22 February 2016

How to determine value of a business?

There were 2 stalls selling chicken rice; one belongs to Mr Tan Ah Kow (quite reputable) and the other one belongs to Mr Lim Ah Seng (not so reputable). Both are in the chicken rice selling business for very long time about 30 over years. One day both Mr Tan and Mr Lim were chatting to each other:

Hey Ah Kow, how's your business recently? Ah Seng asked. Ah Kow replied "Business is still doing good, however recently I'm thinking about selling off my business for retirement, I will be 65 years old next year and I think its times for me to enjoy my retirement and at the same time I can help my daughter to take care of my 2 little cute grandchildren.

"Hmm......, perhaps I should also sell off my business and enjoy my retirement! I have been working for so long and I'm approaching 70 years old soon" Ah Seng thought to himself.

Now lets look at how they have been managing their chicken rice business for the past 30 over years:

Mr Tan is a very hardworking, responsible and cheerful person, his chicken rice is selling at $6 per plate. This has caused some resentment from his customers and feedback that his chicken rice is very expensive as compared to the average chicken rice selling in the kopitiam (aka coffee shop).

Despite that, Mr Tan has a very wide range of regular customers (from young kid to the elderly) buying from him daily. Sometimes he will get scolded as most of his customers need to Q for very long before they could get a taste of his chicken rice.

At times, Mr Tan also responded to customer's feedback regarding the price of his chicken rice. He sincerely apologies to his loyal customer "I'm sorry folks, my profit margin is very little, the quality and ingredients of my chicken rice are among the freshest and the meatiest chicken from the suppliers, also in order to prepare the chilies, I have to wake up 2-3 hours earlier to do all the preparation work"

Although Mr Tan has a very narrow profit margin, he try to adopt cost saving strategy like using only 2 big pails of water to wash his equipment after closing stall and switching off all the lights and unplug all electrical appliances 15 mins earlier before he closes his stall.

Mr Lim on the other hand is someone who always like to take short cut and think of ways to make the most profit from his customers. His chicken rice is selling at $3 per plate as he knows that most eaters like cheap food so he always think of ways to slash his raw material price from his suppliers and ended up he would usually get chicken meat which is not as fresh as Mr Tan. His chilies are also very watery and tasteless.

Very often, Mr Lim would get complaints from his customers that the chicken rice seem overdue as there are sour taste. Mr Lim would usually shows no remorse and told them off: "You want to buy you buy lah, if you don't like you can patronize other stalls!"

Over the years, though Mr Lim continue to enjoy higher profit margin than Mr Tan, his business has been declining although there are still some regular customers mainly the construction workers and foreign workers coming from the construction site and factories located opposite of his kopitiam stall.

To Conclude:

Now imagine both Mr Tan and Mr Lim are selling their businesses at the same price to you. You as an investor are looking to invest in an existing food business with a good system implemented and all these information are not being presented to you, likely you will choose a business with good profit margin and pricing strategy better than the competitors (for example).

However after you had done your extensive research and all the information are presented to you as shown above, would your choice still be the same? Or would you now choose the one with a higher profit margin and less competitiveness in prices? Or rather, would you like to try their chicken rice first before making any decision?

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