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Case for Discussion

Established two and a half decades back, XYZ Ltd is engaged in Information Technology (IT) for mass consumption. Those were the early days for the IT sector in India, and the company had to battle severe odds in its quest to become a market leader. The presence of some iconic names helped. But the acquisition of technology, product development, establishment of brand and developing a customer base were each a challenge by themselves. Surpassing all these was the challenge posed by financial requirements.
The initial idea for the product was simple but the execution from conceptualization to the final product was quite demanding. From development of the prototype to designing of the product, rolling out its services pan-India, development of the dealer network, and training and development of servicing facilities meant that the initial years were loss-making years and free cash flows were hugely negative.
Obtaining capital when the company was established was an easy task; there was a buzz around it and venture capitalists were only too eager to be a part of what was expected to be an iconic company. The company was, however, conservative in accepting funds, not wanting to dilute equity beyond what was essential. The promoters expected the company to be extremely successful and to generate huge cash flows.
Reality often turns out to be quite different from what we expect. Each of the discussed challenges proved to be stiffer than expected. The result was that while the company was successfully establishing itself during the first few years, profits were long in coming and finances were always strained. Given the uncertainty of operations and cash flows, its funds’ management policy was highly conservative.
Huge investment and the consequent negative cash flows in the initial years are absolutely critical to the company’s fundamental business and, if successful, leads to a sustained market leadership and a high valuation. While the operating cash flows during this period were positive, the company had immense opportunities for investment in business, building capacities and expanding the scope of their network. This phase lasting for almost a decade, built on the foundation laid in the first phase, made the company one of the best-known names in the country.
The last five years have seen significant changes, with the company’s business gaining maturity. It attained a significant size, with cash flow from operations continuing to increase every year. At the same time, new business opportunities have vanished. Fixed costs were high but had already been incurred. The variable cost of each sale was insignificant, with the entire sales consideration contributing to covering the fixed costs and generating profitability. Given the monopolistic nature of its business, there was no need to reduce prices to increase sales, which happened almost on an auto mode. High price of its product, large unit sales and insignificant costs meant a huge free cash flow generation every year. The company has by now accumulated a pile of cash flows for which it has no use. This phase is expected to continue in the foreseeable future.

1. Design an appropriate dividend policy for the company for the three phases of its operations.

2. The dividend policy is largely a financial policy. Does the business environment and strategy have any impact on it? Demonstrate with respect to the dividend policy of XYZ Ltd.