Thursday, February 7, 2008

Parmenides' Fallacy

Parmenides' Fallacy is an interesting concept. All our decisions are generally based upon the measurement of the future benifits that can be drawn by making that decision. How will it make us better of than what we presently are. This is the fundamental clause in the decision making of most of the managers while making any investment. But what is interesting to note is that the things in the normal circumstances will constantly deteriorate in their own. So, if we don't take any decision then we might be worse off in future than what we are now. So, if the investment is made then it might be that we would be worse off than now but better off than we would have been without it.

It goes like this. When an investment in the field of innovation is made then in the initial year the cash flows are negative for a certain period of time and then it picks up. Of course all the cash flows are projected ones and are hence based on assumptions which might fail. Now, if the investment decision is to be made then the cash flows after investment in new idea is compared with the present cash flows which is assumed to be unchanging in future. This is a trap. This is becasue if nothing is done (i.e. no investment is made) then the future cash flows will not be same as the present ones as the competitors' sustaining and disruptive investments over time will result in price and margin pressure, technology changes, market share losses, sales volume decrease and a decline stock price. So, in actual terms our present cash flows will decline if nothing is done and a status quo is maintained. It is with this declining cash flow that we should compare the future cash flow from the new investment to make decisions. But this is not practiced in general and the trend is to comapre the future cash stream with the present cash streram extrapolated in future. This is Parmenides' Fallacy.

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