What is liquidity?

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Liquidity, take me away!

Liquidity is a business concept that made me thrill with joy when I learned about it because it explained so much about what goes on in the world–in particular, it explained why a small company that is growing hand over fist will all of a sudden sputter and die.

So, gosh, what is it?

Liquidity is a way to describe an asset. An asset is anything that is worth money, right? Liquidity indicates how easily you can convert one kind of asset into another kind of asset.

In a normal economy, where there’s no massive currency crisis going on, cash is an example of a liquid asset. If I want to eat, I can bring my cash into a store that sells food, and I can exchange my cash for food–easy-peasy.

Let’s say that, instead of cash, I own a whole lot of land!

If I want to eat, I can’t bring my land into a store that sells food and exchange my land for food. Most stores and restaurants do not accept land as payment for food. Instead I would have to convert my land into a liquid asset–i.e. sell it for cash–and only then can I exchange my liquid asset to get some food.

So, is my land called a solid asset? Sorry, you are the wrong kind of dweeb! My land is called an illiquid asset.

How illiquid is my land? That depends on a lot of things–where is the land located, what it can be used for, what the real-estate market is like right now, etc., etc.

If I was very unlucky indeed, I could be someone who owns millions of dollars’ worth of land that can’t be sold any time soon, and at the same time, I could be someone who needs to pay food and housing right now.

If that is me, I am having what is called a liquidity crisis.

You do not want to have a liquidity crisis. A liquidity crisis is very bad news. If you are having a liquidity crisis, you are desperate for cash–and everyone knows it.

What are your options when you’re a business having a liquidity crisis? They are all bad: Taking out expensive loans, selling assets for way less than they are worth, declaring bankruptcy.

But here’s the real bitch about liquidity crises: They’re very hard for a growing business to avoid. Ironically, because of the potential for a liquidity crisis, success and growth can kill a business just as quickly as failure.

How can this be?

K-Pop is actually a really good industry to look at when trying to explain liquidity. That’s because the traditional K-Pop system–you know, the one where people sell their more-attractive children to labels to raise and train–has a lot of built-in liquidity issues.

For starters, there’s that whole period when the labels are housing and feeding and training young people who aren’t making any money yet. That’s why the whole system of indentures developed in K-Pop–to cover that money gap and help prevent that particular liquidity crisis.

Let’s say you own a new (but traditional) K-Pop label. You’ve gotten over that initial hump OK–in fact, you’ve even got enough money in the bank to debut your first K-Pop group, A Large Group of Attractive People.

The debut goes well! A lot of people are interested in A Large Group of Attractive People, and their debut single, “We Are A Large Group of Attractive People” is pretty darned popular.

Of course, you want to strike while the iron is hot and turn A Large Group of Attractive People into stars!

To attract both dedicated fans and endorsements, you arrange for a photo book to come out that will show everyone how very attractive the members of A Large Group of Attractive People are. You know live appearances are important, and the group is going to have to perform more than just “We Are A Large Group of Attractive People” if you want bookings, so you arrange to have a few cover songs choreographed.

Naturally you want more of the group’s own music out there, so you set everything in place for a mini-album featuring two more lead singles (with videos), “Say Hello to A Large Group of Attractive People” and “Give All Your Money to A Large Group of Attractive People.” Plus you start arranging for the debut of their dongsaeng group, A Large Group of Underage Attractive People.

Sounds smart, right? You are capitalizing on the popularity of A Large Group of Attractive People, so your label is bound to do well, right?

Wrong.

Here’s the problem with your business plan–everything you have in the works isn’t going to pay off for months. The photo book and the album (plus videos) have to go through the whole production process before you can even begin to make money off them; the cover songs have to be choreographed and learned, and then you have convince people to book your group; and you don’t even know if A Large Group of Underage Attractive People is going to pay off at all!

And everything you’re doing now, you have to pay for now. The photographer and the producers and the choreographer and the printer and the video director and the CD manufacturer all require money now. They’re not going to wait until after the photo book/album/videos/dances get your group a lot of money–they have bills of their own to pay, today!

If you do all the stuff for A Large Group of Attractive People that you were planning to do, you’re going to have a liquidity crisis. You are going to owe everyone money, and unless you’ve had the foresight to set up some kind of credit line or get some financial backers, you’re not going to be able to pay them, because you won’t have any cash! It’ll be lawsuits and bankruptcy for you!

But if you back off on all your plans in order to avoid this liquidity crisis, don’t you run the risk that A Large Group of Attractive People will never take off at all?

Yes.

That’s the rub, and it’s one of the more challenging aspects of running a business–it’s actually not a simple or easy thing to take advantage of some big trend, even if that trend seems like it ought to benefit you! Managing growth is a very difficult thing, and it’s hard to do well.

The limits liquidity concerns put on expansion is a big part of the reason why K-Pop fans are often pretty frustrated with the pace of promotion for new groups. The fans are going, “THEY COULD BE HUGE!!! PUSH THEM!!! PUSH THEM!!!! NOOOWWWW!!!!!” while the label is looking at its cash reserves and going, “Slow and steady wins the race.”

But liquidity issues never really go away. They’re a big part of why startup labels that expand relatively quickly (like AOMG) are more likely to hook up with a large corporate backer–they either get into a liquidity crisis, or they want to avoid one, so they look for outside capital. (The people who complain about such “selling out” are invariably completely fucking ignorant of–well, everything, but liquidity in particular.)

On the other hand, if a company really wants to remain independent, then it either has to forgo growth or grow very, very deliberately. There are no easy answers here–every approach involves its own set of risks and sacrifices.

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3 responses »

  1. Pingback: What is cost structure? | My Other Blog

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