Old Company, Modern Marketing Strategy: Lessons from Lee Kum Kee Net Present Value (NPV) / MBA Resources

Introduction to Net Present Value (NPV) - What is Net Present Value (NPV) ? How it impacts financial decisions regarding project management?

NPV solution for Old Company, Modern Marketing Strategy: Lessons from Lee Kum Kee case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Old Company, Modern Marketing Strategy: Lessons from Lee Kum Kee case study is a Harvard Business School (HBR) case study written by Bennett Yim, Vincent Mak. The Old Company, Modern Marketing Strategy: Lessons from Lee Kum Kee (referred as “Lee Kum” from here on) case study provides evaluation & decision scenario in field of Sales & Marketing. It also touches upon business topics such as - Value proposition, Corporate governance, Crisis management, Growth strategy, Risk management, Strategic planning.

The net present value (NPV) of an investment proposal is the present value of the proposal’s net cash flows less the proposal’s initial cash outflow. If a project’s NPV is greater than or equal to zero, the project should be accepted.

NPV = Present Value of Future Cash Flows LESS Project’s Initial Investment

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Case Description of Old Company, Modern Marketing Strategy: Lessons from Lee Kum Kee Case Study

The sauce company Lee Kum Kee, one of the best known Hong Kong brands, had a long history that began in 1888 and was run by the same family for four generations. The company was founded by Lee Kam Sheung as a small oyster sauce manufacturer in Guangdong Province, China. It relocated to Macau in the early 1900s and moved once more to Hong Kong after World War II; it remained based there in the decades afterwards. Lee Kum Kee was already expanding beyond the Guangdong-Macau-Hong Kong distribution network in the 1920s to North America, when it was also making shrimp paste. In the 1970s and 1980s, after the torch passed to third-generation leader Lee Man Tat, there was rapid geographical market and product diversification. Lee Man Tat's sons, who were educated in the West, inherited the leadership from their father in the 1990s, and the pace of modernization and diversification continued while the company's marketing strategy remained vigorous and adaptable. The company overcame a consumer confidence crisis--called the 3-MPCD crisis--in the late 1990s and early 2000s and continued to thrive. By early 2003, Lee Kum Kee had already developed more than 200 sauces. Its distribution network covered 60 countries in five continents, and its products were available in more than 80 countries. What lessons about strategic brand management can we learn from the way Lee Kum Kee developed, maintained, and expanded the reach of its products over a whole century? What lessons about crisis management does the company's handling of the 3-MPCD crisis offer?

Case Authors : Bennett Yim, Vincent Mak

Topic : Sales & Marketing

Related Areas : Corporate governance, Crisis management, Growth strategy, Risk management, Strategic planning

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Calculating Net Present Value (NPV) at 6% for Old Company, Modern Marketing Strategy: Lessons from Lee Kum Kee Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10012169)	-10012169	-	-
Year 1	3463712	-6548457	3463712	0.9434	3267653
Year 2	3980016	-2568441	7443728	0.89	3542200
Year 3	3972991	1404550	11416719	0.8396	3335800
Year 4	3237524	4642074	14654243	0.7921	2564422
TOTAL			14654243		12710075

The Net Present Value at 6% discount rate is 2697906

In isolation the NPV number doesn't mean much but put in right context then it is one of the best method to evaluate project returns. In this article we will cover -

Different methods of capital budgeting

What is NPV & Formula of NPV,
How it is calculated,
How to use NPV number for project evaluation, and
Scenario Planning given risks and management priorities.

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Capital Budgeting Approaches

Methods of Capital Budgeting

There are four types of capital budgeting techniques that are widely used in the corporate world –

1. Net Present Value
2. Internal Rate of Return
3. Payback Period
4. Profitability Index

Apart from the Payback period method which is an additive method, rest of the methods are based on Discounted Cash Flow technique. Even though cash flow can be calculated based on the nature of the project, for the simplicity of the article we are assuming that all the expected cash flows are realized at the end of the year.

Discounted Cash Flow approaches provide a more objective basis for evaluating and selecting investment projects. They take into consideration both –

1. Timing of the expected cash flows – stockholders of Lee Kum have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.
2. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Lee Kum shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.

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Formula and Steps to Calculate Net Present Value (NPV) of Old Company, Modern Marketing Strategy: Lessons from Lee Kum Kee

NPV = Net Cash In Flowt1 / (1+r)t1 + Net Cash In Flowt2 / (1+r)t2 + … Net Cash In Flowtn / (1+r)tn
Less Net Cash Out Flowt0 / (1+r)t0

Where t = time period, in this case year 1, year 2 and so on.
r = discount rate or return that could be earned using other safe proposition such as fixed deposit or treasury bond rate. Net Cash In Flow – What the firm will get each year.
Net Cash Out Flow – What the firm needs to invest initially in the project.

Step 1 – Understand the nature of the project and calculate cash flow for each year.
Step 2 – Discount those cash flow based on the discount rate.
Step 3 – Add all the discounted cash flow.
Step 4 – Selection of the project

Why Sales & Marketing Managers need to know Financial Tools such as Net Present Value (NPV)?

In our daily workplace we often come across people and colleagues who are just focused on their core competency and targets they have to deliver. For example marketing managers at Lee Kum often design programs whose objective is to drive brand awareness and customer reach. But how that 30 point increase in brand awareness or 10 point increase in customer touch points will result into shareholders’ value is not specified.

To overcome such scenarios managers at Lee Kum needs to not only know the financial aspect of project management but also needs to have tools to integrate them into part of the project development and monitoring plan.

Calculating Net Present Value (NPV) at 15%

After working through various assumptions we reached a conclusion that risk is far higher than 6%. In a reasonably stable industry with weak competition - 15% discount rate can be a good benchmark.

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 15 %	Discounted Cash Flows
Year 0	(10012169)	-10012169	-	-
Year 1	3463712	-6548457	3463712	0.8696	3011923
Year 2	3980016	-2568441	7443728	0.7561	3009464
Year 3	3972991	1404550	11416719	0.6575	2612306
Year 4	3237524	4642074	14654243	0.5718	1851065
TOTAL					10484758

The Net NPV after 4 years is 472589

(10484758 - 10012169 )

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Calculating Net Present Value (NPV) at 20%

If the risk component is high in the industry then we should go for a higher hurdle rate / discount rate of 20%.

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 20 %	Discounted Cash Flows
Year 0	(10012169)	-10012169	-	-
Year 1	3463712	-6548457	3463712	0.8333	2886427
Year 2	3980016	-2568441	7443728	0.6944	2763900
Year 3	3972991	1404550	11416719	0.5787	2299185
Year 4	3237524	4642074	14654243	0.4823	1561306
TOTAL					9510817

The Net NPV after 4 years is -501352

At 20% discount rate the NPV is negative (9510817 - 10012169 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Lee Kum to discount cash flow at lower discount rates such as 15%.

Acceptance Criteria of a Project based on NPV

Simplest Approach – If the investment project of Lee Kum has a NPV value higher than Zero then finance managers at Lee Kum can ACCEPT the project, otherwise they can reject the project. This means that project will deliver higher returns over the period of time than any alternate investment strategy.

In theory if the required rate of return or discount rate is chosen correctly by finance managers at Lee Kum, then the stock price of the Lee Kum should change by same amount of the NPV. In real world we know that share price also reflects various other factors that can be related to both macro and micro environment.

In the same vein – accepting the project with zero NPV should result in stagnant share price. Finance managers use discount rates as a measure of risk components in the project execution process.

Sensitivity Analysis

Project selection is often a far more complex decision than just choosing it based on the NPV number. Finance managers at Lee Kum should conduct a sensitivity analysis to better understand not only the inherent risk of the projects but also how those risks can be either factored in or mitigated during the project execution. Sensitivity analysis helps in –

What will be a multi year spillover effect of various taxation regulations.

Understanding of risks involved in the project.

What can impact the cash flow of the project.

What are the uncertainties surrounding the project Initial Cash Outlay (ICO’s). ICO’s often have several different components such as land, machinery, building, and other equipment.

What are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

Some of the assumptions while using the Discounted Cash Flow Methods –

Projects are assumed to be Mutually Exclusive – This is seldom the came in modern day giant organizations where projects are often inter-related and rejecting a project solely based on NPV can result in sunk cost from a related project.

Independent projects have independent cash flows – As explained in the marketing project – though the project may look independent but in reality it is not as the brand awareness project can be closely associated with the spending on sales promotions and product specific advertising.

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Negotiation Strategy of Old Company, Modern Marketing Strategy: Lessons from Lee Kum Kee

References & Further Readings

Bennett Yim, Vincent Mak (2018), "Old Company, Modern Marketing Strategy: Lessons from Lee Kum Kee Harvard Business Review Case Study. Published by HBR Publications.