To liquidity and beyond!By Jan Erik Horgen
It was a few minutes before 8 a.m. on one of those grey September mornings in Philadelphia, and the very ordinary looking classroom at the prestigious Wharton School of Business was already filled to the brim with students. The classroom was buzzing with excitement as one of the hardest finance courses in the curriculum was about to start. Already next class, half the students in the room would have dropped out of the class.
At precisely 8 a.m. the professor stormed into the room. He was none other than the both brilliant, charismatic and notorious Jamshed Ghandi, who in addition to being a professor at Wharton was also a trusted advisor to three central banks and chairman of the board of a Swiss bank. Rumor had it that he was briefly expelled from Cambridge as a student for walking the rooftops in campus at night.
What is liquidity?
Upon entering the room, he would never sit down. Before even introducing himself, he had selected a suitable victim, his index finger descended from above and pointed to the student: “What is liquidity?” The professor’s cosmopolitan English was proper Cambridge English with more than a little touch of Indian accent. The student feverishly researched the deepest recesses of his mind and produced a mumbling reply. The index finger searched out another victim: “Do you agree?” An equally hesitant, but otherwise different, answer followed. The index finger reached its third victim: “Settle between them.”
So, what is liquidity, and why should entrepreneurs and business boosters care? To explain the concept, the professor pointed to one of the very ordinary desk chairs in the room: “Is this chair a liquid asset?” What do you think? Well, it will depend on the context. Back then, every fall, at the start of the semester, students would line Locust walk, the central walkway on the campus, to buy and sell the necessities of student life. If you at that time would walk up and down Locust Walk and marketing the chair, you would find a fair number of buyers, and the chair could be considered a relatively liquid asset. If you would try the same in February, all your potential buyers would have disappeared, and the chair would be wholly illiquid. Was the chair any different? No, but the market had changed.
Liquidity continuum of your business
So, liquidity (and say this with your best British-Indian accent) is a continuum. Anything you want to buy, or sell, can be placed at various points along this continuum as circumstances change. OK, that sounds like a theory, but why should I care as an entrepreneur or business booster? You should care, because understanding what forces and circumstances shape the liquidity continuum of your business can give you a big competitive advantage.
What are some of these forces and circumstances? We have already seen one of them – the number of active and present potential buyers in the marketplace. That’s why you dragged the darn chair down to Locust Walk in the first place, to parade it in front of a large group of likely customers. Funny, sounds a lot like reasons for doing Facebook advertising… In other words, if you want your inventory to be liquid, make sure lots of potential buyers are aware of your products and that you have it in stock. Also make sure what you have in stock actually has potential buyers!
Charge extra for providing the added value
Having to carry the chair around is a hassle for you. Having to carry it back from Locust walk is a hassle for your potential customers. That hassle is part of the transaction costs. If you wanted to increase demand for your chair, you could lower the transaction cost by promising to carry the chair to the buyer’s home. Not only are you then lowering the transaction cost for your potential customer, you are also providing added value to your customer by doing that. Unfortunately, that comes at a cost for you; the cost to carry. You will need to use your business acumen and have the pulse of the market to determine if you can charge extra for providing the added value, or if the added value will simply make you the preferred desk chair supplier and close the sale.
If you carry the chair the same way the customer would have, you have not made the market more efficient, you have just transferred part of the transaction cost from buyer to seller. But what if you roller-skated over to the customer with the chair in less than half the time? Now you have decreased the cost of transaction and the speed of delivery and made the market more efficient. Well done!
Is more liquidity always better? Not if you can get paid for illiquidity. I am sure you have heard of the risk-return relationship in financial assets, where risk is the price variation, and return is your return as an investor for holding the risky asset. Fama and French are two outstanding academics, that are famous for having researched what other factors than price variation the market is willing to pay investors a premium for.
It turns out that liquidity is so valuable that investors willing to hold illiquid assets are paid a premium for that. Warren Buffett has made many of his best deals by having deep pockets at the right time, which means being able to buy during a crisis when “everyone” wants to sell, and then hold out through the rough period until the market improves. How can you as an entrepreneur and business booster make sure you are cash positive at the right times? By doing so, you will be providing liquidity to illiquid markets, and that can be very valuable, especially if the seller has to sell.
Cryptocurrency & liquidity
Cryptocurrency is currently doing wonders for liquidity. Transactions that take days with the fiat system take seconds with cryptocurrency. Transaction costs are lowered, speed of delivery increased. There is a vast untapped potential for both cryptocurrencies and applications of the underlying blockchain technology, to dramatically influence the factors that shape the liquidity in many markets.
Will you be the entrepreneur that can harness those capabilities in your market? The combination of cryptocurrencies, blockchain technology and artificial intelligence applications will create big changes in many markets in the years to come. Truly, we can paraphrase Buzz Lightyear and say that in the near future, we are headed “To liquidity and beyond!”
About the author
Jan Erik Horgen is a business owner and trusted advisor in Norway and internationally, to national and local government as well as for other business owners. He has a unique skill set combining finance and business acumen with deep understanding of governance, portfolio selection, programme steering and project management, having led the Norwegian delegation at several international ISO conferences. Detailed profile: Authors Profile