Metrics that work
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Sometime in the next week or so, I will send everyone a copy of a “white paper” that I am finalizing. The paper will detail what key metrics private fleets are using to grow their fleet by increasing competitiveness in both service and cost.
Two of the most complicated metrics covered in the paper will be return on invested capital (ROIC) and Economic Value Add (EVA). To get some help on this topic, I turned to George Carpenter, CTP, Logistics Systems and Technology Manager for the Army and Air Force Exchange Service (AAFES).
I thought it might be helpful to pass on Carpenter’s advice through this blog for how he uses these metrics as benchmarks in his private fleet.ROIC is defined as the cash rate of return on capital that a company has invested. ROIC shows how much cash is going out of a business in relation to how much is coming in. In a nutshell, ROIC is the measure of cash-on-cash yield and the effectiveness of the company’s employment of capital.
The formula looks like this:
ROIC = Net Operating Profits After Tax (NOPAT) / Invested Capital.
At first glance, the formula looks fairly simple. However, in the complex financial statements published by companies, generating an accurate number from the formula can be complicated.
To keep things simple, start with invested capital, the formula’s denominator. Representing all the cash that investors have put into the company, invested capital is derived from the assets and liabilities portions of the balance sheet as follows:
Invested Capital = Total Assets less Cash - Short Term Investments - Long Term Investments - Non-Interest Bearing Current Liabilities.2
Carpenter says he modified the ROIC calculation so that it only pertains to the company’s private fleet. The calculation he uses for ROIC is:
ROIC = (100% Outsourcing Cost - Internal Operation Cost) = Net Fleet Cost / Transportation Assets.
“We use the modified calculation as a benchmark to ensure that our fleet continues to add value to the organization when compared to the 100 percent outsourcing option available,” Carpenter says. “We set the bar high and we expect to keep this number at or above 25 percent before we would seriously consider the outsource option given all of the cost associated with liquidating assets and transitioning.”
Because private fleets often lease rather than own their equipment, the type and terms of the lease would have a lot to do with how to account for it in the ROIC calculation. If a company had long-term leases with a measurable minimum investment that could be capitalized, it could be calculated just as an owned asset. If the lease costs are not capitalized, it would be considered part of the normal internal operating cost portion of the formula.
“In either scenario you accurately account for the expense/cost in order to make an individual decision on the percentage you wanted to set as a benchmark,” Carpenter says.
Economic Value Added is a popular performance metric used by companies and their consultants. Much of its popularity is a result of able marketing and deployment by Stern Stewart, owner of the trademark. However, the metric is justified by financial theory and consistent with valuation principles, which are important to any investor’s analysis of a company.
The formula for EVA is as follows:
Net Operating Profit After Taxes (NOPAT) - (Capital * Cost of Capital)
Carpenter says that AAFES would only use the EVA calculation when looking at the potential impact that its fleet and/or logistics network could have on one of the factors considered in the calculation.“If for example we reduced lead-time and as a result the organization lowered inventory cost then we would use EVA to measure that impact. We would also use EVA to measure the impact to the organization of any initiative to reduce cost of PP&E. This is not purely a fleet measure, but is more appropriate for an organization that has it own logistics/distribution operation and has a private fleet. Further this is a measure we would use as necessary and not necessarily a benchmark that we would use to set ongoing KPI’s.”
Carpenter showed me an example of how he would use the EVA calculation to set the base-line from which to measure the EVA impact of an initiative from the logistics and/or fleet perspective to reduce inventory. In his example, he showed that even a 10 percent change in inventory costs would have a 52 percent impact to the EVA. If you’d like more information on any of these metrics, like seeing how they look in a spreadsheet format, or how to apply them to your fleet, don’t hesitate to email me. I will be happy to ask George Carpenter for more resources.
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