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Financing of new products

Updated on November 3, 2011

On his retirement, Mehrullah took a flight to his hometown, Gwadar (Pakistan), with intent to settle there. He was filled with nostalgia as he remembered his childhood in the small dusty town now spiraled into a city. He had about US$150,000 equivalent in Pak Rupee mainly from retirement benefits.

On reaching home, he discussed his plans with his relatives and friends. Mostly advised him to put the money in secured government saving schemes but he was averse to the idea as it tantamount to ‘interest-income’ forbidden in his religion, Islam. The alternate was a departmental store or a small industry. The latter was very risky, a boom or a bust affair. He thought of risk reduction by going for a running plant, lock stock and barrel but his worries continued.

Risk involved for new comers

The new comers face risk because of tough competition from existing producers. Lack of experience may lead them to fraudalent persons or proposals. Moreover, they face difficulties in attracting well qualified and experienced personnel. Being new, they have to run from piller to post to meet requirements of various government agencies. In short, the initial 2-3 years are very tough.

PROJECT IDEAS
PROJECT IDEAS
LIANA VURV by Pak Suzuki Motors Ltd. Though good in technology, it could compete with Toyata and Honda Cars within its price range.
LIANA VURV by Pak Suzuki Motors Ltd. Though good in technology, it could compete with Toyata and Honda Cars within its price range.

Riskiness of new products

In Pakistan, many products developed by multi-national companies failed to hold ground.

Years of research with billions of investment in R&D has not eased the task of understanding the consumer. New products may fail badly despite best technology and quality.

Mountain Dew, a soft drink from Pepsi, failed because of competition from other soft drink and wrong price strategy. Liana, a car touted by Suzuki Motors as a breakthrough in transfer of technology, did not sell well because of wrong positioning. Its price was in the range of 1.2 million which could fetch Toyota and Honda Cars. A tomato ketchup, promoted by Mitchells could not initially attract customers because it did not come with varieties like hot chili, garlic chili etc. P&G tried its best to market a water purifying powder for low-income group which was technically very sound. It proved very effective in reducing the cases of water-borne diseases. Having failed to generate any profit, the company decided to distribute it freely to people living in slum areas under corporate social responsibility.

A large number of plants for making roti (flat bread from wheat) could not progress and were sold as junk. Main reason was availability of fresh and hot roti being made in Pakistan by the house wives. Similarly, KFC’s TenderRoast was flop though its fried chicken is a hit. Besides, Dr. Pepper, a soft drink said to be No.3 in world, made many attempts to get a piece of the market but its taste was not approved by the consumers.

The reasons, for any product failure, could be lack of innovation, poor positioning, quality and inappropriate channels of distribution. It could be unforeseen changes in the market after the product was launched.

 Some reasons for failure of products from well reputed companies are given below:

PRICE DETERMINATION

When a product is developed in a laboratory by engineers, they just do not consider its cost. This question comes up when the product is proved useful after test-runs. For costing purposes, the product can be disassembled and the value ascertained part by part.

Moreover, a company has to conduct trial run to ensure whether the existing facilities are capable of manufacturing the desired product in good quality. The data generated by the trial run can be used to work-out unit cost and compared with the cost arrived at through disassembling process. If there is no wide difference, the average of the two is taken as estimated unit cost of production.

For a new product, price has to be determined on the basis of costs. There are many techniques for this purpose. Most popular is the cost plus method. A company knows what is its unit cost. It can add a certain percentage of markup based on its past experience. This added markup would take care of all G&A Expenses, Financial Expenses and Taxes. If per chance, the markup proved inadequate, it can be increased any time. The procedure is simple: unit price Rs.15 plus 20% markup= Rs.18 (price for the new product).

A company can also add a markup to ensure certain Return of Investment (ROI). For example, a company has pumped in a sum of Rupees one million in purchasing machinery and equipment for the new product. Now it desires an ROI of 20%. Relevant data reveals that the production would be 100,000 units at a cost of Rs.15 per unit. Thus, one may add total expected return of Rs.200,000 (1,000,000 x 20%) to total cost of Rs.1,500,000 (100,000 x 15). The total would be Rs.1,700,000 which divided by the production of 100,000 would give a price of Rs.17.00 per unit.

Cost or project

Not all products can be produced from the existing facilities. There would be lot many which require new machinery and equipments and other production facilities. A company can add these facilities in the existing setup or may have to setup an entirely new unit called greenfield projects. Its costs would be at least 60% higher than the brownfield project. In greenfield, a question comes up where the project would be located. A company has to consider operational advantages and financial advantages for locating a project.

Supposing, there are two sites for consideration: A & B. If a project is located at A, it would have smooth operations or sales as it is either located near source of raw materials or near market. Location B can be suitable as, being in an underdeveloped area, the government is allowing duty free imports of machines, concessionary finance and subsidies in power and water.

It is debtable whether project cost would be lower at A or B. It all depends upon the nature of the product.

Sources of Funds

Usually, new products are introduced by mega corporations. Such corporations can raise the requisite funds from a variety of sources: (i) internal cash generations, (ii) bank borrowings, (iii) supplier’s credit, and (iv) induction of fresh equity. If a company is well rated in the financial circles, there would no problem in taping these sources.

Problem arises for a newcomer, having no track record. He or she would have to arrange funds firstly from own sources and then approaching others. If a bank loan is a must, a business plan would have to be prepared to give all requisite details. In short, there are 10 sources of fund as shown in the side table.

Venture capital companies

Venture Capital Companies provides equity to new businesses which have potential for high growth such as biotech or information technology firms. Venture capital normally comes from individuals and institutions who believe in high risk and high returns. The funds are invested wisely rather than speculatively. Such prudent investment decisions result in high dividends as against modest return on stocks and bonds. Normally a venture capital firm expects 20% plus return on its investment.

The management of the venture capital company comprises high qualified scientists and researchers or those having in-depth business experience. They have ability to identify new technologies with potential to bring high rewards. They advise young entrepreneurs for a prudent approach thus adding both skill and capital.

Venture capital suits those companies which are new & risky. Such companies are not in a position to secure bank loan or raise capital through public issues. They approach venture capitalist who would agree to investment in their equity after a thorough study of their setup. However, a company availing venture capital would surrender its freedom as the investor would have a significant control over its operations. If a bad time comes, the venture capitalist can take over the company by virtue of its shareholding.

An angel

An angel is an individual with surplus funds for helping new entrants in starting up of a business. At times, an angel saves a failing business through injecting cash to over-come financial crises or improvement of operations. Angel investors are wealthy individuals with a missionary zeal.

Compared to a venture capitalist, an angel would (i) invest lesser funds in a single company (ii) have lesser control and (iii) expect slower return on investment.

Other sources of funds

In addition, a person can avail funds from government sponsored institutions such as Youth Investment Promotion Societies or Micro Finance Companies under soft terms.

Further, there is always possibility of trade credit, spontaneous credit (due to late billings by utilities companies) and bank loans against stocks.

The head, guts, bones, and tail do not go to waste. They fall onto a lower conveyor which transports them to the fish meal plant.

Happy Ending

Despite a dreadful picture painted by friends, Mehrullah went ahead and invested all his funds in a fish-meal plant.

Luckily, his entry in the industy coincided with the opening of Gwadar deep-sea warm-water port. The area became ripe for rapid industrial development because of a vast coastline with abundant fish. Many fish processing plants were established to supply fresh fish to a vast market of Karachi connected with all weather asphalt road.

There is a lot of wastage in fish processing like bones and offal. This became blessing in disguise for fishmeal plants which use the waste as their raw material.

So Mehrullah not only had availability of cheap raw materials but also a thriving market for his output, fish meal, used as a high-protein supplement in aquaculture feed. He has since recovered his investment and is looking for further investment opportunities. Any suggestion?

Comments

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    • umeraziz profile image

      umeraziz 

      6 years ago

      very nice hub sit..

      list of sources is fine.. everyone planning to raise finance should refer this hub,,.. good work..! voted up..

    • asadayub profile image

      asadayub 

      7 years ago

      Thanks a lot sir. I got it now. As regards to the examples, they are very helpful in this article. Thanks a lot Sir.

    • hafeezrm profile imageAUTHOR

      hafeezrm 

      7 years ago from Pakistan

      Dear Asad Ayub, may be there is a typing mistake. Consider Rs.1 million instead of Rs.10 million as investment.

    • profile image

      kamran 

      7 years ago

      awesome...great article full of knowledge

    • asadayub profile image

      asadayub 

      7 years ago

      After reading this hub, i'm a lot clear about what are Venture Capitalists and Angel investors. One of the main goodness of your hubs is that they provide knowledge from all the four corners of a square. thanks a lot sir.

      Sir i'm unable to understandone thing in this article. Can you please kindly elaborate: An example is given in this article about price determination of a product:

      A company can also add a markup to ensure certain Return of Investment (ROI). For example, a company has pumped in a sum of Rs.10 million in purchasing machinery and equipment for the new product. Now it desires an ROI of 20%. Relevant data reveals that the production would be 100,000 units at a cost of Rs.15 per unit. Thus, one may add total expected return of Rs.200,000 (1,000,000 x 20%) to total cost of Rs.1,500,000 (100,000 x 15). The total would be Rs.1,700,000 which divided by the production of 100,000 would give a price of Rs.17.00 per unit.

      In this example, can you please kindly elaborate that how the Return of Rs. 200,000 is calculated? i'm really very sorry that i'm unable to understand it.

    • profile image

      Syed Muhammad Bilal 

      7 years ago

      a very informative article and it will really help all the

      student of project management and Marketing

    • businessfinance profile image

      businessfinance 

      8 years ago

      Interesting article...so many information learned.

    • hafeezrm profile imageAUTHOR

      hafeezrm 

      8 years ago from Pakistan

      Thanks Suhaib for your comments.

    • profile image

      Suhaib Ammar Hafeez 

      8 years ago

      Thank you very much for writing on this subject. It really helped me clarifying my concepts, not only about how to finance a product but also about why products fail. Fish plant is a very good business which I guess no student think about. Our text books lead us more towards FMCG goods or Hi-tech electronics. I suggest that you organize a seminar or a workshop in bahria to enlighten students about the many available options in Pakistan to invest in. We really don't know what are the avenues where we can invest or at least even think of a product on a broader perspective.

      A problem is just an unsorted opportunity, so we need to be aware about our surrounding resources and work on it to extract the honey from the honey bees instead of letting bees to sting us.

    • hafeezrm profile imageAUTHOR

      hafeezrm 

      8 years ago from Pakistan

      Thank creativeone59 for your kind comments.

    • creativeone59 profile image

      benny Faye Douglass 

      8 years ago from Gold Canyon, Arizona

      Thank you for you very informative hub on financing of products, thank you for sharing it. creativeone59

    • profile image

      Steve  

      8 years ago

      I am looking for someone to invest a small amount in my project: http://peaceful-nights.weebly.com/index.html

      Peaceful nights is dedicated to providing materials for the homeless, all the details are on the web, plus the products I have found suitable at present.

      I will be working mainly in Spain during the first few years then when I expand will take products internationaly.

      All the products are given to the homeless free of charge.

      I require a business loan of 15000€uros repayable in 1 year (one)at 25% interet rate.

      The funds are needed to get the busines working properly, office set up, advertising etc.

      If you are interested in this project I would be grateful that you contact me using the contact form on the web site (this is for e-mail security). Please state that you are contacting from HUBPAGES.

      I will provide all the necessary details and the loan would be done through a spanish notary office, all legitimate and fully legal.

      Thanks

    • hafeezrm profile imageAUTHOR

      hafeezrm 

      8 years ago from Pakistan

      Good suggestions, Mr. Emran Ali, for investment of Rs.12.375 million

    • shahnawaz sheikh profile image

      shahnawaz sheikh 

      8 years ago from karachi

      Thankyou for this Interesting Article sir,

      i must say that you are right again because in these times of turmoil so businesses are making profit like manufactures of products of daily use , uni lever again announced profits ,TV channels and Security companies are recruiting more employees , and if we take about investing National Savings is giving the Highest Percentage .

      Lastly i still remember this topic from the class and how you explained it is still quite memorable , i still remember i explained GREEN FIELD projects . ;-)

      thankyou sir and GOD BLESS

    • Emran Ali profile image

      Emran Ali 

      8 years ago from karachi

      Dear Hafeez

      It would had been surely his luck but also his effective way of managing and controlling business activities that is how he recovered his investment . I found your articles very interesting as i enjoy reading them as a story .

      Generally speaking there are many investors in pakistan who are desperately waiting to start lucrative business , but there are always many questions where to invest ? how to invest ? Would we not face any kind of bribery situation ? would we not face threats from local political parties ? would we not face government black sheeps ?

      If an investor ( or Mehrullah )is adroit and capable of facing all these kind of situations than i could only recommend to have a look on the following basic business types . ( $150,000 = Rs. 123,75000.00)

      1) Dairy farming or Chicken or Egg production ( I wish investors focus on this business as these products are basic need of us )

      2) Software house

      3) Fast food and Bar B Q restaurant

      4) Live stock Dairy farming of Cows , Goat etc ( We will surely see high prices of goats and cows in up coming days )

      5) Purchasing of land and start cropping vegetables / fruits ( one can start green field projects )

      I could enlist many other business areas by focusing on consumer needs . These business areas has tremendous growth . I wish good luck to Mehrullah as he has enough fund to start these kind of businesses .

      Apart from all this he could enjoy fruits at home by investing in Govt. Securities .

      Amount of investment = 123,75000

      Interest Rate = 13 % per year

      Per month return on investment = 134,063 ( This is per month Gain without pain )

    • hafeezrm profile imageAUTHOR

      hafeezrm 

      8 years ago from Pakistan

      Dear Sana Rao,

      Please have a faith on your government. Inflation is coming down. Government securities are still the best. Other investment can be in gold. But would you take a risk by holding too much gold?

    • profile image

      Sana Rao 

      8 years ago

      Dear Sir,

      I m thankful to u that u work a lot for students but i want to ask that higher risk higher return but the present suitation gives an idea not to invest in govt securities, in this way wat should a person do?

    • Rufi Shahzada profile image

      Rufi Shahzada 

      8 years ago from Karachi

      Dear Sir,

      Thanks for explaining RISK INVOLVED in such a crucial time...

      It really is a great help.

      Thanks A Million!

      RUFI SHAHZADA

    • hafeezrm profile imageAUTHOR

      hafeezrm 

      8 years ago from Pakistan

      Thanks sumairamalik for your comments. You are right about the situation in Pakistan but there are businesses which thrive in chaos like Security Agencies, TV channels, industries related to home entertainment, Internet-based businesses etc. Let us pray there is peace and prosperity in our country.

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