Financing of new products
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.
- Business failure
According to Dun & Bradstreet reports, Businesses with fewer than 20 employees have only a 37% chance of surviving four years (of business)
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.
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:
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 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.
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?