EBIT after Asset Charge - the new performance metric of Deutsche Post World Net
Starting January 1, 2008, Deutsche Post World Net will introduce EBIT after Asset Charge (EAC) as the new performance metric throughout the Group. Although EAC may seem like a rather technical measure at first glance, it will in fact initiate a profound change toward value-based management at Deutsche Post World Net. By using EAC as the new key performance indicator, the Group will effectively align the incentives of more than 3,000 executives with value creation and thus with the main interest of the shareholders. It will also improve transparency about value generation by using it as an additional metric in external financial reporting. So how does it work?
Value-based management is based on the idea of focusing managerial attention on the efficient use of corporate resources. In order to achieve this goal, a suitable performance and steering metric needs to account for two aspects: profitability and the capital employed to achieve those earnings. Capital tied up in a business comes at a cost, and this cost of capital has an impact on value generation: If the cost of capital tied up in a business exceeds the profits generated from it, a company will destroy value instead of generating it. To turn it around, if a business manages to optimize its use capital and generates earnings in excess of the costs associated with its asset base, it will create value.
This is the fundamental idea behind the very pragmatic Asset Charge concept. EBIT after Asset Charge takes the capital employed into account and charges for it at the cost of capital. The Asset Charge is thus calculated by multiplying a precisely defined selection of balance sheet items, the so-called net asset base of a business unit, by the weighted average cost of capital (WACC) of Deutsche Post World Net, which is currently 8.5 percent. The resulting asset charge is then deducted from the EBIT.
Here is an example: The working capital of a business unit is part of the net asset base. One of the key goals of Deutsche Post World Net is to reduce net working capital to free up additional cash. With the Asset Charge as a metric for performance and executive compensation, managers will be interested in lowering receivables and increasing payables wherever possible, thus reducing their net asset base. This in turn will lead to an increase of the EAC.
Deutsche Post World Net is confident that EAC will foster a management mindset focused on value creation. It ensures that the balance sheet will receive similar attention as increasing profitability. EAC will be introduced into the executive compensation system in a stepwise approach to make the roll-out as smooth as possible. In 2008, explicit EAC target will be set for all operating entities, and 50 percent of management incentives will be tied to the new metric. In 2009, EAC will fully replace the EBIT as the performance indicator in the incentive system. Shareholders will benefit from the resulting consistent focus on value creation throughout the Group.