I can tell you the three most fundamental things you need to know about business in less than 30 seconds. They are hard-won and expensive lessons, but any business that does not apply them will soon be bust. They are as follows:
- Make things that people want to buy;
- Bring in more money than you spend;
- Have money to spend when you need it.
Okay, there are some details that I have left out, but these are the basics. You have to provide something that people are willing to pay you for. It has to cost you less than people are prepared to pay for it, to give you a profit margin. It’s no good having US$1m coming to you next week if you need it today. As they say, ‘Revenue is vanity, profit is sanity, cash-flow is reality.’
A loss will be a loss, and a profit a profit. Billy Connolly, a seemingly down-to-earth Scottish comedian, after relating a story about swimming off his yacht, said “You can’t hide the profits forever.” In the same way, you can’t hide the losses forever either. No business can afford to make an ongoing loss, since its owners or shareholders will eventually run out of patience, money or both. All real businesses are run for the benefit of their shareholders and if there is no benefit being derived and none in prospect, then the shares and the company are worthless. If the company makes an ongoing loss, then it is worse than worthless: you may as well just throw your money onto a bonfire. In such a case, the only sensible thing is to close the business. We’ve seen that in the case of several cement companies recently, where a loss-making factory is simply closed. I think that we will see more of this happening in the future, as CO2 permit costs rise and overcapacity bites.
A loss is a loss and a profit a profit, unless you enter the crazy world of the state-backed company. These cement companies, which include those backed by agencies of the state (such as the military, as in Egypt and Iran), those actually owned by the state (either built by the state or expropriated, as in Venezuela and Cuba) or explicitly or implicitly backed by government (such as various of the Chinese cement companies) are perfectly able to withstand ongoing losses, since they are backed by a shareholder with theoretically bottomless pockets: if they need more money, they just put taxes up. If you don’t pay your taxes, you may end up in jail, so it’s generally a reliable source of funds for the state.
A cement company can theoretically stumble on, neither making profits or losses, or making a small profit one year and then having it gobbled up the next (usually by ‘increasing fuel and transportation costs’ or ‘increased taxes and tariffs’ - we’ve seen all the excuses), for many years. These ‘zombie’ companies would have defaulted in a normal economic cycle but continue to function due to today’s ultra-low interest rate environment. They are able to pay the interest on their debts, but they are unable to pay off the principal. To close them would be to crystallise their losses: the lenders (the banks) would lose the value of the loans (and us taxpayers might end up having to bail them out - again). The banks will have done their due-diligence: they should know that lending money to help build a cement factory that contributes to oversupply will depress prices so that the profit margin for all players in the market reduces or turns negative. However, there are such juicy fees for arranging loans and there are the reliable interest payments on the loans for decades to come: who could resist?
The other thing about zombie companies is that they do have an economic role: they provide jobs for the workers at the cement plant, and for the various contractors that a cement plant relies upon. Each Dollar or Euro paid to the workers is spent on further goods, spreading out in a valuable multiplier effect. That’s one of the reasons why money spent on building concrete-based infrastructure has a general positive effect on the wider economy. (It does at the moment - but with increased automation and reduction in manpower in the cement and concrete industries, there will be less and less of the multiplier effect in the coming years). There’s also the potential loss of face in closing a factory: only the most steely-eyed government minister will countenance closing a marginally-profitable zombie company.
The decision to cease production of the magnificent A380 aeroplane, after having large amounts of money pumped into the project by various governments, is a case in point. A lot of ‘face’ and thousands of jobs will be lost when Airbus stops making the plane in 2021. The plane has never made a profit and now it never will. I remember a few years ago boarding an A380 for a flight to the Middle East and being surprised, 20 minutes later, looking up from my newspaper, to find that we were already airborne. Now it will be consigned to the Apollo-Concorde era of ‘how did we ever afford that’? However, you can’t hide the losses forever.
For the A380 and some cement plants, when the merry-go-round ceases to turn, it’s time to get off.
