Structured madness

Have you ever wondered why many consumer goods are heading to payment plans and away from payment at the point of consumption?

Well the explanation is very simple, finance 101 so to speak. But I just had a chat to a friend, who despite being very educated, had no idea.

So here goes…

Imagine a mobile phone user who uses $100 exactly a month on their phone bills (to make things easier).

On a two-year plan that would mean the phone company will receive $2400 over the two years, which is exactly what they write in the small print of their advertising (as they are forced to by regulation).

However if you are not on a plan and still use $100 per month of phone services, can you guess how much of your future revenues that they can be sure of?

The answer is $898.47.

That is, if their head accountant is sitting in her office looking at two customers with identical phone usage, but where one is on a two-year plan and the other is month-to-month, the accountant can forecast $2400 of revenues from one customer and only $898.47 from the other.

The calculation of the future revenues from the monthly customer is called a ‘net present value’ calculation and is subject to a ‘risk factor’.

For each industry and each business the risk factors can be easily calculated by comparing what actually happened in the past.

For example, if they had 100 customers paying monthly, over a two year period how much revenue did they actually get off them. Well its not $2400 per customer multiplied by 100 customers. Indeed it was much less because some customers changed phone companies, some went bankrupt, some went overseas etc which totalled to a ‘discount rate’ or a risk factor of 10%. In fact the actual revenue number they received was $898.47 multiplied by 100 customers.

Which begs two questions….

1. Why don’t pubs and clubs get their customers onto structured payment plans for their beers?

2. If there is a cartel-style monopoly like there is in Australia for phones, banks, supermarkets, building materials, etc etc – how can the risk factors be over 1%? That is, for any business in these cartels the risk of customer loss is almost fully offset by customer migrating away from their limited number of competitors. Oh that’s right our cartels have licences to print money… silly me. The wonder is why they even bother with payment plan structuring – they hardly need to.