Taxes – more than just a cost

Apparently, it was Benjamin Franklin who said “In this world, nothing can be said to be certain, except death and taxes.” Without going into a detailed analysis of whether death is certain, and whether there are tax-haven countries with sufficiently low taxes to stretch the point a little, I have some comments to make on the throw-away use of the word “certain”.

Taxes are not certain. Even if some amount of tax is unavoidable, the actual tax payable is not certain. This is not a massively complex idea, but does require a shift in mindset to consider taxes as something other than merely a cost that must be paid, something that reduces profits and returns to the owners of a business. I’m not even talking about optimising the amount of tax paid through careful tax structuring (which can be a good idea, if it is legal, and if the loophole stays open long enough to be beneficial, and if the extent of structuring makes business and moral sense).

I’m talking about considering the impact that tax has on business strategy, target market selection, business mix choices and competitive advantage.

A current example for me is the taxation of life insurance companies in Lebanon. Corporate tax on profits is 15% in Lebanon. However, for life insurers, the tax authorities have deemed it too difficult to nail down a clear measure of insurer profitability (another point for another blog, but in fairness to the tax authorities, insurers are rather notorious for adjusting actuarial reserves to arrive at the desired financial result …). Thus, insurers are taxed on “assumed profit” which is set to be 5% of revenue (mostly premiums written, which are considered as revenue, and investment income).

Some things to note:

  • The tax calculation is thus simple, which for most business is a good thing.
  • The effective rate of tax is then 15% x 5% x revenue = 0.75% x revenue.
  • If a company can make a higher margin than 5% of revenue, then they will benefit from the simplified tax system. If a company’s margins are thin and their net profit is less than 5% of premiums, they will pay a disproportionately large amount of tax.

The last point is where tax becomes interesting, and this is particularly ironic because in this case tax is more certain than usual (given it depends only on a single factor, revenue, rather than revenue and expenses). I’ll expand in my next posts on two important impacts this has for insurers and the economy as a whole.

Do you speak word?

Like it or not, MS Word is the most ubiquitous document-creation application out there. There are many other great (many would argue better and certainly cheaper) products as well, but for the moment most of you know Word.

Although my point is that you probably don’t. If you use Word for creating documents of more than a few pages, with a standard format, look and feel, and haven’t heard of the following points, haul out the manuals and the books,help files and the  google  search  results

  • Show formatting marks
  • styles
  • templates
  • cross references
  • Protect Document
  • Custom menus and toolbars
  • Word Count
  • Track Changes
  • Index and Tables
  • Bookmarks
  • Fields
  • Mark formatting inconsistencies

I use all of these with almost every document. If you don’t, you should at least have made the informed decision not to, rather than being unaware of their potential.

Markets, unintended consequences and the spam in the Feudal System

Ok, so the title will only make sense within the context of Blizzard’s hugely popular (and financially successful) World of Warcraft. WoW is, very simply, a multiplayer online game (and by multiplayer we’re not talking of 4 players here, but rather millions of players around the world) where players interact with other players and the virtual world of the game.

A key component of the game is that special items can be purchased. The currency is “gold” and gold can be earned in a variety of ways. The least interesting of which is by performing basic tasks and completing basic quests. These are, in general, not very difficult or challenging, but do still take a fair amount of time. The other piece of the puzzle that is relevant to this post is that gold can be transferred from one player to another.

Without too much difficulty, it should be clear that players with lots of time and little money are incentivised to spend their time earning “in game currency” to sell to time-poor and money-rich players for real world cash (i.e. as in US Dollars). The sale of in-game currency in the real world is a free market, so free-market economics forces act on the allocation of resources (time and money) in a way as to more optimally allocate resources.

Picture if you will the far-eastern sweat-shops manufacturing shoes. Now replace the glue and sewing machines with computers, and replace the shoes with in-game WoW currency. Cheap labour comes to the fore and a business is born. In-game currency is the product, salaries (and a bit of computer, WoW and internet expenses) are the Cost of Sales, and real hard cash from time-poor First World teenagers and adult is the revenue.

Two problems:

  1. Is purchasing vast quantities of in-game gold with real-world currency (presumably earned from applying one’s particular real-world skills and talents in gainful employment) cheating? Is there a moral or ethical angle here? What is it?
  2. How do the “entrepreneurs” boost sales? They advertise! How? By spamming in-game players with messages.

The first point is interesting, and worthy of a blog (and quite likely a UN commission as well). The second point that has seen some recent action from Blizzard, who are suing one of the companies behind the in-game spamming. Will be interesting to see how that develops. Slashdot also picked up the story.
But, understanding how the problem arose is clear with the benefit of hindsight. However, I am quite certain that with some basic analysis of the economic forces in the game, and an understanding of consequences, these problems should have been anticipated by Blizzard. Seems like they have fallen one step behind the spammers, which could also be interpreted as the power of the free market.

Oh, and the Feudal System? The company being sued is “peons4hire”.

Aftermath of 20 May 2007 bomb in Beirut

This is a different sort of post, but given the huge impacts the recent (and not so recent) events all over the Middle East have on people’s lives, countries’ economies and business decisions, it is worthwhile to recognise the very real problems that exist in these markets.
A few photos of the damage and tension after the tragic bomb blast in Ashrafieh, Beirut on Sunday evening, 20 May 2007. Several people were injured and one woman was killed when the force of the explosion caused a wall to collapse on top of her.

Sweeping up broken glass in Ashrafieh, Beirut after explosionLow light photo of Lebanese Army maintaining security near ABC mall after explosion in BeirutGarage door at ABC mall damaged by bomb-blast in BeirutStreet near ABC bomb location in BeirutThe Lebanese Army assisting and protecting at the seen of the 20 May 2007 car-bomb in BeirutBroken window in Ashrafieh near when one woman was killed after carbomb explosion in Beirut

Useful commentary on a useful tool – MySQL

I mostly use MySQL for ad hoc analytical work for specific projects – the sort of work where Microsoft’s Access product just doesn’t cut it because of the size of the data-sets involved. However, this is really just the tip of the ice-berg for MySQL, which powers a large proportion (I don’t really have any idea on the actual stats) of the web’s sites and more.

There are competing products, free and open-source. For some of the analysis that I do, a more specifically oriented statistics package like R or SAS (which is particularly good for large datasets) may also be worthwhile considering.

However, if you’re interested in finding out a little more about MySQL, you can visit their homepage or their developers’ zone. Also, the following two links provide brief pros and cons of using MySQL.

  1. Five Reasons to use MySQL
  2. Eight Reasons not to use MySQL

For those of you who complain that Excel only has 65535 rows (although I hear rumours of more rows in the latest or upcoming version?), perhaps you should consider using the correct tool for the job? Give MySQL a look.

Mbeki points to rand volatility for hurting exports

President Thabo Mbeki made reference to the adverse affect that volatility of the South African Rand has had on South Africa’s export manufacturers. I’ve posted quite a bit about hedging recently, but it seems that the issues just won’t go away.

Volatility hurts planning capabilities. Hedging can restrict the impact of volatility for certain durations. Maybe the exporters need to reconsider the “evil” that is hedging?

With a detailed, technical analysis of the financial and other risks inherent in a business, the appropriate risk management strategies can be defined. Value can be created through the application of these business tools, but only after the application of some sense and knowledge on the damage that volatility can do to a business and sensible measurement of the costs and benefits of alternatives.

Pricing and promoting businesses

David Maister’s blog has an interesting post about the pricing and promotion strategy for a small home-based business. In this case, it’s a pre-school looking for a pricing and promotion strategy. As always, David Maister has some useful suggestions and no doubt his wealth of readers will add some real gold in terms of suggestions soon.

The case involves the pricing and promotion of a pre-school in an area where there are “informal” preschools with little or no qualifications, and formal preschools with highly qualified teachers. The different schools have different prices and demand levels.

I approached the problem by applying a model. In this case it was the “4 P’s of Marketing” model. It is by now an old model, but grew out of a very different time when it was assumed that if you have the best product, customers will beat a path to your door. This was followed by the idea of price competition and price being the all powerful tool to sway consumers in their decision to open their wallets.

Most people now realise that these ideas are too primitive. The 4 Ps are:

  1. Product
  2. Price
  3. Place
  4. Promotion

Some people add a 5th P called “packaging” to the list, which may or may not be useful, and could probably be added under product, with the idea that the product purchased is the full basket of utility attached to buying the item, or added under promotion as part of the more traditional selling process. It’s just a model after all.

I like to apply models to problems as it provides a framework to generate ideas. No doubt there are good models and bad models, and models will sometimes restrict thinking and options as well as freeing up the mind to think of new options. (I am also a big fan of brainstorming and other structured lateral thinking methods to generate creative ideas.) But without a model, it can be difficult to get everybody speaking the same language, and it is easy to look at a problem from only a single dimension. In most cases, applying more than one model is even better. Too many models and you don’t spend enough time applying your mind to the thought patterns under each model.

I mention “models” quite a bit on this blog. Here I am describing mental models for approaching problems, rather than computer-based models for figuring out the numerical answer to a problem. Different application, but both useful.

Here’s my response to the pre-school post:

The question was posed about both pricing and promoting, but then it seems that the rest of the comments all related to price. The 4Ps recipe is an old one, but is still a worthwhile place to start for an initial structure.

Product, Price, Place and Promotion

1 Product

A good product is important, but it isn’t going to sell itself. The analysis presents some information on pricing and supply / demand levels for various “products”, but it is unclear to me whether this analysis is systematic and representative or not. As tough as it is, this is something you need to look at through dispassionate eyes at times. Do other parents want qualified teachers? Or do they prefer a less formal approach. Maybe (and without children myself I am purely putting this out as a possible point of view for discussion) parents feel that they are not handing their children over to an institution if the teachers are less qualified and the setup less formal.

2 Price

Price has been given more airtime than the other components so far. Coming from outside the States, I have no feel for absolute levels of pricing. However, maybe this is an area to brainstorm a large array of pricing possibilities (and get David’s readers to suggest many more!). Maybe you offer reduced rates for the first 5 kids to sign-up, or a discount for upfront payment for a 3 or 6 month period. This could help finance the cashflows early on, encourage some interest and early adoption, but also make it a seamless process to go from discounted prices to a premium-priced service. I do agree with David’s point that it sounds like a tough ask to get a full house in a short space of time, but I suppose a preschool with 2 children isn’t much of a fun place for the children to play and learn.

3 Place

Is the place to which you’re moving right for a preschool? How much has the desire to start a preschool affected the choice of area? Are there other areas that meet all the other criteria (the writer’s own workplace, nearby schools, other amenities and “feel”) but are better suited to start a preschool? What sort of catchment area do you envisage? If the children’s homes are spread around, maybe some form of transport service could transform “place” into something more workable. This again needs a firm understanding of real demands of prospective customers (both the children and their parents).

4 Promotion

How you go about promoting the preschool will be crucial. Flyers placed on cars may be successful (I’m not convinced) but face to face visits to families in the area might add a personal touch, a relationship and trust-building touch that will go a long way to settling anxious parents’ minds and showing that you are serious about a quality, professional product based on whatever mix you are after. If your wife believes in a mostly play-based preschool, then that is what you must show. If it is going to be desks and chalk boards and 18 hours per day of advanced mathmetics lessons, then that is what you convey. Personal selling will allow time for the parents to ask questions and get to know the people who will be looking after their children. If the service fits, I expect the price will be less of a sticking point.

If you use a personal promotion strategy, it also gives you the opportunity to receive instant feedback early on, which you can use to adjust your promotion, pricing and even product strategy. Started early enough, it will advise you whether the “place” you have chosen is going to work to. This goes back to my allusion earlier on that you may need some more hard data and careful analysis before you set everything in motion. The odd discussion with friends over at a dinner party (I don’t mean to suggest you haven’t done more serious research than that, but hopefully you understand my point) does not replace carefully considered homework to make the launch a success.

Because the number of successful promotional visits is quite low (20 or so I gather) it is more sensible than if you needed to fill 5,000 seats for a convention!

A 5th “P”?

There is an occasionally added 5th “p” – Packaging. Unless you’re planning to wrap the kids in bubble-wrap to keep them safe, I think we can safely skip this one!

South African Airlines and hedging

Moneyweb falls into the same trap that many others have stumbled over time and again. David Carte mis-titles SAA loses as oil price falls and makes the mistake worse with the subtitle “A hedge goes the wrong way”. Mr Carte doesn’t belabour the point in the article, but his perspective on hedging is clear. I’ll repeat my comments attached to the story below:

The article reflects a common misunderstanding of hedges. This comment doesn’t necessarily support hedging (since they are good arguments for and against hedging) but it attempts to point out why hedging is not “taking a view” and therefore must not be judged with the benefit of hindsight as to whether the commodity involved (oil in this case) increased or decreased in price.

It isn’t a question of getting the hedge “wrong”. SAA is exposed to the risk of high oil prices. In order to remove this risk, they can hedge against the cost of rising oil prices. This way they are free to concentrate on the operational aspects of running an airline, rather than trying to guess the oil price of tomorrow. In this case, the oil price decreased. The “loss” they have made on the hedge isn’t really a loss – it is offset by the lower cost of fuel for their operations. Similarly, if the oil price had increased, they would have made a profit on the hedge, which would have been offset by the higher cost of fuel in future. The final impact is that changes in oil prices don’t impact them as much as they would have without the hedge.

Now, there are other risks such as “basis risk” and, more broadly, trying to estimate their future fuel needs (i.e. what exposure they need to hedge) but these technical points don’t negate the position that hedging is not about getting it “right” or “wrong”. It is about not wanting to take a view on oil and thus removing the exposure in a company.

Hedging is risk management, it is not taking a view. Having said that, there have been examples of misuse of hedges through mistake, lack of understanding, or trying to use derivatives to take a punt and still calling it a “hedge”.

Appropriate timing for a follow-up to my follow-up on WAR and hedging future gold production. The world of financial risk, hedging, derivatives and risk management require careful analysis, strong technical skills and an understanding of some fairly complicated mathematical models in order to generate value. Throwing a few ideas around because they seem popular does not fit this bill.