Patagonia's Sustainability Strategy: Don't Buy Our Products 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 Patagonia's Sustainability Strategy: Don't Buy Our Products case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Patagonia's Sustainability Strategy: Don't Buy Our Products case study is a Harvard Business School (HBR) case study written by Francisco Szekely, Zahir Dossa. The Patagonia's Sustainability Strategy: Don't Buy Our Products (referred as “Patagonia Patagonia's” 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, Transparency.

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 Patagonia's Sustainability Strategy: Don't Buy Our Products Case Study

In 2005, Patagonia launched the Common Threads Recycling Program. The goal was to reduce the number of products Patagonia customers purchased through a two-fold effort. The first part was to encourage customers to fix damaged clothing. Patagonia began publishing do-it-yourself repair guides to assist customers in repairing their clothing. To provide an alternative for customers who were unable or unwilling to repair their clothing themselves, Patagonia charged an affordable fee to have garments shipped to their repair facility. The second aspect of the Common Threads program was to create a second-hand market for Patagonia garments that did not fit or that were no longer worn. Patagonia collaborated with eBay to develop a storefront and also created an online marketplace on its main website. Patagonia also offered to cover the shipping costs for garments that were beyond repair, which Patagonia would then break down and repurpose. To promote its Common Threads initiative, Patagonia created "Worn Wear," a program that highlights thousands of videos and pictures from customers around the globe who treasure their worn, patched-up Patagonia garments with pride. While most companies would encourage customers to repeat their purchases, Patagonia prides itself and its customers on waste-free purchases. Patagonia's next step was to launch a campaign in 2011 to dissuade customers from purchasing clothing that they did not really need. On the busiest weekend for retailers in the US, a 2011 New York Times ad from Patagonia featured a picture of one of Patagonia's highest grossing fleece jackets below the words: "DON'T BUY THIS JACKET." Underneath was a detailed description that defended Patagonia's rationale based on the negative environmental impacts caused by consumerism. Despite Patagonia's efforts, sales increased by approximately 30% in the nine months following the ad. The case concludes with the business dilemma facing Chouinard: What should Patagonia do?

Case Authors : Francisco Szekely, Zahir Dossa

Topic : Leadership & Managing People

Related Areas : Transparency

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Calculating Net Present Value (NPV) at 6% for Patagonia's Sustainability Strategy: Don't Buy Our Products Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10017377)	-10017377	-	-
Year 1	3455790	-6561587	3455790	0.9434	3260179
Year 2	3973919	-2587668	7429709	0.89	3536774
Year 3	3942359	1354691	11372068	0.8396	3310081
Year 4	3238601	4593292	14610669	0.7921	2565275
TOTAL			14610669		12672309

The Net Present Value at 6% discount rate is 2654932

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. Payback Period
3. Internal Rate of Return
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Patagonia Patagonia's 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 Patagonia Patagonia's 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 Patagonia's Sustainability Strategy: Don't Buy Our Products

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 Patagonia Patagonia's 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 Patagonia Patagonia's 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	(10017377)	-10017377	-	-
Year 1	3455790	-6561587	3455790	0.8696	3005035
Year 2	3973919	-2587668	7429709	0.7561	3004854
Year 3	3942359	1354691	11372068	0.6575	2592165
Year 4	3238601	4593292	14610669	0.5718	1851681
TOTAL					10453734

The Net NPV after 4 years is 436357

(10453734 - 10017377 )

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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	(10017377)	-10017377	-	-
Year 1	3455790	-6561587	3455790	0.8333	2879825
Year 2	3973919	-2587668	7429709	0.6944	2759666
Year 3	3942359	1354691	11372068	0.5787	2281458
Year 4	3238601	4593292	14610669	0.4823	1561825
TOTAL					9482774

The Net NPV after 4 years is -534603

At 20% discount rate the NPV is negative (9482774 - 10017377 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Patagonia Patagonia's 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 Patagonia Patagonia's has a NPV value higher than Zero then finance managers at Patagonia Patagonia's 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 Patagonia Patagonia's, then the stock price of the Patagonia Patagonia's 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 Patagonia Patagonia's 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 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 can impact the cash flow of the project.

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 Patagonia's Sustainability Strategy: Don't Buy Our Products

References & Further Readings

Francisco Szekely, Zahir Dossa (2018), "Patagonia's Sustainability Strategy: Don't Buy Our Products Harvard Business Review Case Study. Published by HBR Publications.