SIGNED AND SEALED - BUT CAN EVA DELIVER?

The U.S. Postal Service has been awash in red ink for years. Can a new performance metric turn things around?

by Karen Spinner

Understand that Riley, 52, is a serious man with a serious résumé: DBA in finance from Harvard, top finance positions in the private sector, including a stint as CFO of United Airlines. Since joining the Postal Service in August 1993, he has taken a number of steps to improve the agency's financial status, implementing finance and management techniques from the private sector to increase efficiency and decrease operating costs. "We have already seen some short-term progress," says Riley, "but we are seeking approval from our board to make more fundamental changes over the long haul."

Last month, the Postal Service's Board of Governors approved one of those fundamental changes: a comprehensive economic value added (EVA) program developed by Riley and Postmaster General Marvin Runyon in conjunction with consultants Stern Stewart Co., EVA's New York City-based proselytizers. EVA is a much-ballyhooed measure of the efficiency with which a company uses its capital, and is simply defined: net operating profit minus the cost of the capital employed to produce that profit. It's a master metric by which a company can evaluate management decisions and gauge the performance of its business units.

Riley says if the EVA program is successful, the Postal Service could generate up to $1 billion in annual profits by the late 1990s--more than enough to decrease the price of a stamp. But that's a big if. Companies that have claimed results from EVA weren't exactly slouches to begin with--AT&T, Coca-Cola, CSX, Briggs & Stratton, to name a high- profile few. How will EVA work with a capital-starved, labor-intensive, highly regulated federal agency with a history of red ink?

If it were a private corporation, the Postal Service would be the 12th-largest business in the United States. And it would have a serious investor relations problem. For starters, the Postal Service has lost money in 18 of the last 25 years; rate increases have been responsible for the few surpluses, which quickly melt (see chart, page 95). Barred from offering volume discounts, the agency has lost share of the profitable overnight- and two-day-delivery market to agile private vendors, like FedEx and UPS. The future doesn't look good, either, as faxes, E-mail, and the advent of electronic banking threaten to carve huge chunks from the Postal Service's franchise. (About 40 percent of first-class mail consists of bills and payments, say analysts.)

OPERATING CONSTRAINTS

Part of the Postal Service's woes, of course, is due to its hamstrung status as an independent government agency. Since 1982 the agency has operated without taxpayer funding, subsisting on postage and fees alone. Price changes must be recommended by the Board of Governors and approved by the federal Postal Rate Commission, a process that usually takes about 10 months.

From a financial perspective, the Postal Service operates under constraints that would frustrate most private-sector CFOs. Riley doesn't have access to a bank line of credit; the agency must go to the U.S. Treasury for short-term financing. For overnight loans, the Postal Service must pay interest equal to the three-month Treasury rate plus one- eighth, a rate most large corporates would not consider favorable. Debt issues must be approved by the U.S. Treasury, which then incorporates the Postal Service issue into Treasury notes, bills, and bonds. (Only recently was Riley permitted to add call options to Postal Service debt.)

The Postal Service is also tied down by Congress and by public opinion. New post offices and processing centers can be legislated into existence, whether or not the agency's management believes such additions are necessary. Retroactive costs can be legislated into the annual budget as well: for FY 1993 the agency was assessed a whopping $1.04 billion in back interest on over $9.5 billion in retroactive retirement costs, which Congress had allocated to the Postal Service in the Omnibus Budget Reconciliation Act of 1990.

Not surprisingly, Riley's first two years on the job were devoted to stanching the hemorrhaging of money and shrinking the debt. For example, he convinced the Board of Governors to reduce the cash reserves the Postal Service is required to hold, from an amount equal to three payroll cycles-- a humongous sum for an organization with 745,000 employees--to an amount equal to one cycle. Riley also requested and won a price increase, raising the cost of a first- class stamp in January 1995 from 29 cents to 32 cents. Unpopular as it was, the 3-cent increase was well below the rate of inflation. (Today's 32-cent stamp would be worth 8.5 cents in 1971 money--a half-cent above that year's first- class rate.)

Riley has set a number of "medium-term" goals for the next few years, including keeping any price increases below the rate of inflation and improving service. To this end, a number of limited incentive programs have been implemented, designed to reward employees for cutting costs, increasing efficiency, or improving customer service. He concedes, however, that such short-term measures are "something of a Band-Aid." "More sweeping changes are necessary," Riley admits. "We have to change the culture here."

ACCURATE ALLOCATIONS

In order to change that culture-- which Riley characterizes as "one of a government mentality, rather than a businesslike environment"--management concluded it was necessary to develop a method of accurately assessing the contribution of various local offices and rewarding employees for improvements. That's where EVA comes in.

The Postal Service is organized into 10 regional units, 85 "performance clusters," and hundreds of district offices and processing centers. The EVA program will evaluate performance at the performance cluster level. Currently, these clusters are managed by teams, including district office managers and processing-distribution managers, often with leadership rotating among the team members.

To gauge whether a given cluster is adding value or not, a new method of allocating costs and revenues had to be developed, says Riley. Under the old system, revenues were allocated independently of the labor required to produce them. He cites the example of bulk-mail catalogs. While, say, the post office in Freeport, Maine, receives tremendous revenue from direct-mail merchant L.L. Bean's postage account, that office has little to do with the distribution and delivery of Bean's catalogs, which are shipped by truck to other post offices equipped to handle high-volume processing. And those offices don't share in the L.L. Bean postage bonanza.

To solve such problems and make it possible to generate meaningful EVA numbers, the Postal Service developed a system of transfer pricing based on statistical analysis. Over a period of time, random samplings of mail from various locations were studied according to the various types of packages "captured," associated revenues, and processing costs. These statistics were used to build a transfer pricing/cost allocation system, which is accurate down to the performance cluster level, says Bill Tayman, a Postal Service analyst who works closely with Riley. "Below the performance cluster level," says Tayman, "estimated transfer pricing does not work because we cannot gather sufficiently large statistical samples for, say, each district office."

By allocating costs and revenues according to work load, employees' energies can be directed in more-productive directions, says Tayman: "If we simply evaluated EVA based on unadjusted revenues, we might see performance clusters attempting to boost their EVA ratings by attracting revenues from other clusters, rather than focusing on increasing efficiency and productivity."

At the same time, the Postal Service is eliminating moldering performance measures that in some cases reward managers for loss-making behavior. (In one absurd example, post offices were rewarded for "maximizing" the productivity of letter-sorting machines, which often resulted in workers spending longer hours at antiquated machines.) Instead, the agency is negotiating with its more than 70,000 supervisors and postmasters to build a variable component into their compensation based on the EVA of their performance cluster.

Starting October 1, 1996, each performance cluster will be charged 12 percent for capital--plants, machines, trucks, offices, and so on. Management would be thrilled if the clusters earned a nice operating profit after subtracting the cost of capital, but Riley says it's enough to break even, on average. "We don't want to be a cash cow," he says. "Our primary aim is to keep costs down and the quality of service for our customers up." To that end, the agency's EVA program has been customized especially for a break-even orientation. Considering the Postal Service's record, breaking even in most years would be a monumental improvement.

CAPITAL GAINS

Implementing EVA won't require a wholesale alteration to the Postal Service's accounting system. Instead, EVA-related data will reside in its own database, and EVA measurements will be calculated following general-ledger reports for each accounting period. "The systems to accomplish this," says Tayman, "are to a great extent already in place."

If systems to measure EVA are already there, the equipment to improve EVA isn't. The Postal Service suffers more from the lack of capital than from its inefficient use; 80 percent of the agency's revenues are consumed by labor costs, which Riley admits is high. "We would like to increase our asset base," he says. "Unlike many firms which have overinvested in fancy equipment, we just don't have enough." Old machines with high error rates will be phased out, he adds. Greater automation doesn't mean that layoffs are in the Postal Service's future; the agency has never had a layoff, says Riley, and the CFO doesn't believe one "is even a remote possibility."

In the end, the Postal Service's problems seem painfully obvious--a public, politically influenced mission, cumbersome government regulation, unproductive labor practices, outmoded equipment. Why does it need EVA to provide the seemingly obvious solutions? "EVA brings together all aspects of the business into one measure," replies Riley. "It changes the focus from the traditional government culture. We will learn to grow revenue only when it is profitable, to invest more only when it produces a good return, and to reduce expenses only when it doesn't hurt service."

Who knows: one day Riley may actually ask the Board of Governors to reduce rates, and the 29-cent Elvis stamp will live again.

Karen Spinner is a freelance writer based in New York.