Generous to a volt

PUBLISHED : Monday, 09 January, 2012, 12:00am
UPDATED : Monday, 09 January, 2012, 12:00am


The current television commercial for Standard Chartered Bank makes a good point: 'Can it not only look at the profit it makes, but how it makes the profit, and stands beside people, not above them?'

It raises an important issue: should companies consider their corporate responsibilities while pursuing shareholder returns?

Given the public outrage that erupted over the recent electricity tariff rises, this issue is very relevant to Hong Kong's power companies - Power Asset Holdings, formerly known as Hong Kong Electric, and CLP Group.

Despite that lofty statement, Standard Chartered is not going to give discounted rates to its customers any time soon. But it operates in a market with many competitors to keep it honest.

Power Asset Holdings is the sole provider of electricity for Hong Kong Island, and CLP for Kowloon. Without the checks of competition, the government regulates the rate of return to ensure the companies don't make excessive profits.

To this end, the government has a scheme of control agreement (SCA) with the power companies (the current 10-year SCA expires at the end of 2018), under which they may charge tariffs that result in them making a net return of 9.99 per cent on average net fixed assets. Green investments are allowed a higher return of 11 per cent of the relevant average net fixed assets.

The power companies should not have been surprised by the negative public reaction to the tariff rises given their experience with such price rises.

Consumers should also not be surprised that tariffs have to be raised to cover higher operating and fuel costs and investments.

What is surprising is that the government did not or could not mitigate the tariff hikes through the SCA or other legal means. It also did not rebut the companies' tariff calculations. Instead, it turned to public opinion to force the power companies to back down, creating the impression that the government might have missed some critical points in the SCA. This also shows the risk of dealing with the Hong Kong government. If it does not like the results, it may seek to overturn it with public opinion.

Merely making a profit (a reason often raised by legislators against price rises) is not good enough. Companies need to make enough profits to generate decent returns for its shareholders.

If the government has rightly or wrongly determined that 9.99 per cent is a fair rate of return for the power companies, why is there such a public backlash against it?

One reason is the general perception that the 9.99 per cent return is relatively rich, given the prevailing low interest rates and low risks of the electricity business.

Because the allowable return is based on investments, the power companies stand to make higher profits if they over-invest (even though the government must sign off on expansion plans) and there is always some flexibility on their part as to what expenditures are capitalised as fixed assets. Expenses can also be inflated to jack up tariffs.

These recent protests show that corporate responsibility (which so far has mostly been an afterthought and involves primarily charitable works or supporting worthy causes) and shareholder returns are not mutually exclusive.

Corporate responsibility, or the perception of it, is a key business strategy. If the power companies had been better able to manage their message of social responsibility, and the view that they have the public's interests at heart when they seek tariff rises (admittedly not an easy task), there would not have been such a bad public reaction.

Customers are important stakeholders of a company, more so for the power companies, which serve the entire Hong Kong population in a duopoly. Relations with these stakeholders have to be carefully managed. The power companies' shortcoming in recent negotiations may not be due to the proposal to raise tariffs; it was their inability to swing customers to the view that the rises are needed for the long-term viability of the power companies to provide power at current service levels, to expand capacity in environmentally friendly ways and, yes, to make some money.

Power companies need to strike a balance between charging tariffs that its customers are not unhappy to pay (customers are never happy with any price increases, no matter how small) and long-term returns.

If the companies had been more sensitive to customer needs in the current inflationary environment, the reduced profitability in the short term may have been recoverable in the future by pushing for higher rates on the back of the potential goodwill currently generated.

They could also have been more transparent and made more efforts to explain and justify the increases.

Maybe the power companies were just playing poker by going out initially with tariff increases and eventually ending up with what they really hoped for.

If that was the case, they shot themselves in the foot. This has been an unmitigated public relations disaster. The damage was already done when the first increase was announced. The subsequent reductions did not assuage public anger, and cast serious doubts on their credibility and numbers. As a result, they have been portrayed as heartless money-gougers.

Khor Un Hun is a former investment banker with extensive experience in advising on mergers and acquisitions and fund-raising in Asia