8. Checking the market’s viability

STAGE 8
CHECKING THE MARKET’S VIABILITY

Overall approach

The purpose of this stage is to make an assessment of the market proposals to ensure that they are economically sound. The market’s impact has to be quantified, expressing costs and benefits in financial terms to see whether the capital and running costs are likely to be covered by the expected revenues. This depends on two factors: expenditure levels and the market’s ability to attract traders willing to rent or lease space. The costs must be covered. In order to achieve this, investments in physical infrastructure must be kept to a minimum by using low-cost construction methods.

The market must also be evaluated in social and qualitative terms. By combining all these factors it should be possible to demonstrate that it is socially, technically and economically viable. The method of doing this is to prepare a feasibility study. The factors involved in making this assessment are explained in Step 8.5. However, before reaching that step it is necessary to make some preliminary calculations (Steps 1 to 4).

Step 8.1
Estimate development costs

Detailed budget estimates of capital works need to be prepared by the engineer. These estimates will provide the basis for making a cash flow projection on a year-by-year basis and should be undertaken as carefully as possible. The cost of preparing a design is a small proportion of the total cost while the benefits derived from ensuring appropriate design can be substantial.

Buildings. For simple markets the estimated cost of buildings is usually derived from the costs per square meter of buildings constructed using similar standards. Open-shed constructions will obviously cost less than buildings enclosed by walls.

Infrastructure and other costs. Infrastructure costs such as roads, bridges and culverts, drainage and water supply, should be calculated by using prices that reflect local conditions and material costs. Preferably, they should be priced in detail using unit rates derived from recent contracts of a similar scale. Other costs might include:

• pre-development costs, including site survey, planning fees, official permit fees and financing costs for banks and other lending institutions;

• land acquisition costs, including legal fees, duties and property taxes;

• site preparation and clearance;

• environmental impact mitigation measures; and

• design and supervision costs (for engineers and planning consultants).

Equipment costs. The most accurate way to estimate costs for equipment or vehicles is to obtain quotations from manufacturers or suppliers. For special items, such as prefabricated stalls or trestle tables, local craftsmen may be able to provide quotations.

Overall costs. An example of how to estimate the development cost is shown in Table 8.

Table 8
Market development costs

Step 8.2
Estimate recurrent costs

In addition to the capital costs of civil works and equipment it is necessary to estimate the annual recurrent costs of operating and maintaining the market. The estimate for a new market requires some guesswork. For an existing market the present recurrent expenditure provides a guide.

The recurrent costs of an existing market may increase or decrease as a result of improvements. An increase will occur if more staff is employed or if additional services are used, such as electrical power. Running costs may decrease if a rationalization of management results in reduced staffing requirements or if improved infrastructure results in reduced operating, cleaning, maintenance or insurance costs.

An example of how to estimate recurrent costs is shown in Table 9.

Table 9
Annual market recurrent costs

Step 8.3
Estimating benefits

The next step is to consider the benefits resulting from market improvements. For the market users these improvements should help to reduce transaction costs by providing more direct and cost-efficient access to marketing channels and by reducing losses of produce by spoilage. These benefits must be sufficient to attract the users to pay more for services in an improved market.

These benefits are best calculated in terms of the revenues that can be collected. There are two approaches to making estimates of the revenues. The first method is to estimate receipts on the basis of charges that are in line with those at comparable facilities elsewhere. The second method is to estimate the revenues on the basis of covering costs. In practice, it is best to use a combination of the two methods, checking one against the other and looking at the impact of the changes on the producers’ or traders’ margins. An example of calculating benefits is shown in Table 10:

The returns are generally very sensitive to the level of daily charges and rents charged for the stalls. The revenues derived from undertaking improvements should ideally be sufficient to cover all operating costs, including putting aside funds for future market expansion (and, possibly, for the maintenance of roads around the market). Revenues may not be sufficient to cover repayment of capital and interest, even assuming both a long repayment period and a grace period before repayment.

Table 10
Annual market benefits

Step 8.4
Test financial viability

After assembling the information on costs and revenues it is possible to test the financial viability of the market.

Discounted cash flows. The approach often adopted for analysis, particularly when there is external funding involved, is to undertake both a financial analysis and an economic analysis using discounted cash flows. This means that the values are shown as “current” costs and revenues. In this way, it is possible to add and subtract costs and benefits as though they all occurred in the same year. The purpose of such an analysis is to assess whether the sum of the discounted benefits exceeds the sum of the costs, i.e. whether the returns from a development will exceed the sum of the investment and discounted recurrent costs. The conventional way of expressing profitability calculated in this way is as an Internal Rate of Return (IRR) percentage. Normally a minimum IRR of 10 to 12 percent is required for a development to be considered viable.

The distinction between the two types of analysis is that a financial analysis evaluates the commercial worth of a development to its owner, whilst an economic analysis assesses a development’s worth to the whole economy (“public good”).In the latter case, the costs are adjusted to account for any distortions, such as subsidies and taxes. The benefits are not necessarily quantified on the basis of revenues but on the basis of reductions in produce losses or timesaving due to reduced traffic congestion.

Sources of how to undertake these types of analysis are given in the list of Further Reading at the end of the manual.

Break-even analysis. A more appropriate approach to evaluating a very simple market development is to use a break-even analysis, which requires only a normal calculator. This method is particularly appropriate if the investment is being locally funded. This approach to development analysis ignores discounted costs and is suitable for checking whether the level of investment is matched by the likely increase in rents and other revenues.

The method uses the familiar concept of defining the point at which a development breaks even, i.e. does not make a profit or a loss. It can be used to answer the following simple questions:

• What is the minimum rent or market fee that would need to be charged to recover all the capital and operating costs?

• Given the expected rents and market fee rates, what is the maximum amount that could be spent on the construction and on operating expenses?

• Given the likely level of operating costs and expected user rates, what is the minimum number of traders that would need to take leases on stalls or attend on market day?

Some examples of applying break-even analysis are shown in Table 11, using the figures calculated in Steps 1-3. This demonstrates that if the overall development costs were $32 000 and operating costs $6 000 a year, the annual revenues from stall hire and rents for 24 traders would need to be around $10 200 to break even. If the analysis produces rent levels that traders would not be willing to pay, the design should be reviewed to see if it is possible to reduce the capital and operating costs.

Table 11
Viability of a simple market development

Step 8.5
Assess the proposals

The purpose of assessing the viability of a rural market development is to enable a financier to make a decision on whether to go ahead with the project. This will be needed whether the financier is a government authority, a private company, a donor, an NGO, a local community, a market committee or a mixture of these.

Questions to consider. The market proposals need to address a number of fundamental questions:

• What are the real objectives of the development and what are the marketing problems being addressed?

• Have alternative strategies been analysed and has the most viable one been selected?

• If the programme is undertaken as envisaged, will it satisfy the needs of producers, traders and consumers? How have they been involved in the project design?

• What is the potential social and environmental impact of the development? Have adverse effects been minimized?

• Are the proposals operationally workable and are there any potential risks?

• How will the market be constructed? What are the potential sources of financing? How long will it take to construct?

• Are there any preconditions for success?

• Will the benefits from development cover the estimated cost? (Answered by Steps 1 to 4).

The answers to all of these questions need to be written down clearly in a report in order that a final decision on whether to proceed can be reached by those providing the finance.

Step 8.6
Amend the designs

The last step is to review the designs again and amend them if they are not financially viable or do not satisfy the traders and other market users. This effectively means re-examining some of the previous stages (site planning, building design, infrastructure and equipment provision and staffing levels) until a reasonable viability is reached.

It may be necessary to adjust the capital costs, recurrent costs and potential revenues. As market development is a collaborative effort, with success depending on the quality of market design and management, it is essential to go back to the users to find out whether it is possible to make these changes and still satisfy their needs.