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Reflections On Le Credit Crunch

Saturday, January 30th, 2010

I think I am now pretty much up to looking back on 2007 – 2009, and thinking about 2010 and forwards.  Le credit crunch and le recession have been a roller coaster, like surfing a bad set of hairy, tumbling roiling waves, but it’s been a truly cathartic time, that has allowed Steenbergs to be reset on a better course.

We’ve rejigged the way we run the business, what we’re trying to do with Steenbergs and truly Steenbergs Organic is now a better business, and one both Sophie and I feel much more comfortable with.

One of the key additional themes has been Sophie’s cancer, which Sophie hinted at in one of the blogs in December.  It certainly makes you focus on what is important in your life, and in our case it’s each other, family and friends first and foremost. We love Steenbergs as a business and it has to work for us and what we want it to be – luckily it appears we can match our interests with the market.

2008: somehow we realised really early on that banking was going to get really tight for small businesses; I would like to claim a sixth sense, but it probably was more a case of realising that they way the banks had been getting us to run Steenbergs was rubbish because we (that’s the owner-directors) were not getting a penny out of the business despite our daily toil and ownership of Steenbergs, and were having to plough cash in at an alarming rate.

In any case, in one of my best ever business deals, we fixed all our development debt into 2 tranches, repayable over 15 years and 20 years at 155 basis points and 200 basis points over base rate plus an overdraft facility.

The rates on the overdraft have been unilaterally changed several times over the last two years for small businesses, but we have been in credit pretty much ever since we renegotiated our long term debt.  This was not the highly clever corporate finance of the City but it was well done and very timely.

While we were on a family holiday in Bridlington in July 2007, there were loads of floods in Tewkesbury where my mother in law lives.  It was like a forewarning of what was to come – in September 2007, Northern Rock collapsed and almost exactly one year later Lehman Brothers was allowed to fail in September 2008, which saw the vacuum that’s at the centre of international credit and finance exposed and the global financial system start falling into that hole.

I say it’s a black hole because it is based on the premise that no-one will ever ask for all their money back from the banks at the same time, so a bank can always borrow money from somewhere else to plug a financing gap; so banks tend to lend long term on borrowings that are short term, whereas most real world businesses operate the other way around.

Also, thinking about risk-reward and whether or not it is commensurate would have helped people with the credit bubble and risks in proprietary trading.  Banking is really a low margin, low return staid old game, so to get higher rewards you need to take on more risk, i.e. bet bigger, to get your profits ahead of normal banking returns, but if the reward and the risk for those actions are uncoupled then too much risk will be taken on.  So if I am a trader/banker and get the reward while a shareholder takes the risk (or even the tax payer) then you are likely soon to get to a situation where too much risk is being taken on for the level of return being generated.  It’s a bit like going down to William Hill’s with someone else’s cash – I would tend to bet bigger and on longer odds because where’s the real downside for me.

During 2007 – 2008, we really tried to batten down the hatches.  We did not replace any staff except for a few essential posts and let our staff numbers drift down from a peak of 15 to our current level of 9, without any change in sales.  Some of those employees were really quite expensive and were not revenue generating.  Also, we let a small 1500 square foot warehouse go, reducing our rent roll.

Simultaneously, anything that wasn’t obviously revenue generating was ditched, so pretty much all advertising has been curtailed as it doesn’t generate us any return on sales, because we are not in the big supermarket chains, and we have cut down on the trade shows we go to, as we have maxed out on the number of direct independent retail accounts that we are going to get (basically while it is going up still and the quality is getting better, the rate of growth of new accounts has slowed and most of the new enquiries come direct to us from our web site or word of mouth and not from trade shows).

But as unlikely as it may seem 2008 was our record year for sales since we started and we were profitable with really strong cash flow.

2009 began with the world full of gloom and doom – the worst financial crisis since 1929 and the worst recession since modern records began in the 1950s.  Actually, we found 2009 a mixed picture – our internet site and sales to retailers had our best year yet with the web site growing sales by over 40%, while our sales of raw materials was down, particularly to those customers that sell directly into the supermarkets who have reduced their interest in organic and premium products despite what their marketing might actually say.

Our retail sales were up as we have done 2 new things: we have targetted specific parts of our product range direct to distributors for the health food market and fine food marketplace, with good sucess for Steenbergs Home Bakery products and our organic Fairtrade mulled wine; and we have widened the scope of the products we offer via the web site to cover more ambient products that green people might want.

Strategically we have been thinking a lot about risk-reward, and come to the realisation that the reward, i.e. gross margins, from selling to the big retailers together with the working capital tied up does not equate with the relative risk that Steenbergs has/would be taking on.  Allied to this, the bulge bracket retailers – Tesco, Morrisons, Sainsbury and Asda – are very much tied up with the big food manufacturers, such as McCormick for spices and British Pepper & Spice and Barts, and British Sugar and Dr Oetker for Home Baking.  So its slim pickings to get the work that falls off the high table of the retailing world, which is already being aggressively fought over by Fiddes Payne, Green Cuisine and a few others.

So we could either go in and fight a price battle on low financing capacity, which for Steenbergs would be a mug’s game or just rejig our business to grow in other ways.  So we have decided to talk cheap and say that Steenbergs will not sell to the grocery multiples bigger in size than Waitrose – it’s cheap talk because while we have done some casual marketing to them all, we are not listed in any of them including Waitrose.  If they approach us, we will just have to say no, as we would want to do it on our terms (our prices and 30 days credit with any big stock up pre-financed by the retailer) and they didn’t want to deal with Steenbergs even when they initially courted us – that’s Sainsburys who said they were very excited about Steenbergs and led us a merry dance via 3 or 4 buyers until finally we were told “we deal with McCormick and cannot see the reason to change this”.  Well, luckily we had only wasted time and not been caught on the hook by investing money – wiser but not poorer.  The truth is that working in partnership with the big retailers means working for the big retailers to fulfil their strategic aims and their margin requirements, one is a bit like a lamprey on shark.

2009 has been a gentle year of managing cash and costs, keeping the ship steady.  Also, Sophie and I have started a process of redesigning key parts of our business.

This began with the complete overhaul of the web site – originally it was conceived as paid for marketing to supplement the development of Steenbergs as a brand for shops, but we now want retailing to be at the centre of what we do.  So the site is now bright, colourful, eccentric and full of rich content that we will carry on adding to and developing as a resource.  The web site also had a massive back end rewrite to make it easier to work with and interlinks now directly into our accounts system.  As a result, we are getting more than twice as many visitors each day and much more stickiness onto the site – we are very, very pleased with the way this has worked.  We just need to work a bit more on speed and navigation.

We have started refreshing our products.  So far, we have redesigned our spice tin and tea tin, with the spice tin relaunched and the tea tin imminent (it’s being made at the moment).  Allied to this, we have redesigned our tea labels and labels for a small range of specialist spice blends in our new spice tins.  We love these as they are bright, fun and happy new products that fit with our personality and web site, rather than being overly serious.  They will be fully relaunched by Q2 2010.

We focused a lot on Home Baking and launched a compact range of 5 high quality extracts that are distributed by a wide array of UK distributors.  To complement this, we redesigned the flavoured sugars, baking powder and bicarbonate of soda (baking soda) labels and launched them in August 2009.

What we are doing is simple, we are pulling out groups of lines within the vast Steenbergs portfolio of blends and creating distinctive designs that still fall within the whole Steenbergs brand features.  They will be bright, fun and have great shelf presence.  This process will continue through 2010 & 2011.

So what do I think about 2010?  I feel it will be tougher than 2009.  2009 was characterised by a very loose financial regime of the government propping up the banks, pumping cash into the larger corporates and printing money, while keeping VAT down temporarily and running a scrappage scheme.  For those still in work, it was an easy year of low taxes, low inflation and very low mortgage payments.  But the ballooning budget deficit will need to be repaid, so the next few years will become (after the impending election) years of abstinence and frugality.

For small businesses, we will be hit by continued tight credit conditions, the uplift in VAT (which Steenbergs has absorbed into our operating margins), the business rates review this year (we are expecting a 20 – 30% increase in costs there) plus a rent review and a complete lack of help from the government, of whatever hue.  We asked for help with some capital investment in Q4 2009 and were told by Yorkshire Forward that we were too small and by BusinessLink that there was no money in the kitty and so while we had a visit by a very nice gentleman last year, nothing came of it.  The answer is simple as always ignore the politicians who know nothing and just get on with doing what you do best and make some money.

I am actually looking forward to the next few years.  The Steenbergs ship is perhaps a bit less ambitious but going in the right direction – and one Sophie and I are very pleased with – and there’s plenty to go for out there that no-one else is targetting well.

It’s back to what we started the business to do – great spices and ingredients in sensible packaging done in a fair and reasonable way.  I will try and explain some of ethics and how we are trying to develop the sourcing and marketing side to get the excitement of the spice trade of old.

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UN Climate Change Conference in Copenhagen

Monday, December 21st, 2009

The UN Climate Change Conference in Copenhagen is the perfect example for the phrase “a damp squib”.  Squibs are small explosives that are used for special effects and in the past for clearing away coal in the mines when they were sold as “Miners’ Safety Squibs”.  In the past, squibs were not protected from moisture and so a damp squib was just an explosion that failed to detonate.

I suppose that we all expected too much from the conference; where views that are so divergent and relative powers so different were being brought together, there was probably nothing but a slim chance of agreement.  The outcome, however, was not unexpected as in the end and in my heart-of-hearts I probably expected nothing much.  Which is what we all got.

For me there are 2 big issues that come out of the conference – one is scientific and the other is political.

The scientific issue is that I am unconvinced that the detail of climate science is there yet and I am unsure that it ever will be.  That is a big problem and will get more and more important as time goes by. 

That climate change is occurring is irrefutable and that it is man made, i.e. anthropogenic, is also clear.  It aslo seems clear that we are heading for a general 4-5oC rise rather than 1.5-2oC rise that the politicians seem to be kidding themselves will happen, and that hotter world looks a pretty scary place (Source: “A World 4oC Warmer”, Santa Barley, New Scientist, 3 October 2009, p 14-15).

However, the temperatures are general, global and vague and I think that this is going to be an Achilles heel for climate change protesters and scientists going forward.  In the end, I, people and Governments need to know with some accuracy what is going to happen where and when?  And I think until this is fleshed out more, people and Governments have wriggle room. 

For example, I have been trying for ages to find on the Internet a report or simulation that shows the impact of differing levels of sea rise on areas of the world (I once saw one at The Deep in Hull which was very impressive), i.e. I know that low lying areas like the Netherlands, London, Tuvalu and Hull will become effected straight away, but what does a 10 metre rise do and what is the percentage likelihood of that?  I know that the Arctic sea ice melt is irrelevant to sea level changes but how much land ice is melting from Greenland, the Antarctic and Canada, for example, per annum and what impact is that having?

And even more precisely, what will the temperature rise be in the UK when the global temperature rises by 2oC?

Or will it actually result in the temperature falling in UK as temperatures rise globally?  My query here is based on the fact that our temperature should really be the same as Moscow, but because of the Gulf Stream we are kept artifically warm.  But if the ice sheet on Greenland and Canada flows into the Atlantic Ocean, it could change the surface density of the ocean and switch off the great ocean conveyor belt and so plunge the UK (and the world) into a cold patch that could compensate for the general rise in global temperatures.  This sudden freezing could be more devastating in the short term than a general rise in temperatures. 

So more detail is needed on anticipated changes and they will need to be accurate as each error will serve to undermine the generally correct concept of climate change.

The second is the concept of sovereignty.  In George Orwell’s Animal Farm, there is the iconic quote:

“ALL ANIMALS ARE EQUAL
BUT SOME ANIMALS ARE MORE
EQUAL THAN OTHERS”

It has been used ever since as a ironic dig at socialism and communism.  However, the concept of equality, democracy and sovereignty is something that worries me; it is something that I cannot really get to grips with as to whether the way the world is run is right or wrong?  It worries me that the UK is more and more being run by the EU and that the EU and the UK Governments are largely run by oligarchs over whom there is very little control.  The expenses scandal and the next election may change the faces and the bums on the seats, but they will still come from the same political parties and the state apparatus will be largely unchanged and most of the regulations and legislation will stay in place.

The same goes for soverign states.  Does the USA have any more legitimacy than the small island states, such as Kiribati and Tuvalu, or mini states like San Marino and Lesotho?  If we are all equal then surely each country should have an equal voice, but (back to Orwell) that’s clearly not the case.  In other words, the world will be driven by the larger states as they have greater power in terms of cash, military might and global influence.

And how about the minority peoples who live in the areas perhaps most directly impacted by the melting of sea ice and land ice, the indigenous peoples of the Artic and elsewhere?  Where were their voices?  Was it but a squeak in the dark, which does not even seem to have been recorded, or maybe it never happened?  Surely the Inuits, the peoples of Chukotko-Kamchatkan family, the Altaic peoples, the Uralic peoples and the Na-dene of the Artic region should be allowed to express their points of view as to climate improvement.  They had their own conference in Alaska in early 2009. 

Which brings me back to the UK.  The parties who cobbled together the weak “Copenhagen Accord” were the USA, China, India, Brazil and South Africa.  That’s the political and military powerhouses within each continent who were clearly being tasked with strong-arming agreement from sovereign states within their areas of influence.  This is vote rigging and gerrymandering on a global scale. 

Where was Britain? Where was the EU? Clearly they are not regarded as drivers of the world going forward.  Gordon Brown can hardly believe is own rhetoric in saying “A breakthrough never seen on this scale before” – I must have missed something, somewhere, unless he was talking about the coup d’etat of the UN by powers other than the UK.

It is important that Britain and the EC who are supposed to be the cradles of modern liberty ensure that any construct arising from the Copenhagen Conference does not deny the sovereign status of all nations and that it cannot be seen as modern, legalised form of global colonialism that binds everyone to the global vision of a few, hugely powerful superstates. 

Small sovereign states are still sovereign states in the same way that every citizen in the UK is equal when it comes to the ballot box. 

And I am not sure my, my family’s or anyone else’s future in relation to climate change is a bargaining chip to be negotiated by a few heads of state.

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Water, Water Everywhere And Not A Drop To Drink

Sunday, December 13th, 2009

As world leaders take themselves very seriously and think themselves very powerful as they negotiate their climate change treaties in Copenhagen, while they drive their big limos and they fly in from around the globe, I have been thinking about water.

We have had an excess of rain here up in Northern England and there is no problem with our amounts of water.  As the planet warms, we may even get more and some of the lowland areas could flood.

But then I read today that the United Nations Development Programme says that 1.1 billion people (15% of global population) worldwide do not have access to clean drinking water and 2.6 billion people (38% of world) do not have access to sanitation.

Of this 1.1 billion people, most of them use only about 5 litres of water a day, that’s water not clean, potable water.  That’s 10% of the water that we use in the developed world.  The EU averages about 200 litres a day, the US about 400 litres and I calculated that I average about 140 litres a day, but like many personal estimates I probably undercooked it.

To bring it even closer to home, our toilets have been converted with a water-saving hippo, so each flush is approximately 5 litres, so each time we flush the toilet at home, we flush away more water than 1.1 billion people get a day.  And the water we use to flush the toilet is potable.  As the Duke of Edinburgh so succinctly put it once “The biggest waste of water in the country is when you spend half a pint and flush two gallons.”

So when the great big soundbites come out about how many billions of dollars have been committed to tackle climate change and what “tough” targets we have all been set on carbon emissions, let’s think about some of the nitty-gritty issues for about one quarter of the global population:

  1. Access to water, then providing potable water
  2. Access to sanitation, such as pit latrines rather than flush toilets

And perhaps the Governments should commit some of our hard earned and taxed money to these little issues.  But perhaps there are no headlines or votes to be won from talking about water and toilets.

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Keep Governments Out Of Saving The World

Tuesday, November 17th, 2009

One of the areas of society that is exercising my thoughts at present is how societies organise themselves, are governed and whether we (as citizens) are actually free … or just whether we are being told that we are free, but in reality are all just tax and regulation slaves beholden to some amorphous and distant SuperState.  And one of those areas of concern relates more specifically to how society addresses environmental problems, such as climate change.

Will there be a tragic destruction of the commons?

Elinor Ostrom is a relatively controversial winner of this year’s Nobel Prize for Economics.  She is not an economist, but a political scientist with a current interest in social-ecological systems, which is the cause of the ruffled feathers amongst pure economists.  The Nobel Foundation cites that her award (she actually won ½ the prize with the other ½ going to Oliver Williamson) is in recognition of “her analysis of economic governance especially the commons”.

However, the concept of social-ecological systems and how to manage the commons is fundamental to all our environmental concerns, and since the potential destruction of the environment is regarded as one of the most pressing medium-term issues for the global economy, we can surely regard her work as impacting on the global economic system.  Or as Stern wrote in his seminal report on the economics of climate change: ”Climate change presents a unique challenge for economics: it is the greatest and widest-ranging market failure ever seen.” (Source: Stern review on Economics of Climate Change, HM Treasury, October 2006).

What is Ostrom interested in?

Firstly, let me explain what is meant by the commons.  It is the natural resources of the earth, ranging from the fisheries, lakes and forests and the soil through to the air quality and temperature and the planet’s biodiversity in animal, plant and microbial life.  Pretty serious stuff.  These are being impacted by everything from massive climate change and local pollution to overpopulation, the advancement of cities and urban developments.

The basic theoretical concept is called the tragedy of the commons.  In 1968, Garrett Hardin coined the phrase “the tragedy of the commons”.  In this case, the tragedy is that people, businesses or countries will continue using a bit more of the the earth’s free natural resources, the commons, while there is still some economic benefit left within Mother Earth until those resources are finally wiped out.  Then everyone suffers.

So for example, in an arid climate, herders will graze their livestock on all available vegetation until finally all the vegetation is destroyed and this method of farming collapses, ie there is no capacity within humans to mediate their actions to maintain the vegetation so that they can continue with their particular agrarian lifestyle.

Or forest communities in the equatorial rainforests have a reputation that suggests they will trash their forests, slashing them down for timber or burning them to clear land for small-scale agriculture.  But is this really so?

Even worse than this, there will be a short-term tragi-comedy where businesses and Governments see significant short-term benefits deriving from global warming as the Arctic becomes ice-free during the summer months within the next 20 years, and largely ice-free within 10 years.  This will open up shipping lanes across the North Pole and will expose land in Greenland, Northern Russia and Canada that can be exploited for mineral, oil and gas resources.  So businesses like Angus & Ross, a British minerals exploration company, which owns large tracts of land in Greenland has seen what were large areas of valueless ice are now fast becoming regions of prospectable mineral wealth as the ice retreats.

How do you protect the commons then?

The mainstream argument goes on that it is best for Governments to intervene, taking ownership and control of the land and so protecting it.  In fact, the United Nations intends to pay Governments to protect their forests ascribing a price per hectare in a way that the European Community offers farmers a subsidy for unused agricultural land under the set-aside scheme.

The climate change meeting in Copenhagen this December 2009 is expected to formalise this method by agreeing a formula for a scheme called Reduced Emissions from Deforestation and Forest Degradation (or REDD). 

But Ostrom’s work contradicts this State driven paradigm.  Elinor Ostrom addresses social-ecological systems at the ground level and how natural resources can be best managed without Government input and without the free market.  She highlights that while the free market might work in many circumstances the non-market part of society is also vitally important. 

She poses questions like the following: “”Why do some locally managed forests thrive better than government protected forests?…what factors affect the likelihood that farmers will effectively manage irrigation systems?…When will the users of a resource invest time and energy to avert “a tragedy of the commons”?” (Source: Ostrom, Science, Vol 325, p420, 24 July 2009, edited by Axel Steenberg and annotated with my emboldening for emphasis).

She suggests that communities will, in certain circumstances, self-organise to protect and manage their resources rather than let them be razed to nothing.

This propensity to self-organise depends on a large number of factors, including the size of the territory (a large resource is hard to manage while a small resource has no value), the predictability of the system (a forest is fairly easy to monitor whereas fisheries are chaotic), the mobility of the resource (trees stay still whereas herds of caribou move around), the number of users (large groups are harder to manage than smaller groups), leadership (respect for the leadership or elders), norms/social capital (where all users have the same moral-ethical code they are more likely to pull together), knowledge of the social-ecological system (you need to understand the resource to be able to manage it), importance of the resource to the users (fisheries off Mauritania are important to the Mauritanians rather than the British, even if the British and the rest of the EC are overfishing the North-West African Shelf, hence this disconnect between the beneficiaries of the overfishing and the actual resource has been and continues to be fatal to fish stocks in this highly productive area for marine biomass) and collective-choice rules (if locals have control over their destiny without interference they are more willing and able to defend their resources).

To quote again from Ostrom: “Larger-scale governance systems may either facilitate or destroy governance systems at a local SES level.  The colonial powers in Africa, Asia, and Latin America, for example, did not recognize local resource institutions that had been developed over centuries and imposed their own rules, which frequently led to overuse if not destruction” (Source: Ostrom, Science, Vol 325, p421, 24 July 2009) and (my words) a 100 or so years later local conflicts have arisen across ethnic groups where the colonial powers rode roughshod over traditional structures as they carved up Africa in the late 1800s and early 1900s.

She shows that if the State gets out of the way, local communities will respond by forming their own local, specific systems to manage scarce natural resources to prevent resource collapse, using their own rules (for which they have local buy in as they are home grown rules) and that this local social-ecological system is an adaptable framework that can apply in numerous different circumstances.

In other words, we (as in the human race) do not have an uncontrollable desire to self-destruct if we are left to our own devices and allowed to develop our own social-political systems on a local scale. 

So when we go back to the concept of REDD as introduced above, we find that perhaps the State is not the solution but perhaps the issue. 

Ashwini Chhatre and Arun Agarwal of the University of Michigan have compared data on carbon sequestration with types of forest ownership and have found that tropical forest under local management stored more carbon than those managed by Governments. 

One reason, per Ostrom, is that locals tend to be better at looking after forests if they own them as they then have an interest in ensuring the long term survival of the natural resource, as it is their livelihood.  Conversely, Governments (however good their intentions) will usually issue licences for destructive logging or free-for-all land grabs that strip forests bare.  The authors also suggest that locals may be better at managing common pastures, coastal fisheries and water supplies.  (Fred Pearce “Let the people look after their forests”, New Scientist p 12, 10 October 2009).

And then with all the best will in the world, you will get local political disasters that will create chaos with globally orchestrated plans, for example:

  1. The Burmese military government does not care about global political views so will continue to strip their tropical hardwood forests for their own gain whatever the developed world tries to tell them and it is estimated that two-thirds of timber revenues in Burma are from illegal trade and most of that simply crosses the border into China’s Yunnan Province and then elsewhere into China; or
  2. In Madagascar where there is currently no effective Government since the President was ousted in a political coup in March 2009 – so now the national parks are being logged at a rapid pace with 750 tonnes of rosewood “legally exported” this year to China while bushmeat hunters are exporting 100s (if not 1000s) of endangered lemurs to sell onto exotic meat restaurants (Catherine Brahic, “It’s open season on Madagacar’s biodiversity”, New Scientist p 12, 17 October 2009).

My current conclusion

What the work of Ostrom, and others, says to me about how to manage our global environment is that: (a) solutions by Governments or States are doomed to failure, as they will be destroyed inter alia by corruption and lack of local buy-in into their imposed schemes (however good and sensible and well meaning on paper); and (b) big global schemes will never work because they will never be specific enough to local factors and will be incapable of flexibility or have any in-built local intelligence, so will fail to marry up with the social, ecological and political requirements actually needed on the ground. 

In the end, global climate change will only ever be addressed by a concerted effort by people – that’s individuals, households and local communities – to work on their own towards a better planet, taking into account their own local, special circumstances.  It will mean forsaking the help of the State, and often working towards a distant, barely visible target, without any apparent success and even some possible failures. 

It really needs a wholesale lifestyle change, a change in our individual philosophies and how we interact with the world.  We need to look at the world holistically and sustainably – respect nature, don’t waste anything, work for a greater good and live together respecting people’s opinions and differences.

It, also, tells me that many of the modern political superstructures that have been built across nations, and even perhaps current social-political systems within countries, need to be re-appraised and new ways of organising societies need to evolve if humanity is successfully to sort out global environmental issues like climate change, overpopulation etc…but that’s for another day.

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Response from Kabul about Schools, Hospitals and Mosques

Monday, October 19th, 2009

Relating to my blog dated 6 October 2009 (see below for links), I have had this response from Mike Hollis, who is Programme and Strategy Co-ordinator, Department for International Development in the British Embassy in Kabul, Afghanistan.

“The answers are:

Education: In the last six months, the UK has refurbished five schools in Helmand province. We also funded the refurbishment of training infrastructure and a teacher training centre in Kandahar province in 2002.

Health: In the last six months, the UK has constructed or refurbished four health centres in Helmand province. Last year, the Bost hospital in Lashkar Gah received approximately £800,000 for a new maternity clinic and college that would not have been possible under the Taliban.

Mosques: In the last six months, the UK has completed three mosques in Helmand province.

The vast majority of our support for health and education is not through direct construction but rather support to the Afghan Government budget. Since 2002, the Department for International Development (DFID) has contributed £360m to the Afghanistan Reconstruction Fund (ARTF). The ARTF is managed by the World Bank and reimburses proven government expenditure on operating costs. The ARTF helps pay the salaries of 320,000 civil servants, including health workers and teachers. A further £165m to the ARTF to 2012/13 will cover 14% of the Government’s recurrent costs in health and education. More information about the ARTF is available at www.worldbank.org/artf

DFID has since 2003 also invested £32m in the National Solidarity Programme (NSP), which has established over 22,000 elected Community Development Councils across Afghanistan. Through these councils, 47,000 projects have been chosen by local people to improve health, education, water and roads. More information about NSP is available at http://www.nspafghanistan.org/”

My links to the two earlier blogs:

http://www.steenbergs.co.uk/blog/2009/10/schools-hospitals-mosques-for-afghanistan/

http://www.steenbergs.co.uk/blog/2009/10/a-better-way-to-help-afghanistan/

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Schools, Hospitals and Mosques for Afghanistan

Tuesday, October 6th, 2009

Following on from my blog of the other day, I contacted the Department for International Development (DfID) yesterday through their website to ask them the following questions:

  1. Are you building/repairing any schools in Afghanistan? If so, how many?
  2. Are you building/repairing any hospitals in Afghanistan? If so, how many?
  3. Are you building/repairing any mosques in Afghanistan? If so, how many?

I shall keep you posted as to whether I get any answers.  If you are interested the report about progress by DfID and the United Kingdom is contained in the Evaluation Report at http://www.dfid.gov.uk/Documents/publications/evaluation/afghan_eval.pd or in summary form at http://www.dfid.gov.uk/Documents/publications/evaluation/afghan-eval-summary.pdf.

There’s also an article on Times Online that provides an overview of the state of the UK humanitarian effort in Afghanistan at http://www.timesonline.co.uk/tol/news/world/asia/article6336722.ece.

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A better way to help Afghanistan

Sunday, October 4th, 2009

Today, General Sir David Richards is quoted in The Sunday Telegraph as saying “Taliban and al-Qaeda know that the conflict will not be lost in Afghanistan, it will be lost in Britain, America and France, and their tactics are designed to get at that vulnerability.  If you look at the geopolitical consequences of failure, it’s not just in the short term on the streets of the UK.  If the Taliban and al-Qaeda – and, believe me they are one and the same – think they have defeated is, what next?  Would they stop at Afghanistan?”

He then uses the domino argument that used to be used for justification of the Vietnam war, i.e. next on the list would be Pakistan, India etc.

I do not believe that he is correct as I think the underlying cause of the issues is poverty rather than religion.

There are very few rational reasons for war.  The only completely justifiable reason is national security, and I mean a genuinely direct threat to national security; even George Orwell, a committed pacifist, accepted and joined in against the potential of invasion of the United Kingdom by Hitler and the Nazis.  Neither the threats in Iraq and Afghanistan were direct threats to national security; the United Kingdom never used attacks by the IRA in Northern Ireland and mainland Britain as a reason to invade the whole of Southern Ireland.

The only other rational reason for war, although in my opinion it does not constitute justifiable reason for wars, is protection of economic interests (which could have been a reason for the American-led invasion of Iraq, but no senior politician has ever admitted this one).

Wars are started for many other reasons, ranging from the pique of national leaders to power struggles.  Worryingly there has been a massive increase in the number of conflicts since 1945, with a massive jump since the mid-1980s.  I suspect that most of these are internal power struggles rather than wars between sovereign states.

It is time for peace.

These wars will not solve some of the key questions that underlie the rise in global terrorism:

  1. How do you close the poverty gap between the developed world and the developing world?
  2. How do you bring education to the developed world, especially to women?
  3. How do you provide finance to new businesses, especially for women, in the developed world to enable them to start their own businesses and struggle their way out of poverty?

War does not solve these questions and the many more detailed questions about how to remove global poverty.  It treats in a very blunt way the symptoms of poverty.

Think about what good could be done for people’s lives if some of the military expenditure were spent trying to build Afghanistan (and rural Pakistan) out of poverty by promoting education.  Doesn’t even this Labour Government acknowledge the importance of education to pulling people out of poverty; this has been a cornerstone of Labour policy for years, even its mantra “education, education, education”, but one they have failed to transfer to other countries. 

Britain spends between £2.6 billion (2008) and £3.5 billion (2009-10) on fighting in Afghanistan.  In contrast, Britain’s development expenditure is about £100 million a year (Source:  Country Programme Evaluation Afghanistan, Department of International Development, May 2009), none of which seems to be for education.  The USA spends about $3 billion directly via its Overseas Development Assistance, with a further two-thirds being indirect bringing their annual total to $9 billion (Source:  Country Programme Evaluation Afghanistan, Department of International Development, May 2009).

What Britain is doing to help Afghanistan is a drop in the ocean.  It looks pathetic against the Americans input.  Also, all the expenditure seems to be being spent on humanitarian projects and big infrastructure developments.

Britain’s involvement in Afghanistan will fail even if it were to become a military success without addressing the overarching question of poverty, and its solution through building an education system and nurturing an economy.

I would estimate that it would cost about £35,000 to build a school in Afghanistan and support for up to 5 years (based on the $50,000 quoted in the Central Asia Institute web site www.ikat.org which is part of Greg Mortensen’s saintly work in rural Northern Pakistan).  Even with the inefficiencies of British bureaucracy, we must be able to build schools for £70,000.

So I think the British Government should commit to building schools in Pakistan. 

The current UK schools building programme is for for 200 new schools each year at a cost of £45-55 billion over the programme. 

So let’s say that the Government should commit to building 200 schools in rural Afghanistan at a cost £15 million, or £3.75 million a year for 50 schools each year.  Intriguingly, that’s less than it costs per school in the UK, which is about £27.5 million, so perhaps we just drop one school from the building programme and commit that to schools in Afghanistan or around the world.

Or how about something even more radical, Britain could build some mosques.  This would show that this is not a religious conflict.  This would act as a counterweight to radical Islamic mosques and support a more balanced and tolerant Islam.  This is also important as much of the teaching is carried out within mosques, especially on the interpretation of the Koran.

Without getting the underlying basics of education correct then you cannot even hope to start solving the economic and political issues.

The downside is that the British Government’s name is so tainted that they may simply not be able to build schools or mosques without causing offence.  If that’s the case, then that speaks volumes about the popularity of our policy on the ground.

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On the Nature and Importance of Business Risk

Sunday, July 12th, 2009

 

One of those slightly nerdy things that has been niggling at my brain for some time now is “business risk”.  Now I don’t mean financial risk which is something that investment bankers and hedge fund managers claim to understand and to deal with, nor do I mean insurable risks which insurance and reinsurance businesses deal with.  These I would class as exogenous business risks, i.e. non-controllable business risks that need to be offloaded from the business so far as is practically possible.

 

In fact, it was by looking at the behaviour of investment bankers that started me worrying away at risk.  In 1992-1993, I was looking at buying Carnegie from PK Bank on behalf of WestLB, the German wholesale bank.  It was eventually bought by Singer & Friedlander.  When I was in Stockholm, I remember chatting with one of the option traders, who showed me his trading screen and on it there was a beautifully simple and elegant curve that showed the pricing of some option over time.  What struck me was 2 things:

 

1.       The trader didn’t actually understand option theory, but knew what his computer was telling him.

2.       What would happen if option theory was actually wrong, but that it had become correct because everyone was taught that an option is priced using the Black-Scholes model or a similar theorem.  So if everyone is told that an option is priced following this theory and all computer programs use this theory to construct their simulations of option pricing, then it becomes a truism that options can be priced using this theory.  But if the theory is simply an artificial construct, then all traders are actually doing is playing a game with a certain set of rules and they may as well construct any different set of rules or play any form of game and pit their wits against each other in a different artificial game.

 

Business theoreticians do acknowledge the importance of risk.  They make statements like “the opportunity cost of capital depends on the risk of the project”.  As an accountant and then invesment banker many aeons ago, I remember learning about Modigiliani-Miller, calculating  beta factors and WACCs (weighted average costs of capital) and using them in valuations of businesses, and working out IRRs (internal rates of return) for venture capitalists. 

 

But in the end, economists and business people simply fudge the answer.  They have created theories based on the following: (i) they assume that all businesses are big; (ii) they assume that all businesses are financed by people that hold portfolios of investments; (iii) they assume that the availability of capital is limitless subject only to pricing; (iv) they assume that all business people, investors and financiers have perfect knowledge and a total understanding of how the markets operate; and (v) they assume that all business people, investors and financiers are rational. 

 

So they simply state that the individual risk of a business does not necessarily matter, rather what matters is the risk in shares of similar businesses on the stockmarket adjusted for a further risk weighting.  Once again, have we created an artificial construct that looks good on paper and enables high financiers to trade businesses, strip out value and pass them on for theoretical values?

 

I think it’s a load of rubbish.  Most businesses have no genuine equivalents on the stockmarket, markets are irrational and capital is a limited resource for smaller businesses and because businesses are really human in their behaviour and are not financial machines.  The difference between treating the world as an animal/human system rather than a machine throws up all sorts of interesting new ways of looking at politics, economics and sociology.  So as most businesses have no actual comparators, anyone who actually deals with project risk cheats a little bit more by deciding what return they want to make. 

 

So, in other words, working out the project risk or individual business risk is too difficult, therefore we will simply state that 15% is a good annual return so we will do anything that beats that rate of return, or if I am a private equity player or hedge fund, I will look to making 30% or more on an annualised basis. 

 

But this circuituous argument misses the crux of the question “what is business risk?”.  I think business risk really does matter and cannot be theorised away.

 

Many people will simply say – so what?  Does it really matter what the risk is if you already know the return you want to make, plus the system seems to work pretty well, so why bother?

 

I think it is important to at least try and understand the empirical nature of business risk for the following 2 reasons:

 

1.      Business risk is the other side of the theoretical business equation: risk = reward, i.e. the profit you make is determined by the risks you take.  So through understanding business risk and the potential to manipulate business risk to your advantage you can improve your profitability; and

2.     Conversely by failing to understand business risk, you can make your business very vulnerable to sudden collapse.  Witness what happen in the Lloyds of London insurance market and more recently in the financial sector, where in each case there was a sudden catastrophic collapse in an industry because too much business risk (which happens to be financial as well in this case) had been taken on with little genuine understanding of what was happening.

 

It is also possible to see how some larger businesses grow by transferring their business risk onto other people.  This is especially simple to see in the classic leveraged buy-out model where the equity providers of a business transfer the financial risk in a business onto the debt providers and tax system.  The second part is even acknowledged in business theory as utilising the tax shield, i.e. you don’t pay tax on the part of the profits used to pay interest on loans, hence if you increase the level of debt in your capital structure, you reduce the underlying cost of equity for a business.  However, by reducing the level of equity in the business by stripping out all the accumulated profit reserves and minimising the cash value of ordinary share capital injected into the ownership structure, the business is much more susceptible to business and financial shocks.  So, for example, Gala has been built up by private equity businesses that have cobbled together many established businesses, however with changes in the economic climate the value of the equity invested by the private equity providers is now zero and, as they have no reserves’ buffer, they must decide whether to invest more equity or let the group go into administration.

 

Let me give an example in our business which is in the small world of spices.  We are regularly being asked by customers to provide a price for buying/selling say 500kg of organic cumin powder over 12 month period or more recently an organic dukkah mix at 60kg every month.  However, when we ask whether we can have a contract for this, there is a lot of huffing and puffing that basically comes down to the fact that customers won’t do this.  In effect, therefore, customers are asking Steenbergs to accept the sales risk of the customers’ end product as well as our stocking risks, the foreign exchange risks of the organic spices and ingredients (the forex risks have been horrific in the last 12 months).  I characterise it as trying to get a fixed forward rate or an option to buy for 12 months without paying the cost of getting that rate.     The volumes trick is another very common trick, i.e. ask for a price for 1 tonne of organic black pepper then place an order for 50kg and never come through with indicated the volumes, yet the customer still expects the same price.

 

An even stronger example of the transferance of business risk relates to Tesco.  Some farming friends of ours entered into a contractual agreement with Tesco in 2008 to grow organic potatoes.  They had never dealt with Tesco and were told by everyone that they were mad to even try as it was like grabbing the tail of a big tiger.  However, they felt that they’d got a contract in place and that you never know how it will work out unless you try.  The credit crunch ensued, organic sales fell and Tesco said that they didn’t want the potatoes; on being explained that the potatoes were growing in the ground and there was a contract in place, Tesco’s response was that if they insisted on delivering them, Tesco would simply reject the majority of the delivery and it would be wasted.  I appreciate that this story is unlikely to be provable as Tesco will have emails or a paper trail to show that the farmer willingly decided to give up the benefits of the contract.  These organic potatoes are still in the ground and are actually growing again this year, so if anyone wants loads of really nice organic potatoes I can tell you where to get some.

 

Going back to my thesis, Tesco sought to mitigate its purchasing risk by entering into a forward contract with the farmer, which is prudent, but it did more as it actually also transferred the sales risk of selling organic potatoes in its potatoes by wriggling out of its contractual obligations, which had been entered into in good faith.  In effect, it really had an option to purchase organic potatoes, however it never paid the actual cost of the benefit of entering into such an agreement. 

 

It is right and proper for Tesco and other retailers to mitigate their purchasing risks and to maintain their supply chain, but it is arguably not fair for them to offload their selling risk.  Selling product is what the supermarkets do and they have all the detailed information on sales patterns, so they should be expected to live with that risk.  If they feel that some of the sales risk should be borne by their supply chain, then supermarkets should have a reciprocal open book policy.  Supermarkets often operate open book policies whereby suppliers must show their accounts to the supermarket so the supermarkets can decide a fair profit for the supplier, so if the supplier must bear some of the selling risks they should be given all the accounting data on the sales and margins of their product lines and competitors “better to plan for future production.”  But I bet that supermarkets have never opened books to anyone!

 

I suppose in the end if suppliers are willing to trade on this basis then that’s what the market is and people like us should suffer the consequences of inequality in the marketplace.  In fact, I think it also indicates 2 opportunities: 

 

1.       You should do everything possible to set up your business in a way that transfers most if not all business risk away from you.  In other words, your business should be as close as possible to being an agency operation but you need to keep the margins at the level or higher than your peer group.  So at Steenbergs, we are now doing everything to shift our business over to this agency concept by increasing the level of outsourced activities within the business. 

2.       If you are a private investors, you need to find businesses that are set up as these agency style businesses, but that have the outside image of being a “normal” business.  While strongly branded consumer products are a classic example of this, some retailers may also have similar characteristics.

Using this concept of business, I also think that you can come up with perhaps a better definition of monopoly behaviour, even if it is harder to verify.  A particular type of business will under normal circumstances generate a particular return or operate at a particular margin.  So for example supermarkets normally have operating margins of around 2 – 3%.  There is then a range of 10-20% either way from the average return due to normal business efficiency, i.e. some businesses are simply better organised at getting the right stock to the right places at the right times, or at billing or whatever.  In the early 1990s, Sainsbury for example was simply atrocious at getting its stocking right which was simply down to bad management, so its operating margins and returns fell.  But a monopoly can shift its returns and margins significantly beyond those anticipated from normal operating, and it does this in part by shifting some its “natural business risk” onto other unconnected people within its operational chain.  In other words, simply looking at pricing is not necessarily the only characteristic of a monopoly but you should also consider how it can change the normal characteristics of its operational environment.  Some of this change will be fine, but the judgement for regulators is to ensure that this behaviour does not become predatory and so instilling greater overall risk into the business environment.

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The West in decline, the rise of the East

Sunday, June 28th, 2009

 

There are 2 recent political events that hint to a major shift in the global geo-political structure:

 

·         The victory of the Sri Lankan government over the Tamil Tigers after 20 years of civil war in a overtly aggressive final push;

 

·         The victory of President Ahmadinejad in the elections in Iran recently which are almost certainly a result of a biased election process.

 

In both cases, the so-called first world or developed world moaned, complained and whined but both the Iranian and Sri Lankan governments simply ignored the views of their supposed betters.

 

This is simply because neither country needs to pay any heed to the views of the Western world, nor does the USA or the UK have any leverage.  The question is how did this happen?

 

In the case of Sri Lanka, they have sold a plot of land at Hanbantota to China to build a base for China’s Navy.  China has the money, China has the manpower, China has the military might.  It now is moving away from its traditionally internal looking political attitude to looking outwards for the first time in over 500 years. 

 

It wants first and foremost to protect is new found economic might.  So, like the British with its global empire, it is beginning by a desire:

 

1.       to protect its ability to trade through protecting its merchant fleet and keeping the shipping lanes open;

 

2.       it is looking to protect its access to base commodities like oil from the Gulf and also look at its (currently unsuccessful) deal with Rio Tinto and new discussions with Anglo American;

 

3.       it is looking to invest strategically by buying key technologies.

 

In the case of its low level military expansion it has acquired sites in relatively weak countries – Bangladesh, Burma Pakistan and Sri Lanka.  Sri Lanka then got military hardware in the form of guns, ordnance and six F7 jet fighters which allowed it to move on the Tamil Tigers.  So when China is providing over $1 billion and the UK £1.25 million and the USA $7.4 million, who cares what the so-called Developed world thinks.  Britain and America are simply impotent.

 

Iran has oil.  The price of oil is now relatively high, so the Iranian state has its own cash resource.  It does not need tax monies to finance itself as the governments do in Europe and America.  As a result, it does not need to listen to its people when it makes a political decision, which in this case seems to be to “elect” its incumbent President at all costs and who cares about auditable legitimacy.

 

The oil states have so far confined themselves to economic imperialism for the simple reason that the Gulf States do not have genuine depth of population, but Iran does.  So in the same way that Nigeria can happily tear itself apart with internal fighting financed through oil, Iran can ride roughshod over the democratic system it has put into place to give itself legitimacy.

 

With the global financial and economic crisis crippling the Western world in the short term and hobbling it in the long term, power has shifted eastwards.  China is in the ascendant and Europe is perhaps in permanent decline.  The USA will survive because of its size and its capacity to innovate and reinvent, but its sphere of interest will shift to the Pacific.  Perhaps it should even move its capital to the West Coast?

 

I don’t know where this change will take us.  However, I do know that the future politics of the world will be very different from the last 300 – 500 years; China and India are regaining their rightful places as the most powerful nations in the world.  Furthermore, countries like Britain must be very careful:

 

(a)     It must get its national accounts positive rather than constantly running in deficit as the cash-rich nations will not bankroll us forever, particularly as they become more powerful and more interested in themselves and West Coast of America; and

 

(b)     It must not become over-reliant on the East to do its manufacturing because they have now become the price-setters for much of our manufactured goods which will not be benign for much longer.

 

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Hope for British democracy?

Monday, June 1st, 2009
 
 


Behind all the excitement of the MPs expenses scandal, there lies a kernel of hope for the British democratic system. 

 

Michael Martin had requested that the Metropolitan Police investigate the leaking of the MPs expenses to The Daily Telegraph, however the Metropolitan Police declined to investigate further as there was little likelihood of prosecution.

 

The police spokesman said: “The assessment was informed by a recent published decision from the Director of Public Prosecutions that was, in part, applicable to this case. From this the Met believes the public interest defence would be likely to prove a significant hurdle, in particular the “high threshold” for criminal proceedings in misconduct in public office cases.

“Whilst the unauthorised disclosure of information would appear to breach public duty, the leaked documents do not relate to national security and much of the information was in the process of being prepared and suitably redacted for release under the Freedom of Information Act.”

The “recent published decision” related to the view of the Director of Public Prosecutions (“DPP”) regarding leaks by the MP, Damian Green, and the Home Office civil servant, Christopher Galley.  Within that statement, the DPP also stated that “some of the information leaked undoubtedly touched on matters of legitimate public interest, which were reported in the press.”

 

I believe, and I cannot believe that many people would believe otherwise, that the information regarding MPs’ expenses, also, touches on matters of legitimate public interest even if the Metropolitan Police did not allude to that.

 

For democracy to work and for the electorate to believe in it, the power of the central governing body has to be controlled and monitored.  In part, this is done via elections, however these are a relatively blunt tool (after all General Elections are only every 5 years and the last 2 Governments have actually hung around for around 15 years each) and have become rather too predictable – two parties competing for power in a mock Machiavellian dance over policy documents that they then ignore and fail to meet.  If politicians were directors of a publicly listed company, they would potentially have been prosecuted for misrepresentation within their Manifestoes.

 

But in this instance, the press has been allowed by the police to carry out genuine, legitimate investigative journalism and expose the electorate to the gross behaviour of their representatives.  And as a result, some MPs are having, or will have, their careers terminated or drastically set back, and it may even bounce the Government into calling a General Election.  After all what democratic legitimacy does the current Parliament have to sort out the current mess over expenses when they have patently failed to get it right in the first place.  The upcoming European and Council Elections will certainly impact the political landscape significantly for all parties with the potential upswing for some minor parties.

 

For me, the most worrying trends within New Labour have been their attempts – in the name of modernisation – to remove some of the checks and balances that have evolved within the Democratic system, and so increase the power of “Parliament”, or at least a small group of people surrounding the Prime Minister (many of whom are unelected). 

 

Gordon Brown believes he is the saviour of the British political system (as well as the economic system), however it is his belligerent belief in his own intellectual ability (perhaps even intellectual superiority) and that it is his right and duty radically to change our constitution that is dangerously arrogant.  Gordon Brown is not Britain and his belief that “I am Britain” (or perhaps in the words of Louis XIV “Je suis l’etat.  L’etat c’est moi” which seemed to be what Gordon Brown was saying on his Radio 4 interview this morning) is the vanity of power before a revolution, and this all looks similar to the build-up to the French Revolution that eventually overthrew Louis XVI, but was actually precipitated by the financial crisis in France after the 7 years war and the American Revolution.  And just like Louis XVI, Gordon Brown was not elected by the people to serve the people as their leader.

 

It is fundamental for the integrity of democracy that the centralising power of the Prime Minister is rolled back.  It is important that external institutions, such as the legal system, the Civil Service, Local Councils and the Press, can be enabled to scrutinise and moderate the natural inclination for the central power to over-reach its mandate.  But this Government does not have the moral mandate to make these changes and this Prime Minister does not have the moral mandate to lead Britain.

 

Overall, I am a great believer in the fact that it is often the small things in life that have a greater impact than the big, so (for example) the quiet word in the ear of a Minister that something within a Bill is not quite right may be more important than the discussion of that Bill in the House of Commons.  Moreover, the House of Commons failed to moderate Tony Blair and stop New Labour waging wars in Afghanistan and Iraq, and the House of Commons has been unable to get a referendum on the Lisbon Treaty which impacts questions of British sovereignty.  More press activity and power in the regions might serve to clip the wings of an arrogant House of Commons and expose the limp acquiescence of Backbenchers and the Opposition to anything the Government and the Leaders of the Parties propose.

 

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