Case study of a CEO 'thinking quantum.'.

• Author: Ehrbar, Al
• Position: Includes related article on EVA - SPX Corp's use of economic value added

How SPX Corp. used EVA and stretch goals to turn a sputtering jalopy into a Formula One winner.

Nearly every company adopting EVA, an acronym for economic value added [see descriptive sidebar on page 38], quickly finds that years (or even decades) of ineffectual capital management have left it rich in opportunities for immediate performance improvements. Many find they can make more profitable trade-offs between inventories and the length of production runs. Others discover that a proper recognition of capital costs suddenly makes outsourcing of some products or components look more attractive. Some find that they have "stuffed" too much output into distribution channels in order to inflate reported earnings. Many become more willing to restructure and dispose of poorly performing assets. And nearly all companies find ways to reduce working capital by speeding up receivables collections or stretching out payables.

Gathering this low-hanging fruit, so to speak, produces handsome increases in shareholder wealth because most gains from better capital management represent permanent increases in the level of EVA. For a company with a cost of capital of 10%, for example, adding $20 million a year to EVA should boost market value and MVA, market value added, by some $200 million. (The formula for estimating the impact on MVA is the permanent improvement in EVA divided by the percentage cost of capital.) However, these are essentially one-time gains, and additional improvements of the same type naturally get harder and harder to come by. Which means that better capital management cannot, by itself, meet the challenge of producing the continuous improvements in EVA that will bring future increases in MVA and shareholder wealth.

The only way to continually achieve exceptional increases in EVA is, of course, through growth, and the EVA system can help in a big way here as well. First, the initial one-time gains are more important than they might appear, because they improve a company's competitiveness and enhance its ability to grow profitably. Equally important, EVA incentives provide strong motivation for managers to search out fresh opportunities to grow, since that is the only way they can continually earn outsize bonuses. And the EVA analytical framework is a great aid in separating profitable growth from unprofitable, wealth-destroying growth for its own sake. But truly prodigious growth requires something more than the right performance measure or analytical framework or incentive system. Some business gurus say the key ingredient is a culture of excellence. In Built to Last, authors James C. Collins and Jerry I. Porras write about the importance of vision, a sense of corporate mission, and an enduring commitment to core values. Others stress the importance of "breaking the rules" in order to reshape entire industries.

A moribund manufacturer

The purpose here is not to assess the merits of various theories about how best to achieve growth. Rather, it is to show how EVA can complement and strengthen growth initiatives. An excellent example in this area is SPX Corp., a moribund manufacturer of autoparts and specialty automotive tools that suddenly became one of the best-performing companies on the New York Stock Exchange by simultaneously adopting EVA and a high-performance technique known as stretch targeting. Stretch targeting usually is identified with General Electric Co., which has been using a version of it for nearly a decade. In simplest terms, stretch is a method to increase the probability of achieving breakthroughs in technology, productivity, and growth by setting goals that seemingly are impossible to meet. As John B. Blystone, the CEO of SPX, puts it: "If you know how to get there, it's not stretch. If you can put a probability on achieving it, it's not stretch. And if it is not uncomfortable, it's not stretch."

SPX is the leading producer of so-called essential tools that carmakers require their dealers to use when they perform repairs on cars still under warranty. It also is the leading global administrator of service-equipment programs for franchised car dealers. In addition, SPX makes electronic diagnostic equipment and emissions testing equipment for car dealers and auto service centers, and produces a variety of components for the auto industry, including die-cast steering components and automatic transmission filters. While the company's products generally are regarded as first-rate, its performance in the first half of the '90s was downright dreadful. Profits peaked in the late '80s, went into a tailspin in the 1991 recession, and never really recovered. Earnings per share, for example, were solidly above $2 in the mid-'80s, but never got much above $1 in the first half of the '90s, when the company operated in the black in just two years out of five.

Part of the problem was that SPX's 10 operating units functioned more like a loose conglomerate than a family of related businesses. There was a large amount of overlap among the divisions in products and distribution systems, and some even competed with each other, doing duplicate R&D work and driving each other's prices down by bidding aggressively for the same customers. The winner in this destructive combat was rewarded for its "victory" by the head office in Muskegon, Mich. Some of the division presidents didn't even know each another, something that Blystone found mind-boggling when he arrived at SPX. The one major goal that the company achieved in the first half of the '90s was getting its revenues over the $1 billion mark, which happened in...