A Guide to businesses — barter.

If barter was a tool, then you should learn to handle it very carefully. Here, in this article, I am trying to convey when, why and how a business should barter.

If you still believe that barter is a trick of an old dog, then you are still living in the myth taught in schools, tailored by few economist, in past, based on baseless assumptions and no facts. Read Debt: First 5000 years to know more.

No doubt, money is the present and is the future of our market economy. There can be no better system of measuring thus trading effectively and efficiently. But the problem arises when we start treating money as a commodity and not just a measure of worth or a unit of account, which lead us to bear an additional cost of acquiring or holding the money.

Why should you barter?

The benefits of barter can be broadly classified into two broad categories both financial and non-financial.

But first I want you to read a small conversation between representatives of two companies -A and B (Mr. A and Mr. B), where A is a loyal consumer of services of company C while Mr. B from company B which is a competitor of C is trying to convince Mr. A from company A to use its products. (I am not so good at bargaining, so please forgive if this sounds funny, but I think this is what it should have looked)
Mr. A: Mr. B, I liked your product, its fine but I am sorry as we are already using C’s product and we are happy with it. Till date, there has been no serious complaint.
Mr. B: Mr. A, indeed, C’s product is fine, there is no doubt, but we are better, an updated and futuristic technology and at the lower cost.
Mr. A: For saving few bucks, I won’t risk rest of the amount. We have been a loyal consumer to C, and C also gives us the special attention to our needs.
Mr. B: Mr. A, you don’t have to risk rest of the amount. I don’t want you to pay me through money, instead, I would take your products of similar worth.
Mr. A: What would you do with my products?
Mr. B: We are the consumer of your product. We sometimes buy it from you or from other company depending upon the best offer.
( Mr. A, a sharp businessman, quickly calculate in his mind, the cost of producing their product is Rs 50 and while its market value is Rs 100, and the market value of B’s product is Rs 1000, so if he barters, he would have to give 10 units of their products and the cost they would have to actually bear would be just Rs 500 that too not in cash. A straight profit of Rs 500, and prevents cash outflow Rs 1000. Mr. A agrees to give it a try)

1. Non-Financial benefits of barter.

If you are thinking, that barter saved Rs 500 of Mr. A, well it did, but there is a bigger picture to it. If you notice how, barter convinced loyal Mr. A to switch from C to B’s products, which otherwise would have been impossible, for Mr. B even after giving a straight 50% discount. If MR. B had given discount he would have reduced his profitability or tarnished its brand image. So the non-financial benefits of barter are

• Brand replaceability — Mr. B, not only saved a few bucks, but he has formed a complex relationship with Mr.A which is profitable to both the parties. If Mr. A, who was determined to not use, B’s products initially, begins to like it, after the trial, then there are high chances that he would switch from C to B in contrast with the previous scenario where the odds were none. It is difficult to convert brand loyal consumers but through barter, it becomes quite easy as the cost of experimentation for the consumer is low.
• Guaranteed trail of your products — Advertising is just the noise, it attracts the attention of the potential consumer but never gives the experience of the product.
• Explore increased sales opportunity in a totally new market: Consumption in barter increases 10x or more as the cost of the product acquired has been reduced. It results in higher product/service discovery which results in increased avenues of sale.

2. Financial benefits of barter.

• Reduce your expenses.
• Lowers cost of per units of goods produced.
• Make a profit with high margin.

These points are well explained in this article.

Is barter suitable for you?

Now you know the benefits of barter. It is important to know if barter is suitable for you or not. For this, it’s important to discuss the business environment in which environment in which business is operating.

If the demand for your product (at certain fixed, decent profit generating price) is higher than what you are/can supply, and you are in no mood of increasing your production capacity then stay away from barter. It is a poison to your business. But how many times does this happens? Expect with few of companies (especially the ones dealing with commodity), I doubt if others enjoy this business scenario. So, here comes the barter.

If the demand for your products/services, is lower than your optimal production capacity, than barter is something which you should surely stumble upon. I do not say it would necessary be profit bearing, it depends, on how you barter.

Demand: When I say, demand for your products/service should be lower, I mean strictly the demand of your product and not the similar product of your competitor or its substitute. In other words, your market share of that product is low.
Optimal production capacity: At this level the cost of production( Cost of goods i.e sum of fixed and variable cost element) per unit is lowest.

How should you barter?

By now, I believe you would have made your mind if barter is useful for your company or not. The question which should pop up in your mind should be — how much you would barter? all? some? or should we barter against all products/service? How should we determine, if we should barter with a certain company or not? Based on the financial benefits, I have tried to conclude its outcome, here, as answers.

The appropriate quantity you should barter.

• Optimal production capacity — Demand of your product/service.
  As explained on top, that you should think of barter only if the demand for you product is lower than your optimal production capacity. Thus, the optimal quantity you should barter should be the difference between the two.

When the demand of a product is lower than the production capacity of the company, then there is two possible way company can be run forward.

i) Cutting down the extra supply to reduce the cost of the raw material and other variable expenses but ultimately it would lead to the increase in the cost per unit of the commodity due to constant fixed expenses and thus reducing the profitability of the company.

ii) Aggressive Selling: By continuously producing the commodity at plants full capacity to keep the price per product at its minimum and then selling the commodity aggressively in the market by giving various discounts or offers, thus tarnishing the brand image of the company.

In the both cases company would suffer a decrease in their net profit and also has a chance of losing its brand image. In such cases, if the company barter away the excessive inventory against their expenses on products/service which they require, then i) they would save cash outflow (in the form of expenses) ii) the net profit of the company would increase.