On Consumer Goods and Durables, and prepaid cards Friday, Dec 21 2007

A few days ago, over tea and pakodas, conversation turned to things managerial. I was sitting with 2 marketing chaps, and we were debating Consumer Goods and Consumer Durables, and how the wise men of marketing classify them.

Firstly we were thinking, “Maybe its about cost. Consumer Durables are usually expensive electronic equipment, and Consumer Goods are comparatively cheap things like toothpaste. And for a time, all was well. But soon people started picking holes into that fine theory. After all, price is a relative thing. An iPod  is incredibly expensive to me…but to Steve Jobs its a very small part of his monthly consumption. But he does not call iPod a consumer good!

So we spent some time researching this topic. Finally, I have an answer that I liked. So here it is!

A consumer good is one which has a finite (And measurable) number of uses. A consumer durable is one that can be used any number of times (or not easily measurable).

For example, toothpaste is a consumer good. Why? Simple! It is because it can only be used for 20 brushings. (25 if you use a small toothbrush). It does not matter if you do not use it for 1 year. After all, its now been rated in number of uses rather than time of use, or of price you paid for it!

We then realized that prepaid Cellphone cards are a perfect example of a consumer good. After all, they have a limited life, and their utility is perfectly subdivided….you can use it for x no. of minutes of talktime.

Now, this brings all sorts of analogies. Today, the cost of a Lux soap is not its manufacturing cost, but is its advertising cost. In the same way, we can expect the Telecom companies to become more brand agents than communication service providers. When is it going to happen? Or is it already happening? I guess we will have to wait and see!

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Negative Working Capital: More Management! Thursday, Dec 20 2007

Well, I promised some slightly more advanced financial stats for you chaps, so here it is! Today, we delve into the world of Walmart and EDLP. That is Every Day Low Price to those of you who know not the world of management jargon.

Let us take the example of Sony flatscreen TV’s. Sony decides to sell Walmart 50 Flatscreen TV’s for $1500 a piece. They would expect that Walmart would sell these TV’s for a bit more…But Walmart decides to sell it at $1500, and sells out these 50 TV’s within 10 days.

Now, people would ask, “How the heck does Walmart make money off this operation?” Well, here is how. These 50 people who bought the TV’s paid up front their $1500, so Walmart had $75k in the bank. However, when they bought the TV’s they told Sony that they would pay them in 3 months time. So, while Sony waits for the payment to be done, Walmart is busy earning interest off the money that its customers pays them! So even though Walmart makes no profit in selling the TV, it uses the time value of money to make some profits.

This brings us to working capital. Working capital is the amount of money that a business needs to stay in business. For Walmart, it actually needs no working capital because it negotiates deals in such a way that it only pays for things it buys 3 months after buying it. Most of the time, the stuff it buys is long sold by then. And people who come to Walmart to buy stuff will pay on delivery, which means that Walmart is actually sitting on a pile of cash that it really does not need. Thus the concept of Negative Working Capital.

So there you have it. If you are in that happy position of being a person who takes money immediately, and pays his debts slowly, then you have the opportunity of making some money by investing that money that you got. Of course, if you are the poor supplier of goods for Walmart, then you need lots of money just to keep your business running…because although Sony is only going to get its money for TV’s in 3 months, it needs to pay salaries and wages for all those techs this month….so it has to arrange for a working capital loan from Citibank!

So there you have it…Negative working capital!

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Back to Management: Net Profits, and Cash Flows Monday, Dec 17 2007

Another long hiatus, I fear. But never fear, I am certainly still here! The last few weeks have seen very little in the way of new things learnt, as a result of which I did not have much to write about. However, a couple of days ago, I was made to learn a concept in finance that I found most impressive. This is the concept of cash flows…and more advanced topics like negative capital flows which will be covered in future chapters.

 

Accounting Wonders: Accrual Net Profit…and The reality, Cash Profits!

 

I would have to explain the difference between accounting profits and Cash profits. Now, Accountants use this concept called the Accrual system when they release their balance sheets and Profit and loss Statements. Briefly put, in the Accrual system, all certain future income and expenses are added to the accounts books. I shall provide it with an example.

 

The Bala-Saurabh partnership firm had to attend a competition in IIM Kozhikode. This meant that they had to travel from Kharagpur in the north to Kozhikode in the south. In order to make the journey on time, they decided to travel by air, and spent about Rs. 16000 travelling, eating, and doing other things. They ended up winning the competition, which carried a prize money of Rs. 100,000. In addition, they were reimbursed travel charges of Rs. 8500, which meant their total revenues were Rs. 108,500. However, this money was not actually paid out. The cheque is still in the mail, as I speak a month later.

In the accrual system, the net profit of Saurabh-Bala Partnership firm is equal to net revenues-Net Expenses

Net Profit = 108,500-16000=Rs. 92,500

But lets have a look at the bank Balance of the Saurabh-Bala Partnership fund. This was Rs. 19,000. After the competition, the amount in the bank was Rs. 3000.

So, although Saurabh-Bala made an accounting Profit, the reality is a bit different. Ratnakar Associates, a collection agency now demands Rs. 6000 as management consultancy fees. According to my net profit, I should have no difficulty in paying off Ratnakar. But if I go check my bank account, I would wind up Rs. 3000 short, and now have to pay the bank interest on my current account overdraft.

So this is a lesson. Watch out for the cash flows as well as accounting profits. This is true for the largest companies…and its true for the individual person as well. It all comes down to cash in the end. Notional things like future cash flows are great…but money in the bank is a great thing when the collection agency comes knocking at your door.

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Contracts and Supply Chains — IIT Kharagpur Style Saturday, Dec 1 2007

So far, I have sung mainly praises of my management consultant, Ms Deepti Potnis. However, when the piper has to be paid….well, you get the picture.

I have now learnt the value of clear contract negotiations. About 5 months ago, when I first contracted management advisory services, the talk did drift towards payment. While I was inclined to pay in cash…or kindness, Ms. Potnis insisted on a commodity based trade. Her advice on blog topics for Cadbury’s Temptations Chocolates. Specifically, the contract even drilled down to the flavour, which was Rum Raisens.

If I had any brains, I would have thought a bit about the nature of such a contract. But then, my cognitive processes obviously went for a walk because I accepted such a commodity contract. This was when I was in Chennai, where Rum Raisen Temptations ™ were available at every corner store.

5 months later, I have had to re-evaluate my views on this contract. In the first place, inflation means that the price of Temptations is now at Rs. 45 rather than Rs. 40. But that is not the real problem. The major issue that I had completely neglected was the inability of Kharagpur to have suppliers of Cadbury Temptations.

I have roamed up and down the streets of IIT Kgp. From the Tech market to the Night Canteens, From Dulal Nandi and Bimala Sweets to the local Tewari Shop. But never a Rum Raisin Temptation did I find. I did find one ancient Almond Temptation, and even a Cashew temptation…but Rum Raisins remained elusive. It was then that I realised the value of commodity contracts. They ensure raw material supply when you might not be certain of availability.

Ms. Potnis does not need to worry about where her next bar of favourite chocolate is going to come from. Heck…that is now outsourced to poor me! And finally, I found my local store owner and have persuaded him to make a special orders for some Rum Raisins from the Cadbury Supplier so that I can fulfil my contractual obligations. I gotta admit, after 2 weeks of searching for the dashed chocolate, it became a matter of pride for me to prove that I could get the blighted thing!

Anyway, tomorrow morning, my search for Rum Raisins ends. And Ms. Potnis can finally get her long overdue compensation for providing sterling service as management consultant for Blahla. And I learnt that next time I negotiate a contract, I will do it in cash and not commodities!

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