You know you're Romanian when....

You know those Facebook groups "You know you're this or you've done that when..." - well there is one for Romania as well! Here are, in my opinion, the "best of"s of that group (the wordings belong to the author, Adrian Popescu):

You know you're Romanian when...

...Everything you eat is savored in garlic and onions.
...You are standing next to the two largest suitcases at the airport.
...You talk for an hour at the front door when leaving someone's house.
...You can fit 10 people into a Dacia.
...Your mom tells you you're too skinny even though your 30 pounds overweight.
...Your dad ever butchered a pig or lamb. [or a chicken for that matter]
...Your mom ever chased you with a rolling pin or a broom telling you to stop so that she could hit you. [I couldnt say that's true for me but it's a funny one!]
...You don't use measuring cups when cooking.
...If you don't live at home, when your parents call, they ask if you've eaten, even if it's midnight.
...Your parents don't realize phone connections to foreign countries have improved in the last two decades, and still scream at the top of their lungs when making foreign calls.
...Your parents brew their own wine and ţuică
...You say "La Mulţi Ani" for every holiday.

Timing investments

I was just reading this article about timing strategic moves and i think this is the key question on every CEO's lips nowadays. As the stock markets start to recover and investors slowly regain confidence, many companies predict a growth in earnings for the following year and start venturing into long term planning and strategic investments again. These strategic investments might be big investment projects or acquisitions of rivals or of complementary businesses. Indeed, there is a lot of value in M&A deals at the moment, as companies that have overcome the financial crisis and have a stable cash position can look into acquiring businesses at a discount of over 30% compared to 2007. Similarly, according to McKinsey Quarterly, some investment projects might be considerably cheaper now than they were before, although I am not sure we can say this is the case for most industries (I am inclined to believe it is more an effect in a specific sector/company than a generalized trend). In any case, investing now is a good move to secure a better competitive position, as it can give the company a headstart compared to its rivals that are cutting growth plans and focusing on the short term. Innovation will be key to get out of the slump, and developing new R&D projects is costly and time consuming - therefore there is a clear benefit for the companies that invest now and will be able to ripe the benefits of innovation much earlier than their rivals. However, we are talking about sizable investments which, if undertaken, can expose the company to a significant risk and maybe even weaken it completely. Therefore timing of these moves becomes key: executives should wait long enough to have some visibility on where the market is going, but not too long, because otherwise they will lose the inherent value in buying these projects now. If they wait too long, everybody will see the interest of these deals and will be willing to invest, the prices will go up and thus will eat up the perceived value. So how can one determine the right timing for these investments?

McKinsey Quarterly proposes scenario analysis, which, I believe can indeed be a good tool. In their case, a certain strategy was clearly superior to the others in all scenarios considered (i.e. invest now rather than wait, because the benefits of waiting are too low compared to the possible losses in the value of the projects). However, what happens if there is no such clear cut strategy emerging? Scenario analysis can give us an idea of where the value of the investment evolves depending on the direction of all the uncertain variables, but it is not always a decisional tool, as it does not offer a combined value for that opportunity on which to decide. It's not like the NPV, where you can clearly state that investing in this project is worth that much, and if it's bigger than this number, we should always go for it. With scenario analysis, you know that if scenario X happens, then your project is worth this much... in order to get a global value of the investment you need to assign probabilities to each scenario which, in my opinion, is impossible to do in the current economic context where any attempt at previsions is mere guess.

What companies need is a tool that allows them to integrate uncertainty, avoid making previsions and still help them decide whether to invest or not, and, most importantly, when is the right time to invest. For corporate internal projects, this is exactly what the Real Options method does. Based on the financial options pricing framework, namely binomial pricing , the Real Options approach considers that management has the option (the right, but not the obligation) to purchase a certain investment project by investing the required amount. This model allows companies to express the full range of the uncertainty in a binomial present value tree, avoiding the need to make predictions and commit to numbers which are impossible to get right. Real Options valuation considers that the project is actually an American call option, and so using financial options pricing allows management to identify the best timing for its exercise (i.e for making the investment). It also discounts into one single number all the possible values of the project, be they negative or positive NPVs, thus taking things one step further than scenario analysis, because it becomes a decision tool. The decision criterion is: if adjusted NPV with RO value > 0 we should invest in the project. Thus, this framework is a bit more standardized and rigorous than scenario analysis for timing investment projects and their phases. However, I have been thinking if this could also be applied to value companies for M&A?... I am not sure yet..i'm afraid I will leave this open for discussion for now.

Funny Dilbert

A different view on strategy

For those who know me for a longer time, you know that I have always been interested in business strategy and management, and that I wasn't much of a finance person. In fact I didn't like finance at all. But an interesting turn of events made me pursue a master's in corporate finance and I am surprised to see, that at the end of this year, my perception has changed dramatically. I now realize I had been looking at the wrong kind of finance - or rather looking at it in the wrong way. Now it's become my favorite subject and I understand, after putting myself in investors' shoes for the whole of last year, that any strategy that doesn't take into account finance is shallow and empty like an old coffer: you expect to find treasure but instead there's nothing but dust.

I could start by giving all these arguments related to investor's motives for starting or financing a business, such as gaining a return higher than they would by putting their money into safe instruments like bonds or bank accounts...and how a company's strategy should be steered to achieve this goal and provide to investors (shareholders) the minimum rate of return that they expect. But there's nothing new here - we all understand this more or less intuitively. What I did not understand that well until this year is just how much corporate finance is a decision tool in setting and steering a company's strategy.

Although that might sound weird at first, by thinking that a company's strategy is in fact represented by its collection of investment projects it all starts to make more sense. Indeed, to see what a company's strategy is, look at its budget. Their investment decisions and the projects they pursue uncover the true direction in which they are heading. Of course, I am not trying to wipe out the entire strategic process - there is unquantifiable value added in setting the long term direction of the company, anticipating future trends in the industry and devising tactics for a better competitive positioning. But when it comes down to one step further towards the implementation of this long term vision, financial decision making is key. If strategy is a collection of investment projects, then project portfolio management and investment decisions are strategy's true drivers, so project valuation and considerations about profitability of investments are key tools used to set the strategy. A great vision about the future but with the bad investment decisions will definitely lead to catastrophic results.

In this context, an interesting question is the issue of cross-subsidizing, especially when we think about product portfolio management. Quite often, a company finds itself in the situation of evaluating a project which is of strategic importance but has a negative NPV so it is not profitable on its own (ex. keeping operations running in a certain country to maintain a position and avoid competitors taking over that market segment completely). Should the company pursue this project? If they believe that the loss they would make by not keeping these operations open is higher than what they lose by committing themselves to this project, then they probably should - based on the fact that the loss of this project will be subsidized by the earnings of another project. But what happens when there are more projects like this to consider? How many and up to what amounts should the company subsidize, to avoid eating down the profits from the other higher value added projects? This is an interesting question to look at in the context of strategy setting. (the Real Options method helps ease the decision making in this context but I will probably talk about that in more detail in a following post). So are mergers and acquisitions - essential growth possibilities for some companies, but which can lead to failure of the entire group if not performed correctly. And here the financial considerations are again extremely important, as there is a tendency to overpay the target thus eating out most or all possible synergies.

These are just a few examples and a few ideas that came to my mind now, but this master's degree has been full of such examples that drew my attention. It truly opened my eyes and gave me a new perspective. I think Porter is good. Porter is great! But if Porter is not backed by numbers, it is worthless, it cannot add value. And unfortunately as I look at the strategy consulting industry I see a lot of times (maybe more so in boutique companies?) that the recommendations are based on pure qualitative analysis, experience of the industry and market studies, but not enough on finance. What will the future look like? I'm curious to find out!