China's Tencent: Leading the Way in Monetizing Platforms 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 China's Tencent: Leading the Way in Monetizing Platforms case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. China's Tencent: Leading the Way in Monetizing Platforms case study is a Harvard Business School (HBR) case study written by Salvatore Cantale, Ivy Buche, Joel Barbier. The China's Tencent: Leading the Way in Monetizing Platforms (referred as “Tencent Platform” from here on) case study provides evaluation & decision scenario in field of Finance & Accounting. It also touches upon business topics such as - Value proposition, Networking.

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 China's Tencent: Leading the Way in Monetizing Platforms Case Study

Worldwide, there is no parallel comparison to China's Tencent Holdings. The $22 billion tech giant is a collective answer to Facebook, WhatsApp, Spotify, Kindle, Skype, Pinterest, Apple Pay and others. This case explains how Tencent built a digital platform business from scratch over a period of nearly two decades. Undoubtedly, it gained significant benefits from being an early mover in developing a massive one-billion-strong user base on its gaming and messaging platforms. However, what is exceptional about Tencent is that it has been able to successfully monetize its social audience at scale - a tough challenge for most digital platform companies. Tencent's double digit growth boosted investor confidence that the company would continue to tap the spending power of its users while leveraging the growth potential of its still-nascent advertising and payments businesses. Could the most valuable company in Asia, continue to meet shareholder expectations in 2017 and beyond? Learning objective: 1. Understand the platform business model compared to the traditional pipeline business model; 2. Recognize how network effects create value on a platform; 3. Examine the three types of value that digital disruptors deliver - cost value, experience value and platform value; 4. Comprehend the challenges in monetizing platforms effectively.

Case Authors : Salvatore Cantale, Ivy Buche, Joel Barbier

Topic : Finance & Accounting

Related Areas : Networking

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Calculating Net Present Value (NPV) at 6% for China's Tencent: Leading the Way in Monetizing Platforms Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10025169)	-10025169	-	-
Year 1	3472025	-6553144	3472025	0.9434	3275495
Year 2	3977385	-2575759	7449410	0.89	3539858
Year 3	3936183	1360424	11385593	0.8396	3304895
Year 4	3238410	4598834	14624003	0.7921	2565124
TOTAL			14624003		12685373

The Net Present Value at 6% discount rate is 2660204

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. Internal Rate of Return
4. Net Present Value

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. Tencent Platform 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 Tencent Platform 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 China's Tencent: Leading the Way in Monetizing Platforms

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 Finance & Accounting 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 Tencent Platform 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 Tencent Platform 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	(10025169)	-10025169	-	-
Year 1	3472025	-6553144	3472025	0.8696	3019152
Year 2	3977385	-2575759	7449410	0.7561	3007474
Year 3	3936183	1360424	11385593	0.6575	2588104
Year 4	3238410	4598834	14624003	0.5718	1851571
TOTAL					10466302

The Net NPV after 4 years is 441133

(10466302 - 10025169 )

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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	(10025169)	-10025169	-	-
Year 1	3472025	-6553144	3472025	0.8333	2893354
Year 2	3977385	-2575759	7449410	0.6944	2762073
Year 3	3936183	1360424	11385593	0.5787	2277884
Year 4	3238410	4598834	14624003	0.4823	1561733
TOTAL					9495044

The Net NPV after 4 years is -530125

At 20% discount rate the NPV is negative (9495044 - 10025169 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Tencent Platform 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 Tencent Platform has a NPV value higher than Zero then finance managers at Tencent Platform 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 Tencent Platform, then the stock price of the Tencent Platform 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 Tencent Platform 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 can impact the cash flow of the project.

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

Understanding of risks involved in 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 China's Tencent: Leading the Way in Monetizing Platforms

References & Further Readings

Salvatore Cantale, Ivy Buche, Joel Barbier (2018), "China's Tencent: Leading the Way in Monetizing Platforms Harvard Business Review Case Study. Published by HBR Publications.