How customer behavior can cause sales plans to change

Understanding customer behavior is a fundamental element of strategic planning for most organizations. The needs of consumers in the different markets differentiate one organization from another and drive a strategic plan to develop a customer base that can be profitable. Sometimes, a gap occurs between what organizations think about their customers and what customers actually expect from an organization. In this context, understanding customer behavior is even more important, as failing to provide superior quality products or services and to fully evaluate customers’ expectations and perceptions about the firm, can lead to a dramatic decline in sales and profitability or even drive the firm out of business.

Today, consumer purchasing habits are constantly changing and organizations need to find ways to adjust their sales plans and forecasts to these changes. Although organizations generally have marketing plans, in majority they do not have customer plans. However, customer plans are vital because they increase customer acquisition and customer loyalty. In particular, organizations that develop customer plans can:

• Analyze their customer base, the potential market, the sales network and competition
• Identify the future target segments
• Quantify the potential market by segment
• Decide the financial penetration and return on investment per segment
• Monitor the evolution of each segment
• Identify new segments and start over

As businesses expand, they require research on consumer patterns to stay ahead of competition. For instance, there has been a lot of discussion about how social media is shifting the control from marketing managers to a network of consumers, who influence product and brand preferences and, ultimately, purchase decisions. This is not necessarily a bad thing considering that the voice of consumers and their concerns should be heard and appreciated by firms. On the contrary, it is a great thing when it manages to drive authenticity and trust between consumers and the company.

But, there are cases that firms do not appreciate changing patterns in consumer behavior. Consumer response to these misapprehensions is usually switching to competition. However, changing consumer behavior is a dynamic factor that affects sales, profitability, business operations, and strategic planning. Therefore, firms need to estimate a potential switch of consumers to competition as a negative factor in their sales forecasts because, otherwise, their sales figures for the next year will be rather off track and inaccurate.

Besides, consumer behavior is subject to the cognitive aspects of consumers that are greatly influenced by (1) the broad availability of options and (2) the impact of media and advertising on their preferences.

(1)    The competitive landscape is cluttered with identical products that serve pretty much the same goals and therefore, product differentiation based on functional differences is becoming increasingly complicated. Consumers have too many options available and even when marketers can convince consumers about a competitive advantage, there are so many copy cats in the market that the functional benefits of a product become less distinct. Therefore, emotional bonding is the only way to establish a relationship with the target customer. And because of that bonding, marketers need to be able to evaluate even minor changes in consumer behavior.

(2)    The impact of media and advertising on consumer preferences is, admittedly, immense. Today, with the ease of a button, consumers can zap through commercials and surf over the Internet and choose which commercials they want to see and which they want to discard. Today’s marketers they use advertising both to inform but also to engage consumers into listening to their message and buying their products. In this way, consumer preferences are shaped according to what marketers need to sell. However, if consumers dislike an advertisement, marketers have no control on what consumers can watch on their TVs.

To anticipate changes in customer behavior, firms use advanced tools of business intelligence and analyze customer behavior analytics by focusing on the customer dimension. Firms identify what are customers buying, what they purchased before, and what they are likely to purchase in the future. All this analysis enables them to create customer lifetime value and perform thorough market segmentation from information that is accessed in point-of-sale transactions. Besides, customer behavior analytics allows firms to market their products more efficiently, to target their customers more effectively, and to increase customer satisfaction and loyalty. Eventually, the discovery of new aspects of customer purchasing patterns alters the obsolete marketing strategies and leads to increased profitability and market share.

Conclusively, a change in customer behavior forces changes in business operations and strategy. However, businesses need to adapt to changing purchasing habits and not force trying to change their customers’ perceptions when introducing a new product. This will cost them both time and effort that will go wasted in the name of a change that most likely will never happen. Customers are the ones to decide if a product will be sold or not. And businesses have to follow.

Effective networking techniques to boost sales

In the competitive market environment of today, customers are more sophisticated and consumer preferences have shifted to a more demanding scheme, requiring consumer needs to be met immediately and successfully. As a result, the job of the salespeople has become increasingly demanding requiring them, not only to continually building a rapport with their customers, but also to continually expanding their network of contacts. In this context, networking is an effective method for salespeople to increase their credibility, and, most importantly, to boost their sales and profitability.

Effective networking is not as straightforward as it may sound. Although for an experienced salesman it would be relatively easy, there are several strategies that should be implemented in order to gain the trust of customers and consequently getting referrals.

One of the most important characteristics of effective networking is to demonstrate sincere interest in people. Salespeople who pretend they are interested in their customers’ concerns when they are essentially uninterested, sooner or later, will be eliminated from their own clients. Effective networking requires encouraging customers to talk about their concerns, asking open-ended questions that encourage conversation and exchange knowledge. In the same context, effective networking is about building long-term mutually beneficial customer relationships on a solid basis and not just for the benefit of short-term sales. It is certain that using the ‘what’s in it for me’ approach does not bring results.

Another important strategy of effective networking is to move beyond own comfort zone. Networking is about meeting new people in the aim of turning them into customers. Therefore, staying within the comfort zone is useless as what a salesman needs is as many connections as possible; the more connections, the more chances to build up on a big network of customers and boost sales.

Effective networking requires also a great deal of respect. Salesmen, who are aggressive and try to dominate the conversation and their clients, typically fail in attracting more customers. On the contrary, salesmen who start with a casual conversation and give time to their counterparts to get to know them a bit before talking business, typically expand their network quickly and successfully. Besides, respect refers also to the time spent with each prospect client. Salesmen, who monopolize the time of people, fail in expanding their connection networks. Effective networking requires effective time-management and the least of respect for other people’s time and mood.

Some of the final steps of effective networking occur after the networking event. Salesmen should always follow up with the people they talked at an event. Lack of follow up is often the primary reason for missed business opportunities. Typically, a follow-up call or e-mail serves the dual purpose of keeping the lines of communication open and reconnect easier for a second, more formal business meeting.

Finally, effective networking requires showing appreciation to the customer. Particularly, in the cases that customers give referrals, they should absolutely be thanked and appreciated. Customers are the lifeblood of any business and the relationship to them should always be valued, particularly in the context of networking.

Characteristics of a good real estate salesperson

Dealing with real estate is a stressful business and hiring the right real estate professional can make a huge difference. Typically, professional realtors possess a huge experience of over 15 years and really know how to build a professional relationship with their clients. This is evident on their excellent communication skills and on the confidence they show during the time they are working for them. In particular:

• Professional realtors are focused

Good real estate salesmen are focused on their job, and take seriously the job they are doing for you. For instance, if your real estate agent is too friendly or doesn’t have a proper appearance or doesn’t have a proper office to carry out the business, it probably means he/she is not professional and lacks experience. Someone who doesn’t take care of personal appearance won’t take care of your business as well. This means you cannot and you should not trust this person in your endeavors to find a house.

• Professional realtors are always available

A good realtor loves to work with people. This means that, even on a bad day, he is available for you to listen to your concerns and give you advice. Professional realtors are always available for their clients and always put their clients’ interest above theirs. If you arrange a meeting with your realtor and you feel rushed, it probably means he cares more about the commission than your case.

• Professional realtors are knowledgeable

Good real estate salesmen have a broad knowledge of the real estate market. They are familiar with the state and local real estate laws and they are specialized in particular areas so that they can direct their clients in the best way.

• Professional realtors go the extra mile

You may find a lot of professional realtors in the market with similar characteristics, who do their job great and bring results. However, those realtors who take care of extra details are those who, eventually, make the great difference or you, the client. Dealing with a realtor who is keeping you posted for every little development in your case; and is always polite and available for you is a win-win situation.

Overall, if you have a realtor who is returning your phone calls promptly, is an effective communicator, a powerful negotiator, an honest and polite individual and grateful for doing business with you, you are really blessed to have a good professional who will definitely take care of your case and will bring results.

A look at economic factors that affect retail sales

The retail sector plays a key role in the U.S economy, not only because consumer demand is an indication of a healthy financial system, but also because retailers serve as large employers. Nearly 10 percent of the national workforce in the U.S. is employed in the retail sector, which provides both long-term career opportunities for young people and seniors. Retailing serves also as a side job when people look to switch between career objectives.

No surprises then why the retail sector is greatly affected by consumer spending. Retail sales are highly sensitive to liquidity and preservation of capital. However, the recent real estate slowdown, the increase in energy prices, the tight credit lines and the general market uncertainty, all have led to a general slowdown of consumer-driven economic growth.

Generally, consumer spending is the driving force of U.S. economic growth and consequently of the retail sector. How much consumers afford to spend determines the profitability of firms and the viability of economy. The factors that affect consumer spending in the context of retail sector are numerous. Some are related to long-term changes in consumer habits and some are a confluence of an economy in recession and depressed consumer confidence.

One of the key factors that influence retail sales is the Internet. Online shopping has evolved into a major competitor of brick and mortar businesses as more and more shoppers do their research and shop online. Particularly, in the electronics industry the Internet has altered the purchasing habits of consumers. Large retailers compete on special promotions and discount offers struggling to offer superior customer service and top brand quality. However, consumers can find instantly and at considerably lower prices the same brands and products from the convenience of their home, without the added costs of excessive marketing campaigns and advertising.

The current financial turmoil is another factor that has caused a sharp decline in consumer spending. Consumers spend their money on discount stores instead of top-end retailers and in quick service restaurants instead of casual dining and white-tablecloth dining restaurants. Moreover, luxury retailers are experiencing a seven percent decline in global retail sales in 2009 after six years of growth and prosperity.

Overall, the retail sector is highly affected by the discretionary income of consumers, which is the amount of income they spend to cover their basic needs such as food, clothing and housing. In other words, if people cannot take care of their fundamental needs to survive, they are not willing to spend a single dime on luxury goods or on furniture, jewelry or electronics. The current market uncertainty has forced many retailers to get out of business and has led many households on the verge of poverty. Inevitably, the retail sector could not have been unaffected by a declining consumer spending and a sharp change in consumer preferences.

Risk management defined

In the extremely volatile financial environment of today, risk management focuses on matters of insurance and is concerned with identifying potential risks, which may have a severe impact on a firm. Firms conduct risk management assessments in an effort to identify new ways of protecting their assets against sharp market fluctuations.

Originally, risk management was related to the acquisition of the proper insurance, which was offered in standardized forms, basically eliminating the need of risk management. Insurance was purchased to cover the cost incurred by fire, theft and liability losses. Over time, globalization and the increased volatility of financial markets has given birth to a great variety of risks, which can adversely affect organizations. This changed the concept of risk management radically, making it increasingly important.

Modern organizations use risk management as a common practice, particularly for any operation, which is related to financial or facilities management. However, risk management is not focused only on financial risks, but on a multitude of risks that may pose potential threats for a firm. In particular, some of the risks, which need to be alleviated or managed by risk management, are:

• Financial risks: they are related to financial transactions. For example, if the organization plans to issue new bonds, it faces the risk of an increase in the interest rates before the bonds are brought to the market.
• Demand risks: they are related to the demand for the firm’s products or services. Given that sales profitability is particularly important for a firm’s viability, demand risks are very critical for the firm.
• Speculative risks: they are related to the speculations a firm makes in regards to potential gains from investment projects or marketable securities. Speculative risks are particularity important because they may incur gains and losses to the same extent.
• Liability risks: they are related to liabilities associated to the firm’s products, services or employees. For example, improper driving of corporate vehicles may incur huge costs for the firm.
• Property risks: they are related to the destruction of production assets from floods, fire and so on.
• Personnel risks: they are related to employee’s actions such as fraud, embezzlement, sex assaults and so on.
• Environmental risks: they are related to polluting the environment, an issue that has acquired increased public awareness and sensitivity in the last years.

Generally, liability, property, personnel and environmental risks are insurable risks, meaning they can be covered by insurance. However, in order to decide if a specific risk will be insured, managers need to evaluate all optimal alternatives. This is a major function of risk management, which facilitates the undertaking of optimal risk measures.

Organizations recurrently undertake a comprehensive assessment of potential risks, at least twice a year. The assessment is being performed by a corporate team comprising of staff members representing all the major functions of the organization.

A complete risk management assessment involves the following stages:

(a)    Identifying the risks

At this stage, risk managers identify the potential risks that may be a threat to the firm. It is important to understand, that risks should not be categorized only by how the industry insurance views them. Each firm performs different activities and undertakes different types of risk. On the other hand, insurance coverage includes a tiny set of risks that modern firms face. Therefore, risk managers should apply a holistic view of risk management to pursue effectively their business objectives. Such a holistic view encompasses risks, which are related to:

• Business partners (interdependency risk, cultural conflict risk)
• Competition (market share, price war, industrial espionage)
• Customers (product liability, credit risk, lack of customer support)
• Distribution channels (transportation, service availability, cost)
• Financial operations (foreign exchange, interest rates, stock market)
• Operating activities (facilities, natural hazards)
• Human Capital (employees, independent contractors, training)
• Political conditions (war, terrorism, intellectual property rights)
• Regulatory & Legislative settings (antitrust, exporting licensing)
• Corporate reputation (corporate image, branding success)
• Strategic management (mergers & acquisitions, joint ventures, corporate agility)
• Technological issues ( complexity, obsolescence, virus attacks, hackers)

(b)   Measuring the potential effect of each risk

There are risks that are tiny and are not really posing any threat to the organization, while others may greatly impact organizational viability. Risk managers should be able to segregate risks by measuring their potential effect and then focus on the most serious threats.

(c)    Deciding on the appropriate handling of each risk

In most situations, risk exposure is anticipated and reduced by the use of several techniques. These involve, but are not limited to the following:

• Transferring the risk to an insurance company: Depending on the nature of the risk, it may be to the firm’s best interest to transfer the risk to an insurance company and pay a premium for it. However, there are cases that self-insurance is less costly for the firm, which prefers to bear the risk directly instead of paying another party to bear it.
• Transferring the risk to a third party: This technique applies mainly to manufacturing firms that may undergo liabilities as a result of problems in their transportation fleet for example, which would have a huge impact on transferring the products from the manufacturing plant to various points across the country. In this case, the firm may contract with a trucking company to undertake the shipping, thus passing the risk to a third party.
• Purchasing derivatives contracts to reduce the risk: Firms use derivatives to hedge risks. For example, financial derivatives can be used to reduce risks that arise from interest rates and exchange rates changes.
  • Reducing or eliminating the probability of occurrence of an uncertain event: The losses incurred by an adverse event are a function of the probability of occurrence and the dollar loss if the event occurs. In some instances, risk managers may reduce the probability of occurrence by taking appropriate risk measures. For example, to anticipate the demolition of property by fire, the firm may use fire-resistant materials in areas with the greatest fire potential. In other cases, a firm may discontinue a product or a service line if the risks associated outweigh the returns.

Business analysis through SWOT

SWOT analysis is a framework to examine a firm’s competitive position and strategy. By examining a firm’s Strengths, Weaknesses, Opportunities and Threats, SWOT evaluates a firm’s strategies to exploit its competitive advantages or defend against its weaknesses. Strengths and Weaknesses involve identifying the firm’s internal abilities or disadvantages, while Opportunities and Threats involve identifying external factors such as competitive forces, development of new technology, governmental intervention and/or domestic and international economic trends that influence a firm’s financial performance and business operations.

Any firm has strengths and weaknesses in the functional areas of business.  No firm is equally strong in all areas. Internal strengths and weaknesses combined with external opportunities and threats created the grounds for establishing successful objectives and strategies.

STRENGTHS

The strengths of a firm provide a company a comparative advantage. A firm’s strengths that cannot be matched or imitated by competition are widely referred to as distinctive competencies. Generally, perceived strengths that build competitive advantages by exploiting distinctive competencies can include superior customer service, high-quality products, strong brand name, customer loyalty, innovative R&D, market leadership, and/or strong financial resources. To remain strengths, they must continue to be developed, maintained and defended.

WEAKNESSES

The weaknesses of firm occur when competitors have potentially exploitable advantages over the firm. Generally, perceived weaknesses can include lack of marketing expertise, poor customer service, poor-quality products, poor reputation, undifferentiated products or services in relation to competition, an/or poor financial resources. Once weaknesses are identified, the firm can select strategies to mitigate or correct them. For instance, a domestic producer in a global market would rather invest in markets that will allow it to export or produce its product overseas. Alternatively, a firm with poor financial resources would rather enter into joint ventures with financially stronger firms.

OPPORTUNITIES

Opportunities, also known as environmental factors that favor the firm can include a growing number of external forces that influence the firm’s operations. Generally, perceived opportunities can include a growing market, a new global market, mergers, strategic alliances and joint ventures, and/or entering new market segments and niche markets. External forces that interrelate and translate into changes in consumer demand are classified into economic forces, social, cultural, demographic, and environmental forces, political, governmental, and legal forces, technological forces and competitive forces.

THREATS

Threats are environmental factors that can hinder a firm in achieving its goals. Generally, perceived threats can include the entrance of new competitors in a domestic market, price wars, impending negative legislation, buyers or suppliers seeking to increase their bargaining power, new technology that could preempt  firm’s product, innovative products from competition, new distribution channels from competitors, and/or high taxation on a firm’s products or services. By recognizing and understanding threats, an investor can make informed investment decisions about how the firm might mitigate threats in the future in order to gain competitive advantage.

Overall, a SWOT analysis should realistically depict the strengths and weaknesses of the firm in a specific and distinct way. If grey areas are included, SWOT analysis won’t distinguish between where the firm stands today and where it aim to stand in the future. Finally, SWOT should always be applied in relation to competition to offer a comparative analysis of a firm and its competitors. Through SWOT analysis, decision-makers evaluate their objectives and strategies and decide on competitive strategy taking into account customer segments, trends and competitors.

Tariffs on China’s tires and revisiting Smoot-Hawley

On September 11, 2009 U.S. President Obama imposed a three-year tariff on car and light-truck tires imported from China as a response to the United Steelworkers union complaint that 5,000 people have lost their jobs since 2004 as a result of the U.S. market being flooded by cheap Chinese imports.

The imposition of a 35 percent duty for the first year, 30 percent for the second year and 25 percent for the third year on Chinese-made tires caused the strong opposition of the Chinese Ministry of Commerce. The Chinese government views the U.S. move as a severe act of trade protectionism that constitutes a violation of the rules of the World Trade Organization (WTO), but also a direct contravention of U.S. commitments at the G-20 Financial Summit.

In effect, this decision can affect the Sino-American trade relations. China has already filed a complaint with the WTO claiming that, in 2008, Chinese tire exports to the U.S. increased only 2.2 percent from 2007, while in the beginning of 2009 they experienced a decline of 16 percent. On these grounds, the U.S. government lacked arguments for imposing such punitive tariffs on Chinese tires.

Secondly, the Chinese government will take responsive action to the protection of Chinese companies threatening to treat U.S. car-parts and chicken exports to China with the same cruelty. This evokes the tremendous retaliatory tariffs imposed by U.S. trading partners as a response to the Smoot-Hawley Tariff Act of 1930, which caused the U.S. exports and imports to decline by more than 60 percent, contributing to a great extent to the severity of the Great Depression. Although initially the tariff caused a sharp increase to industrial production and factory payrolls, in the process the economic system failed as a result of increasing tariff trade barriers on international trade.

Thirdly, the imposition of trade protectionism is likely to cause a chain reaction of unnecessary protectionist measures that will delay global economic recovery. President Obama took this decision to make US manufactured goods more competitive domestically. In effect, he put at stake many more American jobs considering that 2009 is the first year in which international trade is expected to decline. According to the World Bank statistics, Chinese exports fell by 18 percent in January on a year-on-year basis, while Japanese exports declined by 47 percent. In an environment where world trade flows are declining, forcing businesses to get out of business and threatening to compel millions of people into poverty, protectionism comes to wear away competitiveness, growth and employment. Regardless if the Chinese complaint is with or without merit, the complaint itself demonstrates how quickly retaliatory protectionist twist can spread, worsening the global recession.

What you need to know before opening a brokerage account

One of the most important decisions for an investor is to choose a good broker. Opening a brokerage account is perhaps the key to half-way success in investing considering that stockbrokers are not only responsible for trading. They are also responsible for giving their clients good investment advice, being knowledgeable, executing orders in the proper timing to take advantage of the market conditions and providing accurate information about margin interest rates, fees and commissions. However, choosing a good broker requires taking into consideration several factors.

The first thing to consider is the level of service required from an investor. There are full service brokers and discount brokers. Investors, who open brokerage accounts with full service brokers such as Morgan Stanley or Merrill Lynch, work with personal stockbrokers who focus on their needs and offer ideas on how these needs can be met. Besides, full service brokers prepare reports for individual portfolios providing investors with an idea about their returns and overall investment performance. Also, considering that many investors invest in foreign markets, full service brokers are available 24/7 to buy or sell stocks, bonds or mutual funds or reply to any inquiry, concern, idea, or suggestion. Because they offer exclusivity and a variety of resources to investors in order to make well-informed investment decisions, full service brokers charge higher commission fees than discount brokers, but investors are offered the safety of professional management.

On the other hand, discount brokers do not provide investment advice. They execute buy/sell orders and they do not work on one-to-one basis with the investor. Instead, the investor does most of the trading online and when he calls in the brokerage firm, the first available broker takes the order. E-Trade and Ameritrade are discount brokers that charge low commissions in case an investor comes in contact with a broker.

The second consideration when opening a brokerage account is the commissions charged. As already explained, one major difference between full service brokers and discount brokers is the commission they charge for their services. However, there are also differences in commissions between two brokerage firms of the same type. For instance, one discount broker may charge $7.99 per trade, whereas another may charge $14.99. Therefore, investors need to do their research and compare brokerage firms before opening a brokerage account because, in some cases, higher commission may insinuate superior service and faster order execution, but it may also mean nothing.

A third consideration is the amount of trading taking place. Many full service brokers offer a discount for accounts that trade several times per month up to a certain amount. If an investor trades less during a month, he/she should look for brokerage firms that charge a base price. Besides, other brokers charge a fee for investors that do not trade at all over a certain period of time. Overall, a thorough research is the first step before choosing the broker in order to avoid extra fees that may reduce the investment return in the long run.

A fourth consideration is investment tools provided by the broker. All brokers offer investment tools, research tools and such, but they also differ and it’s a matter of what is important to an investor to choose a broker based on these criteria. For instance, execution time is important to an investor, it makes sense to check on the broker’s policies. For someone who is more interested in viewing the portfolio performance, choosing a broker that offers portfolio analysis, dividend records, account balance and portfolio profits is the best option.

Finally, the variety of investment options is perhaps the most important consideration. In majority, brokerage firms offer stocks, bonds and mutual funds, which are the main investment vehicles for the average investor. However, there are investors who are more sophisticated and look for more sophisticated investment alternatives such as ETFs, options, commodities or currencies. There are brokers that are specialized in derivatives trading or currency trading and it’s definitely a better option to go to a specialized broker than to a broker that trader a little bit of everything.

What is a futures contract

The incredible growth in the use of derivatives and the sporadic controversy they stimulate make it important to understand their role in the financial markets.

A futures contract is a standardized contract that obliges the owner of the contract to buy or sell the underlying asset, which may be a physical commodity or a financial instrument (stock, or bond), at certain future date (delivery date) at a certain price (settlement price). The agreement is between (1) the party who agrees to sell the underlying asset for the agreed upon price (short position) and (2) the party who agrees to buy the underlying asset for the agreed upon price (long position).

To illustrate how a futures contract works, we assume that, in February, a producer of wheat wants to lock a selling price for next season’s crop, and a bread maker wants to lock a buying price to determine the quantity of bread produced and the potential profit. These two parties may enter a futures contract agreeing the delivery of 4,000 bushels of grain to the bread maker (long position) in May at a price of $5 per bushel. By entering into a futures contract, both parties secure a price that they agree to pay and receive in May.

Futures contracts are traded on a futures exchange, the quantity and quality of the commodity are specified, the price per unit is specified, the delivery date, location and method of delivery are specified, they are settled daily, and the position is closed prior to maturity.

Futures contracts have virtually no liquidity risk because they are traded on major future exchanges. Also, because of their standardized terms and conditions, such as the quality and quantity of the underlying asset and expiration dates, are allowed to be traded (bought and sold) in secondary markets. Therefore, the owner of a futures contract can buy or sell the contract and offset his position by trading an identical type of contract in the secondary market.

Futures contracts have virtually no credit risk because they are settled daily. Buyers and sellers of futures contracts are required to deposit the initial margin in a margin account, which is typically 3 percent to 6 percent of the value of the contract. Funds are added of deducted form the margin account after each trading session reflecting the daily price changes in the futures contract and this is how the settlement price is determined. Therefore, as futures contracts are settled daily, if the margin account becomes too low, the maintenance margin limit is reached and the investor is required to put additional funds in the account or to close his position.

Through this process, the futures exchange becomes a counterpart to all transactions and if an investor defaults, the exchange covers all losses. In any case though, the daily settlement of the account and the maintenance margin requirements help to spread the risk over the daily cash flows of the futures contract until maturity thus preventing an investor’s deficit from increasing.

Futures markets are regulated by the Commodity Futures Trading Commission (CFTC), which oversees the exchanges and approves new contracts for trading. When a contract expires, cash or assets may be exchanged between the counterparties.

Using valuation to plan your investment position

Valuation process is a part of the investment decision process in which the value of an asset is estimated. Research asserts that the two main approaches to the valuation process are (1) the top-down, three-step approach and (2) the bottom-up, stock-picking approach. Although both approaches may be equally used by advocates of fundamental and technical analysis, they differ in the way each one perceives the importance of the economy and industry in the valuation of a firm.

Top-Down Valuation

The top-down, three-step valuation approach holds that, regardless of the qualities or capabilities of a firm and its management, the economic and industry environment has a major impact on the success of a firm and the rate of return on its stocks. To illustrate this, we assume that an investor owns the stocks of a viable and successful firm. If the shares are owned during an economic expansion, the sales and the earnings of the firm will increase thus increasing the returns the investor receives from owning the firm’s stocks. However, if the stocks are owned during an economic recession, the sales and the earnings of the firm will decline and consequently the stock price will decline as well. Therefore, in order to estimate the future value of a security and its rate of return it is absolutely essential to analyze the outlook for the aggregate economy and the industry that the firm operates in. Investors, who use this approach, forecast which industry can outperform the market by analyzing the broader environment and they choose specific firms to invest in.

Bottom-Up Valuation

The bottom-up, stock-picking approach overlooks economic conditions and industry potential and focuses on a firm’s individual attributes. Investors, who use bottom-up approach, study primarily a firm’s fundamentals such as sales and earnings figures, balance sheet and cash flow statement. Balance sheet reflects managerial effectiveness and wise allocation of capital. Strong cash flows depict a firm which is able to finance its operations without raising additional debt. In addition, studying the potential market size is also required when investors use the bottom-up valuation approach. Although market size cannot be estimated accurately, still weighing its potential provides a good projection of the earnings potential a firm can achieve. Besides, information about a firm’s market share is also required, because the bottom-up valuation approach asserts that successful firms consistently increase their market share and expand into new markets with solid growth prospects. Therefore, if fundamentals make sense and the firm is strong, the business cycle or broader industry conditions are not considered.

The top-down, three-step valuation process is supported by academic studies, which assert that economic environment has a significant effect on firm’s earnings and that there is a relationship between stock prices and economic expansions and contractions. Moreover, the changes in individual stock returns are explained by changes in the rates of return of the firm’s industry. On the other hand, the bottom-up valuation process is challenged as it requires superior stock-picking skills in order to identify undervalued stocks. In addition, the psychological factors and cognitive biases of investors can lead markets off-center.

Conclusively, the top-down, three-step valuation approach is preferable valuation approach because it is not subject to subjective preferences and plain figures. By considering the aggregate economy and market, examining global industries and analyzing individual firms, it determines the value of a security based on market consensus rather than on the individual traits of investors.