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Vyaderm Case

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by

Ali Kinzer

on 22 January 2013

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Transcript of Vyaderm Case

Our Recommendation Vyaderm Pharmaceuticals Company History Vyaderm Founded in 1945 and became a large competitor within the industry in the postwar healthcare world
Thomas E. Finn, former CEO, led the company to financial success with a business strategy focused strictly on earnings per share (by 1996 Vyaderm had a market cap of $2.7BN)
Problem with approach: There was little sharing of best practice or interest in helping build synergies across the company’s 15 subsidiaries to support corporate strategy Economic Value Added Approach In 1997, new CEO Maurice Vedrine, decided to move away from the old earnings per share business strategy and implement an Economic Value Added Approach to:
1. To demonstrate to the investment community the intent to continue Vyaderm’s profitable growth
2. To provide a solution to conflicting management priorities caused by competing financial measures Vyaderm EVA Incentive Program Old compensation system:
1,000 managers received annual bonus
Half of bonus based on objective operating results (business unit sales, earnings, and asset mgmt)
Half based on a subjective evaluation of manager’s contribution
Problem: there was no explanation on how bonus amounts were calculated.
Manager’s focused on their interest (increasing their bonus) rather than shareholder’s interest (profit)
New compensation system: EVA program
3 components
EVA Centers
EVA Target
EVA Interval
EVA Drivers
EVA Performance Level The Dermatology Opportunity January 2000
Main competitor, PJL Laboratories, was required by the FDA to recall all antifungal cream based on quality purposes.
This caused a temporary price increase and substantially boosted the dermatology business’s profit margin.
Profits greatly exceeded their EVA target.
January 2001
Another competitor entered the antifungal cream market and Vyaderm’s prices fell back to historical levels.
Problem: One-time, outside anomaly affected the Dermatology business’s numbers. This would cause a large bonus payout this year, but could potentially wipe out next year’s bonus payout if the business underperforms. 3 EVA CALCULATIONS 2000 EVA for the North American Dermatology Division
2000 EVA bonus payout for a manager earning $200,000, assuming that the manager’s bonus was based 100% on the division’s EVA
2001 EVA and estimated bonus payout for the same manager, assuming that Vyaderm profits fell back to historical levels and the year-to-year EVA improvement goal remained constant Solution 2 Keep the current system of compensation but change the interval to adjust for external factors.

Problem: Managers would have little control over their bonus since upper management could change the interval to create any bonus amount.
Problem: The only way to benefit from the bonus bank is to perform poorly, otherwise the bank continues to accrue bonuses earned without any form of payout to the manager. Solution One Rank each manager within each division and have a set bonus amount based on the ranking. For example, the top performer receives 55% of their base pay, the second highest performer receives 45%, the third highest performer receives 35% and so on.

Problem: Putting employees within each division against one another and against every other division creates an environment of intense, and potentially malicious, competition and possible ill-will towards each other. Ashley Eskenazi - Alison Kinzer - Simone Krame -Hayley Paradise - Alex Patel - Julie Weber Predicament caused by the Dermatology Opportunity One-time, outside anomaly affected the Dermatology business’s numbers.
Vyaderm faced with a difficult situation:
1. should the target bonus stay the same despite this anomaly or,
Advantage: large bonus payout this year
Disadvantage: could wipe out next year's bonus if business underperforms
2. should the 2000 target bonus level be adjusted to reflect the “windfall” created by the exit of PJL from the market?
Advantage: could mitigate “psychological impact of winning big this year and performing poorly the next”
Disadvantage: lost motivation of winning big Potential Solutions 1. Keep Target Bonus the Same
2. Keep Target Bonus the same, but exclude year 2000 antifungal cream profits from calculations
3. Modify current EVA-incentive program
After calculating the 2000 and 2001 EVA bonus payouts, we agree with your colleagues concerns regarding the “psychological impact of winning big this year and performing poorly the next”
Therefore, this is not a viable option Keep Target Bonus the Same Keep Target Bonus the same, but modify year 2000 antifungal cream profits We don’t believe adjusting the target bonus would be the best way to account for the profit anomaly, but an option with a similar desired outcome we considered was to adjust the year 2000 antifungal cream profits
Instead of using the actual revenue produced from the antifungal cream in 2000 when calculating the dermatology department’s total profit, we suggest creating a projected revenue based on historical data
This would be more in line with what the antifungal cream revenue would have been if PJL didn’t exit the market
Although this solution seems viable, we do not recommend it because we believe that the EVA equation used to determine bonuses is flawed and needs to be fixed rather than simply adjusting for the one year profit anomaly. Main Problem with current EVA equation 1. The ability for a manager to receive a bonus with unlimited upside and downside potential
Thus a manager may be rewarded or penalized for results unattributed to decisions and efforts they made
Under this view, the divisional managers should receive a full bonus for the unexpectedly high profits. Under our new calculation, a manager’s total bonus payout has three components:
1.Base Bonus: 5% of Base Pay
a.Provides a manager with downside protection and allows him or her to receive a small bonus in times when external factors negatively affect department
2.Additional bonus due to EVA Improvement a.Determined by:
(a) an EVA performance factor, which is measured by how much the actual EVA improvement exceeded the EVA improvement goal and
(b) the manager’s target bonus b.The manager will receive an additional bonus of the EVA factor x the target bonus when the EVA factor is greater than 0, but the EVA factor will be capped at 1.5
3. 1.5% Motivational Salary Increase
a.So managers are not discouraged by the fact that their bonus is capped, managers will also receive a 1.5% increase in their base salary every year the EVA factor exceeds 1.5. Modify the current EVA-incentive based program Alternative Solution 1 Alternative Solution 2 Why Our Solution Works If a manager has discretion over the timing of EVA improvements (e.g a manager has $10MM of EVA improvement and can choose realize some amount this year and the rest next year), what incentives does the current method of bonus calculation provide for the timing of EVA improvements? What about your proposed method? Under the current EVA system, a manager would be motivated to realize the entire 10 MM improvement in a single year. This way they would have a large amount in their bonus bank to fall back on the following year without contributing to the company’s overall performance.

Under our new EVA system, a manager would look to spread the improvements out over the next few years. This would enable him to raise his salary by the 1.5% each year. Our system does not motivate managers to improve greatly one year and shirk the following year. Chief Consulting Contact Information Main Office- (212) 660-2245
Fax- (212) 660- 2250
Email - name@chiefconsulting.com Questions, comments, or concerns contact us at:
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