By: Juliana Gudiño

Introduction

“Microinsurance” is the generic name given to certain type of insurance designed specially to cover some contingencies faced by low-income people. Microinsurances should have special characteristics, such as small insured sums and low premiums. This is because the insured sums should be according to the patrimony of a low-income person, and the premium should be affordable. Another microinsurance key feature is that it should operate with extremely simplified mechanisms that reduce as much as possible administrative costs in order to keep low premiums. (Churchill, 2009).

1. Origins of Microinsurance

In 2005, around 100 worldwide experts met in Germany to analyze and discuss the characteristics, opportunities and difficulties of microinsurance. (Churchill et al., 2006). This meeting was considered as the microinsurance formal entrance at the insurance market. Nevertheless, there are some historical cases in Europe and the United States about similar insurance operations that predate what we know today as microinsurance. (Crawford-Ash and Purcal, 2010). An example is the industrial life insurance based on life insurance policies with small insured sums and weekly premiums collected door-to-door, marketed in the late 1800s by Prudential Life Assurance Society in the United Kingdom and by Metropolitan Life Insurance Company in the United States.

It has not been possible to know the exact origin of the term “microinsurance”, but the term appeared in the content of the next three publications that date back 1999: 1. Micro_Insurance: Extending Health Insurance to the Excluded by David Dror; 2. Synthesis of Case Studies of Micro Insurance and Other Forms of Extending Social Protection in Health in Latin America and the Caribbean; and 3. Providing Insurance to Low-Income Households: Part 1: A Primer on Insurance Principles and Products by Warren Brown and Craig Churchill. It recalls that the term “microinsurance” came from the older term “microfinance.”

2. Role of Microinsurance

The main role of microinsurance is to serve as an effective tool against poverty, performing as a mechanism to mitigate the impact of shocks¹ which could make that, a low-income person, loses his patrimony which likely was made with big efforts.

From a technical perspective, microinsurance can be used as a mechanism to mitigate the variations in the standard of living that a person who lives below the poverty line may face over time, as shown in Figure 1.

Figure 1.

3. The Target Market of Microinsurance

The potential market of microinsurance is poor people in the world. It is a market of about 4 billion people who live on less than four dollars a day. However, in each country the target market depends on the location of the poverty line. (Table 2).

Figure 2.

4. Types of Risks which Can Be Insured by Microinsurance

In general terms, there are no limits of types of risks that can be insured, but it should be understood that the insurable risks are those that impact low-income people. For example, it is obvious that an auto insurance would be an inappropriate microinsurance, because a car is not a typical good of a person with limited resources. The most common risks covered by microinsurance are:

1. Death: Microinsurance can cover funeral costs of the deceased person, the orphanhood or widowhood benefits, as well as payment of microcredits granted to the insured.
2. Disability. Microinsurance can cover the disabled person family which would be no longer protected, providing aid to children who are minors or a spouse, as well as payment of microcredit debts.
3. Illness or Accident. Microinsurance can cover medical expenses due to illness or accident of the titleholder or an economic dependent, as well as provide an income when the head of the household is disabled.
4. Loss of Property. Microinsurance can cover loss by destruction, theft or other reason for goods that are important to the insured, such as animals, crops, sales merchandise, house, machinery or tools for work.

¹ The term “shock” refers to the economic losses suffered by a low-income person due to an accident, illness, loss of property by natural disasters such as flooding, earthquake, drought or for theft, etc.

The Microinsurance Compendium from Janice Angove et al. (2011) presents the main microinsurance products offered in the world (Figure 3).

Figure 3.

5. Forms of Marketing and Management of Microinsurance

In microinsurance, the marketing and claims management are different from other types of insurances. First, a mass marketing way is needed to reduce administrative costs. The difficulties lie in achieving low premiums and simplifying the claims procedures as much as possible. These difficulties require a scale economy, innovation, efficiency, simplicity and intelligent risk management. For this reason, Churchill (2006) recommends that in microinsurance operations certain aspects should be taken into account, such as the design of the product and risk management, the appropriate marketing strategy, and simplified procedures in collecting premiums and attention and settlement of claims. In practice, the operation models that have provided microinsurance a greater possibility of development are the following:

• Full service model. This microinsurance scheme is in charge of everything: marketing, delivery of products to clients, claims assessment, etc. This is the model best adapted for a commercial insurance company.
• Partner-agent model. The associate-agent model consists in an alliance between the insurance company and its different commercial partners. It serves to reduce adverse selection, since the insurance company works with the infrastructure, databases and knowledge of its clients to a better risks evaluation.
• Community-based groups. The policyholders are the owners of the insurance company and manage the scheme of mutual associations.
• Provider-driven model. It is used above all for health insurance and is characterized by the insurance company and the health service provider being the same entity.

Figure 4 shows the evolution of these marketing forms of microinsurance in the world.

Figure 4.

6. The Regulation of Microinsurance in Mexico

Mexican regulation, based on the document called “Circular Única de Seguros²“, Title 5, Chapter 5, issued by the National Commission of Insurances, points out that microinsurance must be those which “can be classified in: Life, Property, or Halth insurances, and are intended to provide low-income people with the possibility of insurance protection by mean of the use of low cost distribution and operation.” In the same document, the characteristics of the microinsurance contracts to be marketed in Mexico are set forth. A simplified version of the contract must be used and that the maximum amount of premiums and insured sums must be indicated.

7. Worldwide Microinsurance Development

The number of people covered by microinsurance has increased by nearly 6.5 times in five years. The microinsurance schemes increased considerably during that time and currently they benefit about 500 million people, according to the Innovation in Microinsurance Fund of the International Labor Organization and the Munich Re Foundation. The second volume of the guide “Protecting the Poor. A Compendium on Microinsurance” says that the number of people covered by microinsurance increased from 78 million in 2007 to 135 million in 2009, reaching the figure of 500 million, according to the most recent survey published in those documents.

8. Development of Microinsurance in Mexico

Microinsurance started formally³ in the Mexican market in 2006. In spite of experiencing significant growth, microinsurance development is still incipient. According to the Finance Ministry, the number of microinsurance policies sold until April 2010 was 4.4 million, of which 93.1% are life insurance, 4.5% casualty insurance, and 2.4% personal accidents. From 38 authorized life insurance companies, 34 participate in microinsurance, but the only ones that have high sales are: Banamex, Mapfre, Argos, Azteca, Atlas, GIR, ZURICH and Metropolitana.

Up to now, the microinsurance distribution channels have been those linked to credit schemes. Electra (Electronic Devices Company) has the lead with its system of household appliance sales: it associates the credit with the microinsurance and has two million microinsurance policies sold and insured with the Azteca Insurance Company. Banco Compartamos had linked one million of credits with life microinsurance supported by Mapfre. Fifteen microfinancers linked to Pronafin have sold 43,084 life insurance policies in two years with the co-insurer organized by AMIS. Bansefi and the Red de la Gente have sold 130,000 policies and the Red Solidaria de Microseguors Rurales (Redsol), with 60 rural community microfinancers, has sold 115,000 voluntary microinsurance policies. Various insurance companies are addressing other popular savings and credit organizations directly or through intermediaries like Paralife. In new projects, the possibility of resorting to Telecom, Pronósticos Deportivos, IMEMigrantes, Programa Oportunidades and the receipts of CFE as distribution channels is being analyzed. At the present time (2012), there are a total of 8 million policies in Mexico, according to the Mexican Association of Insurance Institutions (AMIS) (Figure 5).

Figure 5.

9. Conclusion

Microinsurance is a tool to combat poverty and promote economic development. Its introduction has given a big boost to the insurance industry. If it was successful in Africa and India, it is beginning to show signs of growth in Latin America. The development of microinsurance requires special measures from government, both to regulate as well as establish financial support programs. When used properly, microinsurance can be a powerful tool for combating poverty in developing countries.?

References

Center for Financial Inclusion at Action International (2009), “Perspectivas para México de inclusión financiera integral”, septiembre, 3-5 y 23-32.

Churchill, Craig (2009), Protegiendo a los pobres. Un compendio del microseguro, Ginebra: Munich Re Fundation, ILO.

Churchill, Craig, Reinhard, Dirk, y Gureshi, Zahid (2006), Microseguro, un seguro que sirva a los pobres, Ginebra: Munich Re Fundation, ILO.

Crawford-Ash, S. y Purcal, S. (2010). “Microinsurance: Insights From A Historical Approach”, Australian School of Business Research Paper No. 2010ACTL06, 1-45.

Kalra A. (2010). “Microinsurnace-risk protection for 4 billion people”, Sigma, November, 9th.

²Circular única de seguros,” Chapter 5.1 of the insurance products registry

³In 2006, the regulation of microinsurances in Mexico was begun and what is understood as microinsurance for regulatory purposes was formally defined

By: Víctor Hugo Luque

Year of the Olympics

The first Olympic Games in modern times were held in Athens in 1896. As of that date, every four years athletes from all over the world compete under the motto “faster, higher, stronger,” chosen by Baron Pierre de Coubertin, founder of the modern games. Since then, with the exception of the XII and XIII games that were canceled during the Second World War, the attention of the sports world has been focused on the competition held in the host city designated by the International Olympic Committee, as was the case of Mexico City in 1968.

In 2012, just a few days before the XXX Olympic Games begin in London, Mexicans are wondering how many medals we will win. Of course, it is hard to tell, but if we look at the Olympic medalists in our country from the point of view of teamwork, we will discover some rather surprising results. Mexico has won 55 Olympic medals over the course of its history, 12 of which have been gold. Of those 12 medals, only one was for a team competition. It was won by the equestrian team at the 1948 Summer London Olympics in a discipline that took into account the total number of points of each athlete in the individual jumping competition.

Working group or Teamwork

Los resultados de los deportistas mexicanos nos sirven para hacer una reflexión sobre por qué se obtienen mejores resultados en las competencias individuales que en las competencias de conjunto. La respuesta apunta a raíces culturales e ideológicas.

Cuando uno piensa en ser profesionista (economista, administrador, actuario, contador, abogado, ingeniero, doctor, etc.), piensa también en la manera de adquirir distintos tipos de conocimiento, de incrementar la gama de capacidades técnicas, y de ejercitar el razonamiento analítico, pero todos estos objetivos se basan en el esfuerzo individual. Tanto en la educación media como en la educación superior, pocas actividades o tareas se hacen como trabajo en equipo, y cuando las hay, generalmente los alumnos se reparten el trabajo y lo unen al final para sumar las aportaciones individuales, de la misma manera que el equipo ecuestre de Londres en 1948.

Ahora bien, cuando una persona empieza a trabajar y a aplicar lo que aprendió en la universidad, al mismo tiempo está consciente de que su desarrollo profesional será basado en la competencia individual que impone el mundo laboral actual. Al paso del tiempo, ese estudiante que se convierte en trabajador se encuentra con situaciones en las que sus actividades requieren el apoyo de otras personas o áreas de empresas e instituciones y tiene que integrarse a un grupo de trabajo.

Si el grupo de trabajo obtiene resultados positivos, el reconocimiento es de todo el grupo, o al menos así debería de ser; pero si los resultados son negativos, ¿la responsabilidad también es de todos? Probablemente entre los miembros del grupo de trabajo habrá distintas opiniones sobre quién pudo tener una mayor responsabilidad por un resultado que no fue el esperado. Si el reconocimiento en caso de un resultado positivo y la responsabilidad en caso de un resultado negativo es de todos los integrantes, hablamos de trabajo en equipo. En cambio, cuando tanto el reconocimiento como la responsabilidad se diluyen entre los integrantes, nos referimos a un grupo de trabajo.

La diferencia pareciera trivial, pero no la es, ya que la impresión que se genera en los integrantes de un equipo, en lo individual, puede generar un concepto negativo y afectar gravemente los incentivos para trabajar en equipo. En particular, en el momento de establecer las metas que hay que alcanzar, debe quedar claro para todos los miembros que, en un equipo de trabajo, todos ganan y todos pierden, dependiendo del desempeño colectivo.

Conditions for teamwork

There is a well-known definition of teamwork: “A small number of people with complementary skills, who are committed to a purpose, a set of goals and a common orientation, for which everyone is responsible.” Every member of a work team should know this concept: a team is much more than the sum of its parts or the individual contributions of each member.

First of all, the complementary skills or different capacities of the work teams must be understood, accepted and taken advantage of for the benefit of the collective. We can classify the skills of an efficient team into three groups: 1) technical or operational experience that is generally more developed in individuals since it incorporates all the knowledge acquired in secondary and higher education and even in most post graduate studies; 2) analytic capacity to make decisions and solve problems, which also is part of academic training and professional development, and that expands as the members of the work teams gain experience in leadership roles; and 3) personal skills, which are usually not acquired in formal education nor developed as one’s professional life progresses. Skills that are indispensable for the proper functioning of a work team include: how to accept constructive criticism; recognizing the interests and accomplishments of others; giving people the benefit of the doubt when their ideas may be different than one’s own; maintaining objectivity and learning to take risks. Unfortunately, these skills are not talked about or assimilated in a uniform manner in our country. (In group sports, the lack of these skills in a team provokes friction, differences and even ruptures between the members, causing what is known as a bad locker room atmosphere).

Secondly, mutual accountability transforms a work group into a work team, where accountability becomes collective rather than individual. This transformation requires trust and commitment on the part of its members. In our country, the misunderstood concept of competitiveness and individualism does not help to develop a team-oriented environment that focuses on both individual and mutual accountability. The idea of mutual responsibility is linked to the group’s performance as a whole, which must be evaluated in terms of the team’s goal and commitment. For example, in a soccer game, all the members obtain the same result as the team, regardless of the individual performances of each player. Has anyone ever witnessed a situation when the defense loses, the midfielders tie and the front line wins?

Thirdly, together with the complementary skills, mutual responsibility and common goal of a team, the corporative and institutional aspects of each company play a central role as promoters of teamwork. For a team to be successful in a professional environment, management must deal with two questions: How do I handle the work teams? Does the company truly support teamwork? The first answer has to do with the leadership profile and the way in which the agents of change lead their teams so that they work together with all areas of the company – to avoid the creation of power fiefdoms that are very dangerous to teamwork. The answer to the second question is related to the culture that the company instills among its workers through activities that foster the integration of employees and systems of recognition and performance that encourage collective results rather than individual ones. (Traditional schemes favor individual over team recognition.)

Finally, teamwork is a necessary condition for companies to improve their performance level. This conclusion is based on the premise cited at the beginning of this section: “The results of a work team will be better than the sum of the results of its individual members. “

It is possible to work as a team?

The question we began with was whether we know how to work as a team. The answer is more than simply a negative one, as we have seen in this paper. Various studies point out that the Japanese and the Germans are the best team workers, according to criteria such as mutual responsibility, recognition of complementary capacities, a common purpose and goals for collective performance.

Both Japan and Germany suffered the devastating effects of the defeat of World War II and rebuilt their countries based on the concept of teamwork, which was widely accepted by the people. Teamwork combined with other cultural and economic factors explain their recovery and demonstrate to the rest of the world that it is possible to work as a team.

We understand that it is easier to cultivate analytical skills and increase technical knowledge than to improve the ability to interact with people. It is also less risky to assume one’s own responsibilities than collective responsibilities and that entrenched individualism inhibits participation in work teams. However, the positive results – the cases of success in other parts of the world and the benefits that teamwork generate – make it evident that companies and institutions in our country must provide organizational support to promote multidisciplinary work teams. It is important for Mexican leaders to reflect on this. These elements form the basis so that we stop acting as individual components of a work group and become genuine players. In this way, we will contribute to building successful work teams in our professional lives.?

References

http://www.caremexico.com.mx

http://www.amte.org.mx/portal

http://hbr.org/magazine

http://www.london2012.com

http://www.olympic.org/mexico

and Jorge Omar Moreno Treviño

The valuation of financial statements is fundamental for understanding the nature and dynamics of companies. Among the elements that pose the greatest difficulty in determining the value of the company, capital cost is basic for estimating and calculating the various items of the financial statements. This valuation can be somewhat challenging when the company operates in an emerging economy, because its situation may be incompatible with the methods applied in more developed markets.

The objetive of this article is to show the reader the many options that accountants and management have for determining the discount rate that best approximates the opportunity cost of the capital of the entity or company (hereinafter, capital cost), taking into account its particular characteristics, the economic situation in the country, and the type of transaction being carried out. Specifically, this paper focuses on methods that are compatible with the cases of companies that operate in emerging markets like Mexico.

According to the Mexican financial reporting standards (Mexican FRS), particularly FRS A-6, Recognition and Valuation, the fair value “represents the amount of cash or equivalent that market participants would be willing to exchange for the purchase or sale of an asset, or to assume or settle a liability, in a transaction between interested, disposed and informed parties, in a market of free competition. When no exchange value is available for the transaction, it should be estimated using valuation techniques.”

Specifically, the standards define the present value technique as a tool for valuation based on expected future cash flows, discounted at an appropriate discount rate. This discount rate should “observe: a) the yield investors demand on investments that will generate cash flow in the equivalent quantities, term and risk profile to those that the entity expects to obtain from the asset, reportable units, or cash generating unit, or b) the market rate to which the entity has access for settling its liabilities.” In other words, the rate in question should be such that it would lead to the capitalization cost of the company.

Given these elements, both FRS A-6 and traditional financial theory recommend using the weighted average capital cost (WACC) as the discount rate.

WACC has various components, which are expressed as follows (Equation 1):

Where:

• Kd* is the cost of debt, which is measured using the implied rate on future outlays for the payment of interests and principal, less the tax benefit provided by the deductible portion of interest expense
• VD is the market value of the debt
• VA is the market value of capital stock
• Ka is the minimum rate of return shareholders expect in accordance with the company’s risk.

In Equation 1, Ka evaluates the investment risk cost, which can be estimated though the capital asset pricing model (CAPM) which is used to determine the ratio of risk to return. If we assume that there is competitive balance in the securities market, the model theoretically relates the rate of return expected by shareholders of the company as the sum of the risk-free rate (premium for the change from consumption today to consumption tomorrow), plus a risk premium (compensation for the risk of taking investment) (Equation 2). Particularly:

Where:

• E(r_j) is the expected return on investment.
• R_f is the risk-free rate (an instrument considered risk-free has no risk of default, meaning there is no risk that the issuer will fail to make payment of interest or principal when the instrument matures).
• E(r_m) is the expected return on the market portfolio. “The market portfolio contains all the existing risky assets in the international economic system in proportion to what its value represents with respect to the total value of the rest of the assets” (Haugen, 2000).
• ?_j is the base of the company and describes the stock’s response to changes in the market portfolio. The beta is defined by the following formula (Equation 3):

Where: r_j and r_m symbolize the returns of company j and the market, respectively, cov(r_j,r_m) is the covariance of the returns r_j and rm, and ?²(r_m) is the market return variance..

Traditionally, the estimation of employs various statistical and econometric methods to determine its value using securities market data (Berndt, 1991).

The beta of a publicly-traded company can be calculated using the above formula, or more elaborate methods using the market price of the stock; while private companies can proxy their beta based on the beta of their industry or comparable firms, adjusting it for the risk of the company or project analyzed.

The debt and capital market values for a company that is not publicly traded can be determined using other similar countries in the respective industry as a benchmark, or the proportions of debt and capital in an objective capital structure (Copeland et al., 2000).

Although the CAPM model is a solid method from the theoretic standpoint, and its empirical implications yield a series of interesting results in terms of the breakdown of risk into the portion that is systemic and the portion that is idiosyncratic for each company, it continues to have its detractors.

The most recent critiques on the use of the CAPM model for emerging markets (Pereiro, 2002) focus on both the assumptions on which it is based (competitive balance in the securities market and complete information from agents), and on the statistical and econometric methods used to calculate it. For example, as Godfrey and Espinosa (1996) point out, recent studies have empirically found a negative beta, and even for some stocks, a beta of zero, which would indicate that the assets serve as “hedges” against market risk, in the former case, or are assets free of systemic risk, in the latter.

Another criticism is that, in principle, CAPM is a better fit in developed markets in which it is possible to better diversify assets and reduce non-systemic risk. This is closely related to the theoretic assumptions that sustain the equation of competitive balance. The more developed the financial market is, the more information flows between a larger number of buyers and sellers, which allows prices and returns on assets to adjust in equilibrium, according to the premises of the original CAPM model. But this situation is not necessarily present in emerging markets in which information is expensive or the costs of trading on the securities market are significant.

In addition, emerging markets, the data time series necessary to estimate the beta values in CAPM are small or nonexistent, and it can be expensive to obtain them.

What alternatives to CAPM model are there to approximate the cost of capital stock, particularly in emerging markets like Mexico? In the following section, we will present some models that expand on and adapt CAPM to our environment.

1) CAPM global variant

In recent decades, the integration of international financial markets has made it increasingly necessary to incorporate the variable globalization in traditional models for studying investment alternatives. According to this factor, an agent or institution can invest anywhere in the world. Thus, we can develop an adjustment of CAPM as follows (Equation 4):

Where:

• K_a is the equity cost of capital
• R_fG is the global risk-free rate. Generally US bond rates are taken as a reference.
• ?_LG is the beta of a local company calculated with the global market Index, once again using the US indexes a reference, under the assumption that the US is a large, efficient and developed market.
• R_MG is the global market yield.

In this model, we have assumed that the value of the assets is not correlated with exchange rates. There is abundant empirical evidence to show that the covariance between stock returns and exchange rate movements is very slight. The model may be accurate in developed markets, but not necessarily in the emerging markets, where country risk remains as a very important variable.

2) CAPM local variant

When financial markets are integrated, country risk is irrelevant, because portfolios must be highly diversified. Nevertheless, according to a survey by Keck et al. (1998), only 5% of respondents believe that financial markets are fully integrated. Thus, when there is a segmentation of financial markets, analysts propose the following variant of CAPM, adapted to the local environment (Equation 5):

Where:

• K_a is the equity cost of capital
• R_fL is the local risk-free rate, which is composed of the global risk-free rate and the country risk premium
• ?_LL is the beta of the local company, calculated with the local market index
• R_ML is the return on the local market index

Pereiro (2002) proposes that stock performance may be more closely linked to the volatility of the local economy than with fluctuations and trends in the corresponding international industry. In other words, this indicates that the local CAPM tends to overestimate risk, because the market index includes a part of the country risk.

In this respect, Erb et al. (1995) conducted a study of more than 40 developed and emerging economies and confirmed that country risk explains an average of 40% of the variation in the market yields, while the market risk of the stocks explained the remaining 60%, so the following model corrects this problem.

3) Adjusted CAPM local variant

This new model corrects the above alternative focusing on systemic risk premium. It takes a factor (1-R_i²) in which R_i² is the determination coefficient of the regression between the volatility of the local company’s returns and the variation in the country return (Equation 6):

The considerable volatility of emerging markets makes very difficult to calculate the long-term market premium and betas, since both are highly unstable over time and an historic average tends to be unreliable or unavailable. Because of this problem, analysts prefer a more flexible model that incorporates elements of the previous alternatives.

4) Hybrid adjusted CAPM variant

This fourth alternative of the CAPM model calibrates the global market premium with the domestic market using the local beta. This parameter is the sensitivity of stock returns in the local economy to global returns (Godfrey and Espinosa, 1996). This model, as its name indicates, is hybrid, because it combines global and local risk parameters, as shown below (Equation 7):

Where:

• BC_LG is the slope of the regression between the local market index and the global market Index
• B_GG is the average beta of comparable companies listed on the global market
• R² is the determination coefficient of the regression between the volatility of the local market stock with the variation in country risk

Here, too R² can be interpreted as the variance in the volatility of the local stock market that is explained by country risk.

1. Example

Example

Having presented the models, and to illustrate the value of knowing these alternatives, we decided to carry out an empirical analysis of a Mexican services company in the education industry, projecting its revenues for the period from 2011 to 2020, in order to obtain discounted free cash flow as of 2011, and later, discounted free cash flow for stockholders into 2011, to estimate the price of the stock, as well as the multiple of market price (forecast or valuation) to the book value of stockholders’ equity (P/BV) as of 2011 and compare these results with the industry multiple for the same fiscal year according to each model, beginning with the traditional CAPM and ending with the hybrid model. In this analysis, the projected cash flow was the same for every scenario; the only variation was the results of the equity cost of capital, according to what each method requires for its calculation (table 1).

The results of each model are shown in table 2. Note that because only one company was considered, the results apply only to this company and cannot be generalized, because the circumstances of each industry and each entity vary considerably.

Although, as we can see, the ratio of the stock price to the book value of stockholders’ equity (P/BV) estimated using discounted cash flows is very different from that of the industry using any of the models, the one that offers the best result is the price estimated using the hybrid variant of adjusted CAPM, which, as we explained earlier, calibrates the effect of the global market with the domestic market and attenuates the incorporation of country risk.

We should stress that this result cannot be extrapolated to other industries or companies, since the models were tested on a single company. In this case, the local variants underestimated the value of the stock price, while the global and hybrid variants overestimated it, taking as a point of reference the result from the traditional CAPM. Thus, to answer the question of whether we should continue applying the traditional CAPM model, it is hard to generalize. Every company should consider the type of transactions it carries out, whether they are global, local or hybrid, and the economic situation of the country and the industry, and decide which model is most appropriate.

To conclude, it is crucial that we understand the role of the analyst or public accountant in calculating or backing the models and assumptions that each entity uses to determine a reasonable value through financial techniques. The person who prepares the accounting and valuation is responsible for verifying, among other aspects, why a given model may offer the best results, if the premises applied in preparing the cash flows are reasonable given the company’s situation and that of the economy at large and, finally, whether the assumptions applied to determine the discount rates are acceptable and verifiable. Thus, with an informed criterion that identifies the elements associated with each capital cost model, the accountant can determine whether the fair value presents useful and reliable information for the users of the financial statements, who require that information in order to efficiently make decisions.?

References

• Berndt, E. (1991). The Practice of Econometrics: Classic and Contemporary. Addison-Wesley.
• Copeland, T., Koller, T. y Murrin, J. (2000). Valuation: Measuring and Managing the Value of Companies. John Wiley & Sons, Inc. 3ª. ed.
• Erb, C.B., Harvey, C.R. y Viskanta, T.E. (1995). Country Risk and Global Equity Selection. The Journal of Portfolio Management, pp. 74-83.
• Godfrey, S. y Espinosa, R. (1996). A practical Approach to Calculating Cost of Equity for Investments in Emerging Markets. Journal of Applied Corporate Finance, 12 (3), pp. 14-28.
• Haugen, R. (2000). Modern Investment Theory. Prentice Hall. 5a. ed.
• Keck, T., Levengood, E. y Longfield, A. (1998). Using Discounted Flow Analysis in a International Setting: A Survey of Issues in Modeling the Cost of Capital. Journal of Applied Corporate Finance, 12 (3), pp. 63-72.
• Pereiro, L. (2002). Valuation of Companies in Emerging Markets: A Practical Approach. John Wiley & Sons, Inc.

Fuentes electrónicas

• Página de Internet del Banco de México consultada en febrero de 2012.
• Página de Internet del Banco Nacional de México consultada en febrero de 2012.
• Página de Internet de Damodaran Online consultada en marzo de 2012.
• Página de Internet de Yahoo Finance consultada en febrero de 2012.

By: José Frank González

Debts are not like good wine; they don’t get better with age.

Robert Dickinson, English barrister

How many times have we heard the phrase “A sale isn’t closed until it’s collected?” In effect, the ultimate goal of every financial administrator is to optimize the company’s cash flows, and relates directly to maximizing the company’s value. A steady increase in sales is important, but it is also essential to verify that the buyer has enough money to pay; this will ensure that the primordial purpose of every organization is fulfilled.

Collecting on debts in times of economic stability is difficult enough, but in a time of crisis it becomes a nightmare for many businesses, because they do not know how to approach their clients to inform them that they owe money; some are excessively patient and courteous, while others sin in the opposite direction.

For this reason, besides applying effective collection strategies, recovering accounts begins with an evaluation of our clients to identify and assign limits to the risks. In other words, we must analyze and consider contingencies to somehow quantify the risk that is taken on with each client. In this analysis, the credit area must be in permanent contact not only with the financial area, but also with the commercial area, because if it is true that a sale is not closed until it’s collected, this means that the two departments must coordinate to ensure that there are signed contracts, appropriate hedges, compliance with assigned risk limits, etc. To understand this, we will comment on the essential elements of credit, but given the magnitude of the topic we will not deal in depth with the question of proper risk management.

Essential elements of credit

Credit has three elements: personality, capacity and risk.

1. Personality

Personality, or legal standing, allows us to determine whether not a client is capable of signing a contract with us. There are two types of clients:

1. individuals
2. corporations, legally incorporated and with sufficient powers.

2. Capacity

1. Payment
2. Investments: properties, assets, etc.

3. Risk

We know that every credit operation is a risk; but it is a risk we need to take, and we must be aware that we are taking it.

We can define risk as follows:

Figure 1. Aspects of credit risk

The customer’s willingness to pay is 50% of credit risk, because even if we have a signed contract or the best credit instrument, at the end of the commercial relationship, a client who does not want to pay will put up all manner of obstacles to delay or avoid doing so.

Legal aspects are also very important, because if they are not properly covered, the risk we take on is even greater.

We must also bear in mind market factors, which are closely related to credit. You must know what type of client our products are going to.

Documentation is also a component of risk. From the outset, we need to know what are the collection elements that we can use to recover the account from our client.

To sum up, in every credit transaction, the following formula sums up what we have just described:

PERSONALITY

+   CAPACITY

+ RISK

Basis for extending credit

The EIGHT C’s of credit research

Today, many companies extend credit to their clients based on the trust they have earned over time and which is reflected in the record of their purchases.

In contrast, there are other companies that try to boost their sales by offering credit based on the information clients may supply in an application or credit form, which may be false, erroneous or not entirely true. In these cases, we need to conduct credit research to corroborate the information and demonstrate not only our clients’ economic solvency but also their moral solvency, in order to be sure that the credit will be recovered for the product or service extended that clients will remain current in their payments. Public accountant Luis Henrique Ruiz Sierra points to eight key factors that should be taken into account when conducting credit research:

• Conduct: moral, history of payment with other vendors, etc.
• Economic Capacity: to pay the full amount of the credit.
• Capital (of applicant): investments, assets and properties.
• Circumstances of the credit: Convenient sale, future market effects, excess merchandise, etc.
• Collateral: Endorsements, guarantees, proposals, etc.
• Criteria used by the analyst to weigh the risks.
• Confidence that the applicant inspires when the credit is extended.
• Collection: communication problems with the client.

Collection Processes

The Collections Department should attempt to follow a friendly process. Collection problems often originate from the moment the credit is recognized.

The collection portfolio can be divided into three parts:

a) Normal collection. This is the collection in which all we have to do is keep an eye on clients and avoid as much as possible any delay in payment.

b) Persuasive collection. This is done with clients that are already late in paying. This is a more direct collection process, intended to prevent at all costs having to resort to legal collections.

c) Drastic collection. When all negotiations have failed, the company must resort to legal collection.

To get an idea of what a delinquent loan portfolio costs, we must calculate portfolio days, which is obtained in three ways: traditional, quick, and by depletion or extinction.

Traditional method

By formula

Quick method

The balance of the portfolio is divided by sales in the period. The result is multiplied by the number of days in the period, resulting in sales days in receivables.

By depletion or extinction

In this method, we take the portfolio balance and begin subtracting sales starting in the current month and going back to preceding months, until completing the portfolio balance. At the end, we add up the days transpired to reach the balance.

After determining the number of sales days in receivables, we can calculate the cost of the delinquent loan portfolio, which, depending on the amount of money we are handling, may be considerable. In this case, top management should be notified of situation, so that they can provide some support with clients whose failure to pay is dragging down the company’s profits.

Basis for effective collection

There are essentially three pillars on which an effective collection system is built: prevention, management, and administration and sales.

Figure 2

Ideally, collection should have four characteristics: it must be appropriate, prompt, complete and encouraging.

1.Appropiate

Fundamental recommendations:

1. First, collect reports on the borrower:
   1. Type of clients
      • Industries
      • Wholesalers
      • Supermarkets and private drugstore chains
      • Government client
      • Consumers
   2. Record of prompt payment
   3. Commercial importance
2. Size of the receivable and its current collection phase (reminder, insistence or drastic action).
3. Try to investigate the real reason for the delay.

2.Prompt

The failure to promptly carry out steps toward collection is one of the main reasons for over-investment in accounts receivable.

We must make it as easy as possible for the client to meet its commitments, and if the account is late in payment, urge the client to settle the outstanding amount after a reasonable grace period.

Many clients do not pay until they receive the collection call, so we should avoid allowing the lack of initiative and constancy in our collection to serve as an excuse for them to delay their payments.

The difficulty of obtaining a payment or clarification on a receivable, after a certain time, increases in direct proportion to the age of the account.

There are some elements we should be careful of so that we do not contribute to the delay in client payments:

• Comply with the clients’ requirements for accepting invoices for review or settlement. Pay special attention to the new electronic billing system in Mexico, because statistically this factor has been responsible for more than 65% of the delay in company collections in the last 12 months

.

• Keep your client records up to date in the company’s computer system.
• Make sure the invoice contains the correct prices and that the invoice or credit note that complements it specifies any discounts or promotions that apply.
• See that the merchandise was actually dispatched, and if possible, that it was delivered with reasonable speed in relation to the invoice date.
• Avoid passively waiting for the Shipping Department to supply the necessary documentation or for representatives to send the collections they perform.

3.Complete

We should make an effort to settle all of the invoices, except for authorized discounts (supported by credit note) and reduce discrepancies, which may be small compared to the original amount, but added together, could have a considerable impact on our company’s results.

The main reasons for the discrepancies that affect Accounts Receivable are:

• Prompt payment discounts that go beyond the authorized period of time.
• Errors or misunderstandings about normal and promotional prices or discounts.
• Merchandise returned before the vendor receives it, and as a result, issues the corresponding credit note.
• Other deductions that have not been investigated by the person responsible for the collection, or are not communicated to the credit supervisor.

It is very important that we do everything possible to have a slimmed-down accounts receivable portfolio, and to clarify, credit or swiftly charge the differences deducted by our clients so that they do not affect the term of the receivables and sales days in receivables. This is crucial with clients with whom we have many transactions, like supermarkets, because it is difficult, costly and impractical to delve into past files for the information needed to clear up the deductions they have applied.

4.Encouraging

We must place all of our enthusiasm into the collection dialogue, and be insistent and prudent, because maintaining cordial relations with our clients– which can sometimes be affected if we are more insistent than is necessary–is just as important (and sometimes even more) as obtaining the payment. In some cases, it is better to give the client a few additional days to settle an account (if possible, in exchange for a post-dated check) then insist on paying on the date the collection is made, if it damages commercial relations.

The report the Collections Department must always have on hand is the age of receivables report, because it helps that department to determine the real status of the receivables portfolio.

Negotiation

A person who does not know how to negotiate cannot collect. We must be clear on the negotiation procedures necessary for effective and friendly collection. But above all, we must not forget that behind every receivable there is a client to protect. For this reason, it is indispensable to remain calm when collecting an account, because we risk losing a good client. We need to determine what type of debtor we are dealing with: have they inadvertently forgotten to pay the account, or do they simply not want to pay? Depending on the answer, we must define our strategy.?

Googling, engagement, profiles, followers, “like” and hashtag have become everyday expressions among 40 millions active cybernauts in Mexico, which means they are elements of contemporary life that company directors should know how to manage.

The use of smartphones brought of global revolution in the way we consume the content of social networks and the time we spend using them. In Mexico, according to the Mexican Internet Association (AMIPCI), 68% of people who connected the Internet use PCs, 67% from laptops and nearly a quarter of them connect through smartphones. On average, the executive segment alone spent three and a half hours a day browsing the Internet in 2010.

A study conducted by Master Research for CICOM in 2011, called “The Value of marketing investment in Mexico,” found that the ways to reach consumers have changed, for example:

• Investment in Internet advertising has risen 38%
• Investment in market research has grown 8.4%
• General investment marketing has risen 13.7%.

Edmundo Ramirez, director of the market research agency Master Research, proposes the following: “Companies should be 100% aware of what happens in the social networks regarding their brand and their competitors. With this in mind, we designed the Digital Intelligence methodology.”

Figure 1. Digital Intelligence

Agustin Castañeda, director of the Digital Intelligence area for Master Research, shares his view of the issue: “The Digital Intelligence service we offer is based on competitive intelligence applied to the online environment, and encompasses the brand, the customer, the competition and the network environment.”

This type of research provides companies that are active on the web with tools for making assertive investment decisions, and for assessing their online content in the following areas:

• Knowing the current climate and the main players
• Knowing the brand customers (real potential behavior)
• Evaluating online content and the total conversations about the brand and the competition
• Assessing the company’s efficacy
• Tracing the browsing path (origin page, destination page after visiting the companies website)
• Analyzing actions by the competition

Besides helping to effectively direct online advertising investment, another benefit is that we can find out how much time visitors spend on the company’s webpage, how many of them are there and how frequently they visit, based on age and sex of the cybernauts.

Agustín Castañeda remarks: “Digital Intelligence has helped our clients to increase their online effectiveness in order to counter actions by the competition, improve the design of their website, facilitate the online experience and improve their online advertising. All of these elements lead our clients’ customers to express greater engagement and an increase in ROI.”

Digital Intelligence step-by-step

The Customer Panel is one of the main techniques of Digital Intelligence. It is used to explore, identify, analyze and interpret users’ interaction with online media and with the brands and other offerings that may find in the digital environment (competitive benchmarking).

Master Research has developed Digital Intelligence methodologies, which Edmundo Ramirez explains as follows: “We analyze the performance of sites linked to a corporate website and distinguish between the type of connection (public and private). For example, in the financial industry we can not only analyze and generate metrics on the website of the Financial Group (which is often the central site) but we could also separately analyze the sites that converge in it, for example its insurance company, bank and even sites or micro-sites for specific products or segments. One of the main distinguishing features of free analysis sites is that they allow us to analyze and contrast the virtual gaps in the webpages and sites of their competitors, examine the origin of incoming and outgoing traffic, and audience habits, which means we can enable our clients to focus their commercial and communication strategies on effectively directing promotional efforts and optimizing their investment.”

Figure 2.

The analysis would not be complete without historic indicators that show trends in the sites and enable us to study the effectiveness of competitors’ digital strategy in terms of number of visitors. With these indicators, the people in charge of digital strategy activities can take more targeted action.

Table 1. Site traffic.

Table 2. Hits por competitor.

Castañeda tells us that when we take this methodology and add monitoring and value analysis of content and trending topics in social networks, we can identify additional consumer issues with regard to their product or service, with the Internet and with other customers, and measure their impact. One of the critical factors is the time and capacity to respond to occasional crises that can negatively affect brands and products.

Figure 3. Classification of mentions.

When we conduct an exhaustive analysis of verbatim mentions, the digital channel performance and audience behavior, we can design successful commercial strategies from a perspective that integrates an analysis of the internet with analysis of opinions and statements made by the institution’s target market in social networks.

Figure 4. Analysis of mentions

To conclude, by applying these tools, companies can fine-tune their online advertising budgets and complement them with activations and traditional advertising material, which combine to create better positioning and impact in the target market.?

Note:

Master Research is a company known for the loyalty of its clients, who have worked with the company continuously for almost two decades.

Since 2004, Master Research has been defined as a highly reliable company because its expertise and involvement in its clients’ businesses, through research processes conducted under the quality and ethical standards of the Mexican Association of Market Research and Public Opinion Agencies (AMAI), which in 2005 awarded it ESIMM 2.0 certification (Service Standard for Market Research in Mexico).

The firm is also known for having pioneered the development of the competitive benchmarking method in Mexico.

Master Research is can be found on Twitter @MasterResearch and Facebook/MasterResearch, where it provides useful information for its followers.

Contact:

Susana San Román Oñate

Tel. 04455 3047 9499

rp@masterresearch.com.mx

susanna.sanroman@gmail.com

Twitter @suxsan

One aspect that distinguishes managerial communication in business from other types of communication is that no matter how brilliant the message may be, it means nothing if it does not achieve the desired result. In other words, successful communication is dependent upon the response expected from the audience.

Unlike other types of presentations, such as conferences, speeches or training courses, a business presentation is an exercise in persuasion. Persuasion is a process that takes the persuader as well as his audience to new ground. In an ideal situation, the audience understands, agrees and acts in accordance with the proposal. However, in reality this does not always happen so the presenter must acquire certain skills to keep the audience interested and involved.

Mary Munter says that communication should not be seen as a straight line that flows from the sender to the receiver, but as a circular relationship that takes into account five elements: the communicator, the audience, the message, the channel and the culture. These elements are interrelated in such a way that each has an impact on the other. For example, when choosing the channel by which to communicate, the presenter must consider the audience as well as the culture and the message. In order to understand these relationships, it is important to analyze each element and formulate the most appropriate strategy for each one.

Approach

The first step in developing an effective presentation is choosing the approach. It is important to define the goal of the presentation, the audience and the context. The approach must be directed at the desired result and must be the driving force behind the presentation. In order to define the approach, questions like these should be answered: What is the purpose of my presentation? What kind of response do I want to get from the audience?

Audience

Given that a presentation is a dialogue between the presenter and the audience, the more you know about and understand the audience and the context of the presentation, the better you can tailor the presentation. The analysis of the audience is a challenge frequently overlooked in managerial communication. Often the communicator focuses only on his goals or communication needs and forgets to whom he is actually speaking. It is important to know who your audience is: characteristics such as age, education, sex, profession, hierarchical level, as well as their preferences and needs; familiarity with the topic and whether they consider it controversial; expectations for the presentation; whether they are there by choice or by necessity; how much they know about the presenter and who the decision-makers are. The better prepared the presenter is, the more likely he will succeed.

Message

After deciding upon the approach and analyzing the audience, the next step is to design the message. What do you want to communicate and how will you combine arguments, information and examples that are directed to this goal? The message should be prepared in three steps:

1. Define the main message, the idea you want the audience to remember and what you want them to do in response. This message is derived directly from the projected goal.
2. Go over the arguments that support the message. It is important for you to provide reasons why the audience might share your point of view.
3. Determine at what point it is important for the audience to respond, whether by participation, reaction or conviction.

Since you are dealing with a persuasive message, you should decide whether additional elements might help you achieve your goal. It is important to use arguments that are reasonable, to establish a common ground and use memorable images.

Organization

Once you have define the goal, the audience and the message, the next step is to prepare the presentation and give it structure. You should organize the content so that the audience easily understands and remembers the main idea. Usually a presentation is composed of three parts: introduction, body and conclusions.

A well-organized presentation begins with an attractive introduction. In the opening, it is recommended to use a hook – a comment, a question, anecdote or example that grabs the interest and attention of the audience. The audience’s memory curve illustrates that it will remember most the beginning and end of a presentation. Once the audience’s interest is aroused, you can go to the body of the presentation.

The conclusion is the closing of the presentation. The presenter summarizes the main points of the message in order to reinforce them and to allow the audience to further reflect on the subject. In the closing, the presenter makes a call to action – what he wants the audience to do as a result of the presentation.

When organizing the presentation, you should decide what visual aids to use to enhance the information, making it easier for the audience to retain it. Various studies show that people assimilate 75% of their knowledge visually, 13% by listening, 12% by smell. It is also known that words and images together are six times more effective than words alone.

Visual aids help keep the audience’s attention and assist in the retention of the information presented. However, you should be careful using visual media – it may also cause an audience to become distracted.

Practice

Rehearsing your presentation is essential in assessing whether it is ready, if changes are needed, whether there are weaknesses, or if it is too long. It is recommended that you practice in front of a test audience that will offer you feedback. Rehearsals should adhere as closely as possible to the conditions under which the presentation will be given in order to take into account issues such as space, voice volume, lighting, etc. If it is not possible to organize such an audience, you can tape the rehearsal so that you can study it and decide what changes and corrections are needed.

Stage Fright

When presenting in front of an audience, it is very common to get stage fright. When it is about time to start the presentation, people experience a discharge of adrenaline, their hands begin sweating and trembling, their mouth gets dry and their confidence fades. This even happens to those who are accustomed to speaking in public. Communication and psychological research has come up with various strategies for overcoming nervousness and its effects. Good preparation and familiarity with the audience and the site of the presentation help reduce anxiety. It is also good to focus on the audience and not on yourself: by putting attention on others, you stop thinking about what you look like and listen and focus on conveying the message. Do not adopt rigid rules about what a good presentation should entail. Try several physical and mental relaxation techniques that work for you. For example, there are exercise routines you can do before the presentation – progressive relaxation and deep breathing strategies, methods for preparing the voice and reducing the effects caused by nervousness. For mental relaxation, you can try positive thinking and rationalization techniques, creating a positive self-image and visualizing pleasant environments in order to connect with the audience and transform negative energy into positive energy.

Conclusion

In today’s business world, one of the essential skills needed to advance professionally is the ability to speak in public and to lead professional presentations. Every presenter should master how to convey a message, influence the perception and behavior of others, and convince an audience to obtain goals. To achieve these goals you need to plan the presentation well, analyze the audience, clearly define the goal, develop the message and create visual aids.

Like many other activities, a persuasive presentation is a process that converts entries (ideas, information and arguments) into products (what the audience perceives and the actions it carries out). And as with any process, there is always room for improvement. ?

References

Munter, Mary (2011). Guide to Managerial Communication: Effective Business Writing and Speaking, novena edición, Prentice Hall.

Brody, Marjorie, y Shawn Kent (1993). Power Presentations: How to Connect with Your Audience and Sell Your Ideas. Willey and Sons.

Zelazny, Gene (2006). Say it With Presentations: How to Design and Deliver Successful Business Presentations. McGraw Hill.

Marton, Betty (2000). Mastering the Art of Persuasion. Harvard Management Communication Letter.

Hattersley, Michael (1991). Persuasion. Industry and Background note. Harvard Business School.

Daly, John, e Isa Engleberg (1999) Coping with Stage Fright: How to Turn Terror into Dynamic Speaking. Harvard Management Communication Letter.

By: Carlos Alcérreca

The traditional process of strategy formulation normally begins with an analysis of the external environment; then the characteristics of the organization, then possible courses of action and, finally, how to implement the selected alternatives. Although this process may be logically correct, it means that a lot of the time and resources allocated to the process are used up in the first two phases, leaving the last two as a consequence of the analysis. Perhaps the lack of attention to strategic action is due to a lack of awareness, or the complexity of its concepts. As a result, many observers conclude that the field of strategic management is somewhat removed from organizational ¡ction and a company’s day-to-day activities.

The same argument can be made about execution activities, which up until recently (Kaplan and Norton, 2001) were taken into account only when the first three phases of analysis were complete.

The purpose of this article is to review the basic concepts that have been proposed to evaluate strategic actions, and to propose that these concepts be used more widely so that strategic action is more relevant in the day-to-day life of the organization. This is a simple question of priorities: it is the strategic actions (and their execution) that ultimately affect the organization’s performance. In this text, we propose some guidelines for analyzing strategic actions based on concepts that have been developed in this area, and we recommend that, except in cases where the strategic formulation process is being undertaken for the first time, they be used for an annual strategic review.

The actions taken by an organization can be seen as strategic actions or operating actions. Operating actions are those taken to follow an established procedure within the framework set for the organizational strategy; for example, procurement of raw materials, payrolls, manufacturing a product, or serving customers. Strategic actions are those that modify the administrative system, resources and competencies, competitive advantages, domain, mode of growth or performance objectives. In some companies, the difference between operating and strategic actions is recognized by allocating some resources to an operating budget an others to a strategic budget. This company’s strategic budget can be seen as the money it puts into changing the company; for example, changing its market share or adopting new directions, new markets, new business resources and models.

We find the distinction made by Mintzberg (2007) between intentions and realized action to be useful. These are different, because there are intentions that are never carried out and there are realized strategies that are never premeditated. In other words, there is an ongoing process of learning on the go, which modifies intentions during the realization phase, because internal and external conditions change, sometimes quickly, and over time important elements that were not initially taken into account come to light. We can distinguish, then, between actions that were planned or unplanned, and actions that were carried out, or not:

• Deliberate actions are planned actions that are effectively carried out. The primary learning took place before the actions.
• Detained planned actions are actions that were planned but ultimately were not completed due to changes in circumstances or priorities, or because something was learned during the implementation process that was not known earlier.
• Emergent actions are actions that are carried out but were not specifically planned in advance. The learning took place during the execution in the rehearsing the action. The action is modified during the process.
• Truncated emergent actions are those that begin being carried out without planning and are halted, perhaps because of poor results; these are failed experiments. The learning took place during the execution, but the decision was made to curtail the action due to poor results, lack of resources, lack of policy support, etc.

The concepts in which we can see the application of these ideas are as follows: the portfolio of strategic actions, the phases for formulating strategic actions, the degree of commitment to an action, and real options. At the end, we offer some general recommendations on the way to model a system of strategic action.

The Portfolio of strategic actions

Here we present a classification of strategic actions by their impact on the organization’s performance goals, domain, competitive advantages, resources and competencies, mode of growth, or administrative system.

Performance objectives. In terms of their impact on performance objectives, strategic actions can be divided into those which change the level, growth or trajectory of organizational financial performance, including changes in revenues, costs, profits, returns, risk and values. Changes in the relative weight of current performance with respect to future performance are important. It can also help to have an idea of the degree of leeway or financial flexibility that the organization wishes to maintain given uncertainty in its environment.

• Domain. Actions relating to the organization’s domain include those carried out on the current domain, market expansion, product diversification, business models, technologies, and vertical integration.
• Current domain. Includes actions to change the size or appeal of the current market and the company’s market share.
• Market expansion. Encompasses actions to expand or shrink the geographic domain of the business and actions to enter or withdraw from given market segments in the same geographic domain. Some actions result in a larger coverage of the market and others in a closer focus on certain segments or areas.
• Vertical integration. Upstream vertical integration means entering a new industry, where the company’s current suppliers operate. Downstream vertical integration means entering a new industry in the next phase of the production process or the company’s distribution channels.
• Product diversification. Includes actions to increase or reduce the range of products offered, which may be in the same line or represent new product lines. They may be within the same chain of productive activities, with the same competencies and technology, with the same resources or the same business model, or they may seek changes in these dimensions.

Competitive advantage. Strategic actions frequently seek to change the capacities and positioning of the business with respect to its peers, through the following aspects:

• Changes in the benefits perceived by the customer or the customer’s willingness to pay for its products compared to those of its competitors or peers. The company may try to position itself in a different cost-differentiation combination than its rivals.
• Changes in prices, credit or collection scheme for the product or service.
• Changes in the cost or efficiency of the company’s activities.
• Changes in distribution or availability of the product or service.
• Changes in image and likelihood of product purchase, attained through promotional efforts.

Actions taken to change competitive advantages may be made in response to similar actions by competitors, or at the company’s own initiative. In the case of competitive reactions, the company may seek to surpass, equal or reduce the impact of rival actions.

Resources and competencies. These include changes in the efficiency of the utilization or leverage of current resources (physical, financial, technological and human), the development of new resources for potential utilization in the future, and acquisition of new competencies with existing resources or those that may be developed in the future.

Mode of growth. In this category we normally find acquisitions and divestitures, organic development, and joint ventures.

Administrative system. This may include: changes in the organization’s corporate governance (who has the authority and responsibility for making decisions), changes in top management team and its coordination, changes in the chain of command (centralized or decentralized), changes in organizational structure (by functions, geographic areas, product lines, matrix or hybrid); changes in information system and incentives, changes in strategic planning and organizational learning system, changes in corporate values and philosophy, and others.

We recommend preparing an inventory of the portfolio of past, current and intended strategic actions. Some of the questions that arise from this diagnosis are:

• Does the organization carry out enough strategic actions? Is there a certain paralysis or sluggishness in action? Does the organization do too many things at once?
• Are actions focused on a certain issue (objectives, domain, etc.)? How dispersed or focused are it strategic actions? Are they consistent among themselves? Are performance objectives consistent with domain goals? Are domain goals and competitive advantages consistent? Are competitive advantages consistent with resources and competencies? What new resources and competencies must be developed to sustain a strategy? Are the resources and competencies consistent with the administrative system?
• What actions does the company not want to carry out? Why not? Does this decision fail to take advantage of resources and competencies, or the administrative system?
• Are current actions consistent with past actions? Are they consistent with future actions? Why? Is this what we want?
• What results have the actions brought in the past? What type of action should be evaluated more carefully?

Phases of an action’s development

Phases of an action’s development

1. Creation of an original concept. The original idea may be a combination of previous ideas generated by an executive, employee or client of the company, either individually or in a group.
2. Development of a formal proposal. Normally, the development of a formal proposal requires some executive to sign off on it, so that the financial organizational resources can be devoted to it, because these resources, not to mention time, will be consumed. It may require market research or technology, etc.
3. Modification and consensus gathering. The proposal may be modified to meet the needs of affected or interested participants, so that it can be approved. This would take place through a process of negotiation.
4. Announcement of the decision. This happens once there is a consensus among executives with decision-making power, or when the appropriate executive committee or Board of Directors approves the action.
5. Initial investment. Resources are allocated before the ideas are put into practice, in order to build facilities, acquire assets, sign contracts, etc. Many times, the action is taken on a pilot basis in one division, product or market, in order to learn from the results before applying it in a general manner to other products, markets or divisions.
6. Operation and later investment. The proposal begins operating and is modified, expanded or scaled back, depending on the results of the learning.

A similar process can be seen in Bower and Gilbert (2005). We recommend performing a diagnosis of how many strategic actions the company has in each phase of the process, and how many actions go on from phase to phase. Comparing the number of actions in the early phases and in the later phases indicates the company’s degree of strategic maturity. A company with a few actions in the early phases does not innovate much, and its future may be in jeopardy. Some questions that arise from this scheme are the following:

• How many actions or projects are there each phase of the process? How many projects go through the process in a given time, for example in one or five years? Is this strategic process effective?
• Do enough projects pass from one phase to the other? Are too many filtered out? Do too many make it through? Is the strategic effort diluted in too many directions?
• Are there enough ideas on new concepts to choose from? If there are few ideas, why does this happen? Is the company in a mature industry in which there are no longer many opportunities, or have the creative personnel given up because it is too hard to push new ideas through the system? If there are a lot of ideas, is this a good thing? Is it necessary to limit the generation of ideas in the company?
• What actions are planned in the organization? What actions are not planned? When is it better to learn before acting and when is it better to learn on the go? Is more planning required? Should emergent actions be encouraged more?
• What scheme is used to generate formal proposals? Is a person or group assigned to be the official critic, or “devil’s advocate?” Are two different groups assigned to develop similar proposals? Is the current system appropriate? Should it be made easier or more difficult? What incentives do the people with the winning proposals have?
• Is the process of consensus gathering to political? Do some group defend its ground by vetoing proposals that could affect it? Are new projects subject to excessive restrictions?
• Our only project with guaranteed success approved? Are the criteria for approval of new actions clear enough? Is it possible to carry out experimental actions with a high probability of failure? Is it necessary to make political concessions to certain groups to obtain approval? Are these concessions reasonable?
• Are sufficient resources assigned to carry out new actions? Does the organization learn from and modify the project or proposal on the go or does it stick rigidly to what has been approved? Is control over the resources so closely held or so complex it is difficult to accelerate or stop the process? Is it possible to back down on a project, or is it politically unviable?
• What is the new project’s risk of failure? Is success acceptable, or unforgivable? Is failure acceptable, or unforgivable? Could it cost the person who proposed it their job? Are there ways to change the project, expanding it, accelerating it or scaling it back, according to the initial results?
• How can organizational efficacy be improved so that more actions are deliberate and emergent?

Commitments and options

For our purposes, we can classify strategic actions into two types: commitments and options. Commitments are major investments, difficult to go back on, which attain the desired objective under a certain future scenario. Options are tentative investments but leave the door open for other future investments and that can generally be abandoned. The company may invest in options to hedge the risk that the scenario will be different from what it expects. Commitments are major bets in which much can be won, or much can be lost. Options are minor investments that allow the company to maintain flexibility by building up capacities that may be useful in the future. If the future is as expected, the company can invest more and profit from it; if the future is not as expected, it will only have lost a minor amount. To put it metaphorically, a commitment is like marrying a strategic course of action; an option is dating a strategic alternative. For example, buying land on the beach could be considered purchasing an option to build a hotel there in the future. Building a hotel would represent a commitment for the organization. It is easier to sell the option, the land, than the hotel, because the latter is a much more specialized asset. In this example, construction of the hotel is considered the project underlying the option.

The expected value of a business can be seen as a combination of two elements:

1. The present value of future flows generated on the investments that have already been made in commitments taken on the past.
2. The present value of future flows that will be generated by the investments that will be made in the future. This is the value of the company’s investment options.

All of the projects that make up a business have something of these two elements; but for commitments, the value of the first element is greater, and for options, the second has greater value. The company’s total value can be seen as a combination of these two types of projects. Normally, in young companies, the second element-the value of its options-is more predominant, while in more mature companies, the of the former-established commitments-is greater. For every plan of action, the company should evaluate the commitment that it requires and the options or possibilities for investment that it generates.

Commitments

For Ghemawat (1991), “commitment is the tendency of organizations to persist in their alternate courses of action or strategies.” Sull (2003) defines commitments as follows: “a commitment refers to any course of action undertaken in the present that obliges an organization to follow a course of action in the future [...] An action becomes a commitment when the company’s future options are restricted in such a way that it would be too expensive to turn back” (page 84).

Commitments have various phases: announcement, allocation of resources, reinforcement and cancellation. Among the positive characteristics or benefits of the commitments mentioned by Ghemawat and Sull are the following:

• They are major investments in durable, specialized and illiquid assets that may be difficult to imitate in other companies. These assets are called “sticky” assets, because they are so hard to unload.
• They help to obtain the resources needed for an organization to survive, because they attract investors, employees and clients.
• They may dissuade possible competitors from entering the market.
• They may induce clients, partners and allies to step in with complementary investments and adopt the standards proposed by the company.
• They inculcate a feeling of deliberation and purposefulness in employees, which can help to establish priorities and coordinate actions, and also motivates and inspires them to persevere despite the difficulties.

But commitments also had negative aspects:

• They may limit an organizations flexibility. They prevent certain actions or the development of certain abilities.
• They obviate the possibility of taking certain courses of action or to pursue certain options the company had open before.o They may lock an organization into obsolete patterns of operation and competition.

Types of commitment

Sull says commitments have a lifecycle, by which they can be classified into three categories:

• Initial commitments, when a company begins a business and the first decisions give an identity to the organization, defining what it can and cannot do.
• Commitments that reinforce previous commitments. When the business matures, executives reinforce the company’s identity with new commitments.
• Obsolete commitments. When a business is in decline, the original identity may be insufficient or counterproductive, and the business must be transformed through new commitments, which may be a complete turnaround from the previous ones.

Factors that increase commitment

According to Ghemawat, there are four main factors that increase commitment to a project or business:

• Sunken costs. These arise when a company invests in durable, specialized, non tradable (difficult to buy and sell) or intangible assets; when it is difficult to unload the assets acquired. Some examples of this type of asset are production capacity, customer base, and organizational know-how.
• Opportunity costs. These rise as the window of opportunity for investing in a project closes. To estimate the importance of opportunity costs, we can evaluate the possibility of re-acquiring assets that were sold off in the past, the possibility of reassigning resources to other new uses and the possibility of maintaining liquid reserves that enable the company to maintain its flexibility and to move quickly to take advantage of new opportunities.
• The time it takes to make changes in the strategies or resources. A company’s ability to change its assets and strategies is restricted by the commitments it has at a given time. It takes more time to modify its fixed assets than its marketing expenses. It may take years to change the company’s assets and strategies. The criteria to evaluate this factor are the cost and time it takes to accumulate the assets, the cost of adjusting them, and the cost of accelerating their accumulation or modifying them.
• Organizational momentum due to psychological and sociological reasons. When a company has a strong organizational culture, many decisions are made on a routine basis, or according to general principles, more than a calculation of their costs and benefits. Even in situations in which decisions are based on the rational calculation of costs and benefits, the ones making the decisions have psychological trends and distortions that are difficult to avoid. In contrast, a company that makes all its decisions based on analysis of costs and benefits is considered opportunistic, it is accused of failing to respect its long-term commitments. The criteria used to evaluate this factor are the degree of inactivity or passivity of the organizational culture, the prevailing use of routines and tendency to make decisions based on principles, instead of a rational cost-benefit analysis.

Executives should differentiate their decisions by the degree of commitment they require. The concept of commitment obliges us to think of the future in terms of the momentum and delay of change, the opportunity costs and the sunken costs. The questions we should ask under this approach are:

• What are the main commitments acquired by a company: production capacity, the client base or organizational know-how?
• What degree of commitment do the new actions that the company wants to carry out represent?
• Are there sunken costs involved? Are there durable, specialized, non-tradable (difficult to buy and sell) or intangible assets? Are other major opportunities lost with their acquisition? Has the window of opportunity on these closed?
• Would it take a lot of time to change strategies and assets once they are acquired?
• Is there a strong organizational culture in favor of established routine, the use of general principles, and little analysis in decision-making? Should this be changed?
• Do the strategic leaders have psychological trends that result in a predictable type of decision?
• In what phase of evolution are the company’s commitments? Are they initial? Have they been ratified? Are they in the process of change? What commitments should the company make or change in the future? What is needed to do this?

Options

A popular definition of the concept of option defines it as “the right, but not the obligation, to buy (or sell) an asset at some point within a predetermined period of time for a predetermined price” (Copeland and Keenan, 1998). Options can be classified as financial or real. Financial options refer to financial assets that are bought and sold on the securities markets. Real assets are non-financial assets that are bought and sold in their normal markets. Real options can be formal or informal. Formal assets are backed by a written contract that allows the parties, for example, to rescind it in a specified term. Informal options are rights to buy or sell assets on the open markets with no existing contract. These informal options are the most interesting strategically. Let us examine some examples of real options (Copeland and Keenan, 1998):

1. Growth options, which allow the company to increase the size of its facilities with an additional investment or to extend its investment into another industry where it has advantages from having invested in the first.
2. Defer and learn options, which allow a company to defer investment until it acquires more information or abilities. For example, if in a given situation there is some uncertainty over the future, but it has cleared up, the company may make the decision to launch a pilot product and, depending on the results (of the learning), launch it on a nationwide basis.
3. Quit options, which enable the company to reduce the investment or exchange it for more flexible or less costly assets, based on the new information.
4. Combinations, like multi-stage growth, in which in a sequence of phases, each one depends on the preceding phase. Once a phase is successful, the company moves on to the next. There are times when it must invest in various phases, and at each step there is the possibility of quitting the project, deferring it or spending more to speed it up. By making a combination, another option is generated, additionally to cash flows, which is sequential investment or multi-stage investment. In effect, when the first investment is made, the company gains the right to carry out the second phase.

An analysis of options focuses on the possibility of expanding or shrinking a project according to the results obtained in the market. The characteristics of the project are not assumed to be fixed from the start, but in fact are designed with certain points at which they can be changed. For Luehrman(1998), a business strategy is like a series of related options. Executing a strategy requires making a sequence of important decisions. The strategy establishes the framework in which those decisions will be made, but room should be left to learn from what happens in the business and to act on the basis of this learning. It is said that exercising an option is like investing in the underlying asset, in other words, in the primary project that the option allows for.

Luehrman suggests that investment options be constantly evaluated. Executives must observe the business, cultivate it with investments in maintenance, and seek ways to influence the variables that determine the value of the options that it represents.

Leveraging the value of options

The value of an option can be increased before exercising it, so that it is worth more than the price paid to acquire or created. This is done through value leverage. Turning again to the equivalencies in terminology between financial and real options, we find that the value of an option:

Increases with the value of the underlying asset or project. This is the estimate, provided by the market, of the present value of all the cash flows or intrinsic asset value that the option enables the holder to acquire.

• Increases with uncertainty. Uncertainty can be estimated as the standard deviation of possible growth rates in future cash flow generated by the asset. In the options framework, the holder is only exposed to uncertainty on the positive side of the distribution of growth rates; if the result is negative, the holder simply fails to exercise the option.
• Declines when the cost of exercising the option (or purchasing the asset) increases. The exercise cost is the present value of the expected cost during the life of the investment opportunity.
• Increases with the amount of time remaining to exercise it. This is a period which the investment opportunity is valid; it is the window of investment opportunity.
• Increases in parallel to the interest rate on risk-free assets, because the present value of the exercise price declines as interest rates rise.
• Is reduced with the cost incurred in keeping the option open.

For Luehrman, active management of a portfolio options involves: a) increasing the ratio of value to cost their projects, in other words, increasing the ratio between the value of the underlying asset to the cost of exercising the option, which can be done, for example, by reducing capital expenditures, increasing prices, cutting costs, etc.; and b) increasing the amount of time available, the volatility of the project (other words, the time the project may be put off) or the variation in its value. Over time, the index of project’s value and volatility declines. Active management of the portfolio of options allows the company to push them in the right direction.

Types of real options

According to Luehrman, strategic options can be categorized according to their investment priority. The recommendations are the following:

1. Invest now. The business must exercise the option and invest in the underlying asset. The company must commit to investment in the project to create the value. The project is mature.
2. Maybe now. The business can still wait. It must determine whether it is worth investing in soon, evaluating whether the benefits of waiting are greater than the cost of waiting, which include the loss of market share, the risk that a competitor will take the lead, the risks that regulations will change, the closing of the window opportunity, etc.
3. Probably later. The business must try to separate the more valuable projects from the less valuable ones.
4. Probably never. There is little hope that the project will be worth the trouble in the future.
5. Never invest. The option should be left to expire. The window of opportunity should be allowed to close. The project is considered to have no value for the company.

We must also consider future options that do not yet exist, but which may emerge later on.

1. Probable options. These are the options that will be created and that will receive attention and resources in the next five years.
2. Possible options. These are options that may be generated in the next 5 to 10 years.
3. Options that are impossible in the medium term. These are options that the company is unlikely to devote attention or resources to in the next 10 years.

The questions that can be asked in this framework are the following:

• What options does the company have? How are other options created to increase the company’s formal and informal flexibility? Are the options being considered options of growth, reduce or quit, learning, mixed?
• How does the value of viable options increase? Can we increase the ratio of the underlying value to the exercise price? Can we expand the window opportunity or the volatility of its value? What investments are required to keep the possibility open of continuing to invest?
• What options must we exercise by investing in the underlying asset in the short term? In the medium term? What options should we not exercise? Might there be a buyer interested in them?
• What options is it possible to create in the future? What are the options of buying or investing in a project or of selling and divesting of a project? Who would be interested in buying the option to invest or divest? Who would be interested in selling the option to invest or divest?

The strategic action system

The task of analyzing strategic actions can be visualized in two dimensions: the portfolio of actions or the process of generating actions; or the dimension of commitments or options. This results in four primary tasks:

A model for the system of strategic action to integrate some of these ideas incorporates the following elements:

1. Its causes. These are the factors that determine that the action is carried out. Causes can be classified into: a) the achievement of the performance objectives that results in the planned actions; b) having the resources and competencies to act and to be able to act, which generally results in emergent actions; c) actions imposed by the government or society to maintain a company’s legitimacy; and d) other “prefabricated” actions that do not contribute to the explicit goals of the organization or make use of its available resources and competencies.
2. Strategic actions. These are actions that change the objectives, domain, competitive advantages, resources and competencies, mode of growth administrative system of the organization. They can be viewed as options or commitments.
3. Results. These of the consequences of the actions of various organizations within the context of the restrictions of the situation. There the way in which the performance of an individual, business, company, industry and society may vary with the actions carried out. They may also be seen as the effect of the organization’s actions on participating groups, clients, shareholders, employees, vendors, and society at large.
4. Others’ actions. Competing actions from other organizations may weaken a company’s performance. Cooperating actions by other organizations may improve the company’s performance (Brandenburger and Nalebuff, 1996).
5. Business climate. This includes restrictions that limit the company’s margin of action, as well as elements in the surrounding climate that favors stimulate certain actions. This includes government, society, and the institutions that frame the organization’s action.

Decision-makers need to analyze three important connections: a) the connection between causes and actions (what causes the actions?), b) the connection between actions and results (what is the mechanism of transmission from action to results?) And c) the connection between results and causes of the action (what importance do results have as a determining factor in the actions?). (Ansoff, 1969). These three questions are important for understanding the system. The unit of analysis is not the organization or any of its parts, but rather the system that constitutes an action. According to this model, an analysis of the actions should focus on studying:

• What strategic actions has the company carried out or wants to carry out?
• What competing or cooperative actions have other organizations carried out?
• Why are those actions carried out? To what extent are the expected results taken into account to determine the actions? Is there an orientation toward results? Who makes the decision to carry out the actions? Are there trends or errors in the perspective of our organization or in competing and cooperating organizations?
• What results do these actions produce in individuals, business, company, industry and society? Are the actions aligned to impact all five levels at once? Are their actions taken only to improve the performance of one of these levels? What problems could a lack of alignment cause?
• What elements in the environment, and in what way, restrict, stimulate or force organizational actions?

This analysis may be historic, if it encompasses the main actions taken by a company in a certain period, or forward-looking, it examines the main actions that will be taken in the future. We suggest preparing a table with a list of possible strategic actions on the lines, and the type or level of commitment or the options in the columns. The portfolio of the company’s current and future commitments and options indicates it strategy. Areas of action where it has established commitments are as important as areas where it does not plan to act in coming years.

This table describes the projects or actions related to the lines and columns, in order to form an idea of how many actions there are and what are the priorities. We can then evaluate the company’s portfolio actions according to the following categories:

• Mature portfolios. Well-defined. Many commitments, few options.
• Young portfolios. Very flexible. Few commitments, many options.
• Decadent or failed portfolios. Commitments with few options, and which must be modified or canceled.
• Incipient portfolios. With just a few options.

The company must invent its future by phases and chart a general panorama of what each phase will contain, in other words, define what its portfolio of actions will be when each phase. Explicitly planning by phases has advantages and disadvantages. The main advantage is that many times, a company can act better in the present phase if it knows what the future phases are, and how these phases articulate with each other. The disadvantage is that because circumstances change, assuming that excessive commitment to certain actions may later bring a sense of failure that discourages the organization. Organizations need to maintain a certain flexibility in order to take advantage of the opportunities that arise and reinvent their future.?

References

Ansoff, H. I. “Toward a strategic theory of the firm”, en Ansoff, H.I. (comp.), Business Strategy, Middlesex: Penguin, 1969.

Bower, J.L. y Gilbert, C.G. From resource allocation to strategy, Nueva York: Oxford, 2005.

Brandenburger, A.M. y Nalebuff, B.J. Co-opetition, Nueva York: Currency Doubleday, 1996.

Copeland y Keenan, “How much is flexibility worth?”, The McKinsey Quarterly, 1998, núm. 2.

Copeland y Keenan, “Making real options real”, The McKinsey Quarterly, 1998 núm. 3.

Courtney, H. 20/20 Foresight: Crafting strategy in an uncertain world, Harvard Business School Press, 2001.

Dixit, A.K. y Pindyck, R.S. “The options approach to capital investment”, Harvard Business Review, mayo-junio de 1995.

Ghemawat, P. Commitment: The dynamic of strategy, Nueva York: The Free Press, 1991.

Kaplan, R.S. y Norton, D.P. The strategy-focused organization: How balanced scorecard companies thrive in the new business environment, Boston: Harvard Business School Press, 2001.

Leslie, K.J. y Michaels, M.P. “The real power of real options”, The McKinsey Quarterly, 1997, núm. 3.

Luehrman, T. “Strategy as a portfolio of real options”, Harvard Business Review, septiembre-octubre de 1998.

Luehrman, T. “Investment opportunities as real options: Getting started on the numbers”, Harvard Business Review, julio-agosto de 1998.

Mintzberg, H. Tracking strategies, Oxford: Oxford University Press, 2007.

Sull, D.N. Revival of the fittest: Why good companies go bad and how great managers remake them, Harvard Business School Press, 2003.

By: Claudia González Brambila and Daniela Ruiz Massieu

“A failure can still blossom into a great wonder”

- Anonymous

Mexico joins other countries in its conviction that the creation of new businesses is a way to spur more dynamic economic and social development. For this reason, various government agencies support the creation of businesses, particularly those with high growth potential and the ability to create value. New companies have shown that they stimulate the economy by paying taxes, and these resources are what the government uses for infrastructure and services, that in turn create jobs and greater consumption – all which result in a virtuous circle.

It is also known that countries with entrepreneurship support programs have higher rates of business creation. (Acs y Laszlo, 2007; Peng et al., 2009; Peng et al., 2008).

However, people who decide to launch new businesses run great risks. All entrepreneurs hope to be successful, but many fail in their first attempts. According to BBC México (2010) and the SME community of The Economist (2012), each year 200,000 new businesses are started in Mexico, but about 80 percent close before their second year. And more than 50 percent of those companies that survive suspend operations before five years.

There are many causes for failures. Among the most common are a lack of knowledge of the market, a lack of planning, a weak business model, and the lack of expertise in managing a company. Making mistakes is inevitable; we have all experienced failure. However, in the case of entrepreneurship, failing is part of the process and can yield great benefits. When entrepreneurs learn from their mistakes, the possibility of failure decreases dramatically after the first couple attempts. In fact, failure can have very positive results if, when analyzing its causes, the support programs have a direct impact on the causes and generate important information about the entrepreneurship initiatives that do not work. (Hoetker y Agarwal, 2007; Knott y Posen, 2005).

Therefore, if we can benefit from failure, why are we so reluctant to fail? Why not try to understand, manage and learn from our mistakes? Why not help entrepreneurs learn to fail, recover and try again in search of that much coveted success?

Errors should also be seen as a source of innovation.

Many important technological advances have come about as the consequence of what has been learned from mistakes. For example, 3M’s successful product, Post-it, is the result of an error by Spence Silver, a scientist who worked at a company in 1968 and tried to invent glue with a high degree of adherence. The product he invented was a “failure” for a while, until Art Fry, another scientist at 3M, found a useful application for the product in 1974. Both could not image the extraordinary success it would be.

Another important example is Viagra, a product that failed in a particular area, but was very successful in another. What we now know as Viagra is the result of the work of Simon Campbell and David Roberts, two researchers from the pharmaceutical company Pfizer, who in 1985 sought a compound that could control high blood pressure. Seven years later, they concluded that it didn’t work for vascular problems, but the secondary effect produced in volunteer patients could be commercially lucrative.

Not all countries embrace a culture of acceptance of failure in the business world. On one end is Japan, where suicide is the third leading cause of death among entrepreneurs who failed in a business venture. The other end is the United States, where the probability of obtaining a bank loan is higher if the entrepreneur has already had some experience in business, whether it is good or bad.

A good example of this attitude is the case of a young IBM executive who in the 1960s made a decision in the area of innovation that cost the company approximately10 million dollars. Tom Watson, director general at IBM at that time, called this executive, who assumed he was going to be fired, into his office. “Fire you? No way,” Watson told him. “We just spent 10 million dollars on your education.” (Heath, 2010).

This example illustrates an attitude that assumes that failure in entrepreneurship is an evitable part of its activities, a way of learning and maturing. Therefore, we can say there is a world of difference between understanding failure as a result and understanding it as part of a process. Those who see it as part of a process are more likely to achieve success.

Accepting failure as a learning process and a source of ideas is a strategy that innovative companies incorporate in their culture. For example, Google designates 10 percent of its resources to experimentation, innovation and risk taking.

In essence, we’re also talking about a matter of expectations, both social and personal. If you want to have an ecosystem that fosters the creation of new businesses, you have to give greater social recognition to those who take risks, although they are not successful in the first attempts. They are the best candidates to make important contributions to the development and well being of society.

Not only managers of companies should instill the importance of failure in their organizations, but also schools and universities, as part of the entrepreneur ecosystem, must teach students to prepare for and learn from the mistakes and failures they will inevitably face in their professional life.

This trend has taken root in some U.S. universities. For example, at Babson College, not only success stories in business are studied, but also the topic of failure is addressed by analyzing various models, theories and case studies. In class, professors emphasize the importance of understanding and exploring the causes of failure in order to develop better strategies and make better decisions in the future. Students learn that entrepreneurs should not only celebrate success, but also embrace failure. The bottom line is that many businesses fail, and accepting this and learning from the mistakes of others are central components in launching a business.

The experience of starting a business is unpredictable and must be repeated. To succeed, entrepreneurs must be able to tolerate frustration and failure; they must be prepared to learn and respond, to try again and take more risks. In conclusion, being better prepared to fail is the only way they will succeed.?

References:

Heath Chip y Heath Dan, “Switch: How to change things when change is hard”, Broadway Business, 2010.

Nájar, Alberto; BBC Mundo, 7 de enero de 2010.

Naranjo, Fabiola, “El Empresariomx”, Comunidad PYME de El Economista, abril de 2012.

Neck, Heidi, “Reframing failure as intentional iteration: New research on how entrepreneurs really think”, Babson Entrepreneur Experience Lab.