of business


units.

ESOPS are not self-funded

Are self-funded in the sense that the employee earns only


after the shareholder is adequately rewarded.

Are not clearly related to wealth


creation but to market value.

Are closely related to wealth creation in actual terms.

THE IMPLEMENTATION OF EVA: PRELIMINARY STEPS


Six group companies of Godrej went in for EVA implementation. This was facilitated by Stern
Stewart & Company, a New York based management consulting firm that pioneered the
development of the EVA Framework.
GCPL has implemented the EVA programme
at all non-unionised levels. Implementation involved various steps:
1. EVA of various businesses was measured and the implications of the numbers understood.
2. Targets on EVA improvement were then set over a three year time frame.
3. An exhaustive manual was made about what each function could do to improve the EVA of the
business. This was a detailed task involving the consultants, the functional heads and HR
department. Details of what some of the functions did are provided below

HUMAN RESOURCES AND FINANCE:


* Employee Benefits: These service departments had plenty of reorganizing to do. One of the
initiatives taken up by the HR department was outsourcing the housing loans to IDBI. Earlier,
housing loans were given at a subsidized rate of 5% to the employees. IDBI was offering this
facility at 11%. The remainder was passed on as a benefit to the employee. To the extent
outsourced, the capital was freed up. The company may also outsource its vehicle loans and

discontinue company owned cars.


* Maintaining and developing talent: During the year, the company implemented a system of
performance linked variable remuneration (PLVR) of employees based on improvement in EVA of
the company. This EVA-based PLVR accounts for about 35 per cent of a senior manager's total
remuneration package, and 25 per cent of a junior manager. The PLVR scheme has been
devised in such a manner that it provides an incentive for employees to create EVA on a long
term and sustained basis. The company also implemented another unique program by which
employees participate in training programs through an online initiative, aptly called E-gyan. In
collaboration with Satyam, this new knowledge initiative helps employees improve their skills and
knowledge without having to remove themselves from their work environment.