EXTENDING THE CONCEPTS BEYOND THE SINGLE ENTERPRISE

So far we have looked at a single enterprise, with its accounts and shareholders.
This will stand us in good stead in level 1 and level 2. When we get to level
3 and beyond, we need to be able to judge the effectiveness of our investments
not only on our shareholders but also our value chain partners. RONA is still
a good measure, but there is another useful indicator � economic value added
(EVA), which factors in the cost of capital for the different players in the value
chain.
EVA is a measure of true financial performance, with particular emphasis
on the efficient use of capital, that corrects distortions caused by anomalies in
generally accepted accounting principles and takes account of the cost of all
capital invested in an enterprise, including equity. More than any other traditional
financial measure, EVA provides the highest correlation between corporate
performance and increase in shareholder value.
EVA will increase if one or all of the following strategies are adopted:
_ Operating profits are grown without additional capital investment.
_ New capital is invested in any and all projects that earn more than the
cost of capital.
_ Capital is diverted from business assets that do not cover their cost of
investment.
EVA is calculated by multiplying the economic book value of a firm�s
capital by the difference between the return on capital (r) and the cost of capital
(c):
prise processes and create what amounts to a value chain P&L account and
balance sheet, by adding up the P&L and balance sheets of the constituent parts.
The judgment on increasing overall performance can now be made using EVA
as the overarching value chain metric. Managing transactions in this environment
is reasonably straightforward: cash flows from the final customer back
along the value chain. The major consideration is the profit taken by each
company at each stage.
Funding decisions are more complex, as shown in Figure 3.9. To maximize
value in the whole network, it is quite likely that an investment made by one
company, say Company A, results in value in a second, Company C, farther
down the network. Of course, the investments will be in improving the processes
that cross the boundaries between the partners. An investment in equipment
to improve the Make process in A may result in the reduction of material
costs for the Source process of C. Until the thinking of level 4 and 5 comes
into play, there are barriers to making this type of investment. There must be
trust between the value chain partners that value will be shared, and there needs
to be a mechanism in place to calculate the value and share it.