2012

Asahi Glass: Implementing EVA

Submitted by : Group 9
Aman Singh Preethi RS Priyankar Biwas Tina Gupta Shipra Agarwal

[CASE ANALYSIS: WRITE UP]

Case Write Up: Asahi Glass

AGC is a Japanese Multinational company (operating in an oligopolistic market structure) with operations in 25 countries and a network of 200 subsidiaries. It operates in 3 businesses: Flat glass, Chemicals and electronics and displays with global leadership in most of the businesses. The flat glass business remains core with 53% of the group sales and 56% of operating profits and 21 % of the world flat glass market. Since 1960s AGC has performed vigorously well in the global market. The company adopted drastic steps to better face the changing environment. This included: 1. 2. Creating value through reorganization Corporate governance reform (outsider in the boardroom, delegation of power to in house companies, nomination committee to oversee executive succession etc.) 3. Using Economic value added at Asahi Glass

As with any organisation Asahi had to face resistance for the changes introduced and we will address each of these questions in detail as we go further EVA as a tool for maximizing the shareholders wealth

EVA ensures that: y y y y Profits are shown in the way shareholders count them Company decisions are aligned with shareholder wealth A financial measure is used that line managers understand The confusion of multiple goals is ended

In case of Asahi, it introduced EVA as a tool for both resource allocations as well as for performance evaluation.
a. Resource Allocation:

AGCs resource allocation was now part of the 3 year planning cycle. Each SBU was to give its investment and cash flow projections and then AGC ranked them based on their strategic fit and value to the firm. Thus moving towards value portfolio This required a method where each SBU could be measured against its own cost rather than an overall hurdle rate. To explain it, if market is saturated then the kind of returns would be different from an emerging/new market. Likewise; each geography had a different risk return profile; hence it made sense to go for a system which considered each of these points. Sam e for each type of business (e.g. in flat glass AGC was a market leader, so the kind of returns would be different for the capital invested)

Under the new system; each in house company would be independently responsible for its own EBIT, operating assets and EVA. This will enable them to better plan their investment decisions. (Increased funding - increased opportunity with greater responsibility) The EVA method ensured that the NOPAT of each BU and each country is measured against that particular component of cost and hence more accurate investing decisions are taken. Like; earlier a lower hurdle rate was used for emerging countries which lead to over investment in these countries.
b. Performance Evaluation:

Bonuses tied to EVA performance will ensure people putting in 100% percent and to shun their relaxed attitude. Now each individuals own survival is directly linked to companys success. For executives as they are directly into decision making a higher WACC of 8% is used whereas for lower level employees in Japan a WACC of 5% was taken (only into implementation) The methodology used: EVA=NOPAT - CE*WACC

Where; NOPAT: Net Operating Profit after Tax; CE: Capital Employed and WACC: Weighted Average Cost of Capital Calculating EVA for each country and each business unit: To do so we need WACC for each country and each BU which was computed as follows: Deriving Cost of Debt and Cost of Equity ----Industrialized countries: In industrialized countries, the local currency is used for the calculations. The cost of debt is the risk-free rate in the country plus a 100 basis point credit spread. Rd =Rf + Credit Spread The cost of equity is calculated using CAPM model: ------Emerging Markets: In emerging market, the US dollar was used for calculations: The cost of debt was calculated by adding the US 10 year T-Bond yield, a credit spread of 100 basis points and the country risk premium.

Therefore, Rd = US 10 year TB yield + Credit spread + country risk premium The cost of equity was estimated based on information provided by JP Morgan and Ibbotson In the same way, the WACC calculation for a business unit- Asian Flat Glass Business can be done by weighted average capital invested in the relevant countries the unit is operating in: e.g. The result of the WACC calculation for a business unit- Asian Flat Glass Business is 10.0%, while the result for FLAT- PANEL display unit is 7.2% due to the fact that the Flat Glass Business is mainly situated in emerging market (46% of the capital employed = (18+13.2+33.6)/116.4 = 45.7% round up to 46%).

Challenges in implementing reforms in corporate governance and new performance management system 1. Corporate governance system: Even though the corporate governance system was too radical and well ahead for the Japanese company; it did not see any major resistance. People accepted the concept as it brought in larger transparency and ensured that board focused on narrow but more strategic issues 2. Performance system y Some senior employees who were too used to old system resisted linking bonuses directly to performance (not every contribution can be evaluated in financial terms) y Granting financial independence may lead to inconsistencies between overall company goal and individual BU objective resulting in ve results for AGC y Also since each region has its own economic and business environment having a common SBU goal may not suffice

People resisting to the new reforms and their arguments Due to globalization of customers of AGC, it was essential to reorganize AGC according to products rather than the current geographical organization. This was necessary to coordinate efforts across regions and provide uniform service and products to global clients across geographies. The plan was to create four in-house product companies and to delegate significant authority to each of these SBUs. But there were reservations on this reorganization as this would provide considerable freedom to the in-house companies in taking their decisions. From the financial perspective, the CFO of AGC felt that the presidents of each of these independent companies might not understand AGCs financial position and hence could make capital structure decisions that could impact the creditworthiness of AGC

On the other hand, there were issues from the corporate planning side as it would result in conflict with the interests of the local partners because they tended to pursue profits for each local company. Another challenge was facilitating communication across the global SBU which would require relocation of people across regions. On the accounting front consolidation of accounting statements of each of these regional entities which followed different accounting standards was difficult. The corporate governance reforms which included 4 member nomination committee to oversee executive succession and induction of independent directors (2 out of 7 directors) on board marked a departure from Japanese norms hence attracted severe resistance from the Japanese management Moreover, appointment of non Japanese executives to manage the glass business which accounted for more than 50% of the total sales lead to resentment and discontent amongst Japanese employees. In addition, globalization of human resources meant that the percentage of employees at AGC would decline going forward which again marked a departure from Japanese practice of fostering career spanning relationships with employees. Changing the mindset of employees and fit the new management system with AGCs operations? Was it successful? Justifying our stand

The changes in the structure of AGC were aimed at transforming its image as a global player rather than a Japanese firm. This reorganization required significant changes in the mindset of employees who were used to working in the closed Japanese work culture. But as per the case this change was driven from the top and the reason and vision behind such reorganization was not communicated to the employees leading to fear and scepticism. Moreover, no efforts were made to involve the employees in the change management process. In fact as per the statements of Ishizu, he did not anticipate that such reorganization would require participation and involvement of employees to make the change acceptable. Thus, we believe that not much efforts were put in to explain such drastic changes in the structure to employees and hence despite introduction of EVA based performance management system many of the senior managers still looked at profitability clearly indicating that efforts to change the mindset were a failure.