Comment by roel_v | Hacker News Reader

Comment by roel_v | Hacker News Reader

Parent Full thread

What, and let shareholders wait for three years for any profits? These businesses operate on the edge - in the margin as an economist would say. They need every single bit of competitive advantage to survive. Storing capital that can be put to productive use in a warehouse is a liability, to be remedied asap. Every business has risks, credit risk is just one of the many. When managed well, there is no problem with relying on outside credit to finance short-term debts. Running a big company (or a country, for that matter) is _not_ the same as balancing a household budget. Risk is an essential part of doing business, and managing risk is one of the aspects that can give a company a competitive advantage.

A few days ago there was a link here on HN about marginal advantages in game design, how the best Starcraft players thrive in environments where they are just a smidgen ahead of their opponent, and maneuver themselves in such a position, in contrast with the amateurs who want to 'win big' - have a big lead and crush their opponent in an overwhelming fashion. It's an eye-opening read, putting in words a property of winners that I never quite managed to capture myself. The theory applies to businesses equally - in a mature market, you can never be hunkered down, playing an all-defense game while you build up resources and then crush the opposition. By that time, that competition will have eaten your lunch and driven you out of business.

A) Cash on hand has value.

B) Banks do charge them interest on that money. So their opportunity cost = (Money * (Potential return - bank interest rate), but risk also has a cost.

C) As a public company Edit:(Ahold) could sell stock and gain capital without making their numbers look bad.

IMO, if there was a 5% risk of going bankrupt it's a now brainer. If it’s less than 5% they can mitigate it by keeping more cash on hand.

"As a public company they could sell stock"

(Like it says in the OP) Zappos is not a public company, and if the Zappos board had been confident that Zappos could become a public company, they would not have objected to the direction desired by the CEO.

Sorry, the “they” I was talking about was Ahold. I think Zappos probably chose the correct path. As a rapidly growing company they had fewer options.

Of course cash on hand has value. Question is how much of it is needed to optimize profit. And of course credit lines cost money. That's where the 'risk management' part comes into play. My point is that there are hundreds of people running models and doing calculations on what the optimal way to finance operations in a company of that size is. Contrary to popular opinion these people aren't stupid. It's unreasonable to, a priori, rule out financing inventories with credit, just because there is risk involved. It's about balancing pros and cons, and whoever balances it the best, wins (i.e., makes most profit, or can lower prices to gain customers and grab more market share, or buy competitors, or...)

(about Ahold, without knowing the details, the liquidity problem was at the time when details of shady accounting in a US subsidiary came to light. You can't issue more stock in a few days to cover immediate liquidity problems. plus investors aren't going to be too happy when you're diluting their stock just to cover an operating loss. It's a different thing when you're doing it to raise money to expand the business.)

Question is how much of it is needed to optimize profit.

No, optimizing for profit ignores your risk to capital. The US banking history has a long history of Martingale style investments where a high probability for modest return risks huge amounts of capital. http://en.wikipedia.org/wiki/Martingale_(betting_system) The important difference is banks risk far more capital than they have so a Martingale style bet works in their favor.

Alhold however, was risking 15 billion in capital to make a modest return. IMO, if you’re going to risk 15 billion then go whole hog and run a financial institution to better balance your risks. Why risk zero when you can go all the way to negative 15 billion etc.

PS: I know that's not what you meant by optimizing for profit, but they were still making a 15 billion dollar bet for a few millions of dollars in annual return.

Yes, I meant 'optimize for profit/risk ratio' I think - Ahold is a 'safe' company so low profits are tolerated by investors in return for a 'certain' return, as compared to investments in high tech where a higher yield is demanded because the risk is higher.

I think we're on the same page but I don't understand your last line - are you saying that companies with 'low' (single digit) returns are suboptimal choices for investors?

What I meant by they were still making a 15 billion dollar bet for a few millions of dollars in annual return. was the company risked its market cap for whatever return they received from their approach to managing money. Credit crunches are not uncommon and often kill large companies when something bad happens in the middle of one.

As to safe return, as you say their stock holders where paying a premium for safety and unless the R/W was awe inspiring I suspect most of them would rather gone to safer route.

Oh, I guess we're not on the same page then after all. They're only "risking" 15B in the sense you're implying in a black/white world. They were/are taking a calculated risk, well within 'normal' bounds, and certainly within well accepted bounds for most investors (as in, investors with the most money on the line). Credit crunches 'often' killing large companies is hyperbole. Small companies yes, but for large companies it's relatively rare as far as I know. Then again what do I know, I'm open to number that prove me wrong.

Do you have a link to that Starcraft article?

Took a bit of digging, finally found it in my history: http://news.ycombinator.com/item?id=1402929 .

Reply on news.ycombinator.com