How To Quickly Evaluate Manufacturing Decisions Using The EVA Framework

Posted on April 05, 2018

Manufacturers face a complex set of challenges when making decisions. At the heart of any manufacturing company are three distinct, but interdependent, disciplines: Demand Operations, Supply Operations and Financial / Strategic. Bringing those disciplines together to agree on where to invest for optimal return can seem like a Herculean task. Enter Integrated Business Outcomes (IBO). IBO provides a structured approach alongside a unique set of IP that analyzes and optimizes how these disciplines can make value-driven decisions.

Many of the toughest decisions and execution challenges occur not within any one discipline but at the intersection of all three. IBO recognizes this dynamic and uses Economic Value Add (EVA) to align management decisions at those very intersections. EVA is one simple, but powerful metric that allows each discipline to view potential profit through the same lens.

EVA = (Sales-Operating Costs) - (Net Assets*Cost of Capital)

To take one example, Commercial believes they can raise margin by increasing a service level in a specific market segment (Demand), but it will require additional warehouse space (Supply) and working capital (Financial).[1] If the simple three-line profit calculation increases EVA, the decision is a go. Evaluating competing opportunities from a mutual vantage point makes consensus easier to gain. It’s simple: the initiative with the most positive EVA will drive the most value and should “win.” In turn, all three disciplines “win,” paving the way for a higher-performing, more collaborative organization.

EVA Works With Planning Cycles

Core to the IBO operating methodology is a framework that helps firms determine how to make decisions within each of the standard supply chain time horizons. IBO applies the EVA philosophy to each of these horizons:

  • Strategic (focusing on the next 12 – 36 months, conducted annually and updated quarterly): Determines how the firm should align its products and network structure to support its target markets. This determination includes strategies to enter, grow or exit specific markets or customer segments; prioritization of customers or products; configuration of the firm’s network, including its own assets as well as those provided by partners; and validation that these strategies are aligned to drive positive EVA over the next one to three years.
  • Sales & Operations Planning (focusing on the next 3 – 18 months and conducted monthly): Maximizes service levels and profitability by determining how best to leverage assets based upon current market conditions. Decisions are often focused on how to maximize margin per minute (aka profit velocity) as the optimization objective when balancing demand, supply and working capital (inventory). These determinations are tested against the estimated EVA targets set through the strategic planning processes.
  • Near-term Operational Planning (focusing on the next 3 – 12 weeks and conducted weekly / daily): Aligns the actual demand with supply; assures planned capacity is consumed with the correct demand; sources production on the correct facility; and aligns production to meet the expected throughput / efficiency targets, thus generating the expected profit velocity targets set in the S&OP processes.

Applying EVA in Fix / Transform Cycles

EVA is also an effective metric for assessing whether a change in an operating capability will positively or negatively impact the IBO processes. Venetia Partners has calibrated over 200 discrete operating capabilities and the typical impacts these have upon key EVA drivers. EVA is calculated for the current state operations of the firm to provide a baseline. Once the future desired state for these operating capabilities is defined, the impacts to EVA are simulated through multiple planning scenarios. Using EVA as a predictive tool in this way provides insight into the possible impact on shareholder value and shareholder returns.

For manufacturers that want to make the best possible decisions, it just takes two things: IBO and EVA.

 

Measure Business Performance With EVA

[1] It’s important to note that EVA does not penalize the use of capital; rather, it rewards the effective use of capital.