Monday, 15 December 2008

Reducing the capital needs of European companies

According to Robert Peston, European corporations are going to have to repay about $1 trillion of debt in 2009. $800 billion is owed by financial companies and $200 billion by non-financial, which provides some reassurance - no doubt much of the financial debt is owed to other financial companies and some will net out.

But without further huge government guarantees (and we might get them anyway) I think we are going to have to restructure some businesses to operate on less capital.

Here is a list of ways in which they may be able to do that:

  1. Change in revenue and pricing models. One example is a method called structured pricing, where payment for goods and services is made after the fact based on the value they create. I have developed a model which shows that this can reduce the capital requirements of the economy by around 7-10%; I will be posting a more detailed paper on this within the next few weeks. Of course there are many other examples of how to do this, but it is definitely achievable.
  2. Greater efficiency and faster turnaround. One of the main reasons to hold capital is to cater for delays in the supply chain. With cheap money available over the last few years, technological progress has not been directed towards this end. Much economic effort in the coming years will be diverted into creating more just-in-time structures which will minimise the need for working capital.
  3. Greater use of equity instead of cash. This could be a very healthy change - for example increasing employee share participation in companies is likely to be good for motivation and give people a longer-term, more meaningful relationship with their employers. Generally increasing the proportion of equity investment relative to debt makes companies less risky (though possibly less profitable).
Your ideas are welcome - please leave a comment with your suggestions of how to create a low-capital economy.

Update: According to the FT, companies worldwide are sharply reducing their inventory levels; this makes perfect sense in the above context, although the article puts a slightly different interpretation on it.

Possibly supporting this argument or possibly not, another FT article points out that European companies have successfully issued record volumes of bonds in the last two months, including substantial bank debt issued without government guarantee. Maybe next year won't be so bad after all.

1 comment:

creating my life said...

i got to u via ur comments on peston's blog. thanks for giving another interpretation from peston's on the findings about the economy. it seems there are exactly opposite interpretations that are equally valid on the same set of data. so what does it mean? that nobody really knows what and how and when people in general will reacte to the news and so anyone's guess as to where the economy is going, or what impact the govt's actions will be,is as good as another. btw, commenting on this post about how businesses can operate on less capital, how about bartering, and using LETS(Local Exchange Trading Systems).Those systems do not use capital, but also do not generate lots of capital either, so there is no incentive to use them. No one is going to be a millionaire using those systems.