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Quantitative Economic Analysis Mitigates Investment Risks


Accounting and financial models that forecast revenues, costs, profitability, cash flows, and return on investment are essential tools in business decisions.  However, the past does not always foreshadow the future.   Investment analysis in the 21st century requires greater risk mitigation than just simply examining an existing business’s financial history, or in the case of a startup, a business plan endorsed by experts in the field.  Indeed, when a company considers capital investment in new technology through either organic growth or by acquisition, key assessments are generally derived from accounting data and financial assumptions.  These are and have been the Gold Standard by which companies create the valuation and estimated financial numbers to determine a trajectory for the future. However, Economic models, based on real market forces, can provide risk mitigation with additional beneficial information as a powerful component of assessing probabilities of future events.

econometric analysis

Since the Internet communication revolution of the 21st century, traditional accounting valuations and business plan metrics today are significantly impeded in their ability to forecast change.  Today, metrics are much touted by investment and private equity groups but they lack Quantitative Economic Analysis such as a Regression Models. As an example, quantitative economic analysis, using a Regression Model can plot a business plan’s assumptions against key demand and demographic variables yielding a best fit numerical indicator as to whether the capital investment approximates the actual capital requirements.  Other quantitative tools, such utility coefficients, demand elasticity and probability event horizons, can provide solid economic information for ROI which can often enable investment and private equity groups to be an added lever bringing in former equity investors who are undecided.  Unfortunately most private equity groups tend to rely solely on “trend analytic data”, considering it as cutting edge but in fact it is nothing more than retrospective historical trending analysis as a form of predictive demand. This type of analysis is as antiquated today as a company using a FAX machine for documentation transfer rather than using 21st century FAX mail software.

As life science companies drill further into new technologies of the 21st century, so are new global competitors moving at geometric rates.  Large corporate entities can reduce expenses and overhead via the information revolution, and still operate with gorilla maneuver tactics in remote locations, while startups can simultaneously compete in the same markets using the same leverage of the information revolution.  Thus, a small startup can operate like the mature entity, just as the mature entity can maneuver with the same agility as a small startup. The ballfield is leveled and competition multiplies geometrically.

The marketing and distribution patterns today are driven by new competitors (domestically or globally), with new technologies for manufacturing processes or products for retail consumption.  GMOs (Genetically modified Organisms) or GEDs (Genetically Engineered DNA), whether for vaccines, diagnostics or solutions for increasing world food supplies, advancing technology from government sponsored global tech centers and start up tech companies are all benefiting from a multiplier effect through the proliferation of shared free access global information.

Adding visibility through enhanced Quantitative Economic Analysis can reduce risk and add intelligibility to an investment decision.  Mature businesses and technologies are often eclipsed in as little as 18 to 36 months by new market entries or new technologies.  Similarly, for early stage or start-ups, Quantitative Economic Analysis can make the difference between under or over funding the project, resulting in unnecessary dilution.  Misgauging the timelines can also adversely affect a company’s ability to raise capital at a critical stage in its launch and result in lower ROI for investors.  Today’s technology investments need to go beyond the same old business investment assumptions which can only be measured through an extrapolation of past events or assumptions about how the same components will perform in the future.

Nietzche, the philosopher wrote, everything changes, only nothing stays the same and his words are as profound today as they were when penned in the 19th century.  In a rapidly accelerated commercial world, real Quantitative Economic information vs. retrospective trend analysis can achieve better risk mitigation on capital investment for private equity groups.

By Ken Peters PhD
Professor Baruch College, Zicklin School of Business, CUNY
Principal, Analytic Medtek Consultants LLC

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