Economic Value Added (EVA) Business Model: Is it Sustainable ?

1. Economic Value Added (EVA) Business Model: Is it Sustainable ? • Dr. Lim Mah Hui • INTI College, Penang • July 21, 2012

2. Introduction • What’s the raison d’etre of a firm or company? • Experience of EVA workshop

3. EVA Model • Maximization of Returns to Shareholders • EVA = (r-c).K = (rate of return – cost of capital) x capital employed OR • Maximize NPV of FCF ( Net Present Value of Free Cash Flow) • FCF = EBIT +Depreciation – Changes in Working Capital – Capital Expenditure

4. EVA applied to banking at every level • Bank wide • Department • Individual • Way to increase EVA is to reduce costs and usage of capital – best way is to leverage, trading and fee based activities • Banks become NON-LENDING banks

5. EVA • Relate experience in Indonesia during the Asian Financial Crisis • Banks withdrew from lending to SMEs • Concentrate on foreign exchange trading • Banks, companies focused on short term gains rather than long term growth

6. Banks – systemic crisis • Larry Summers – after GFC we need change in conceptual approach from one based on fallacy of composition – that in regulating each individual entity, you are regulating the whole system – to one based on what is necessary for systemic stability

7. Fallacy of Composition • Methodological flaw in which understanding of and conclusion on an economic or social fact is based on analysis of its individual components • Rational Expectation Theory in Economics • But the whole is > sum of its parts

8. Fallacy of Composition • Each individual or part acting to maximize its self interest instead of contributing to collective good can lead to systemic dysfunction

9. Examples • Keynes Paradox of Savings • Tragedy of Commons • Jobless Growth

10. Business Ethics and CSR • Icing on the cake • Cant create responsible business when over-arching value and principle is maximize profits at all costs • Reward and performance structure more powerful than “individual morality” • Cant depend on business to self regulate esp with externalities

11. Role of State (government) • State not only to provide legal, social and physical infrastructure for business • Role of state also to regulate, to provide checks and balance, to guard social interest • Mega trend of 21st century – relationship btw state and market

12. Externalities –definition and examples • Action of private actor’s benefit individual but generate social and economic costs that are passed on to society • Manufacturing industry – pollution • Banking industry – over leverage and lending > financial crisis and tax payers carry costs of bail out

13. Externalities – Housing Industry • Property construction industry - developers profit maximization – build to maximum density causing traffic congestion • Hill slope cutting causing erosion • Housing treated as means of investment and speculation rather than consumption (living) • Create international demand

14. Externalities • Impact on domestic prices – house price increase outstrip wage increase > unaffordability • Health industry – private hospitals suck up resources from public hospitals resulting in deterioration – 70% of specialists cater to only 30% of population.

15. New Business Model • Social Enterprise • Consider other stake holders • Socially Acceptable Rate of Return (SARR) rather than EVA • Job creation and job satisfaction • Employees have say in business • Workers participation in production

16. THANK YOU