The Hindu Business Line : Thin margins on large volumes could be a recipe for disaster

Story so far: After visiting people who were literally at the receiving end of recovery operations by banks, I am yet to recover from the after-effects! Why should all customers be treated as defaulters, I wonder. Also, I ask myself if those who apply for consumer loans could be bargaining for trouble that can land them in hospital.

Episode 169

Ever wondered how the retail stores offer super discounts? If you are like everybody else, you buy the tangiest pickle jar (yes, the large one) and simply love your store that offers you great deals everyday. But if you were someone like me, then you would stop for a moment to figure out how you can have two jars at the price of just one! They must be crazy or else. Brace yourself for the two most important words in business: margin and volume.

Most businesses buy/procure raw materials at cheap prices and then offer it to you after adding a margin (which includes cost of storing the product, packaging, manpower, profits, etc.) The best, and arguably the biggest, businesses boast both margins and volumes. But increasingly, some businesses are growing large by just doing one side of the business well. And that’s where the danger lies for the small guy.

Example 1: To understand this let’s take you to a sabzi mandi (vegetable market) in North India. [Don’t confuse it with the Mandi District in Himachal Pradesh.] Sabzi mandis are the best places to discover how the onions that you use at home are priced. Its hurts when we have to pay Rs 28 per kilogram of the tear-jerkers but is it really in such short supply?

Economics teaches us that price is just a function of the demand and supply scenario. If onions are priced at Rs 28 per 1,000 grams of it, they must be difficult to grow or less in supply. Apart from being situated in and around villages, mandis are local markets that offer a social arrangement allowing buyers and sellers to discover information and carry out a voluntary exchange of goods or services.

But unlike free markets, where the prices of goods and services are arranged completely by the mutual consent of sellers and buyers, here the seller is at complete mercy of the buyer.

We ask 45-year old Bholuram about how much he gets by selling one kilogram of onion. “Chaar panch rupiya milta hai maiji,” (I get around Rs 4-5 per kilogram, madam) he says. How can this be? We pay Rs 28-30 for every kilogram. We ask to whom he sells the onions. He motions in the direction of a trader Duttaram (everybody here calls him Ram Saheb). He has attended primary school and offers tea. He explains in broken English. “Some margin we has to keep sister. Onion go to big trader who take it to city. Then big traders sell it to big shops,” revealing the gamut of exchanges that add thin margins leading to us paying a least seven times more than the actual price. This is the effect of margins!

Example 2: Day-to-day business often tweaks a word for all eternity. Volume is a prime example of that. Actually it is number, but volume sure sounds more filling. Meet Ashok Rajan. Forty-year-old Ashok had the aspirations most successful businessmen have nurtured in their lifetimes.

So after working for around 15 years in a job that paid him less than he was worth (he thought), he ended up wondering whether there was another way of earning a living. Having one’s own business sounded like the perfect idea and his savings ensured that he could start off something right away.

After making some changes to his ‘once’ ancestral property but vacant piece of land as a production unit of sorts, Ashok started his company that made bottle caps. Ashok did brisk business as he took low margins. “Soon enough, big orders started flowing in and, at one time, my whole business expanded to four units, all free of debt. This is when I got my biggest client,” he reminisces.

After striking a 10-year deal that would make his margins wafer thin, the client promised 10-lakh bottle caps a month. “This was volume. All my units produced around 2-lakh caps per month but this was five times. Sure I had to start new units, but think of the business,” Ashok said. He is broke now, after being unable to sustain losses in the business as a cruel stroke of luck cost him his entire business. The client stepped up his order to 2 million pieces a month and Ashok took debts to rapidly build up capacity.

One fine morning, Ashok’s manager called him on his cell-phone. “Sir, the client has cancelled all the orders! They have returned it saying the caps don’t fit the size specifications,” the manager said. Ashok’s business, that grew 10 times over the past five years, was not big enough to absorb the financial loss. An order going late is okay but an order being cancelled means death. And this, my dear readers, is all about volume and its ill effects.

Post-mortem: What should a seller do when he doesn’t have bargaining power? What should a seller do when volumes lure him, often to his undoing? What price should a grower demand? What margin does an entrepreneur keep as safe? As always, there are a lot of questions but few answers in sight.

“Big businesses thrive on volumes, which smaller businesses strive for. Hence you see a perfect fit. But the balance is horribly skewed against the small guy. The Goliath will just buy goods from the next David he comes across,” says Professor Rajaram Nedungutti, after listening to the two stories.

“Farmers will always complain of low prices. But, for us, it is important to find out why the goods we buy should change so many hands. We pay an exorbitant price for something that is dirt cheap,” remarked Prithvi Satyan, a second-year commerce student.

The problem is the small grower or producer of goods is becoming smaller. The big ones are getting bigger. What do you propose we should do? Stop buying such goods? Nah, it would be sheer utopia to think we could keep our hands off not one but two packets of private label corn flakes.

“One thing we can do is ensure a sort of a minimum and maximum price for all goods and products. Nationwide. This, if enforced, would take care of a lot of problems. We do have such a thing but the authorities should be more authoritative,” says Deepika Chandian. She has returned to India after two decades.

When I brought up the topic of a maximum price, Mr Ravikanth shot down the idea immediately. “I am not sure the maximum price thing is a good idea. Prices will tend to float to the pinnacle then. What we need is to check whether the demand and supply for anything is artificial or not,” 52-year-old ex-government employee, who took voluntary retirement, opined.

He has a point. But what about the beckoning of large volumes that led to Ashok’s downfall. A good reply came from Tridib Bala, who is the most unlikely of fellows to have found an answer for this. Mr Bala is an IT analyst at a multinational firm.

“Revenues should be earned from multiple streams. Too much dependence on one client will always be a situation just shy of a disaster waiting to happen.”

Well explained, but are the ground realities so easy? Is saying no to a big client so easy, knowing he can offer continuous stream of business?

Won’t you be hard-pressed to say no to a thicker margin when given the carrot of humongous volumes?

We all talk about letting the fruits of growth trickle down to the masses. Smiling farmers, successful traders, happy customers and productive companies make the picture complete.

I conclude today with just one question:

Does today’s financial system allow the small guy to survive? If you have an answer, I want you to tell me. You have 6 days.

Mail your thoughts at swatilistening@gmail.com

Letters received in response to Episode-168, ‘ Mutuo caveo: Borrower beware’ (Business Line, November 19.)

It is incorrect to accuse banks of treating all customers as defaulters. Out of 100 loans sanctioned, only 5 to 10 per cent turn defaulters, that too as chronic, wilful defaulters. This 10 per cent deserves bad treatment. Of this, 1 or 2 people might have turned defaulters for genuine reasons. This is like when police is lathi-charging the unruly mob, one or two good people also may get beaten up.

This is inevitable. Ninety per cent of borrowers are promptly repaying the loans as per repayment schedule (originally agreed upon), otherwise it will amount to premium for dishonesty. Banks initiate legal action as has been hitherto, but of no use. The defaulters may not appear in the Court as the case will be decreed ex-party. The decree is valid for 13 years and the borrowers are further benefited by this method by gaining time. This type of system has not yielded any results in the past. Ramalingam Ayyappa

When the whole nation talks about financial inclusion, bankers advertise themselves as customer-friendly. But the recent incidents involving their recovery agents prove it otherwise. In my opinion, the recovery of loans should not be outsourced, as this involves customer relationship. When the bankers give so much of importance to “Know your customer” at the time of the introduction, why don’t they try to know the credit-worthiness of the customer. While the loan is lent by the banker, the recovery is done by a stranger, often using all wrong and violent methods.

This is one of the reasons why the poor are afraid of banks and prefer the money-lenders, in spite of the high interest rates they charge. I am not defending the defaulters but I am against the methods adopted by the bankers to recover the loans. Banks should be made user-friendly. They need not disburse loans over phones. Let them know their customer and lend. They can have their own recovery departments instead of hiring unqualified persons. Let more people come to the banks and enjoy the benefits. Only bankers can help achieve financial inclusion. Let the bankers educate the borrowers and make banking a pleasure.

R. Thesinghrajan, Ooty

In the episode No 168 you had mentioned the harsh and abusive steps adopted by certain banks in the recovery procedure. The RBI had also expressed its displeasure and warned the banks concerned. But banks need alternative solution to recover their dues and to reduce their NPAs. I would like to mention a few problems faced by banks in collecting their dues from the defaulters.

One, more than 75 per cent of the overdue borrowers are intentional defaulters. Of these, 75 per cent, about 50 per cent have money to repay the bank dues, but they don’t. The banks usually follow a definite procedure for the recovery process.

Bank members make personal visits to the borrowers’ office or residence either in the morning or late evening. There are number of incidences in which the customers do not inform the bank about the change of their addresses and the bankers have to toil to find out the new addresses of the borrowers. Considerable time is wasted in recovery procedure.

If the borrowers go to the bank and explain their difficulties, bankers are ready to help them by re-phasing the loan, allowing rebate on overdue interest etc. Instead, they make the bankers to chase them. The productive man-hours of the bank staff gets wasted. If the recovery procedure is shortened, most of the problems could be solved.

S. Mahadevan, Nagercoil

Letters received in response to Episode-167, ‘Is gold still a safe investment?’ (Business Line, November 19.)

Thanks for a very thought-provoking article on gold. Though gold may not be a safe investment, the urge to buy the yellow metal is inherent.

Your thoughts clearly show that there is a great demand for gold. One of the reasons could be that the bankers could have entered the market to tap the disposable income of youth. Public perception that gold need not be in the form of jewellery, created an opportunity for investment. The increase in the price will not slow down the consumption. Probably people are waiting for the prices to stabilise. The stock market boom has attracted more people to invest in shares. Whatever be the growth in stocks, people will always have a charm for gold because it has a mass market. We will have to admit that the purchasing power of many Indians has increased to a great extent, though many are still living in abject poverty. It is very difficult to predict the growth of the shares or gold.

R. Thesinghrajan, Ooty

SwatiListening@gmail.com

Blog at: http://Swati-CA.blogspot.com

More Stories on : Marketing | Non-Performing Assets | Swati CA

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Air India working on cost-cutting moves

A change in the paper pattern

How much can I invest in capital gains bonds?

Composition scheme vs Cenvat credit

Massage that message

Put on your thinking cap

Are you sure about the quality of gold that you bought?

8 words to banish from your vocabulary

Just Do It

Number Crunch

Thin margins on large volumes could be a recipe for disaster

The only true failure is the person who gives up trying

Suggestions and Ideas