Speed of Money

In a classic little book “What the CEO wants you to know” published twenty years ago, Ram Charan, famed business consultants and then professor of Kellogg Business School, told a story of a street vendor in Managua, Nicaragua?to illustrate a fundamental business principle to his MBA students.?Most of the street vendors were poor peasants or merchants who were selling some kinds of produces, t-shirts, or hand made small crafts. When the group approach one of the women vendors and asked her where she got the money to pay for the merchandise. She said she borrowed it, at an interest rate of about 34% a year. When she told the group that she typically made about 5% profit for her sales, Professor asked his students how could she survive with 5% profit while borrowing at 34% interest rate.

I have over the years taken many visitors to the famed Silk Market or Pearl Market in Beijing. I have personally visited the Grand Bazaar in Istanbul, or markets in Vietnam, India and many other countries. Most of them operate the same way with a very thin margin on borrowed money. The people may not use the typical business school jargons, but all intuitively understand that a good return is dependent on two components: profit margin and speed. They have to work and hustle very hard to sell their goods at the “5%” again and again every day. The fast they can sell the goods, the more “5%” they can accumulate to cover the 34% annual interest and then hopefully make a return. Professor Charan summarized the case with the simple equation: return = margin x speed.

Fundamentally, all businesses operate under the same principle, regardless of you are a street vendor or CEO of a large corporation. The principle Charan highlighted translates into how it works about decision making for business operation or investment. In a fast moving dynamic world, the faster you can efficiently move prospects through your sales pipeline and converting them into closed-won deals, the higher sales velocity you would have. Without the speed, just better products or higher margin do not always guarantee better business results. Similarly, if it always takes more time for you to plan and execute any business investment activities than your competitive, you better believe your investments would have sufficiently higher margins to offset the speed of money in order to keep up the growth.

Interestingly, I came across this chart by Fed Reserve Bank of St Louis about speed (or velocity) of money in the US as a country which currently sits at near all-time low. In a conventional time, the velocity of money can be used to gauge the economy’s strength or people’s willingness to spend money. When there are more transactions being made throughout the economy, velocity increases, and the economy is likely to expand. The opposite is also true: money velocity decreases when fewer transactions are being made; therefore the economy is likely to shrink. The current economy is anything but conventional due to the the current pandemic and the ballooning money supply from stimulus since the 2008 financial crisis. Economists will debate for a long time on the current decreasing speed of money and implication on economic recovery.

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