Amazon vs. Walmart: Bezos Goes for the Jugular with Whole Foods Acquisition
Key Highlights
- On Friday, June 16, Amazon announced it was acquiring Whole Foods Market for $13.7 billion, the largest acquisition in the online retailer's history.
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Facebook community is now officially 2 billion people!
Facebook CEO, and founder Mark Zuckerberg shared a Facebook status announcing and sharing his joy on the growth of his social media empire which he founded and launched from his dorm room at Harvard.
Chief Scientist @ Bitcoin Unlimited's Introduction To Bitcoin
Peter R. Rizun, Chief Scientist @ Bitcoin Unlimited started by saying:
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Do More With Your Google Mail Account
Google is no doubt one of the biggest tech companies in this modern century, with various products and offers to be accessed from only one platform, which is the internet.
Apart from just sending and receiving mails from business associates, clients, family, friends, i will offer 5 other services offered with an email account registered on mail.google.com
Selling Your Business? Stop Leaving Money on the Table
Key Highlights
- Current market conditions are prime for selling a business. The market is experiencing high multiples due to plentiful dry powder held by private equity firms, record amounts of cash held by strategic corporate buyers, a low interest rate environment, and high prices for publicly-traded equities.
- The time it takes to sell generally ranges from five to twelve months. The determining factors around timing include the size of your business and the dynamic balance between buyers and sellers in the market.
- Valuations are more of an art than a science. The best business valuation methods typically involve cash-flow. Still, the three most commonly utilized valuation calculations are the discounted cash flow, market multiples, and asset valuation.
- The best practices for maximizing shareholder value include the following:
- Make sure the business can thrive without you. You need a management team or key employees that can continue to drive cash flow, especially if you plan to exit the business or will have limited involvement in day-to-day operations. You should also broaden your customer base so that the business is not at risk if a couple key customers leave post-sale.
- Learn the dynamics driving acquisitions in your industry. Many business owners spend their time focused on keeping the business running instead of devoting energy to planning for its sale. Stay apprised of the motivations for financial and strategic buyers in your industry, as this can help you negotiate a higher exit value.
- Hire the right advisors. Don’t do it alone. An experienced M&A advisor can market your company to a larger group of potential buyers than you can access on your own. Early engagement of an independent valuation specialist can provide a market check on valuation and allow you to incorporate value drivers into your pre-sale planning.
- Examine and adjust operational efficiencies strategically. If necessary, it could be worth adopting efficient operating procedures before the sale. This may involve investments in new equipment or technology or changes in staffing.
- Factor tax considerations into sale decisions. Decisions around how to sell your business (merger, sale of stock, sale of assets) should consider tax implications carefully. It is also important to anticipate changes in tax law.
Investing in the Sale
For many business owners, their business represents the culmination of their life’s work and a primary source of wealth. The reasons leading one to sell a business can vary—perhaps a competitor has presented you with an unsolicited, lucrative offer. Or, perhaps you are simply ready to retire. Regardless of your motivation, the sale process can prove to be complex, with considerations including the right time to sell, whether or not to employ advisors, which business valuation method to use, and how to maximize the valuation. Therefore, when thinking about how to sell a business, you will want to maximize the value through a combination of planning and timing. Building a solid exit plan can take several years, and business owners ideally should start planning for a sale 3-5 years before they wish to transition out. You’ve invested in growing your business. When it comes time to sell your business, you must do the same.
The following analysis will help you understand the current acquisition market environment, how long it takes to sell businesses (small and large), other major considerations during the sale, how an accurate price is determined, and how to maximize acquisition value.
Current Market Conditions for Selling a Business
Currently, with acquisition multiples at a record high, market conditions are optimal for selling a business. According to PitchBook, the median EV/EBITDA multiple hit 10.8x in 1Q 2017, a significant difference from the 8.1x multiple in 2010.
The following factors have converged to create a robust market for acquisitions with high acquisition multiples:
Record “Dry Powder” Held by Private Equity Firms
Research company Preqin reports dry powder for private equity buyout funds of $530 billion at the end of 1Q2017, a significant increase from the recent low of approximately $350 billion at the end of 2012. Further, new fundraising by private equity fund managers shows no signs of slowing. In the early part of 2017, Apollo was seeking $20 billion for a new fund, and KKR had raised $13.9 billion for its new fund.
Strategic Corporate Buyers are Holding Record Amounts of Cash
According to Factset, US corporations held $1.54 trillion in cash reserves as of the end of 3Q2016, the highest total in at least ten years, and a dramatic increase from the $700+ billion figure reported in 2007. Of this, much is held overseas, and if repatriated, a portion may be used for acquisitions.
For a strategic buyer, acquisitions can deploy cash reserves and generate returns in excess of corporate treasury bank accounts and investments. Corporations also seek acquisitions that create operating efficiencies or bolster their position in consolidating industries. Consequently, strategic buyers often pay a premium for acquisitions compared to financial buyers such as private equity firms.
Low Interest Rate Environment
Those interested in selling a business benefit from low interest rates, as they directly affect acquisition prices. Duff & Phelps, which publishes a widely-used study of the cost of equity capital, incorporates the ten-year trailing rate on the 20-year Treasury bond in its benchmark figure. The 3.5% figure reflects the low yields of the last ten years. Duff & Phelps’ comparable rate at the end of 2008 was 4.5%. At the same time, the equity risk premium also decreased, from 6.0% to 5.5%.
High Prices for Publicly-traded Equities
Business values are often determined with reference to public equities, and with the S&P 500 and NASDAQ at or near record levels, those looking to sell a business benefit from a comparable increase in prices.
All of these factors have led to an acquisition market ideal for selling a business. Large acquisitions have recently been made for eye-popping prices. Over the past year:
- JAB Holding Company offered to acquire Panera Bread for $7.5 billion, approximately 19.5x Panera’s EBITDA according to Nation’s Restaurant News.
- Private equity owned Petsmart acquired pet product site Chewy in the largest acquisition of a VC-backed internet retailer. Chewy is one of the fastest-growing eCommerce retailers on the planet.
- Unilever acquired Dollar Shave Club in 2016 for $1 billion, paying 6.67x 2015 sales and 5x projected 2016 sales.
Despite these favorable conditions, selling a business still requires advance planning and thought. Numerous factors can positively or negatively affect the value of your business. Addressing these issues early can be beneficial when it comes time to sell.
How Long Does Selling a Business Take?
The duration of the sale process varies. One determining factor is the size of your company. As of the end of 2016, the median time a small business was on the market was a little over 5 months (160 days), down from a peak of 200 days in mid-2012. For larger companies, the sale process can take between 5 and 12 months, as indicated below.
As a business valuation expert, my experience is much the same. The owner of a larger business is more likely to employ a M&A advisor to sell the business, and the advisor is more likely to conduct an auction process to maximize the business value. In addition, as the business becomes more complex, the involvement of more people can lengthen the due diligence process. I have led due diligence teams in large acquisitions where we regularly conducted meetings with as many as fifteen people, including specialists from various departments. Inevitably, inboxes became crowded and the frequency of meetings increased. It became more difficult to ensure that everybody involved was on the same page.
The time it takes to sell your business is also based on the dynamic balance of business sellers and business buyers in the market. The importance of this is particularly pronounced in the small business acquisition market, as seen in the chart below. In 2012, fewer buyers had the resources to buy a business, and acquisition financing from banks and other lenders was still negatively affected by the 2008 financial crisis. As the number of buyers and availability of financing increased, the demand by buyers increased, and median time to sell a business decreased.
Considerations in Determining When to Sell Your Business
Your Motivations for Selling
In general, the value of a business is equal to the sum of all expected future cash flows. When the value of the offer is greater than your projected future value of the firm, it’s time to sell.
“Value” can have many meanings. For one, the business may hold financial or strategic value that makes it compelling to an acquirer. Alternately, the business owner may have other financial uses for the sale proceeds—if the return on the alternative investment is higher than on the business, it’s also time to sell.
However, there can be non-financial motivations for selling a business. I frequently see business owners who have spent a significant portion of their lives building a business and are simply ready to move on to the next venture. Others sell for lifestyle reasons: a former client sold several businesses over 20+ years to fund his travels around the world. Had he agreed to stay with these companies post-sale, he would have received higher valuations. Still, the flexibility to travel and pursue adventures remained his priority.
This is consistent with seller surveys. According to a 2016 survey, the top motivation for small business owners to sell their businesses was retirement (40%), followed by burnout (21%) and the desire to own a bigger business (20%).
Business Growth
Above all else, a buyer wants assurance that the cash flows paid for will be realized after the sale. Selling a business will be easier, and the value received by shareholders maximized, if the business is growing and profitable. The ideal time at which to sell a business is when cash flow, growth, and consequent valuations are going to peak. When a seller or buyer anticipates a decline in the rate of growth, it could result in a significant drop in value. As you might expect, this is not a recommended time to pursue a sale.
The importance of growth to business value and sale timing can be illustrated by the Constant (Gordon) Dividend Growth Model: Value of the Stock = Dividend / (Required Rate of Return - Expected Dividend Growth Rate)
Let’s apply this formula to an example. If a business pays $1 million in dividends, and the required rate of return is 13.5%, a business that has no dividend growth, all other factors held constant, would be worth approximately $7.4 million. On the other hand, if the same business is expected to grow 1% per year, the value increases to $8 million. For a company that does not pay dividends, the same principle can be applied to cash flow. In this example, each percent increase in expected growth leads to an 8% increase in value.
Tax Considerations
Just as the legal form of business at a business’ inception is determined by tax considerations, when it comes time to sell a business, the choice among a merger, sale of stock, or sale of assets should also factor in tax implications.
For example, a sale of assets will likely result in capital gain or loss treatment, whereas an employment agreement results in ordinary income and is taxed at a higher rate. Even in a sale of assets, you should allocate the purchase price among assets in a tax-efficient manner. An allocation to inventory or short-lived assets will typically result in more favorable tax treatment than an allocation to real property or goodwill.
Even expectations of a change in the US tax laws can impact the sale of businesses. If the current presidential administration were likely to simplify the tax code and decrease the capital gains tax rate, business owners would likely wait to sell. When I’ve experienced cases such as these, the running joke among M&A professionals was that business sellers would likely live on artificial life support in order to survive into the new tax year and reap higher net proceeds.
Buyer Motivations
The market for acquisitions is dynamic. An owner or manager seeking to sell a business should be aware of industry-specific developments and direct their selling efforts to leverage those trends.
In my acquisitions work for an insurance company, our growth strategy was to acquire companies in markets that were overseas and less competitive. We also focused on acquisitions that would add internet sales to our existing team of insurance agents. Some of our competitors were seeking similar acquisitions. Business owners aware of those industry dynamics were able to develop a business sale strategy based on these dynamics, maximizing shareholder value.
Here are additional examples of industry-specific strategies:
- A fast-growing business in a slow-growth industry should focus on strategic buyers seeking high growth. In May 2016, food company Hormel paid $286 million for Justin’s, a fast-growing producer of organic nut butters.
- Companies with a younger customer base can be good acquisitions for established companies in the same space. Wal-Mart recently sought to expand its customer base to younger consumers by spending $200 million on eCommerce startups with direct-to-consumer models, including Jet.com, Moosejaw, Shoebuy, and ModCloth.
- For private equity buyers, businesses that lead to increased sales, lowered overhead, and increased gross margins continue to be attractive. These buyers are attracted to assets with considerable scope for optimization and efficiency enhancements.
- For strategic buyers, decisions about capital investments are often made by comparing build vs. buy options. A business that enables a strategic buyer to reach its financial or strategic goals will always have a pool of potential acquirers.
The Value of Advisors
In selling a business, you may be tempted to cut costs and undertake the task alone. However, the utilization of experienced M&A lawyers is always advisable, as contracts allocate the risk of the transaction between parties, and often contain detailed financial terms. Retaining an M&A advisor can also lead to a higher price for the sale of a business. Additional advisors such as accountants or technology and human resource specialists can also add value in specific situations.
As a financial consultant, I worked with a business owner who initially attempted to sell his business on his own by generating his own list of competitors and other potential buyers. After failing, he assembled a team of lawyers and M&A advisors late in the process. Ultimately, this unsuccessful sales attempt tarnished the sale process and raised questions about the value of the business, ultimately leading to a 25% lower sale price. In addition, the owner, who was originally interested in remaining with the business post-sale, was forced to sell to a financial buyer with a different strategic vision. He was soon forced out of the company. Though this was an extreme case, I cannot overstate the importance of building out an experienced team of advisors.
Financial Intermediaries
The two types of financial intermediaries include a) M&A advisors, and b) business brokers.
Business brokers are generally involved in the sale of smaller firms (typically with values of under $5 million). Many business brokers list businesses for sale in an online database with basic information but do not proactively call potential acquirers. With transactions of this size, the broker faces more difficulty “fully marketing” the transaction and contacting a large number of potential strategic and financial buyers. Compared to business brokers, M&A advisors handle larger transactions and engage in more pre-transaction business planning. They also contact a wider variety and larger number of potential buyers.
The Benefits of Using a Financial Intermediary Include:
- Reduced time and attention necessary from the business owner. The process of selling a business can often last between six and twelve months. Most business owners don’t have the time or ability to supervise each stage of the process without diverting needed attention away from current business operations.
- Buffer between buyer and seller. This is especially important in situations where the seller of the business is seeking to keep its plans confidential; an intermediary can solicit interest on a “no-names” basis.
- A level playing field between novice sellers and experienced buyers. Especially with financial buyers or active strategic buyers, the difference in knowledge of the acquisition process can be vast. Private equity buyers can buy dozens of businesses each year, and the most active strategic buyers, such as Google, can acquire 10+ companies in a year. A business owner selling a business will have trouble competing in knowledge.
- Network of potential buyers and knowledge of marketing pitches. An experienced financial intermediary with a strong network and marketing knowledge is well-positioned to generate interest in your business. If successful, the price at which you can sell your business will be enhanced by creating competition among buyers in an auction process.
- Experience with the due diligence process and legal documentation. The due diligence process whereby buyers examine the books and records of the business being sold, can be too time-consuming and complex a task for business owners to undertake themselves. In addition, experienced financial intermediaries help create a transaction structure and collaborate with attorneys on legal documentation.
The Drawbacks of Using a Financial Intermediary Include:
Price
Financial intermediaries can either charge a fixed transaction fee, a retainer, or both. The business seller will also be responsible for the expenses of the intermediary.
- Business broker fees are generally in the range of 10% of the acquisition price. They typically do not charge a retainer, and fees are only paid upon the sale of the business.
- Fees for M&A advisors vary more widely. The fixed transaction fee for selling a business generally starts in the $40-60,000 range, and many advisors base their “success fees” on the “Double Lehman” formula: 10% of first $1 million of transaction value, 8% of second $1 million, 6% of the third $1 million, 4% of the fourth $1 million, and 2% of everything above that. According to a 2016 survey, typical middle market transaction fees were as follows (based on percentage of transaction value):
- $10 million 3.5% – 5%
- $50 million 2% – 3%
- $100 million 1% – 1.5%
- $250 million 0.75% – 1%
You should align your incentives with those of the intermediary. If an advisor’s retainer is disproportionately high, their incentive to complete a deal is lessened. In these cases, the business owner should resist fee arrangements that include a relatively large up-front fee. On the other hand, if the “success fee” is disproportionately high and the advisor only receives significant compensation upon a sale, it creates an incentive for the advisor to complete a deal—even a bad one.
Disclosure of sensitive information
An M&A advisor may contact hundreds of potential buyers and circulate confidential business information in an effort to create a robust auction and maximize business value. The mere disclosure that the business owner is considering a sale can significantly impact customers, competitors, and employees. An experienced advisor can limit the risk of confidential information being disclosed.
Independent Valuation Experts
Retaining an independent valuation expert can maximize value, especially when used in conjunction with an M&A advisor. With a large percentage of M&A advisor fees being paid only if a transaction closes, the M&A advisor experiences an inherent conflict of interest. That is, a business cheaply valued will sell more quickly than one that is fully valued. An independent valuation expert provides the business owner with a second opinion and a market check.
As with employing a financial intermediary, the downside of retaining an independent business valuation expert is price. They can also lengthen the sale process. For many businesses, an appraisal can cost between $3,000 and $40,000 and take 4-6 weeks, although more cost-effective options are available for smaller companies. Valuations of larger or more complicated business can take months and be far more costly.
Legal Advisors
The involvement of experienced merger and acquisition lawyers is critical. After all, structuring a business sale transaction and negotiating the documents are exercises in risk allocation. These documents ensure that the seller will receive the full amount owed to them and will have limited liability post-sale, while also ensuring that buyers receive the value from the acquisition.
To counter typical buyer protection provisions such as representations and warranties or noncompetition and nonsolicitation agreements, experienced legal advisors can help you obtain favorable terms and secure protections for you. This is especially important if you are selling to a business of much larger size, which would inherently have more negotiating power.
Determining the Right Price
Over the years, I’ve come to find that business valuation is as much art as science, as evidenced by the fact that 27% of business sale transactions don’t close. Of those that don’t close, 30% fail because of a gap in valuation. However, experts generally agree that there are three primary methods of business valuation: discounted cash flow, market multiples, and asset valuation.
While all of these methods can prove useful in the right situation, valuing earnings or cash flow will generally provide a more accurate view of the value of the business being sold. Even better, a business owner selling a business knows of an identical business that has been recently sold and knows the price that it has been sold at.
Discounted Cash Flow and Capitalization of Earnings Methods
Absent a recent comparable business sale for benchmarking, discounted cash flow or capitalization of earnings valuation methods can be utilized. On one hand, discounted cash flow models are typically used to model growing businesses, and they estimate pro forma projected cash flows for a reasonable period into the future. These are then discounted back to the present using a market-derived discount rate. Capitalization of earnings models, on the other hand, are used for businesses where future growth is difficult to estimate. This method’s valuations take pro forma earnings and divide them by a capitalization rate.
The pro formas are adjusted for unusual or nonrecurring events and are intended to normalize the numbers. For example, with private companies, it’s not uncommon for executive compensation to vary from industry standards. The model should be adjusted to reflect compensation levels that would be more typical. Similarly, private companies may have contracts with other companies also owned by the owner, and the pro formas should include adjustments if those contracts vary from industry norms.
It is important to note that the appropriate discount rate can be difficult to determine. The discount rate always starts with the “risk-free rate,” a long-term US Treasury bond, and is adjusted upward to take into account the extra risk of buying a business. An equity risk premium is then considered, available from sources such as Duff & Phelps, and may create an additional premium for a smaller company or a company in a more uncertain industry. On top of those adjustments, the discount rate may be adjusted even higher on the basis of “rule of thumb” estimates that the business appraiser believes are appropriate to determine the true risk of the company.
Market Multiples
The starting point for a market multiple valuation is a public company in the same industry. Multiples such as price-to-earnings, price-to-sales, price-to-EBITDA, and price-to-book are widely available from sources such as Bloomberg and Google Finance. The multiples for the public companies are then applied to the appropriate data for the business being valued. Adjustments to the resulting number are then applied to account for the difference in liquidity between publicly traded stock, which can be sold easily, and a controlling interest in a company, especially if it’s privately held.
Though high public comparables are great for owners selling their business, they may not reflect the actual value of the company. This is because the prices for public stocks are strongly influenced by general stock market sentiment and investor enthusiasm for sectors that are currently in favor. For example, a technology company will currently have higher market multiples than companies with similar business prospects because of keen investor interest in stocks in the technology sector. In addition, business valuation experts relying on market multiples often find it difficult to develop an appropriate group of public companies. A business valuation that starts with a broad group of comparable companies may not truly reflect the value of the company being sold.
Asset Valuation
The asset valuation method of valuing a company being sold is generally limited to holding companies or asset-rich companies since the value of a business’ assets have little to do with the company’s future cash flow generation. In the case of a holding company, the value of the company is made up of a collection of other corporations or equity or debt investments. Each asset may have its own policy about cash flow distributions to the holding company, so a discounted cash flow valuation is meaningless.
However, exceptions exist with energy or commodity companies. In the case of natural resource companies, cash flow is important, but the value is ultimately determined by the company’s assets underneath the ground. Similarly, a gold company may provide cash to its owners on a regular basis, but its gold is the most important value driver. The price of gold decreasing from $1,850 per ounce in 2011 to $1,200 per ounce in 2017 will outweigh any change in dividend policy by management.
Maximizing Shareholder Value
A significant portion of businesses that are offered for sale eventually don’t sell. As mentioned previously, one of the major causes is the gap between what the owner believes the business is worth and the price the buyer is willing to pay. Oftentimes, this is because an owner has focused too much on business operations, and not done enough to research or plan for its eventual sale. To avoid this issue, implement the following best practices:
Create a Deep Management Team
The common advice for employees is to “make yourself indispensable”—that is, contribute so much that you become irreplaceable by others. However, for business owners, the best course of action is the opposite: you should ensure that the rest of the team can operate without you. Though you may have been the main point of contact with key customers for years, consider delegating and transitioning these relationships to your team. Otherwise, if and when you leave, there is no guarantee that these clients will stay with the company. The risk of losing important sources of revenue or supply can significantly reduce a purchase price or lead to a failed transaction.
Examine and Adjust Operational Efficiencies Strategically
Examine your current business practices and, if necessary, adopt efficient operating procedures before the sale. This may involve investments in new equipment or technology, or it may mean adding or reducing staff. For example, buyers will be less interested in a business that diverts the time of highly-compensated employees towards tasks that can be done more cost-effectively by others.
I have been involved in many transactions where the pro forma financials and resulting purchase price are adjusted to account for needed or excess employees. If a buyer senses a risk that efficiencies and cost savings are not achievable, they will adjust the purchase price downward. Therefore, implementing these measures before a sale reduces can help justify a higher valuation.
Broaden Your Customer Base
For most businesses, sales revenue dictates the majority of its value. Buyers will always examine the business’ customer base and evaluate the risk of customers leaving after the sale. For businesses with a concentrated customer base, the risk of losing of one or two customers can place downward pressure on the purchase price. You should broaden the customer base to reduce reliance on a small number of key customers.
Alternatively, if you are heavily reliant on a single distribution channel, diversifying the distribution of products or services can also help maximize value. Multiple sources of revenue are always going to lead to a higher valuation.
Build Out Robust Financial Reports and Systems
Buyers need to rely on accurate financial statements and systems to assess the financial performance of a business. I’ve seen many large and complex businesses lack robust accounting and financial processes, relying too heavily on basic financial systems. This represents a risk to buyers. Ultimately, if the buyer can’t rely on the seller’s numbers, the buyer will either adjust the purchase price downward or cancel the transaction completely.
Buyers prefer seller financial statements that are audited by a high-quality, independent, auditing firm. Many business owners use local accounting firms when they start their businesses, and stay with them as the business grows. As a result, the numbers may not properly incorporate procedures that would be used by a larger firm specializing in business accounting. The inability to provide comprehensive and professionally-prepared statements to a buyer might reduce the value of the company.
Meet Robocop, World's First Robot Police
Just as illustrated on cinemas wayback 1987 and 2014, “Robocop,” is the newest member of the Dubai police force, debuted on Sunday at the Fourth Gulf Information Security Expo and Conference, where it greeted guests.
What Is Hindering You From Getting Promoted At Work?
Career progression is a major key in every job you spend time and efforts on. The ultimate nightmare is to be stuck in the same job, doing the same thing at the same pay for the rest of your life, as costs around you continue to rise.
So why has your career been progressing so slowly? What is hindering you from getting that promotion year after year? Here are five reasons that could be causing your bosses to withhold those promotions.
The Truth About Website Speed Evolution
A key part of fixing web speed is a programming movement called progressive web apps, or PWAs, that Google helped develop and that it's now promoting at its Google I/O developer conference. With PWAs, using the web can be a lot more like using a native app. Websites load fast, work even when there's no network connection, and notify you when a message arrives.
Is a Cashless Society the New Reality?
Key Takeaways
Only have a minute? Here are the salient points from the article:
- Many countries (Sweden and India) and regions (EU) are adopting cashless habits or policies. Driven by “contactless” pay technology, increasing digital penetration, costs of using cash, and policy initiatives, the idea of a cashless society is no longer a figment of the imagination.
- In the near term, we are likely to witness a transition to less-cash societies, rather than a switch to cashless societies. Cash still accounts for 85% of total consumer transactions globally. Among established alternatives to cash, cards are the fastest growing payment instrument.
- Cashless economy pros: increased scope for monetary policy, reduced tax evasion, less crime and corruption, savings on costs of cash, and accelerated modernization of citizens.
- Cashless economy cons: potential violation of privacy, increased risk of large scale personal and national security breaches, and technology-dependent financial inclusion.
- Migrations to a cashless economy include considerations ranging from the purely financial, to those social in nature. Consequently, a country’s specific technological, financial, and social situations will inform its specific benefits, drawbacks, and approach to such a transition.
- Two case studies in the transition to cashless are 1) India, driven by a governmental digitization and demonetization measures, and 2) Sweden, driven by a high-tech culture and digital consumer habits. In Sweden, the government and central bank play facilitatory roles.
- Countries best positioned to go cashless include the US, the Netherlands, Japan, Germany, France, Belgium, Spain, Czech Republic, China, and Brazil.
Money is Technology. Will it Be Replaced?
From barter to cash to checks to online banking, money is an evolving technology that has been part of human history for thousands of years. While cash is expected to remain a significant payment instrument in the near future, factors such as “contactless” pay systems, increasing mobile penetration, and high costs of cash (ATM fees for individuals, cash storage for businesses, currency printing for governments, etc.) are prompting society to reconsider its ubiquity. Some experts support less-cash operations, arguing that high denomination notes should be phased out as smaller bills slowly fall towards disuse. Others are more extreme, declaring a war on cash and advocating for an outright ban on physical currency.
We conclude that we are likely approaching a less-cash future, not a completely cashless future. And, while progress has been made in this transition, it has hardly been universal or uniform. A migration to a cashless economy includes considerations ranging from the purely financial to those social in nature. Consequently, a country’s specific technological, financial, and social situations will inform its specific benefits, drawbacks, and approach to such a transition.
The following discussion of cashless societies pertains to a shift whereby physical cash is replaced by its digital equivalent. Money will still serve as a unit of account and store of value, but no longer as a physical medium of exchange. This piece delves into current global payment trends, the pros and cons of a cashless society, an analysis of country readiness, and case studies of India and Sweden.
Global Payment Trends
Despite adoption of digital payment methods, global cash use remains high. In fact, cash still accounts for 85% of all consumer transactions globally. Across the world, cash in circulation has remained stable, with the ratio of cash circulation to GDP even increasing across major markets. It continues to be resilient because it provides anonymity and universality to the payer. According to a 2016 report, cash is still expected to remain a significant payment method in the near future. However, services based on immediate payments are more efficient than cash and are expected to accelerate the move to digital payments.
Global non-cash transaction volumes reached 387 billion in 2014, experiencing an unprecedented growth rate of 8.9%. This increase was primarily driven by close to 17% growth in developing markets, compared to 6% in mature markets.
Among established alternatives to cash, cards—debit cards in particular—have been the fastest growing payment instrument since 2010. Meanwhile, check usage has declined consistently for the past thirteen years. More recently, the emergence of mobile card readers, electronic networks for processing large volumes of credit and debit transactions, and digitized private currency have threatened the prevalence of cash.
Though cash will remain prevalent for the foreseeable future, a migration to a cashless society is undoubtedly underway in certain countries. Sweden has long embraced cashless transactions, and the EU has imposed restrictions on large cash payments. In 2014, China had the fourth largest non-cash transaction market by volume, behind only the US, the Eurozone, and Brazil. Financial analysts have estimated that by 2020, eCommerce in China will be worth more than eCommerce in the US, the UK, Japan, Germany, and France combined. So, what are the drivers behind such a major shift?
Pros of a Cashless Society
Increased scope for monetary policy: In normal times, people choose cash’s convenience (at a zero interest rate) over other safe assets offering higher yields. During economic downturns, governments have difficulty stimulating the economy by lowering interest rates, because people choose to hold cash instead. Therefore, due to the existence of paper currency, governments and central banks possess limited power to stimulate economic growth. This is known as the zero lower bound theory.
However, in a cashless society, the inability of consumers to withdraw money from the financial system and store it in physical cash would provide governments and central banks with greater control of the economy through monetary policy. In particular, the unusual solution of a negative interest rate during economic downturns could more effectively be introduced. In a negative interest rate environment, people would pay banks to store their deposits, instead of earning interest on their deposits. This is intended to incentivize banks to lend more. It is also meant to encourage businesses and individuals to invest, lend, and spend money rather than hoard it. In short, a cashless society would enable governments and central banks to more effectively utilize negative interest rates. If -0.5% doesn’t create enough stimulus, perhaps -1% will. If -1% still doesn’t do the trick, then perhaps -3%. In theory, negative interest rates do not have limits to how low they can go. Carnegie Mellon’s Marvin Goodfriend argues in favor of negative interest rates, contending that they would allow central banks to independently pursue monetary policies to stabilize domestic employment and inflation.
Reduced tax evasion: Digital money and money services would bring about increased transparency in transactions, providing governments with enhanced abilities to track and analyze citizens’ financial activities. Ultimately, this would decrease tax evasion and increase tax payouts to the government. A 2016 study conducted by the nonpartisan Centre for Studies in Economics and Finance (CSEF) studied the effects of electronic payments on tax evasion in Europe. CSEF found that the use of electronic payments such as debit and credit cards reduced tax evasion, and that there was a positive statistical relationship between cash withdrawals and tax evasion.
Though difficult to pinpoint, experts estimate that the tax evasion amounts to between $100 billion and $700 billion a year in the US The IRS estimates that in 2006, taxes not paid voluntarily were over $450 billion, with a gap of $385 billion still remaining after tax collection efforts. These costs would be even higher in Europe, where tax rates are even higher.
Less crime in black markets: The anonymity and untraceability of paper currency facilitates the operations of corrupt activities. In a cashless society, the elimination of this medium of exchange would disrupt their normal operations and force them to rethink their business models. As Peter Sands writes for the Harvard Kennedy School, without high denomination notes, those engaged in illicit activities would face higher costs and greater risks of detection.
The size of the black market, or shadow economy, is substantial. Estimates of its size in the US start at around 8% of GDP. In Europe, where taxes are higher and regulation more onerous, estimates suggest that the size of the underground economy is considerably larger than in the US.
According to Harvard economist Kenneth Rogoff, there is an enormous difference between the amount of currency most OECD countries have in circulation, compared to the amount that can be traced to legal usage in domestic economies. Currency not in the domestic legal economy or in the global economy is mainly in the the domestic underground economy. As of March 2013, there was $1.3 trillion US currency in circulation. This translates to around $4,000 for every man, woman and child living in the United States. Further, nearly 78% of the total currency value was in $100 bills, meaning more than thirty $100 bills per person. By contrast, denominations of $10 and under accounted for less than 4% of the total value of currency in use.
Savings on costs of cash: Nations can benefit from the shift to cashless transactions by saving on the cost of cash. These costs of cash include ATM fees for individuals, cash storage and transportation expenses for businesses, and currency printing costs for governments. According to research conducted by the Tufts Fletcher School of Law and Diplomacy, the aggregate cost of cash in the US is $200 billion annually. The estimated cost of cash is MXN 3-6 billion annually in Mexico, and over Rs 200 billion annually in India.
Proponents claim that cashless transactions and elimination of cash costs can be advantageous for poor individuals and small businesses. These are the parties for which the costs of cash are disproportionately borne. For individuals, cash imposes a regressive tax and impacts the unbanked the most. The unbanked pay four times more in fees to access their money than those with bank accounts, and are at five times higher risk of paying cash access fees on payroll and EBT cards.
For businesses, paper currency must be stored, guarded, and accounted for. Mom-and-pop stores, many of which operate in poor neighborhoods and rural areas, often cannot afford security and cash transportation services. Removing cash from the equation could result in savings for the marginalized. As The Fletcher School’s Bhaskar Chakravorti declares, “It is time we acknowledged the cash paradox: While cash may be considered the poor man’s best friend, it also places a disproportionate burden on the poor.”
Fostering the adoption of new wireless technologies: A cashless society could accelerate the path to digitization, pushing those who might otherwise be reluctant—or previously have no need—to modernize. According to the McKinsey Global Institute, digital finance could provide an additional $2.1 trillion of loans to individuals and small businesses as providers gain improved abilities to assess credit risk for a larger pool of borrowers. Financial services providers would also benefit from a shift from traditional to digital accounts, potentially saving $400 billion annually in servicing fees.
Cons of a Cashless Society
In addition to myriad potential benefits, this transition might be accompanied by several drawbacks:
Violation of privacy: In a cashless society where all money, payments, and money services are digitized, there is concern around “big brother” surveillance activities by the government and organizations seeking to profit from the traceable data. Some opponents of cashless societies view the ability to take one’s ability to spend cash anonymously as central to freedom within society.
Elaine Ou, former lecturer at the University of Sydney, equates a cashless society with the surrendering of individual monetary control to financial institutions. As she articulates in her editorial, “A world without paper money is a world without money. Money belongs to its current holder. It doesn’t matter if a banknote was lost or stolen at some point in the past. Money is current; that’s why it’s called currency! A bank deposit, however, grants custody of money to the bank. An account balance is not actually money, but a claim on money.”
Importantly, a claim on money means that every transaction in a cashless society would have to pass through a financial gatekeeper. If banks and other private institutions hold our money, they would also have the right to refuse transactions at their discretion. Inevitably, then, certain payments would not be given due process. After all, previous attempts to prevent money laundering have sometimes resulted in the removal of financial services access for legitimate individuals, businesses, and charities.
Increased risk of security breach: A cashless society may bring about increased risks to personal and national security. From a personal security standpoint, the risks we already experience when we lose credit cards or our phones would only be exacerbated in an environment without paper currency. Today, becoming a victim of digital hackers can lead to denied payments, identity theft, account takeover, fraudulent transactions and data breaches. These risks would still exist in a cashless society, though the volume of cashless transactions and points of exposure for the average consumer would be much higher. What’s more, without cash reserves in households and businesses, a cyber attack or computer malfunction would leave consumers without a safety net.
From a national security perspective, during financial and global crises, cash has repeatedly demonstrated its importance for consumers and members of society. During the financial crisis of 2008, cash provided a safe haven for consumers. For example, the Australian Reserve Bank experienced a 12% rise in demand for cash in late 2008 in response to the financial uncertainty.
Decreased financial inclusion: While some experts, as mentioned previously, believe a shift to cashless transactions could eliminate the costs of cash for the marginalized, others believe this shift would exacerbate the existing issue of financial inclusion. While utilizing cash is direct and simple, moving to a cashless society would place pressure on these individuals to sign up for formal financial services, something the poorest might be unable to do.
In developing countries, 2.5 billion people do not have access to traditional financial services. Traditional banking infrastructure struggles to serve low-income customers, particularly in rural areas. The issue of financial inclusion also extends to modern countries: in the US and Western Europe, nearly 70 million and 100 million are unbanked, respectively.
A method of combatting these effects is the promotion of mobile connectivity. According to research published by GSMA, mobile phones and mobile banking have been powerful tools for bringing access to payments, transfers, credit, and savings to unbanked people. In conjunction with governmental support and incentives, mobile is uniquely positioned to overcome the challenges of payments: It provides a platform to combine digital identity, digital value, and digital authentication for low-cost access to financial services.
While it may seem counterintuitive for developing countries to have high mobile money services usage, many off-the-grid families and small businesses own basic mobile phones with alphanumeric keypads and black and white display. Another enabling factor includes regulators, who are increasingly recognizing the role that non-bank providers of financial services can play in fostering financial inclusion. Consequently, they are establishing more enabling regulatory frameworks. In 47 out of 89 markets where mobile money is available, regulation allows banks and non-banks to provide mobile money services in a sustainable way. In addition, it would be helpful for governments to promote access to financial services or the technology necessary for the services as a public good, just as it does with education and water.
Currently, 255 mobile money services are now live across 89 countries, and the number of registered mobile money accounts globally also grew to around 300 million in 2014. Globally, there are now fifteen countries with more mobile money accounts than bank accounts, indicating that mobile money is a key enabler of financial inclusion.
A successful example of mobile in emerging markets is M-Pesa, which is transforming the financial landscape in Kenya. Launched in 2007 by large mobile network operators, the service allows users to deposit money into an account stored in their cell phone, to send balances via SMS text messages to other users, including retailers, and to redeem deposits for cash. It is considered to be a branchless banking service, whereby customers can withdraw and deposit money with an extensive network of agents that act as banking agents. In 2014, there were 81,000 M-Pesa agents in Kenya alone. To better understand the penetration of the service, consider the following: M-Pesa is used by 17 million Kenyans, equivalent to more than two-thirds of the adult population, and around 25% of the country’s GDP flows through it. M-Pesa has also launched in India, Albania, Romania, and multiple African countries.
The above benefits and drawbacks can help us understand the reasoning behind a country’s decision to go cashless, or the timing at which a country may go cashless. Let us now examine which countries are currently best positioned to adopt cashlessness.
Which Countries Are Best Positioned to Go Cashless?
According to the Harvard Business Review, the first major consideration is the aggregate cost of cash, which will identify the countries with the most to gain from the change. The cost of cash is derived from: 1) The cost of ATM maintenance for banks, 2) Cost of cash to consumers, including the costs of obtaining cash, such as transport to ATMs and ATM fees, and 3) The tax gap, which is the estimated amount of tax money owed to the government but goes uncollected or unreported due to cash transactions.
The map below represents these aggregate costs of cash. A caveat in its interpretation: Countries indicated with “low” costs are not necessarily closer to being cashless societies. The map simply indicates that the costs of cash in these countries are relatively lower than other countries.
Here is a breakdown of cost of cash categories, borne by different parties:
- ATM maintenance costs borne by banking institutions: These are disproportionately high in many parts of the developing world, such as sub-Saharan Africa and Latin America. It is also high in geographically large, sparsely populated countries, such as Canada, Russia, and Australia, where there are many logistics challenges.
- The absolute cost of cash to consumers: These costs are high in some of the world’s most populous countries, including Indonesia, Nigeria, Bangladesh, India, China, and the United States. They are high in many of the major European countries, such as Germany and France, as well as in Japan. These costs are lower in several Scandinavian countries with relatively entrenched mobile payments systems, such as Sweden, Finland, and Denmark, as well as countries with rapidly evolving mobile payment systems, such as South Korea and Kenya.
- Tax gap as a cost to governments: Tends to be higher in emerging markets, where shadow economies tend to be larger. In India, for example, the tax gap could be as large as two-thirds of overall taxes owed. The larger the tax gap, the more the country has to gain from a migration to a cashless economy.
The second major consideration in determining a country’s readiness is its level of digital advancement and infrastructure. Developing countries in Asia and Latin America are leading in momentum. They also benefit from ongoing investment, remaining attractive destinations for startups and for private equity and venture capital. On the other hand, most Western and Northern European countries, Australia, and Japan have been slowing down in momentum.
Based upon these factors, the US, Netherlands, Japan, Germany, France, Belgium, Spain, Czech Republic, China, and Brazil have the greatest potential for unlocking value by policy and innovation led migration to a cashless society.
Clearly, various regions have different benefits to consider and are at varying levels of readiness for a cashless economy. The following section details case studies of two countries already experiencing such a transition. The first country we explore is India, whose transition has largely been propelled by the government. The second country we examine is tech-forward Sweden, which has experienced a more natural progression towards a cashless society, prompting the Swedish government’s role to be more of a facilitator.
Spotlight on India’s Demonetization Campaign
India is an interesting case study because of its historical reliance on cash and its lower digital evolution index. Yet, it stands to benefit significantly with regards to financial inclusion, corruption, and relatively high costs of cash. Interestingly, much of the transition has been initiated and driven by the government through both voluntary and involuntary measures. It seems, then, that the Indian government believes the benefits of a cashless society significantly outweigh its potential issues.
A shocking mandate occurred in November 2016, when India’s Prime Minister Narendra Modi made a surprise public address via live television. He announced that after 50 days, all 500 ($7.50) and 1,000 ($15) rupee notes, representing 86% of the currency in circulation, would cease to be legal tender. While citizens were permitted to exchange 500 and 1,000 rupee notes for higher denominations, the government prohibited individuals from exchanging more than 4,000 rupees ($60) at a time.
Prior to the announcement, over 95% of India’s transactions were cash, 90% of vendors did not have means of accepting electronic payment, and nearly half of the population did not have bank accounts. Modi’s ostensible motivation was to reduce corruption, believing that these high denomination notes were used to finance terrorism, fund illegal drug sales, fuel the black market, drive counterfeiting, and pay bribes. Since the announcement, however, the claimed objective of the exercise has transitioned from rooting out black money to modernizing the Indian economy.
Modernization has been a priority for the Indian government in the last decade, during which it has taken several measures to accelerate digitization. In 2009, the government launched Aadhaar to improve digital identity. Then, to provide citizens with bank accounts, the government sanctioned the launch of 11 payment banks, offering incentives to open accounts. When the United Payment Interface launched in 2016 as a way for banks to transfer money directly to one another, the Reserve Bank of India advocated for it. After the demonetization announcement last year, the government introduced incentives for digital purchasing, including discounts on petrol, diesel, and railway season tickets.
Perhaps unsurprisingly, the controversial demonetization policy has been met with both pointed criticism and praise. Here are a few details regarding the results:
Effects on citizens: In the immediate aftermath of the announcement, chaos erupted. Long lines formed at ATMs and banks, and altercations broke out as people waited for hours (sometimes for over twelve hours). Often, repeated trips to the bank were necessary. Banks, which also had not been notified of the change, did not have enough of the high denomination notes for the masses looking to redeem their canceled notes.
Monishankar Prasad, a New Delhi-based author, pointed out that the unbanked citizens and the poor were taken off guard. Without access to structural resources, these people were hit hardest.
University of Pennsylvania’s management professor Mauro F. Guillen, however, argues that the long-term benefits outweigh the short-term costs: “In the short term, [the move] could stifle some businesses that are legal and clean, if they use cash payments. But everyone will adjust. And while it can hurt some small businesses and individuals, it is better to do it than not.”
Effects on corruption: It was originally thought that the shadow economy would not be able to exchange or deposit their illicitly-obtained wealth. Theoretically, by having canceled banknotes going unredeemed, the Indian government would then add a large sum of assets on the balance sheet, an amount estimated to be $45 billion. However, even with strict limitations around banknote exchanges, the black market was still able to unload much of their money. It is still being investigated as to how they were able to achieve this, but it seems a variety of tactics were utilized, including cutting deals with corrupt bankers, threatening bank officials, or utilizing inactive bank accounts. India’s Enforcement Directorate has been investigating bank branches throughout the country.
While experts acknowledge that the move could create a temporary obstacle in black economy operations, many question its efficacy as a long-term solution. They assert that certain trades and areas cannot be digitized just by willing it. Others warn that it is only a matter of time until the black market utilizes alternative financing techniques such as the US dollar or the pound sterling.
Effects on digitization and modernization: As expected, Modi’s demonetization campaign has proved to be a boon for the country’s e-payment providers. For example, Paytm reported a 3x surge in new users while Oxigen Wallet’s daily average users increased by 167% since demonetization began.
Market and political response: The market has downgraded India’s growth in the short term, but is optimistic that they will be outweighed by the long-term benefits. In December 2016, S&P Global Ratings decreased its estimated economic growth rate for 2016-17 by one full percentage point to 6.9% to reflect the disruption. However, Dharmakirti Joshi, Chief Economist of Crisil, a subsidiary of S&P Global, noted that, “We expect lower private consumption in fiscal 2017, but expect demand to revive and growth to rebound in fiscal 2018. India should shortly revert back to an 8% annual growth trajectory.” The Wall street Journal similarly comments that while GDP growth slowed as a result of the demonetization policy, “India is expected to remain one of the world’s fastest-growing large economies.”
In addition, the March 2017 victory of the BJP party, of which Modi is a part, is viewed by some as an endorsement of Modi’s groundbreaking demonetization policy. The stock markets rallied at the prospect of the BJP victory. The next trading day, the Bombay Stock Exchange Sensitive Index (Sensex) shot up 496 points (1.71%). The National Stock Exchange 50-share index also closed at more than 9,000 for first time in history.
Spotlight on Sweden
Next, we move onto Sweden, a country with lower costs of cash and advanced digital infrastructure. Unlike India, consumers’ habits and the markets have largely dictated the transition to a cashless society, with the government and central bank (Riksbank) helping to facilitate the change. Sweden is also one of the first countries to adopt a negative interest rate, leveraging its citizens’ cashless preferences to stimulate the economy.
The Swedes are notorious for their embrace of technology and cashless transactions. Swedish buses and the Stockholm metro do not accept cash, and retailers are legally entitled to refuse coins and notes. Street vendors and even churches increasingly prefer electronic payment. Hooked on the convenience of digital money, cash transactions made up a mere 2% of the value of all payments in Sweden last year. In shops, cash is now used for less than 20% of transactions, half the number five years ago and significantly below the global average of 75%. When it comes to alternative payment methods, Swedes use cards three times as often as the average European, yielding an average of 207 payments per card in 2015. Preferring to pay digitally, Swedes have low demand for cash, which is dropping at a rate of 20% a year. As a result, about 900 of Sweden’s 1,600 bank branches no longer keep cash on hand or take cash deposits. Cash machines are being dismantled, especially in rural areas. Circulation of the Swedish krona has fallen from around 106 billion in 2009 to 80 billion last year.
Taking note of its citizens’ preferences, the central bank and other major banks jointly created the popular digital wallet Swish to enable payments between bank accounts in real time. Riksbank’s involvement in Swish’s creation and the credibility it lends to the service, has been critical to Swish’s success. Swish is now used by close to half of the Swedish population. In addition, capitalizing upon its citizens’ embrace of technology and cashless transactions, Sweden is one of the first countries to have its central bank adopt a negative nominal interest rate. Earlier this year, in a continuous battle against deflation, the Riksbank held its nominal interest rate at negative 0.5% and stressed chances of further cuts. Although retail banks have yet to utilize negative interest rates, it may only be a matter of time until they do so.
For individual consumers, the move towards cashlessness has led to a number of complex issues. Last year, the number of electronic fraud cases reached 140,000, which represents more than double the amount more than a decade ago. In addition, there is concern that the ease of electronic payments in combination with negative interest rates are driving soaring debt burdens. Their fears are not unfounded, as Swedish household debt is at an all-time high, with the average Swedish household debt to disposable income metric at a record high of 180%. Sweden is also currently experiencing a housing crisis; money is so cheap to borrow that the Swedes are funneling cash into property.
Critics also point to concerns that pensioners in Sweden who use cash may be marginalized and excluded; only 50% of Swedish National Pensioners’ Organisation members use cash-cards everywhere. Perhaps for these reasons, cash is not dead—Swedish central bank Riksbank predicts it will decline quickly, but will still be circulating in twenty years.
The Paths to a Cashless World Are Many and Varied
A cashless society is no longer just a figment of the imagination. While cash still reigns globally on aggregate, progress towards cashlessness is particularly pronounced in specific countries. Additionally, it is clear that there is no “one size fits all” blanket solution for such a major shift. Because the migration involves technological, financial, and social considerations, we can expect each country to select an approach according to their unique positioning and capabilities.
Regardless of approach, the transition to digital money and money services will have profound implications on some of the most basic aspects of society. This great change presents opportunities for governments to improve issues surrounding income inequality and poverty, and opportunities for entrepreneurs to create innovative, disruptive businesses.
