VideoOn a cumulative basis, Packard found that since Vanguard's inception in 1975, it had a VEVA of $45 billion. The total for 1998--the total return differential for the year times the invested assets that year--was even more astounding: it came to approximately $15 billion in added value to shareholders. Furthermore, Packard calculated that about two- thirds of that value was created by Vanguard's investment performance, with the balance credited to its expense-ratio advantage. (This year's total VEVA is tracking at $8 billion to $13 billion.)
"This was a superior innovation," says CEO Brennan. "I've taken VEVA to our clients and told them, This is what we've done for you. They have found it a more helpful way to understand our success than being told we're at $500 billion in assets."
Dissecting Expenses
While VEVA has proven to be a compelling measure of value creation, Packard worried that it was too difficult for employees to relate to. He wanted a measurement that would help them to better appreciate their contribution to adding value. "We wanted to come up with something that was actionable," Packard says.
The expense ratio for Vanguard's funds, which is consistently lower than its peers', had fallen 10 percent between 1995 and 1998, from 0.31 percent to 0.28 percent of net assets. But while the company has easily maintained its competitive position as low-cost provider, Packard was concerned that the dramatic market appreciation, as reflected in the denominator of the calculation, was largely responsible for the recent expense-ratio decline.
"We could easily spend at high levels without adding much value to our shareholders and still have the lowest expense ratio in the industry," Packard observes. "We needed a measure that removed the benefit of market appreciation and established itself as the standard."
The result -- Vanguard's market-adjusted expense ratio -- compensates for market appreciation by including only the cash flow from investors on the asset side of the expense-ratio calculation, and is about 40 percent higher than its straight expense ratio. Moreover, Packard discovered that the market-adjusted expense ratio actually increased in 1998.
"Many crew members had the false impression that they were doing a fantastic job on efficiency," he says. "They may not have seen areas that needed improvement or opportunities to reduce costs." By calculating the market- adjusted expense ratio on a departmental level, Packard says the metric has brought more discipline to the planning and budgeting processes and to capital-allocation decisions.
It has also been a tremendous motivator. For 1999, Vanguard set a corporatewide target of reducing its market-adjusted expense ratio by one basis point. And in the first six months of the year, Packard reports, the company is on its way to meeting that goal. Moreover, the balanced scorecard is now used to determine the overall bonus pool.
A quarter-century ago, it took sheer determination to get the sailors stationed in Hawaii to care about costs. "Back then, a balanced scorecard would have been completely foreign," Packard quips. Although also once foreign to Vanguard, that concept now allows everybody to better understand where this ship is sailing.
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