The Store Is Dead - Long Live the Store 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 The Store Is Dead - Long Live the Store case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. The Store Is Dead - Long Live the Store case study is a Harvard Business School (HBR) case study written by David R. Bell, Santiago Gallino, Antonio Moreno. The The Store Is Dead - Long Live the Store (referred as “Retailers Showroom” from here on) case study provides evaluation & decision scenario in field of Sales & Marketing. It also touches upon business topics such as - Value proposition, Marketing.

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 The Store Is Dead - Long Live the Store Case Study

At a time when many traditional retailers are closing their physical stores, digitally native vertical brands such as Bonobos, which specializes in men's apparel, and Warby Parker, which specializes in eyeglasses, are aggressively expanding into offline locations. In this article, the authors explore two related trends: (1) the expansion of online-first retailers into offline stores that "supercharge"customer value and (2) the transformation of stores run by traditional, offline-first retailers from fulfillment-dominant centers into experience-dominant centers. As authors David R. Bell, Santiago Gallino, and Antonio Moreno note, as digitally native vertical brands have learned to build relationships with customers, traditional retailers have been reducing their store sizes and inventories and are attempting to improve and elevate the customer experience. "Showroom experiences," they write, "create better customers." When customers are exposed to the brand in a showroom, "they are better able to resolve any uncertainty about the nondigital attributes of the retailer's product."Similarly, the authors say, "showrooms create better retailers: When customers are physically present in the retail environment, observation of their behaviors can lead to meaningful insights." The authors developed their early insights into what customers value while working closely with Bonobos and Warby Parker. Through simulations, they saw that stores with smaller footprints and a higher level of service led to better results economically -improved margins, smoother logistics, and better control of inventory. They found that, rather than being dead, physical retail stores were very much alive with a profound shift in focus -from fulfillment to experience-oriented environments. The authors conclude that online-first retailers and traditional retailers have something to learn from each other. Offline-first retailers can benefit from copying the showroom concepts originated by online-first retailers; online-first retailers can benefit by opening more traditional stores.

Case Authors : David R. Bell, Santiago Gallino, Antonio Moreno

Topic : Sales & Marketing

Related Areas : Marketing

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Calculating Net Present Value (NPV) at 6% for The Store Is Dead - Long Live the Store Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10007539)	-10007539	-	-
Year 1	3464495	-6543044	3464495	0.9434	3268392
Year 2	3980377	-2562667	7444872	0.89	3542521
Year 3	3958680	1396013	11403552	0.8396	3323784
Year 4	3246501	4642514	14650053	0.7921	2571533
TOTAL			14650053		12706230

The Net Present Value at 6% discount rate is 2698691

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

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

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Formula and Steps to Calculate Net Present Value (NPV) of The Store Is Dead - Long Live the Store

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 Retailers Showroom 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 Retailers Showroom 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	(10007539)	-10007539	-	-
Year 1	3464495	-6543044	3464495	0.8696	3012604
Year 2	3980377	-2562667	7444872	0.7561	3009737
Year 3	3958680	1396013	11403552	0.6575	2602896
Year 4	3246501	4642514	14650053	0.5718	1856197
TOTAL					10481435

The Net NPV after 4 years is 473896

(10481435 - 10007539 )

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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	(10007539)	-10007539	-	-
Year 1	3464495	-6543044	3464495	0.8333	2887079
Year 2	3980377	-2562667	7444872	0.6944	2764151
Year 3	3958680	1396013	11403552	0.5787	2290903
Year 4	3246501	4642514	14650053	0.4823	1565635
TOTAL					9507768

The Net NPV after 4 years is -499771

At 20% discount rate the NPV is negative (9507768 - 10007539 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Retailers Showroom 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 Retailers Showroom has a NPV value higher than Zero then finance managers at Retailers Showroom 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 Retailers Showroom, then the stock price of the Retailers Showroom 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 Retailers Showroom 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.

What can impact the cash flow of the project.

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

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.

Understanding of risks involved in 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 The Store Is Dead - Long Live the Store

References & Further Readings

David R. Bell, Santiago Gallino, Antonio Moreno (2018), "The Store Is Dead - Long Live the Store Harvard Business Review Case Study. Published by HBR Publications.