EVAluation

Volume 5 Issue 1 April 2003

Stern Stewart Research

The Americas

ValueBased Management
Done Right:
The EVA Implementation at Harsco
James A. Singer
Senior Vice President
(703) 536-4331
jsinger@sternstewart.com

Devin L. Millar, CFA

Associate
(212) 261-0683
dmillar@sternstewart.com

In February 2001, Harsco Corporation, a $2 billion industrial services

and products company headquartered in Camp Hill, PA, engaged
Stern Stewart to help implement the EVA management system.
Although Harsco has long had an orderly and conservative financial
management discipline, its decision to implement EVA enabled the
company to formalize these practices under a single framework
throughout the company, including its international operations
where recent acquisitions had been made.
The EVA Implementation at Harsco was structured using Stern
Stewarts Four Ms:
Measurement designing a measure of value creation that
best reflects economic reality in a particular industry.
Managementdeveloping policies, procedures and tools
which link decision-making to the measure of value-creation.
Motivationestablishing incentive plans that simulate
ownership by giving managers a share of value created.
Mindsetincreasing the business literacy of employees
through training and communications.
Harsco has employed EVA to improve its capital allocation process,
incentive compensation systems and the overall business literacy of
its employees. The efforts undertaken by Harsco have, in many
ways, resulted in a model program for the effective implementation
of value-based management.
Total return for Harsco shares is 22.7% since management began
the implementation of the EVA management system in February
2001 versus a negative 35.8% return for the S&P 500. The performance is also impressive when compared to other diversified industrial companies, whose average performance in the same period is a
negative 10.9%.

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n February 2001, Harsco Corporation, a $2 billion industrial services and

products company headquartered in Camp Hill, PA, engaged Stern Stewart
to help implement the EVA management system. Over the next ten months,
teams of Harsco managers and Stern Stewart consultants worked to craft an
EVA implementation that uniquely fit Harscos business model and operating
characteristics. Over this period and the year that has followed, Harsco has
employed EVA to improve its capital allocation process, incentive compensation
systems and the overall business literacy of its employees. The efforts undertaken by Harsco have, in many ways, resulted in a model program for the effective implementation of value-based management. This article details the steps
that Harsco has taken.

Harsco Corporation
Harsco Corporation is a diversified, international company providing high
value services and products to major industrial markets. The company has
operations at more than 400 locations in over 40 countries. Its businesses are
organized in four core sectors: Mill Services, Access Services, Gas and Fluid
Control, and Other Infrastructure Products and Services. Throughout Harsco,
the senior management team has instilled a clear corporate missionto
achieve consistent, superior financial returns from operations complemented by
targeted and prudent growth in markets and technologies familiar to the company. Enhanced shareholder value will be obtained by developing and maintaining lead industry positions in the markets served through the delivery of
products and services that provide the best value to the customer.
Although Harsco has long had an orderly and conservative financial management discipline, its decision to implement EVA enabled the company to formalize these practices under a single framework throughout the company,
including its international operations where recent acquisitions had been made.
Chairman, President and CEO Derek Hathaway and CFO and Treasurer Sal
Fazzolari saw that maximizing EVA over the long term was fundamentally consistent with the companys goals for maximizing shareholder wealth and increasing share valuation. With EVA, Harsco would now measure performance,
make financial decisions, and make incentive payments on the basis of a single
measure, thereby enabling the company to create a focus on value creation that
would impact all its management activities.

The Harsco EVA Implementation

EVA is more than a performance measure; it is the focal point of a management
system and a mindset. EVA affords the Company the ability to establish clear,
accountable links between strategic thinking, capital investment, day-to-day operating decisions, and shareholder value.
- Introduction, Harsco Corporate Finance Manual
The Harsco implementation focused on what Stern Stewart calls the Four Ms of
the EVA Management System:

Stern Stewart & Co.

Stern Stewarts 4Ms

1. Measurement (M1)
The initial step in the EVA implementation process is developing the EVA
measure. Key adjustments to GAAP accounting translate financial statements from an accounting framework into an economic framework.
Although the recommended adjustments vary from industry to industry and
even company to company, the overall goal of the EVA measure remains the
sameto better capture the economic performance of the measured unit.
Adjustments are selected on after weighing factors such as behavioral
impact, materiality and complexity. Common adjustments include the
capitalization of research and development, operating leases, and unusual
items such as restructuring charges.

2. Management (M2)
The management phase of the implementation brings EVA into action to
drive better decision-making throughout the organization. Included in this
component are the review of key projects and the development of spreadsheet-based decision tools to help improve the analysis of business issues,
consistency of decision-making, documentation, and approval processes
throughout the corporation.

3. Motivation (M3)
A key component of any EVA implementation is the creation of incentives
that link directly to the creation of shareholder value. By creating an incentive plan based on EVA, managers are rewarded only if they create shareholder value through sustainable improvements in operating performance.

4. Mindset (M4)
In order to transition employees into a mindset of value creation, a significant
effort is made on training and communications. Training of key staff on
EVA concepts and corporate finance topics creates a foundation for better
understanding. The continued communication of the EVA philosophy and
its successful application then builds on this foundation and maintains the
momentum of these ideas.

M1: Measurement
We were doing very wellor at least appeared to be performing wellduring the
economic boom of the 90s. But, when our markets began to weaken in 1999, our
returns on capital dropped pretty sharply, and our market valuejust as EVA said
it wouldwent down along with them.
- Sal Fazzolari, Journal of Applied Corporate Finance, Fall 2001
The Measurement phase is the initial step in the implementation of an EVAbased management system. At Harsco, the overwhelming theme was a focus
on simplicity to ensure that EVA would become an ingrained part of the
corporate culture.

Stern Stewart & Co.

The focus on simplicity dictated that the number of adjustments be limited to

items that would motivate changes in behavior. As an example, the lease adjustment, which recognizes lease commitments as investments in capital, was excluded. Although Harsco has a number of operating leases in place, it was determined
that the existing controls sufficiently limited the ability of employees to game
the system to generate apparent improvements in EVA without creating value.
All lease evaluations still need to be completed on a corporate template and are
treated as capital for calculating EVA and establishing a capital budget.
Furthermore, an EVA lease/purchase analysis must be completed and approved
by corporate Treasury. Thus, the decision to lease is economically driven. This
framework gives senior management added confidence that operators will only
enter into operating leases when they add value.
The EVA measure is also designed to only capture changes in the operating
results of the company. As such, the cost of capital and the tax rates are set and
generally held constant to allow managers to understand their hurdle rates.
Fixing these rates ensures that swings in interest rates or unusual tax events do
not unduly affect the measure of operating performance. Major non-operational
items, such as gains and losses on asset dispositions, are either excluded from the
measurement or capitalized to reduce volatility.
Finally, a critical consideration for the measurement of EVA at Harsco was the
international diversity of the company. Harsco had previously measured international results in U.S. dollars to reflect the investor base that had invested in U.S.
currency. This continued under the EVA plan, but due to the potential volatility of exchange rates, a mechanism was put in place that adjusts for unusually high
levels of currency volatility and protects managers from being whipsawed by factors beyond their control.
Overall, the success of the measurement phase can be summarized in saying that
Harscos measure is straightforward and simple to explain to financial and nonfinancial managers alike, while effectively capturing the economic reality of the
companys operations. The measurement phase of the project also benefited
greatly due to the strong information systems available at Harsco. Specifically,
Harscos Hyperion system allowed adjustments to the accounting base to be captured relatively easily and incorporated into Harscos regular internal reporting.

M2: Management
Raising the financial sophistication of our managers was one of the key goals of
our value-based management program. And as evidence of our commitment,
one of the key deliverables in our EVA project is what we call the Harsco
Corporate Finance Manual. This manual contains a very detailed and comprehensive analysis of a variety of corporate transactions, everything from lease-versus-buy decisions to evaluation of major capital projects. In fact, we have tried to
cover every type of financial situation that a manager is likely to encounter in the
field.
- Sal Fazzolari, Journal of Applied Corporate Finance, Fall 2001
Step two of an EVA implementation is using EVA to make better decisions.
Harscos portfolio of businesses has developed over time as management supplemented organic growth with a series of acquisitions and divestitures designed to
meet its strategic goals. One result of this diversity was that decision-making had
become more complex and consistency within and between divisions had diminished. As a result, the need for standardized and consistent decision tools was
critical. The Stern Stewart and Harsco teams worked together to build a complete set of tools and documentation to address this need.
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Early tool development focused on quick hits to demonstrate and build support
for the EVA decision framework. The first tool in place was the Terms Evaluator.
This is a common EVA tool that allows purchasing managers and sales reps to
quickly understand the trade-off between price changes (NOPAT impact) and
receivable/payable days (Capital impact).
The second tool was a Repair versus Replace model that allows operating managers to compare the cost of repairing equipment versus replacing it. Although this
decision is often complicated by the different expected lives of the two options, the
model handles this calculation in the background to allow managers to focus on
operating results.
Over the course of the project, the focus shifted to creating an all-encompassing
Capital Budgeting Model. The team developed the model for and generated feedback from all the key users throughout Harsco operations. At completion, a userfriendly model that could serve each of the very different business units was implemented throughout the company.
The development of the International Cost of Capital framework was another key
component of the implementation. By adjusting for sovereign and currency risks in
local markets, the project team applied a framework that was simple yet analytically robust and allowed Harsco to evaluate all projects on a consistent basis regardless
of the region or currency. In combination with the Capital Budgeting Model, the
tools completed a typically complex financial analysis of international issues. As a
result of these and other tools, managers now spend less time putting numbers
together around a project and more time doing the difficult work - interpreting the
output of the analysis.
This entire project was encapsulated in the Harsco Corporate Finance Manual.
This manual covers the major topics of corporate finance including EVA measurement, leasing, and capital budgeting. The manual standardizes the companys procedures and assumptions to improve the consistency of decision making and allow
easier comparison at the corporate level.

M3: Motivation
As we further grow our businesses, improve our processes, and provide the highest
quality service to our customers, EVA will act as a framework to help ensure that
the business decisions we make every day are focused on creating value.
- Sal Fazzolari, Harscos EVA press announcement, March 21, 2001
Stern Stewart works with each of its clients to craft an incentive plan that creates
better alignment between an organizations goals and the goals of its employees.
For most publicly traded corporations, this means using EVA performance measures to drive incentive payments. By utilizing EVA as the key performance metric,
senior management and the board of directors can ensure that decisions will be
made that are consistent with the goal of creating value.
Another goal of the Harsco EVA incentive plan was to create a sense of ownership
among managers in each of the companys divisions. For a widely diversified company spanning several industries, business models, and geographic regions, creating alignment at the company level can be very difficult. At the same time, achieving this feeling of ownership is crucial to the success of the company, as division
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Stern Stewart & Co.

management, by necessity, knows more about its particular industry than the central
management team. As a result, the delegation of decision rights to subsidiary management is an important part of the EVA management process. This delegation is
only successful, however, when managers can be reasonably expected to think and
act like owners. This ownership mindset is enhanced further by basing incentives
to the degree practicable on business unit performance, thereby creating appropriate line-of-sight for divisional managers.
In addition to creating a sense of ownership in results, the Harsco incentive plan
was designed to help restore the budgeting process to its intended purpose. In
many companies, bonuses are tied to whether a particular group is able to meet or
exceed its budgeted level of performance. Although the intention of this structure
is to encourage strong performance, the result usually is just the opposite: managers
try to ensure a rich bonus by negotiating a lower budget target. As a result, the budgeting process in many companies has deteriorated from an important and productive process of gathering information and assessing strategies to a long, drawn-out
negotiation around the definition of acceptable financial performance.
By tying bonus awards to objective, multi-year targets tied to the level of expected
EVA improvement implicit in Harscos stock price, Harscos management has effectively removed any incentive to sandbag a budget. Instead, managers are now
encouraged to budget aggressively because they will not be penalized for falling
short. Business managers now have every incentive to work with senior management to figure out the best possible performance that can be achieved, and the
resources necessary to get there. Our previous incentive plan involved numerous
metrics, Mr. Fazzolari said. It was complex, administratively burdensome, and
somewhat subjective. EVA has greatly simplified our incentive system, and most
important, has focused everyone in the organization on one value-creating metric.
Finally, in an effort to extend the decision-making horizon of all managers, the
Harsco board of directors was asked to approve three years of incentive goals,
instead of just one. As a result, managers can worry less about the short-term
impact that a particular project might have on incentive payments and look to the
life of the project. Further, by approving three years of targets, the Board has made
a commitment to its managers and to its shareholders that managers will be held
accountable for continuous improvement in value.

M4: Mindset
We are changing the culture of the organization. People are really starting to
think about capital efficiency and shareholder value as their number one priority.
- Sal Fazzolari, Journal of Applied Corporate Finance, Fall 2001
Training was a critical component to developing a value-creating mindset at Harsco
and revolved around three key areas:
1. Three day EVA Experts Training
2. Two day Managers Training
3. Two day Capital Budgeting Training
The three day EVA Experts training course was designed to instill a detailed level
of understanding among key finance staff to ensure that an understanding of the
measure was institutionalized within the company. The Experts Training course
covered all aspects of the measure from a basic overview of the EVA management
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Stern Stewart & Co.

system to the details of the EVA calculation at Harsco. EVA Experts now serve
as the main contacts for EVA-related questions throughout the organization.
The two day Managers training supported the development of a value creation
mindset in the company. Key operations managers were provided two-day training on topics such as the EVA measure and the details of the compensation plan.
The training was designed to be interactive, with a focus on EVA in action in
real-life operating cases. The course ended with the EVA Game, a computerbased simulation that allows participants to use their EVA knowledge in analyzing decisions of varying complexity.
The two day Capital Budgeting Training was a final training component
designed to create a more consistent understanding of EVA throughout the
finance staff and ensure consistency of decision making. The course reviewed
methodologies for capital budgeting, created standards for assumption inputs,
and educated users on the use of the EVA decision tools described above.
A parallel effort in the training program was the use of the Stern Stewart EVA
Training Tutor and Training Tutor Express. The browser-based training
program was distributed to Harscos worldwide non-financial operations and
administrative managers to provide a basic, professional introduction to EVA
principles and applications.
In total, well over 300 financial and operations managers, as well as the companys senior management team, received formal EVA training prior to the actual
implementation of the program.
The success of this comprehensive training effort was, and continues to be, supplemented by the equally important initiative of continued communication.
Harsco developed its own Intranet-based site for EVA information and communications called EVA Central, which is available to employees throughout the
company. The site was designed to provide basic introductory information as
well as more advanced EVA research and tools to satisfy the interests of both
newcomers to EVA and the companys more experienced EVA users. Harsco has
also incorporated EVA updates into its newsletters and other communications to
show the connection between EVA principles and front-line applications such as
the adoption of LEAN Manufacturing. By providing consistent reinforcement
of the EVA mindset of thinking and acting like owners, Harsco has shifted the
implementation of EVA from being a one-time event into a fully integrated way
of doing business.
This communication initiative has been extended to Harsco's investor relations.
Since the implementation began, senior management has provided updates on
the progress of EVA at each of its quarterly earnings calls and has provided
directional EVA results in its quarterly earnings releases. This external communication serves two important purposes. First, it states clearly to the market that
Harsco is focusing on all aspects of its financial picture, not just earnings per
share. Management has let it be known that a healthy balance sheet is a priority and will not be sacrificed to hit an earnings target. Consequently, management can better expect analysts to take balance sheet improvements into account
when assessing Harsco's overall financial health. Also, the external communication serves to further support the internal communication efforts. As managers
see the company's senior leadership stress the importance of EVA to all audiences, they can be even more confident that the focus on EVA is a lasting one.
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Stern Stewart & Co.

Total Shareholder Return Since Harsco EVA Implementation

80.0%
60.0%
40.0%
20.0%
0.0%
-20.0%
-40.0%
-60.0%
Jan-01

Apr-01

Jul-01
Harsco

Oct-01

Jan-02

Apr-02

Peer Group

Jul-02

Oct-02

Jan-03

S&P 500

Results
The success of the EVA implementation at Harsco starts at the top. Under the
leadership of Harscos chairman and its CFO, senior management has made
clear that value creation through EVA improvement is a primary financial goal.
They have set the tone through consistent communication of managements
philosophy, both internally and externally, and have made it clear to each of
their managers that they are being held accountable for results.
As a result, the EVA implementation at Harsco bore fruit even in its first year.
In its 2002 annual report, the first year the EVA incentive plan was in place,
Harsco announced the following:
"Our first full year under the formal Economic Value Added system has been
encouraging. There is an increased discipline being demonstrated throughout our
operations toward the more efficient use of capital. The average capital employed
across our four market sectors is being reduced, and we look forward to steady
improvement as our EVA culture takes deeper root. The incentive compensation of
all our senior managers is now tied directly to EVA performance."
To fully appreciate this accomplishment, one must take into account the very
difficult market conditions that Harsco faced. The slowdown in non-residential construction and in the overall U.S. manufacturing economy created a very
difficult environment in which to generate improvement. Harscos management, however, was able to adjust to the conditions and focus its capital in wellplanned, strategic areas.
Harscos stock price has also reacted favorably to the way in which EVA has
meshed with the broad strategic goals of becoming more international in scope
and centered on high-value industrial services. Total return for Harsco shares is
22.7% since management began the implementation of the EVA management
system in February 2001 versus a negative 35.8% return for the S&P 500. The
performance is also impressive when compared to other diversified industrial
companies, whose average performance in the same period is a negative 10.9%.

Stern Stewart & Co.

The question then becomes, How has this performance been achieved? Many
think of EVA as a finance or accounting initiative with the primary work being done
in the back offices of corporate headquarters. In fact, as Harsco has demonstrated,
the success of the EVA management system is only as great as the efforts of a companys operators. EVA improvement is achieved when managers understand that
capital has a cost and make decisions reflecting that fact. To reinforce this fundamental behavior, Harsco and Stern Stewart jointly developed an EVA Drivers
chart that graphically illustrates some of the ways that EVA improvement can be
generated. The chart is used daily by Harsco managers and employees worldwide
to focus their EVA decision-making.

EVA Drivers: Strategies for Improving EVA

EVA
NOPAT

Grow Sales
Grow Sales
Grow Sales
Without Adding by Investing in
Capacity
Superior Return
Opportunities
Market Share
New Markets
Brand Mgmt.

Acquisitions
New Contracts/
Projects

Capital

Control Costs

Manage Assets
Inventory
Management

SG&A

Employee
Productivity

Equipment
Optimization

Operating
Expenses

Outsourcing

Taxes

Safety

Mfg. Capacity Sell Under

Optimization -performing
Assets

Risk Mgt.

Accounts
Receivable
Management

Utilize Idle
Assets

Conclusion
Every company is different and the ways in which value-based management can be
employed to improve a companys overall management system are too numerous
to mention here. Harscos success in this project, however, points to the primary
success factor in any such undertaking: strong leadership from a senior management team committed to driving shareholder value. By clearly stating managements priorities and taking action to enforce them, the Harsco team created an
example that its managers were glad to follow. The recent demise of companies
such as Enron and Worldcom, where managements focus and drive was not for
creating value but instead for driving accounting earnings, has shown that this
leadership is very valuable indeed.

Stern Stewart & Co.

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EVAluation is a series of periodic reports from Stern Stewart & Co., drawing on the depth of our experience and internal research, to
cover issues of valuation, organizational design, decision making, remuneration, and corporate governance. We assist in understanding
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The views expressed in this report are based on Stern Stewart & Co.s general knowledge, analysis and understanding of value,
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