Week five and we’re back at it, having more fun that a human being should be allowed to have in distance education at Norwich University.  It hit me last night!  When I get done with this class in a few weeks, I will be 1/3 through my MBA program.  Wow!  Time is flying.

This week, we’re talking about the risk we take when we lay out our capital budgets.  Establishing the cost of our capital budgeting decisions is critical to ensuring that we set the performance level for projects at a high enough level where we attain an increase in shareholder value.  Additionally, we know that our projects have risk associated with them - and so it's key that we take that risk into account when planning.

The cable TV industry is very volatile in many ways that I have described in previous posts. Not only is the competition pretty tight, the level of innovation is not like that of other industries. We're not going to come out with a new, eye-catching product every year like the iPod or a computer with the latest technology or high capacity hard drives. We spend a lot of our capital budget expanding and improving the services we currently offer in hopes of gaining market share over the competition.

One of the risks that we take in the process of capital budgeting is that we allocate a large amount of money to "build out" new areas. This might be new neighborhoods under development, areas where small businesses are expected to open, etc. In order to provide service to those areas, we have to build infrastructure that can service that area. If you've ever been exposed to the cost of the infrastructure of a cable system that can provide voice, data and television services, you know it's not cheap by any stretch of the imagination.

When we build out a new area, we expect to gain a certain percentage of penetration in that area (i.e. we expect that 75% of the new home owners will have our service). If those numbers are not met, then we have lost out on revenue expectations and it takes much longer to pay for the expansion we've competed through allocating capital expenditures.

If we're unable to recoup the money spent on the expansion, we either have to account for it in years to come, or raise rates to keep up with the cost of maintaining that service. Raising rates is not something that is popular with the consumer, so we're at constant risk of stretching out the ROI for several years longer than we would normally.

In order to help make a more educated decision on the most efficient way to spend this capital, we outline our options and the cause/effect on a probability tree (A schematic representation of a problem in which all possible outcomes are graphically displayed). Doing so provides a graphical representation of where we will stand in yearly increments if we were to move forward with the build-out, or if we did nothing at all.

Doing nothing will allow us to save that capital for other projects, but then we run into issues with the competition moving in to gain that market share. Once that is done, it makes moving into that neighborhood even more difficult. So there is risk on multiple levels.
Compare the scenario I just described to distance learning and getting a degree online.  Every example I have provided here can be applied.  You are going to spend a certain amount on your education.  With that, you expect to get a return on your investment through increased salary, better job, etc.  You can also decide not to spend the capital on education and the competition (other people) will beat you to the punch when it comes to better jobs.  See?  It all works the same.

What risks to you take in terms of capital expenses in your life and in your job?  Email me and let me know.