Grofers: Re-Energizing Kirana Stores through M-Commerce 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 Grofers: Re-Energizing Kirana Stores through M-Commerce case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Grofers: Re-Energizing Kirana Stores through M-Commerce case study is a Harvard Business School (HBR) case study written by Reema Khurana, Susmi Routray. The Grofers: Re-Energizing Kirana Stores through M-Commerce (referred as “Grofers Grocery” from here on) case study provides evaluation & decision scenario in field of Leadership & Managing People. It also touches upon business topics such as - Value proposition, .

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 Grofers: Re-Energizing Kirana Stores through M-Commerce Case Study

In 2014, the food and grocery industry in India experienced a surge in the online grocery market. Before that time, existing e-business players had largely avoided the online grocery market because of its complex logistics requirements and issues related to last-mile delivery, or reaching customers in remote areas. The rise of online grocery businesses raised concerns for brick-and-mortar stores, especially local kirana stores (corner stores), about becoming redundant in the future. With limited or no technology adoption, these kirana stores had no way of going online. Grofers came to the rescue of these local stores with a mobile commerce (m-commerce) model for groceries that promised on-demand delivery within 90 minutes. However, with very low margins in the grocery business compared to lifestyle products, in addition to last-mile delivery and returns complexities, it remained to be seen whether Grofers would be able to carve out a niche in the grocery industry with its innovative model. Considering the low entry barriers and the easily replicable business model, how viable and sustainable was an m-commerce business like Grofers? Reema Khurana is affiliated with Institute of Management Technology, Ghaziabad. Susmi Routray is affiliated with Institute of Management Technology, Ghaziabad.

Case Authors : Reema Khurana, Susmi Routray

Topic : Leadership & Managing People

Related Areas :

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Calculating Net Present Value (NPV) at 6% for Grofers: Re-Energizing Kirana Stores through M-Commerce Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10014998)	-10014998	-	-
Year 1	3456772	-6558226	3456772	0.9434	3261106
Year 2	3955382	-2602844	7412154	0.89	3520276
Year 3	3951120	1348276	11363274	0.8396	3317437
Year 4	3238780	4587056	14602054	0.7921	2565417
TOTAL			14602054		12664235

The Net Present Value at 6% discount rate is 2649237

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. Payback Period
2. Internal Rate of Return
3. Net Present Value
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 Grofers Grocery 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. Grofers Grocery 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 Grofers: Re-Energizing Kirana Stores through M-Commerce

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 Leadership & Managing People 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 Grofers Grocery 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 Grofers Grocery 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	(10014998)	-10014998	-	-
Year 1	3456772	-6558226	3456772	0.8696	3005889
Year 2	3955382	-2602844	7412154	0.7561	2990837
Year 3	3951120	1348276	11363274	0.6575	2597926
Year 4	3238780	4587056	14602054	0.5718	1851783
TOTAL					10446434

The Net NPV after 4 years is 431436

(10446434 - 10014998 )

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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	(10014998)	-10014998	-	-
Year 1	3456772	-6558226	3456772	0.8333	2880643
Year 2	3955382	-2602844	7412154	0.6944	2746793
Year 3	3951120	1348276	11363274	0.5787	2286528
Year 4	3238780	4587056	14602054	0.4823	1561912
TOTAL					9475876

The Net NPV after 4 years is -539122

At 20% discount rate the NPV is negative (9475876 - 10014998 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Grofers Grocery 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 Grofers Grocery has a NPV value higher than Zero then finance managers at Grofers Grocery 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 Grofers Grocery, then the stock price of the Grofers Grocery 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 Grofers Grocery 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 –

Understanding of risks involved in 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.

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

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 Grofers: Re-Energizing Kirana Stores through M-Commerce

References & Further Readings

Reema Khurana, Susmi Routray (2018), "Grofers: Re-Energizing Kirana Stores through M-Commerce Harvard Business Review Case Study. Published by HBR Publications.