In my previous article I discussed the concept of value and how important it discard old ways of thinking in terms of products and costs, to re-focus around the consumer.

In this article, I will further the case for considering services in your business by distinguishing products from services.

Part Three, will look at the success of the Apple Strategy and some real examples of real profit margins including from the sector spread Woolworths enterprise.

So Why Services?

[...]

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Unfortunately, it appears my predictions were correct.  Australia is now in the full swings of the ‘Dutch Disease’, as our economy approaches US Dollar parity, our exports are unable to compete with deliberately deflated countries such as India and China.  Australia is at a terrible trade disadvantage, while drunk with high Dollar driven consumption.  It beggars belief that only 6 months ago, when I originally wrote my articles questioning Australia’s ‘Economic Miracle’, I was heralded as ‘Doctor Doom’ in some circles.  I counter that I was merely offering a seldom heard counter analysis drowned out by the never ending declarations of Australia’s economic victory over the Global Financial Crisis.  I maintained, that the crisis was not averted, it was merely delayed.  For how long, I will not pretend to hold insight, however that is inevitable, I am sure.

More background on my scepticism of the ‘Australian Miracle’ can be found here:

Australian Coal Exports Continue to Expand

House price growth to slow – or grow?

Business Investment Falls

Australia’s Export Composition

Government Spending Props Up Economy?

Two reports emerged this week, that I am aware of in my current superficial following of the mostly subjective media outlets:

ABC Australia’s 7:30 Report, Tuesday 05 October – will Australia’s resource boom hollow out Australia’s economy? This report should have been aired 10 years ago, not today.  However,  am relieved that at last the assertions of outcasts such as myself are being acknowledged.

Canberra Times, Thursday October 7 2010 “Overvalued housing market threatens to derail economy” (David McLennan). Surprise surprise.  In the mad obsession to divert all available capital to the unproductive sector (residential housing), we have starved the productive sectors of capital, at a time when they need it most as the strengthening Australian Dollar squeezes Australia out of the global market.  Not to mention various layers of market and labour distortion in to the mix that have not helped, but that touches on a contentious area I am not yet brave enough to venture in to.  It is brave enough to question the dominant economic religion in Australia as it is.

In other news, the Reserve Bank of Australia (RBA) held interest rates last week.  This suggests that the RBA does not seem to subscribe to the dominant religion either.

So Australia, drunk on consumption, is blinded to a few dangerous factors that threaten to de-rail our economy and bring back the dreaded 1980s “Banana Republic”.  All of these factors together, can add up to a devastating fire storm.  Anyone who has lived near an area afflicted by a bush fire storm knows how this works.  Any factor in isolation is damaging.  Together, they can add up to something spectacular indeed.

1) High currency, aka the “Dutch Disease” (more on this later) hollowing out Australia’s economy, leaving little left after the mining is gone.

2) Consumption driven economy, fuelled by the above

3) Diversion of capital to the unproductive residential housing sector.  Not in terms of jobs as the dominant economic religion encourages us to believe, but in what this capital ultimately produces, which is nothing.  Residential houses are a lifestyle choice and a psychological support, they are not productive in the sense that a factory or office building is.  There is no net job creation like a factory will produce.  The jobs only exist for the construction of the homes.  It’s a zero sum game if anyone is looking for a ‘economic stimulus’ in residential housing.  We would be better off building factories and critical infrastructure if we needed ‘stimulus’.  And that of course also excludes ‘school halls’.

4) Sectors outside of of housing and mining continue to be starved of capital, when Australia should be making hay while the mining sun shines.  Nothing lasts forever, and China is not exactly quiet in it’s ambitions to buy up resources in Africa and South America.  Australia can only hold China to ransom for so long.  And countries without democratic election cycles, for all their ills, can play the waiting game much better than any democratic country.  China is not a country to under-estimate, and is a client relationship we depend extremely heavily on.

5) If the housing bubble bursts, the Emperor will suddenly have no clothes.  Or as other commentators have suggested, when the tide rushes out, we will see who is standing naked.  Unfortunately, this will mean that assets on balance sheets across the country will be written down, leading to catastrophic devaluations in stock markets and retirement funds.  I do not believe the effects will be as bad as in the USA, however the effects will still be severe, when Australia is facing a demographic bulge that is famously under-funded for its retirement and as economic volatility will continue to threaten government revenue.

If Australia continues on its current course, we will indeed become a banana republic when the party’s over.

However, there are options, one of which is to conduct a thorough survey of the assets in the national economy.  One of which is corruption and transparency.  Australia has long since left the USA and most of Europe, including the UK, behind on this measure.  That is a asset to be exploited in the financial markets.  Managing overseas superannuation or pension funds for Islamic countries is a once in a generation opportunity we can not afford to miss.  Within a generation, Australia could transform from hole in the ground to tower in the sky.  And it would not be difficult, it just relies on some diversion of capital, the right legislative frameworks to be in place and some smart marketing by the government and by our financial institutions.  Any financial product targeting overseas Islamic (or any overseas) pension fund management market should be tax exempt at the very least.  Countries such as China and Korea do not hesitate to support their national economic strengths in much more overt ways.  There is no reason why Australia should not do the same.  This would benefit the global financial system, as well as our own well-being.  Australia has a ready resource of highly educated Islamic students and citizens ready to go.  We should encourage them to stay, not let them all go to Singapore where a government less encumbered by democratic voting cycles than our own, has seen this potential and is happily harvesting this resource with full page advertisements in every global magazine.

This is only one option, and there are many others.  I will expand on these over the coming months, while I continue to challenge the dominant economic religion in Australia that threatens to de-rail our economy and send us all in to poverty unless we start investing heavily in our economic strengths, now.

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What an exciting ride in economics this week!  And what an interesting time to see so much contrasting and conflicting reports come out.  The Australia property sector is an ongoing focus of mine, because apparently, property can never fall if you believe the Retail Institute of Australia, and we just need to release more land to solve the housing affordability problem.

However, information now emerging shows that this view  is not shared by international investors, and that even with all the full force of a federal election putting pressure on banks, it is unlikely that bank interest rates will remain as constrained as official RBA interest rates.  As sentiment moves toward regarding Australian residential property as a riskier investment, expected rates of return (interest rates) demanded of Australian banks will rise.  If banks are to remain viable, and this is in everyone’s interest despite what some popular media outlets tell us, they will have to pass on the increased cost of borrowing to mortgagees.

With Australian property now the least affordable in the world, it is not unreasonable to expect a correction.

The question I will continue to ask and look out for signs for, is will the coming bushfire be a healthy one that clears out the forest to make may for newer healthier growth in housing and the economy overall, or will it be something more serious?  Despite all the reports coming out, I am optimistic that the coming economic bushfire about to erupt in the Australian property market, will be a healthy correction and nothing to fear although spooked investors will make it look like something to fear.

Here are a few interesting articles floating around that you may not have seen, as this sort of information rarely receives broad attention.

Early June (almost one month ago)

“AUSTRALIA’S biggest banks have become the victims of aggressive international hedge funds, which are shorting the banks’ stocks after growing concern about the strength of the domestic property market .. A New York hedge fund manager, who did not want to be named, said sentiment towards the Australian banks had soured because of doubts that the strength in the national property market would be sustained“

via US hedge funds dump Australian bank shares | The Australian.

(Well, at least something’s growing)

Yet despite this coming out a month ago, reports in the Australian media are still reporting contrasting and at times conflicting information.  However, that any conflicting reports are emerging, is a sign that a few measures are becoming more widely known.  Eventually, a cunning journalist will connect the dots and see there is something worth investigating here.

Tuesday (June 29)

Reports are emerging that the cost of lending to Australian banks is rising, regardless of any level of ‘political pressure’, because well, the foreign markets where our banks source their funds don’t answer to our politicians.  So while bank bashing will become a popular sport in the coming federal election, it is unlikely this will achieve very much outside of the polls.  Banks may ‘reconsider’ their discount rates, however a bank is not a charity, they still need to make money, and we need to them to make money.  Love them or hate them, events in the USA in 2008 showed us very clearly how struggling and failing banks are in no ones interest.

“The ‘big four’ banks are struggling to maintain their home loan status quo as higher wholesale funding costs increase the pressure on banks to raise their home loan rates. But faced with the potential political backlash for increasing interest rates out of sync with the RBA’s cash rate changes has lead to banks reconsidering their discount rates for new home loans, The Australian reports.”

via Banks to slash loan discount rates due to politcal pressure | Dynamic Business.

“Borrowers are unlikely to get any relief through lower costs in the forseeable future as the big banks face replacing tens of billions of dollars of cheaper-priced debt at much higher rates.  That was the message underlined by ANZ yesterday when it disclosed that its long-term debt was now costing 20 per cent more across its $90 billion portfolio of borrowings, extending to the 2014 financial year.”

via More pain as banks prepare to pass on costs.

Wednesday (June 30)

A report suggesting the housing market is very strong.  Except it’s largely attributed to being artificially created by taxing the future to boost the present (aka ‘stimulus’).

Building permits soar – ABC News (Victoria)

“The value of approved housing permits has climbed to almost $12 billion, up almost a third on the same period a year ago”

“The Building Commission .. Deputy Building Commissioner Sarah McCann-Bartlett says .. it is a combination of very strong growth in the domestic sector, particularly driven by the first home owners grants, and public housing programs, and then the school stimulus package as well as growth in other public buildings,” she said.”

So not much actual real private sector growth there.

New home sales slump, prices stagnate – ABC News

“The widely watched RP Data – Rismark Home Value Index showed a rise in city home prices of just 0.5 per cent (seasonally adjusted) in May .. new home sales slumping by 6.4 per cent in May”

So outside of the publicly supported property market, prices growth is slowing.

Today (Thursday, July 1)

Building approvals slide, retail sales edge higher

“building approvals slipped 6.6 per cent in May (seasonally adjusted), following on from a steep fall in April .. The bureau says all states except South Australia (up 30.6 per cent) reported a fall in building approvals in May, with falls of 24.8 per cent in Tasmania and 13.9 per cent in Western Australia the worst results. However, the total value of building approved rose 2.7 per cent in May driven by a strong rise in non-residential approvals.”

So the property market is strong, where public funds have been diverted to support it.  Elsewhere, it’s sliding.

Interesting times are ahead..

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Following my earlier thoughts on Australia’s unsustainable export composition

The ABC has reported that yet another deal has opened up for Australian coal exports, this time for brown coal which is low grade coal.

This concerns me for two reasons:

1) Australia is continuing its reliance on coal exports to prop up our enviable lifestyles and this leaves the Australian economy dangerously exposed to a volatile global economy – and in case you need a reminder (graph taken from the Department for Foreign Affairs and Trade)

2) It further increases Australia’s responsibility for global greenhouse emissions. In the rush to move Australia toward a ‘low emission’ economy, we are conveniently pushing our responsibility further out of our awareness by ignoring where our imports come from – name China – who may not yet share our growing enthusiasm for low emission economics – while we happily base over one quarter of all our national exports on the most polluting export we can dig up and ship out as fast as the ships can take it.

So we sit in our solar powered homes, with our low emission cars, and wear many proud badges declaring our achievement, while the bulk of our consumer goods are produced in high emission economies.

The net result of this is to create a bubble of blissful ignorance around Australian consumers while through our exports and overseas consumption, may in fact be the most polluting people per capita on Earth, regardless of all the wind farms and solar panels on our roofs.

Coal is an incredibly important commodity to the Australian economy, one which we must, eventually, move away from. It should be seen as a stop gap measure while Australia builds up more economically and environmentally sustainable exports for the long term, not something to be celebrated.

Otherwise, considering where our imports come from, and what we export, we may as well be honest with ourselves and stop pretending we are an environmentally sustainable nation, however low our domestic emissions fall.

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Frank Zumbo  writes in the Herald Sun (Road to NBN may leave a debt mountain) of questions we should be asking about the NBN.  As a nation building project, it would fill the nation with pride and drive our small isolated nation steadfast in to the 21st century, no doubt.

However, I have several concerns with the NBN proposal

1) Can the Australian economy afford another 20 or 40 billion (more likely 60 billion after inevitable delays and blow-outs) to be imposed on businesses already struggling to rebuild after the GFC?  With our public debt already very high, and our levels of private debt threatening to destabilise the economy, it is uncertain if questionable large scale projects of this nature are necessary right now except for political reasons.

2) What is the economic benefit of a blanket nation wide broadband network, over incremental upgrades of poorly served areas, such as Gungahlin in Canberra which has suffered for well over a decade from very poor Internet reliability, if it can be obtained at all.  I am fortunate to be serviced by an extremely reliable and very affordable Internet connection care of Internode, as are many others.  I do not require an NBN in my life at the moment, I have everything I need for now.  The NBN will open up new business models such as digital media content delivery.  However there again, what is the benefit of this over a rail system upgrade in Sydney to reduce worker commute time for example?

3) What about submarine cables?  This is my main concern that I have been raising for many years.  It appears that in our rush to begrudge ISPs of charging higher prices than in other countries, and to build a national broadband network, we seem to forget that most of our Internet traffic is international, that Australia is a long way away from anywhere else, and that few other countries want to connect to us.  This means that Australia has a limited capacity of self funded submarine cables to link us to the world.  All the NBN in the world won’t change that, in fact it could bring our network to a screeching halt if this is not recognised, like building many freeways leading to a main road.  You get a traffic jam.  Few seem to recognise that Australia has only 3 or so main cables, and that the only reason we have been enjoying falling Internet prices in the last year or so is due to the PIPE cable coming on line (the cable that almost went bankrupt due to a lack of private and public sector interest).  At around 2.5 terabit/s capacity, the PIPE cable has been the single most significant Internet event in recent Australian history, yet almost no one knows of it except a few informed investors. (Note – I will update this post as more information comes to hand on the Australian submarine network and its current capacity).  So I question if building the front end first (NBN) before building the real infrastructure needed to make it work (submarine cables) is a wise move.

Overall, I just don’t think the economics or the social benefits of the National Broadband Network in a fragile economy where the recession has not hit us, yet, is a smart move without these and other questions being answered before extracting another 20 or so billion dollars from Australian businesses and citizens to fund it.

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It seems conflicting views of the Australian property market have begun to emerge, as could be reasonably expected around this time in the cycle before someone realises the emperor may be scantily clad.

House price growth to slow says expert | Herald Sun.

Economists predict 22pc house price rise

The emergence of diverging opinion in mainstream press heralds some interesting times ahead the for the Australian economy, and possibly some quite positive changes. A consensus is emerging that a bushfire of some description will burn through the property market at some point in the near future, however it remains to be seen where this bushfire will range from winter backburning to catastrophic firestorm.  I am optimistic, considering Australia’s less lax bankruptcy and default laws than that in the USA, and the psychological obsession Australian consumers have with housing, that any bushfire sparked when the bubble bursts, will be of moderate intensity and clear weedy undergrowth to make way for a newer healthier market to grow through. In other words, it will be positive for the Australian economy and for housing affordability. With any luck, it may also re-align investment activity to assets that are actually productive, i.e. businesses.

Some others however are less optimistic and talk of a crash, a raging bushfire that will leave a wake of devastation and economic ruin.  I am not yet one of those commentators, although I represent but one of many diverging opinions.

Interest in the Australian Property Market

Curiously however, interest in the Australian property market has gradually declined in search terms on the Internet since 2004, while news reference volumes have dramatically increased in volatility since the breakout of the GFC.  However interest has spiked recently.  Less curious are the search origins, with English, and then ‘Chinese’ as the dominant languages, and Hong Kong and Singapore presenting significant search origins, as to be expected by reports of foreign investment in to Australian property.

If anyone has any thoughts on any of the above, I would like to hear from you. Please feel free to leave a comment with your thoughts.

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According to TheStreet.com, the Australian Dollar has risen recently (now sitting at a more ‘normal’ level of around 84 cents) due to suggestions that the ReSPecT Tax could be wound back to something more sensible – i.e. not levied on profits above the bond rate.  Although Karl Marx considered the ‘Super Tax’ to be a wonderful concept, Karl Marx also did not understand the concept of business risk and could not understand why any asset or profit should yield more than the labour component of a product.  In a world where anyone can front up the required capital for any business concept without requiring debt or equity, this could work.  However in the real world, to even open a simple cafe, one must often take on considerable debt or equity (investors) over a period of up to 2 years before a ‘profit’ can be realised.  ‘Super’ profits, above the government bond rate, would be required after 2 years to make it worthwhile to open a cafe, risk business failure, and work very hard for up to two years to make it worthwhile, or even convince a bank or family members that the investment is worthwhile.

In other words, the profits from cafes can not be limited to the labour component going in to cafes (i.e. government bond rate of return which is slightly above inflation) or we would have no cafes.

Ideally, any tax reform would also only be applied to forward investments to minimise any potential impact to a nations sovereign risk rating, which directly effects the cost of capital for all other businesses in an economy, as these days most of Australia’s capital is sourced from overseas.

In an environment where it is quietly reported that Australia’s business investment levels are declining sharply, it is important to remember how crucial it is that the Australian economy encourages investment in business, to reduce the disproportionate burden that West Australia and Queensland resources are expected to carry, and to diversify the Australian economy to hedge against commodity price risks.

What this means for the average family is greater job security and more stable taxation revenues in to the future to fund essential services such as hospitals, police and social workers who will always, and should always, require public funding to operate.

Profit is not a dirty word, in fact it is quite the opposite.  Profit is what has carried human civilisation forward since we commenced farming tens of thousands of years ago.

The questions we should be asking are not about the concept of ‘profit’ per se, but rather the role of government in creating a stable and fair regulatory environment to allow honest and stable profits to thrive and feed back in to the rest of human society.

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Michael Janda from the ABC notes that “Government spending props up economy” noting that of the 2.7% GDP growth estimated so far this year, 0.7% of that is from “government spending”.  However, again buried in the article, is a little note that “business investment in equipment and buildings was a major drag on economic growth, with the fall in that sector subtracting 0.6 percentage points from GDP” and that “Household consumption also grew, adding 0.3 percentage points to economic growth”.

When I read this, I think of the USA financial crisis, a crisis of reckoning where it becomes evident sooner or later that an economy can not survive off consumption alone, it must, some day, produce something.  At the moment, “pick up in terms of trade”, meaning our household balance sheet as an economy (how much we consume compared to how much we earn), is due entirely to rising prices for coal and ore.

These rising commodity prices, combined with government spending, which remember has to be repaid through either taxes now or in the future, or through inflation (printing money) which erodes wealth and drives up prices and interest rates, fund our lavish lifestyles.  All those big televisions and cars and nights out that we all enjoy so much are all *consumption*.  And this *consumption* is what is being celebrated in the media as an achievement in economic ‘growth’.

It’s not.  It’s an achievement in ‘consumption growth’ and it is not sustainable if the world decides it needs less coal and ore.  It is also not fair on Western Australia to expect that state to continue to bail out the rest of Australia and fund our lifestyles.

The fall in business and capital investment raises concerns that the Australian economy is not building enough productive capacity to sustain us in to the future.

We can’t keep consuming, we need to start thinking about producing.  We need more investment in our economic strengths and rewards to investors who do so.

Because if it starts raining, we’ll be glad we made hay while the sun shined.

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For those with an interest in economics.  Notable comments that seem get buried in all the other news and declarations of the ‘success’ of the fiscal stimulus.

Glen Dwyer in Crikey writes today – “a sharper-than-expected fall in business investment” – “a fall in private investment (down 0.6%) and in net exports. The fall in net exports was due to an increase in imports (up 1.8%) while exports fell (down 0.5%)”

While you will hear “the terms of trade rose 4.2% and real gross domestic income jumped 1.3% as the improvement in the rebound of the resources exporting sector kicked in” which sounds great – I read “Australia starts digging big holes again to ship off coal and ore, to buy big cars and big televisions, while Australia continues to focus its economy on investing in the unproductive housing sector rather than the productive business sector”

The RBA clearly agrees, as indicated by it delaying much needed rates increases yesterday.

Meanwhile, auction clearing rates in Melbourne are declining despite the best efforts of the Real Estate Institute of Australia to report otherwise, and continue to beg the RBA to keep rates on hold despite declaring that housing prices will ‘never fall’.

I do not object to building homes for families, I do not object to families receiving retirement wealth through the sale of their family homes and needing strong property prices for this.  What I am concerned with is the buried news about the ongoing decline in business investment, despite the rise and rise of commodity prices.  As a country, we seem to have been blinded by the constant stream of positive news coming from a few very very big holes in the ground in the most remote and inhospitable parts of the planet where workers are sacrificing comfort and families to support the rest of our economy.

Education continues to be a success story, despite any clear support.

If China, Japan and South Korea were to suddenly decide, or realise, they do not require so much coal and ore, would we look back and regard the current decline in business investment as a smart move?

Who will pay the bills then?

We all need houses to live in, but we also need to pay for them.  To pay for them, we need jobs.  To have jobs, we need exports, factories, cafes and sandwich shops.  In other words, we need business investment.

I hope I am wrong, I hope no one loses a job and at that no family loses their home.  But if we are having such high levels of mortgage stress and falls in housing approvals in ‘boom times’ with abnormally low interest rates, what will happen when declining business investment and rising interest rates have a real effect?

We need an economy to feed and house us and pay taxes to fund everything else we take for granted.

To have an economy, we need incentives to invest in business.  We need rewards for doing so.  Not penalties.  Not more incentives to invest in ‘investment properties’.

Any Australian investing in entrepreneurial businesses on the ASX should be applauded and rewarded.

We need to reverse the decline in business investment, quickly.

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In this weekend’s Australian Financial Review (Perspective, May 15-16, 2010, p. 30), I note with concern a small comment buried in the article “The Great Property Puzzle” written by Ben Hurley investigating an ‘unexplainable’ drop in home owner occupied loan approvals, now sitting at a 9 year low, and falling for several months in a row.  Conversely, investor loans have increased for five consecutive months.

Hurley proposes two explanations:

Firstly, “Investors with existing portfolios who are buying with their equity, which will have swelled nicely in the last year.  Loans to investors have increased for five out of six consecutive months, ABS figures show, and the quantum dollar value of loans to investors in March was 34 per cent higher than one year earlier”

Secondly, Chinese investors are acting through resident family proxies to bypass foreign investment regulations.  These ‘invisible investors’ would be subject to the vagaries of foreign exchange fluctuations rather than the whims of Glen Stevens from the RBA.  It would also be difficult to quantify how much this is occurring.

The first reason concerns me the most.  Either these loans are taken out against the rising prices of property as security, or the sale price of property is used to fund ever increasing property purchases.  Both rely to varying degree on continued rising of property asset values to continue to prop up, and secure these loans, and to continue the upward spiral of property prices.  Both are built on sand.  Loans secured on the premise of forever rising property values, is alarmingly similar to that which occurred in Detroit, USA, in 2007 that ignited the the GFC raging financial bushfire.

The second reason concerns me to a lesser although still significant degree, as this further exposes how reliant the Australian economy is on Chinese money.  Any investment adviser will always suggest spreading your investment portfolio over a range of investments to average out risk.   The Australian economy, however, has invested greatly in China.

And all the while this is occurring, in a part of the economy that does not produce anything unlike factories, chip shops and cafes.   Houses do not add any productive capacity to the economy, in fact the resident density in homes is falling, so if homes were productive, even this figure would be weak.

This strengthens my argument that the Australian economy must be re-engineered to invest in the productive sector, away from residential homes, thereby lessening the pressure on struggling home buyers, and boosting our productive capacity beyond digging colossal holes and planting vast fields of crops.  In short, Australia should make hay while the sun shines, because nothing lasts forever.

Populist calls to ‘extract’ a greater communal return from the mining sector will amount to nothing, if that revenue is not invested in maintaining and capitalising on Australia’s competitive strengths in the services sector (corruption, stability and competitive education and other service provision).

Failure to do so will condemn our children to a protracted period of the ‘depression we had to have’, when the combined effects of rising interest rates and inevitable challenges in the Chinese economy exert their full influence.

Success in doing so, will entrench the Australian economy as a long term valued member of the global economy, and ensure our children enjoy a prosperous and stable future to fulfill their needs, and their dreams.

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