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2000 Excellence Awards: Richard Kelson

By reconfiguring both metrics and planning, Alcoa's finance chief wins twice.

1Oct

In the fall of 1997, storm clouds suddenly darkened the horizon for Alcoa Inc. Aluminum prices, a leading indicator of Alcoa's earnings, plunged 12 percent during one 60-day period. The Asian crisis weakened demand, and Alcoa's stock began to lag the industrial averages that it had beaten the previous two years.


CFO Richard Kelson was fresh on the job, having moved over from general counsel the previous May. With the company's 20 business-unit presidents anxiously awaiting next year's budget for their production and productivity goals, what was a new CFO to do? Kelson's answer: Plenty.


The then-23-year Alcoa veteran not only knew the company well, but he also understood the macroeconomic conditions surrounding its 180 operations in 28 countries. And he was extremely familiar with the finance side through Alcoa's acquisitions. So, when Kelson suggested scrapping the existing 1998 operating plan and starting over with new metrics, then-CEO Paul O'Neill and then-COO Alain Belda listened. The two, now Alcoa's chairman and CEO, respectively, ultimately agreed, putting into motion a dramatic redirection that would make Kelson the only double winner in this year's CFO Excellence Awards-- in the categories of Planning Process/Resource Allocation, and Performance Measurement.


The drive to rebuild both Alcoa's planning and its metrics has developed into the centerpiece of a financial transformation for the 112-year-old Pittsburgh company. Gone are the 1-year plans, replaced by 3-year stretch goals. And six- quarter rolling forecasts now focus on changing expectations.


"The forecasts I was getting weren't worth the paper they were printed on, and I didn't care to see them," says O'Neill of the old Alcoa planning system. "After Rick overhauled the process, I was asking, 'When will I see the forecast?'"


The metrics overhaul was equally enlightening. Previously, for example, the company used yardsticks considered too myopic by Kelson. While Alcoa knew how many cans per hour or car doors per machine per year could be produced, such data limited comparisons. Now Alcoa blends three main approaches to metrics--cash flow return on investment (CFROI), a tailored form of economic value-added (EVA), and a balanced scorecard-- strongly boosting the performance-based element at the company. And measuring more in financial terms let Alcoa stack its results against companies across all industries. "We said, it's not enough to be the best of the metals anymore," explains Kelson. "We tried to look outside of ourselves and ask, What do people expect of high-performance companies?"



Lofty Goals

Those expectations were determined initially by benchmarking the top market-performing companies in the area of return on capital--using a Stern Stewart & Co. EVA model. Kelson then applied Holt Value Associates LP's CFROI software to get the additional buy-side perspective of portfolio managers looking at Alcoa.


Using both measures, says Jim Knight, who leads Chicago-based SCA Consulting's performance measurement practice, helps the company communicate to diverse audiences. Both address use of capital, but while EVA is easier to explain to nonfinance employees, CFROI numbers give investors more confidence in the company.


"In order to be truly successful," says Knight, "you have to drive beyond stock- price and cost-cutting targets and identify the value drivers and figure out how to get there." To wit, some 60 percent of Alcoa's balanced- scorecard measures are financial, including capital intensity and overhead costs. The rest concentrate on such issues as minimizing lost-workday injury rates among factory workers. (Such injuries, incidentally, were halved between 1997 and 1999.)


To drive longer-term performance, Kelson created three- year horizons for all the redesigned Alcoa metrics. Then managerial compensation was tied in. Many goals that Alcoa set were lofty--a $1.1 billion cost-cutting, for example, and a stock-price boost to put Alcoa in the upper quintile of companies on the Dow Jones Industrial Average by year-end 2000.



Writing the "Philosophy Book"

Since most measurements were now financial, tracking progress toward goals became easier. To make progress obvious--or to highlight shortfalls--Kelson introduced unit-specific data books with graphs and charts comparing monthly results with historical trends, and tracking results alongside future goals. "The data books eliminate any temptation for 'sound-bite' management. You're now looking at things very much in context," he says. Introducing quarterly revisions to the forecasting process has added even more integrity.


While Alcoa's business units have some autonomy, each must earn a minimum 12 percent return on capital before any significant capital is invested in its growth. And compensation is based on both the return and the growth. As a general guide to allocation decisions, Kelson devised a "philosophy book" that outlines positions on everything from off-
balance-sheet financing to funding small joint ventures.


Alcoa vice president William Christopher, who heads the forged-products unit, says the business-review process makes "what-if" scenarios easier. "Now the challenge is analyzing the numbers, rather than generating them," he says. In one recent case, he planned for a slowdown seen far ahead in the heavy-trucking industry. "In the six-quarter rolling forecast, it became very obvious that the downturn was coming. In prior years, we would have been up to our eyeballs in meetings for two weeks about what to do right now."


In the last quarter of the original three-year plan, Alcoa is now hitting most targets. The company as a whole, currently at a 13.9 percent ROI, is aiming for 15 percent in 2001. Alcoa's stock was the top performer on the DJIA in 1999, gaining nearly 126 percent--and creating a tidy sum for Kelson, whose $5.8 million in options-based compensation last year was sharply above his 1998 options income. While the stock's performance has been distinctly rockier over the first half of 2000, it was again climbing above the DJIA at the end of August, trading in the mid-30s.



Making Acquisitions Easier

Standardized measures also allow the company, now with 25 business units in 36 countries, to close its books in less than five days. "There are very few companies in the world that operate on a global level that can do that," says analyst Thomas Van Leeuwen of Credit Suisse First Boston Corp.


Kelson is especially proud of the fact that internal processes have increased profitability enough so that Alcoa can both insulate itself against the cyclical industry's downturns and gobble up competitors. Alcoa has been particularly active in the latter area, acquiring major U.S. rival Reynolds Metals Co. for $4.5 billion last May, and buying Alumax Inc. two years earlier. Yet, despite all its acquisitions, Alcoa managers "haven't seemed to increase spending. They've been very careful about how they've allocated capital," says Wayne Atwell, a managing director of Morgan Stanley Dean Witter.


Rising aluminum prices have helped, but Alcoa's cost reductions and merger-related operating efficiencies have also contributed to the 59 percent rise in net income for the first half of the year, despite charges stemming in part from the Reynolds Metals acquisition. Kelson's business-review process will be rolled out "immediately" at Reynolds, says CEO Belda.


Kelson and Belda recently sent a draft version of their 2003 goals to business-unit leaders, and are waiting for their comments. For now, they will say only that the goals will be designed to make Alcoa "the best company in the world," and eventually double its current revenue base of around $20 billion. "Not so long ago, such a vision would have been ridiculous," says Belda. "Not anymore."



Showing Its Mettle

 19961997199819992000*
Revenue**$13,061$13,319$15,340$16,323$10,100
EBITDA**$1,963$2,478$2,645$2,932$2,058
Net Income**$515$805$853$1,054$732
Working Cap. (Avg.)**$1,999$1,936$1,861 $1,777$1,451
DWC5653444026
Return on Shareholder's Equity11.6%18.1%16.3%17.2%17%
Return on Capital8.3%9.9%9.3%9.9%11.5%

*Six months. 
**in $ millions 

Source: Alcoa Inc.

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