Competing in the Age of Omnichannel Retailing 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 Competing in the Age of Omnichannel Retailing case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Competing in the Age of Omnichannel Retailing case study is a Harvard Business School (HBR) case study written by Erik Brynjolfsson, Yu Jeffrey Hu, Mohammad S. Rahman. The Competing in the Age of Omnichannel Retailing (referred as “Retailing Omnichannel” 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 Competing in the Age of Omnichannel Retailing Case Study

Erik Brynjolfsson (MIT Sloan School of Management), Yu Hu (Georgia Institute of Technology), and Mohammad S. Rahman (University of Calgary)This is an MIT Sloan Management Review article. Recent technology advances in mobile computing and augmented reality are blurring the boundaries between traditional and Internet retailing, enabling retailers to interact with consumers through multiple touch points and expose them to a rich blend of offline sensory information and online content. In the past, brick-and-mortar retail stores were unique in allowing consumers to touch and feel merchandise and provide instant gratification; Internet retailers, meantime, tried to woo shoppers with wide product selection, low prices and content such as product reviews and ratings. But as the retailing industry evolves toward a seamless "omnichannel retailing"experience, the distinctions between physical and online will vanish, the authors suggest, turning the world into a showroom without walls. This will push retailers and their supply-chain partners in other industries to rethink their competitive strategies The growing prevalence of location-based applications on mobile devices is a critical enabler. Mobile technology is well on its way to changing consumer behavior and expectations, the authors argue. By giving consumers more accurate information about product availability in local stores, retailers can draw people into stores who might otherwise have only looked for products online. The enhanced search capability is especially helpful with niche products, which are not always available in local stores. The availability of product price and availability information, the ability of consumers to shop online and pick up products in local stores, and the aggregation of offline information and online content have combined to make the retailing landscape increasingly competitive. Retailers used to rely on barriers such as geography and customer ignorance to advance their positions in traditional markets. However, technology is removing these barriers. The authors point to several possible success strategies for companies operating in the new competitive environment, including providing attractive pricing and curated product-related content; harnessing the power of data and analytics; avoiding direct price comparisons; learning to sell niche products; establishing switching costs; and embracing competition. In an omnichannel world, the authors say, there is a premium on learning rapidly from consumers and catering to their needs.

Case Authors : Erik Brynjolfsson, Yu Jeffrey Hu, Mohammad S. Rahman

Topic : Leadership & Managing People

Related Areas :

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Calculating Net Present Value (NPV) at 6% for Competing in the Age of Omnichannel Retailing Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10018957)	-10018957	-	-
Year 1	3462441	-6556516	3462441	0.9434	3266454
Year 2	3975356	-2581160	7437797	0.89	3538053
Year 3	3960802	1379642	11398599	0.8396	3325566
Year 4	3223110	4602752	14621709	0.7921	2553005
TOTAL			14621709		12683077

The Net Present Value at 6% discount rate is 2664120

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. Profitability Index
3. Payback Period
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. Retailing Omnichannel 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 Retailing Omnichannel 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 Competing in the Age of Omnichannel Retailing

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 Retailing Omnichannel 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 Retailing Omnichannel 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	(10018957)	-10018957	-	-
Year 1	3462441	-6556516	3462441	0.8696	3010818
Year 2	3975356	-2581160	7437797	0.7561	3005940
Year 3	3960802	1379642	11398599	0.6575	2604292
Year 4	3223110	4602752	14621709	0.5718	1842824
TOTAL					10463874

The Net NPV after 4 years is 444917

(10463874 - 10018957 )

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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	(10018957)	-10018957	-	-
Year 1	3462441	-6556516	3462441	0.8333	2885368
Year 2	3975356	-2581160	7437797	0.6944	2760664
Year 3	3960802	1379642	11398599	0.5787	2292131
Year 4	3223110	4602752	14621709	0.4823	1554355
TOTAL					9492517

The Net NPV after 4 years is -526440

At 20% discount rate the NPV is negative (9492517 - 10018957 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Retailing Omnichannel 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 Retailing Omnichannel has a NPV value higher than Zero then finance managers at Retailing Omnichannel 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 Retailing Omnichannel, then the stock price of the Retailing Omnichannel 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 Retailing Omnichannel 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 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.

Understanding of risks involved in the project.

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

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 Competing in the Age of Omnichannel Retailing

References & Further Readings

Erik Brynjolfsson, Yu Jeffrey Hu, Mohammad S. Rahman (2018), "Competing in the Age of Omnichannel Retailing Harvard Business Review Case Study. Published by HBR Publications.