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the value of cash

By Sigrid Folkestad

18 March 2016 16:49

the value of cash

Aggressive attacks from a strong company can push a competitor out of the market. However, when the predator is about to get its prey, the weak company can survive if it has plenty of cash.

Finance researcher Xunhua Su has researched predatory behaviour in business and industry. When, without warning, a strong competitor launches an aggressive attack on a financially weaker company to kill it off, this is what is known as predatory behaviour.

One method is setting prices so low - predatory pricing - that you remove rivals or ensure that they are kept away in the future.

Escaping the predator

In his article, "Product Market Threats and the Value of Corporate Cash Holdings", Xunhua Su looks at what a financially weaker company can do when the hunting instinct has been triggered in a competitor and it attacks without warning.

Or more specifically: what is the value of cash to companies that are attacked?

A legendary example of a fight between a predator and its prey is the war between Microsoft and Netscape in the 1990s.

"At that time Netscape was a rising star with the Navigator browser. Microsoft had developed Internet Explorer and was ready for a completely new and far more aggressive strategy," says Xunhua Su, a postdoctoral fellow at the Department of Finance.

Pushed out

Not many remember the story of the "browser war" that began to heat up in 1995.

"Netscape had a market share of more than 80 percent, but the company was still vulnerable because it was relatively small and most of its income came from one product. Microsoft saw that they had an excellent opportunity to push Netscape out of the market. The price of the Microsoft product was radically reduced and, after a few months in the market, Internet Explorer became free of charge.

"No one wanted to purchase Netscape. The dominant strategy succeeded and Netscape was almost pushed out of the market in the space of five years, despite the fact that they were doing really well in this market.

"Isn't this form of price-setting illegal?

"It is legally complicated, but even if it were to be illegal in a specific instance, it is difficult to identify with certainty while it is occurring, which means that, in practice, there will be an opportunity to implement these types of strategies.

Value of Corporate Cash Holdings

Su's article, "Product Market Threats and the Value of Corporate Cash Holdings" will be published in Financial Management (see below).

"The story is like this," Su says and continues:

"In the market there are companies that are developing well, but they are competing with a strong company that sells similar products. Therefore, some companies will commence strategies to be able to dominate the market. This can be setting the price at an extremely low level or starting to sell everywhere.

Another strategy that can be implemented at the same time is to head-hunt specialists, and even top executives, from the financially weaker company. They can attract them with very high wages. All of this constitutes a predatory strategy," Su says.

"Is this a costly strategy?"

"Yes, it is expensive, but only in the short term." If the company is able to drive the competitor to bankruptcy, it is perfect in the long term.

So, what does the prey do?

If the threatened company is to survive, it has to build up its cash reserves," says Su.

"The response is to increase cash holdings. They have to reduce their costs and, for example, cut the payment of dividends to shareholders. They collect money and stash it away.

"Is this the "long purse" concept that you write about?

"Exactly. Long purse or deep pocket theory as it is also known. When a big company comes along and threatens you, the cash holdings can be used to fight. Because you have cash, others will be scared to fight against you. That is the simple version. The point is that when companies are threatened, money becomes more valuable.

If the small companies survive, the large companies have failed to push them out. They discover that it is not optimal to push them out and therefore cease the strategy. The objective is no longer to manoeuvre them out of the market, but to give them trouble.

Preying on Tesla?

Predatory behaviour is not unusual in the high-tech industry," Su says. Many high-tech companies struggle, at least in the short term. They often experience losses every single year.

The finance researcher at NHH finds the rumours about Apple's entry into the motor vehicle market to be interesting. Several websites have reported that hundreds of Apple employees are working on a prototype electric car with the code name

"Project Titan"

"Tesla is operating with a loss. They are rapidly increasing production, but are losing more than NOK 171,000 for every electric car they sell. I believe Tesla may be facing a predator in the form of Apple.

Apple has 206 billion US dollars in cash holdings and can use enormous amounts of cash. The company has so much money that they could give every person in the USA a check for 632 dollars.

The Tesla graveyard

"Apple is trying to recruit people from Telsa. There are many rumours in the market right now. We don't know how this will develop. The war between Microsoft and Netscape is a completely different story and we known what the outcome was there.

In response to the flow of rumours about Tesla employees, Elon Musk said the following to the German newspaper Handelsblatt:

"They have hired people we've fired. We always jokingly call Apple the 'Tesla graveyard┬┤." "You can quote me on that" (www.handelsblatt.com 24 October 2015).

This quote from October already generates 113,000 hits in Google.

"The situation concerning Telsa is something we are observing now while it is happening. I think there could be major pressure on Tesla," concludes Xunhua Su.

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