Archive for September, 2008

Look For Alternative Forms of Financing

The cost of borrowing money just went up. Unlike their US counterparts, Canadian banks that held positions in high-risk US mortgages will likely not receive a bail-out package.  The net impact of the mortgage crisis is that Canadian banks will have to increase their lending rates to make up for their losses.

This is a great opportunity to explore alternative financing options.  Two programs which many businesses are not aware of are the federal government’s IRAP (Industrial Research Assistance Program) and SR&ED (Scientific Research and Experimental Development) programs.

IRAP is run in conjunction with the National Research Council of Canada (NCR), and provides non-repayable contributions to Canadian small and medium-sized enterprises (SMEs) interested in growing by using technology to commercialize services, products and processes in Canadian and international markets. NRC-IRAP also provides mentoring support and invests on a cost-shared basis for research and pre-competitive development technical projects, upon assessment of a project and firm by a team of Industrial Technology Advisors.  Canadian SMEs with under 500 employees and industrial associations desiring to enhance their technological capability are eligible for support.

The SR&ED program is a federal tax incentive program, administered by the Canada Revenue Agency (CRA), that encourages Canadian businesses of all sizes, and in all sectors to conduct research and development (R&D) in Canada. It is the largest single source of federal government support for industrial R&D. The SR&ED program gives claimants cash refunds and/or tax credits for their expenditures on eligible R&D work done in Canada.

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It Doesn’t Always Pay To Build The Better Mousetrap

A year ago it looked like game over for Nintendo’s storied console business. The Nintendo Entertainment System had ushered in the modern age of video games, but was not bleeding market share due to newer, more powerful systems from Sony and Microsoft.

Nintendo’s response was the handheld DS, followed by the Wii. The DS two-screen touch handheld was a test study that focused on gameplay and “fun” instead of trying to compete with Sony and Microsoft on graphics and hardware.  The DS was a success, so the Wii followed suit.

Nintendo built the Wii: a cuddly, low-priced, motion-controlled machine that focused on interaction and unique gameplay.  Their strategy was to expand the target market, because to compete with Sony and Microsoft to develop the best hardware would have been suicide.  Nintendo used a cheaper and lower-powered processor for their Wii console because they firmly believed that they could appeal to children as young as 4 and adults as old as 70 if they could:

  1. Make video games easy-to-play, interactive, and “fun.”
  2. Sell a complete gaming system at an affordable price point. 

This strategy was an astounding success!  Families, women, children, and all grandparents all embraced the gameplay of the Wii, and the low $300 price point increased sales volumes drastically.  And because of the decision to adopt older technology, they were able to sell the console with a $50 profit margin! (Sony and Microsoft both sell their consoles in the $400 to $500 price range at a loss)

Nintendo now projects that the Wii will take a 40-45% market share in this generation.

This case study illustrates the fact that innovation and R&D is a necessary part of any business’ survival.  Businesses are constantly competing to build the better mousetrap.  However, the business that figures out how to deter the mouse from entering the house (at an attractive price point) will steal market share from their competitors.

Further information:

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The Death of Lehman Brothers

… is dead. Bankrupt.

Lehman Brothers, America’s fourth-largest brokerage, and one of the latest victims of the US sub-prime mortgage crisis, has filed for Chapter 11 bankruptcy protection. The current disaster is one of the biggest meltdowns in modern-day history because it has affected stock markets across the globe.  In Canada, the TSX slid by more than four per cent, or 515 points. That represented the TSX’s second worst day of the year.

Garth Turner, in his published book “Greater Fool,” believes that the US real estate crash is about to sweep into Canada.

“When bungalows in Vancouver cost $900,000 and resale homes with no parking in midtown Toronto are $1 million, it’s only forty-year mortgages and an embracing of debt that sustain the unsustainable.  The inevitable conclusion is that the current Canadian real estate market is floating on a sea of unrepayable, and perhaps unserviceable, debt.

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How to Outperform a Mutual Fund

Many investors don’t realize that stock market indices, throughout the history of the stock market, have outperformed the average mutual fund. Very few mutual funds are able to consistently outperform indices throughout the course of time because:

  1. They charge high management fees which erode any profit potential, and
  2. What works in one decade doesn’t work in another decade.

“The best proof of the market’s intelligence is that even the professionals can’t keep pace with it. Over any period of a few years or more, about 80% of actively managed mutual funds lag behind the market. They\’re weighed down by the salaries of their managers, by research costs, by marketing expenses, by fees paid to financial planners, by trading expenses.”  Canadian Business Online

Furthermore, mutual fund histories can be deceiving, due to survivor-ship.  Losing mutual funds tend not to survive.  They either disappear, or they are incorporated into larger, more successful mutual funds.  Therefore, when you look at the prior performance of existing mutual funds, you are automatically discounting all the mutual funds that have failed or that have ceased to exist!

How can you combat this?  One way is to gamble on your luck.  If you can always pick the “hot” mutual fund at the right time, you will outperform the index.  But how lucky can you be?

Another way is to buy stock yourself.  TD Waterhouse is a great discount broker which charges minimal transaction fees.  However, buying individual stocks takes significant capital (i.e. to buy enough to fully diversify your portfolio), and time (i.e. to research company fundamentals).

A third way to ensure that you outperform the average mutual fund is to buy index funds.  Recall that a stock index will outperform the average mutual fund.  Dubbed the “Couch Potato Portfolio,” this strategy entails diversifying across several index mutual funds.  To invest in the Couch Potato Strategy, buy the market by investing in a small collection of low-cost index funds. These funds passively follow the ups and downs of market indexes, such as the S&P/TSX Composite index of Canadian stocks or the Standard & Poor’s 500 index of U.S. stocks. The key advantage of the Couch Potato strategy is that it gives you wide diversification among hundreds of stocks and bonds at rock-bottom cost.

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“It’s the Economy, Stupid”

With a federal election just around the corner, Canada is experiencing weakest GDP growth in almost 17 years.  The deteriorating health of the Canadian economy is reflected in recent polls, in which Canadians now rank the economy ahead of health care and the environment as their chief concern.

“For too long, we allowed high commodity prices to make us feel wealthy,” says Glen Hodgson, chief economist at the Conference Board of Canada. “In a perfect world, we’d have an election campaign that debated how to improve our lagging productivity, which any economist will tell you is the key to sustainable prosperity.”

According to Anne Golden, President of the Conference Board of Canada, steps that are needed to ensure sustainable prosperity include:  enhanced labour mobility, a credentialing system that more rapidly integrates skilled newcomers, along with measures to improve health care.

I think that the key to turn around the economy is to enhance labour mobility by investing in R&D and scientific innovation.  Investment dollars need to be spent to encourage students to pursue advanced studies in engineering, physics, and math, because these are the fields of studies that are pre-requisites to scientific innovation.

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