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By | Tim Worstall 22nd February 2011 22:30

Kogan turns consumers into working capital

Is there such thing as an economic free lunch?

When everyone is selling the same things, made in the same Chinese factories, how can a retailer manage to gain an edge? That's the problem that Kogan Technologies had: and its solution is, to be fair, pretty cute.

Kogan is already Australia's largest online retailer of consumer electronics, so it was obviously doing something right before: that generally meant negotiating with and buying direct from the original manufacturer, rather than going through layers of distributors and wholesalers. No-name or retailer's own name branding helped, of course.

But what's the next step? How about getting the consumer to pay for the goods before they've ever been made? This is the idea behind LivePrice and the company is already claiming success after making $325,000 in sales on the first day.

The background to the idea is simple enough: someone, somewhere, needs to be buying the kit which is then assembled into the gear which can then be shipped from China to Oz and into the welcoming arms of our gadget-obsessed bludger. That someone will be wanting to turn a profit on having provided the cash with which to purchase that kit.

In the larger “western” (perhaps "industrialised" is better) countries, this isn't a great problem. Working capital is available from a selection of banks at reasonable rates: sure, they might charge 10-12 per cent a year, but that cash can be turned around 10-12 times a year, adding at most one per cent to the price of each item.

However, in China, this sort of lending is extremely hard to get: the Chinese banks are indeed stuffed with cash and they'll hand it out in great gobs to all sorts of people: those covered by what remains of the plan, for example, or those connected to the local authorities. But not, unfortunately, to the various consumer electronics factories which don't have such links (guanxi).

It would also be possible for Kogan itself to raise equity finance, but that would mean selling off a part of the company to get it: not all that attractive if another method of gaining finance could be found. And of course there is another such source: the end customers themselves. Those who are willing to shell out $1,300 for a big screen TV might well be willing to pay 30 or 45 days before they get it if they also got 20 per cent (or more, Kogan claims up to 50 per cent savings on some items) off the sticker price.

Everyone's happy here: the consumer gets a lower price, and Kogan and the Chinese factories get their working capital without paying excessive interest or having to give up equity. And that greater amount of working capital removes the major constraint upon how fast Kogan can grow for, yes, access to working capital is the main determinant of this.

So who could possibly object to such a scheme? Well, actually, some people could, for there's very rarely an economic free lunch in this world.

Industry newsletter Smarthouse points out, if Kogan Technologies were to unexpectedly go out of business there'd be no one to refund the customers' money. A similar situation might prevail if one of the factories involved went broke, or if a dispute between factory and Kogan prevented delivery of the goods.

Pre-paying for stuff is just fine: as long as everyone remembers that if the people you've just pre-paid to go out of business then you're just shit out of luck. If Kogan takes your money and then passes it on to some parts supplier in China, various calamities could befall it: the parts company might not deliver, or it does but the assembly factory messes up or goes bust itself.

The consumer has no real comeback and Kogan's not going to do all that well either: it'll still owe the money or the product to the consumer. It's one of these schemes that works just great as long as everything works just great. Bring in a problem and it will eat itself: rather like the US mortgage market in some ways.

But while there's a possible concern, that's not to say that there haven't been extremely successful similar (and yet subtly different) schemes elsewhere in the the world. Dell for example, has famously played its suppliers wondrously over the years. To be a Dell supplier you must stock your product, without being paid for it, at the Dell assembly plant. Only when Dell actually takes the part to use, from that warehouse into the assembly area, does it even agree it owes you. You'll then wait 30-45 days to get paid for it.

Dell only takes it from the warehouse when it's received the order for the finished product: that's usually when it's already been paid by someone for it too. So they have a free float of 45 days or so of the customers' money before they pay suppliers.

A very effective method of solving that working capital problem: especially when you think that this leaves the suppliers taking that one per week decline in the value of components as they sit in the warehouse. Oh, and yes, Dell does charge them rent on that warehouse space.

The big difference between Dell and Kogan is who is taking the risks of the system breaking down. With Dell it's other big companies, and they're all big boys and can be assumed to know what they're doing. With Kogan it's the consumers themselves; and while we perhaps should regard a sentient adult as capable of looking after themselves, that's not the way that consumer protection laws actually work.

Which is why at this point no one knows what the Australian Competition and Consumer Commission is going to have to say about it all. ®

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