Arogya Parivar: Novartis' BOP Strategy for Healthcare in Rural India 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 Arogya Parivar: Novartis' BOP Strategy for Healthcare in Rural India case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Arogya Parivar: Novartis' BOP Strategy for Healthcare in Rural India case study is a Harvard Business School (HBR) case study written by Amitava Chattopadhyay, Jean Wee, Anuj Pasrjia, Olivier Jarry. The Arogya Parivar: Novartis' BOP Strategy for Healthcare in Rural India (referred as “Parivar Arogya” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Innovation, Marketing, Social enterprise, Strategy.

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 Arogya Parivar: Novartis' BOP Strategy for Healthcare in Rural India Case Study

"With the publication of CK Prahalad's "The Fortune at the Bottom of the Pyramid" (2005), the poor were suddenly seen as a potential market in the eyes of multinational corporations (MNCs). Although poor, the BOP is a large and growing market. The development community tends to focus on meeting the needs of the poorest of the poor (the 1 billion people who live on less than US$1 a day), but there is a larger segment of the low-income population, comprised of 3.8 billion people with incomes between $2 and $5 a day, that could be the focus of a market-oriented approach. They have no bank accounts, no access to modern financial services, no phones, are dependent on informal or subsistence livelihoods, and lack access to amenities and basic healthcare. Influenced by Prahalad's work, the top management at Novartis decided that it was time to seriously consider the pursuit of commercial opportunities among the world's poor. The case offers a description of the first steps to setting up the Arogya Parivar initiative by Novartis in India and raises strategic questions like how to improve its supply chain reliability, how to deal with the fact that many consumers were women and yet there were few female health educators, how to make the treatment affordable, whether to launch new brands of medicines for this segment, how to convince consumers to seek medical treatment and ensure compliance with the treatment protocol, etc., going forward. Please visit the dedicated case website http://cases.insead.edu/arogya-parivar/ (copy and paste the url into a browser) to access case videos and other support material."

Case Authors : Amitava Chattopadhyay, Jean Wee, Anuj Pasrjia, Olivier Jarry

Topic : Strategy & Execution

Related Areas : Innovation, Marketing, Social enterprise, Strategy

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Calculating Net Present Value (NPV) at 6% for Arogya Parivar: Novartis' BOP Strategy for Healthcare in Rural India Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10010153)	-10010153	-	-
Year 1	3453153	-6557000	3453153	0.9434	3257692
Year 2	3981340	-2575660	7434493	0.89	3543378
Year 3	3936246	1360586	11370739	0.8396	3304948
Year 4	3229192	4589778	14599931	0.7921	2557823
TOTAL			14599931		12663841

The Net Present Value at 6% discount rate is 2653688

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

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 Parivar Arogya 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. Parivar Arogya 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 Arogya Parivar: Novartis' BOP Strategy for Healthcare in Rural India

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 Strategy & Execution 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 Parivar Arogya 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 Parivar Arogya 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	(10010153)	-10010153	-	-
Year 1	3453153	-6557000	3453153	0.8696	3002742
Year 2	3981340	-2575660	7434493	0.7561	3010465
Year 3	3936246	1360586	11370739	0.6575	2588146
Year 4	3229192	4589778	14599931	0.5718	1846301
TOTAL					10447653

The Net NPV after 4 years is 437500

(10447653 - 10010153 )

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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	(10010153)	-10010153	-	-
Year 1	3453153	-6557000	3453153	0.8333	2877628
Year 2	3981340	-2575660	7434493	0.6944	2764819
Year 3	3936246	1360586	11370739	0.5787	2277920
Year 4	3229192	4589778	14599931	0.4823	1557288
TOTAL					9477655

The Net NPV after 4 years is -532498

At 20% discount rate the NPV is negative (9477655 - 10010153 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Parivar Arogya 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 Parivar Arogya has a NPV value higher than Zero then finance managers at Parivar Arogya 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 Parivar Arogya, then the stock price of the Parivar Arogya 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 Parivar Arogya 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 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.

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.

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 Arogya Parivar: Novartis' BOP Strategy for Healthcare in Rural India

References & Further Readings

Amitava Chattopadhyay, Jean Wee, Anuj Pasrjia, Olivier Jarry (2018), "Arogya Parivar: Novartis' BOP Strategy for Healthcare in Rural India Harvard Business Review Case Study. Published by HBR Publications.