The RMG industry has made a very significant contribution to Bangladesh’s national economy by generating foreign exchange earnings and creating employment opportunities that reduce poverty. Various reports have emphasised the potential for future growth of the sector based on higher volumes, more sophisticated products and the provision of added value services.
Of prime importance is generating sufficient returns to retain and grow investment in the sector. It must be remembered that value is created only when the return on capital invested is greater than the cost of that capital. For the investors who provide the capital, the return must be greater than alternative investments that have the same or lower risk.
Profit alone is, therefore, not sufficient to determine the value of a company and its attractiveness to investors. A more useful parameter is Economic Value Add (EVA). This parameter is calculated by subtracting from a company’s profit after tax, a charge for the capital employed to generate these profits. The charge is based on a weighted average cost of capital taking into account the cost of both equity and debt financing. It is only when you consider the cost of capital that you can truly determine the economic value of a company to its stakeholders and investors.
Firms only create value by employing capital in the case where there is a positive difference between its profit after tax and the cost of its capital. If profits equal the cost of capital, the firm is providing a return that is just sufficient to compensate both debtholders and shareholders for the risk they bear. No value is created beyond this compensation. A negative difference implies that the capital employed is not able to earn sufficient profits to pay the cost of capital and investors will seek alternative investment opportunities.
It should be remembered that EVA is calculated for one period and therefore can be affected by short-term factors. The relevant multi-periodical measure is the market value added (MVA). It is a cumulative measure of firm performance and is based on the assessment of the Net Present Value (NPV) of a company’s current and planned investment projects. Remember only businesses with a positive NPV create value in the long run. Maximising MVA should be one of a firm’s top priorities, and EVA should be used to measure periodical performance.
How is value created in RMG firms? A company only creates value when the products it sells provides enough value to its customers to generate profits that provide a sufficient return on capital. There is therefore a direct relationship between the economic value of the company and the value it provides to its customers. According to a McKinsey and Co. survey of Chief Purchasing Officers, Bangladesh offers its buyer-customers the key advantages of price and capacity and provides satisfactory quality for the value and entry-level, mid-market products. This means that firms create value for their shareholders by maximising the production of low-margin products through their factories.
It is inevitable that wages will rise in the future, potentially reducing margins. This creates pressure to improve production efficiency in order to increase throughput to keep revenues at the levels that will provide the necessary returns to investors. Alternative means of improving returns are by providing more value to customers by moving into more sophisticated products such as outerwear, ladies’ intimates and functional clothing and by providing added value services.
It is important that firms carry out customer value analyses to make sure that they are positioned in their market to return as much value as possible. Customer value analysis is usually based on investigating the relationship between price and the benefits or value of the product to the customer. This is accomplished by constructing a graph that plots price against what the customers perceive are the value of the products in the market and then drawing a line which represents the average relationship between price and value.
Products that fall below the line provide more value than the average and may capture more of the market with time. Products above the line deliver less value than the average and risk losing market share over time. Individual firms should be aware where their products fit within their market. The customer is often an international purchasing officer and firms need clarity around where their product fits in comparison to their competitors in terms of price and the purchasing officer’s perception of the value of their product. The value will not be limited to product attributes but also speed to market, capacity, compliance etc. Firms need to know whether they are above or below the line on the customer value map as this will be an important input to their strategic planning.
For the retail consumer, customer perceived benefits in the garment sector are somewhat difficult to quantify and are often associated with brands. Successful brands provide a sophisticated mixture of image, fashion, design, function and quality that builds customer loyalty and allows a relatively high price to be sustained. The highest value activities in the value chain are therefore found in design, branding, and marketing of products and not in manufacturing.
It is therefore important for at least some of the Bangladeshi industry to move up the value chain to become Original Design Manufacturing or Original Brand Manufacturing enterprises to provide higher returns as wages inevitably rise. This requires creative, commercial and technical skills to ensure the transition can be successfully achieved.
In conclusion, for firms to develop successful strategies for the future, they need to analyse their economic value and therefore their real return to investors. Through careful customer value analysis, they need to position themselves to maximise the net present value of current and future investments. A firm’s success depends on having a clear measure and a plan to improve the value it provides to both investors and customers.
Dr Bill Humphries is a Professor at Melbourne University, Australia and Principal, Humphries Scientific