Enrons Business Model

Topics: Enron, Enron scandal, Stock Pages: 5 (1852 words) Published: May 9, 2010
A business model of the times
The Enron bubble was a prime example of the dominance of speculative finance in business. V. SRIDHAR
MORE than two months after Enron, the seventh biggest corporation in the United States, filed for bankruptcy, the stench of scandal refuses to die. Shocking revelations about the company's modus operandi continue to pour in. Public and media attention was initially focussed on the company's close ties with the political establishment and the policy-making bureaucracy. However, more details of Enron's "business model", so successful until it crashed dramatically after October 2001, indicate that the Enron bubble was just an example of the manner in which speculative finance dominates business. ROSSMAN DAVE/GAMMA

Enron's chief executive officer Kenneth Lay with wife Linda. In 1985, Enron started as a pipeline company selling gas. The deregulation of the energy and electricity markets, particularly since the 1990s, for which Enron was a leading campaigner, played a major role in determining its business model, which endeared it to Wall Street for more than a decade. The new opportunities that came its way after deregulation, particularly the ambiguously defined energy-trading rules, gave Enron a head start over others. Enron increasingly became an energy broker, selling electricity and later, other commodities. However, Enron went beyond merely bringing together buyers and sellers - which is what brokers do. Enron's innovative spirit, for which it was recognised by Fortune magazine as the "most innovative" corporation in the U.S. for six years running, was in evidence early. Normally the broker's brief is to arrange a contract between buyers and sellers for a commission on the contracted price. Enron went a step further. It entered into separate contracts with both buyers and sellers in a contract, making a profit on the difference between the two quotes. The general lack of federal controls and monitoring of energy trading enabled Enron to keep its books shut. Of the three sides involved in energy-trading contracts, only Enron knew both sets of prices. Over time, Enron began to design more complex contracts - essentially derivatives purportedly aimed at hedging risks arising out of uncertainties in interest rates or currency fluctuations. Often, more complex forms were aimed at hedging uncertainties about the weather or even a customer's ability to settle a contract. Since Enron's collapse, former employees have revealed that the company employed a battalion of doctorates in mathematics, physics and economics to manage these complex contracts. Wall Street analysts, wiser after the collapse, have been saying that the company was essentially betting on a mass scale. Between 1996 and 2000, Enron's sales increased from $13.3 billion to $100.8 billion. These were far above revenues generated by other large American companies such as Microsoft, General Electric or Exxon Mobil. Enron was described by an analyst as "a giant hedge fund sitting on top of a pipeline". While its revenues were boosted through innovative accounting practices, its operating margins were rather thin - about 5 per cent in 2000 and 2 per cent in 2001. Its return on capital in 2001 was just 7 per cent - rather low in the highly risky business of hedging. Consequently, while revenues were successfully inflated by ingenious accounting devices, Enron's profitability was never as high. Wall Street analysts, tuned to the more short-term figures on revenues and share prices, rarely questioned Enron's practices. KNETEN ROCKY/GAMMA

The Enron Corporation headquarters in Houston.
Two things were needed to keep the show going. One, investor confidence had to be maintained so that Enron, the organiser of the betting system, was perceived as having pockets deep enough to sustain it. Enron's partnerships played a crucial role in maintaining the myth of the company's invincibility. Debts had to be kept off its balance-sheet because that would...
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