Wednesday, June 20, 2007

More than just paper money?

This is necessarily short because this is still work in progress. In economics, we learnt that people hold money for 3 reasons.

1) 1. To buy things with it (transaction motive)

2) 2. As a safety net (precautionary motive)

3) 3. To invest or speculate, so as to make more money (speculative motive)

Now, what if something else is used for any of these purposes? I am not talking of the barter economy in failed economies. Instead, look at today’s world of commodities trading. Here, people are supposed to buy steel or cement or sugar for the purpose of using it. Instead, today, the market for commodities is clearly dominated by speculators. These are people who try to make money by speculating that the price will move up or down...buy the commodity contract, only to sell it later. Thus, they never usually accept delivery of the commodity itself...just buy and sell contracts.

I think a case can be made that these commodity contracts are a new form of money. They can be freely traded, they have a fixed value that does not change with time, and are convenient. However, most people recognize that paper money is worthless unless you can trade with it (exchange or buy things with it). This is not the case with commodity contracts, where there is a value attached to them, which is equivalent to the value of the commodity.

But this does not detract from the essential case. Today’s commodity markets are just another form of money being traded around. But we all know about inflation and money. How does that work in the commodity markets? And does it work at all? Its something I have not got an answer to yet...but it makes for an interesting case.

Friday, June 15, 2007

Back To Management--Bottlenecks and Customers

Well, today I was thinking of touching upon a topic that has been done to death by the book "The Goal". Written by Eliyahu M. Goldratt, who is known for his work on the Theory of Constraints, a cool management idea.
Of course, like most cool management ideas, this one is rather simple, and would be called common sense...but strangely enough, common sense is not really that common. Ok...enough digression, back to the topic itself.

How is a product made?
A product is made by subjecting it to a series of processes, from raw material to finished goods. For example, You take some mud from a mine in Jharkhand, subject it to a series of processes, and a few hours/days/years later, out comes a sheet of rolled stainless steel.
The example that I gave was very limited indeed, where there was only one raw material, and one finished product. But a more realistic example would be a car industry, where the inputs would be numerous, from steel and plastic to rubber for the tyres. And there would be several types of cars being produced, from small cars right up to 18 wheeler trucks. Now then it becomes a bit tougher to document the processes.
In essence however, a product can be thought of as a series of inputs, which go through a process, which hopefully adds value at each step, so that you have a final product that can be sold.

What is a bottleneck?
A bottleneck is a process whose speed determines the rate at which your final product can be manufactured. hmm...now this is not as clear as I wanted it to be. So lets try that again with a simple example. I think we have talked about our potato farm. Now the farm sells its produce to the local factory which makes crackling chips out of it (with cheese and lime flavouring). Now, my potatoes now go through a process. First they are cleaned and peeled(by hand) and then there is this awesome set of machines that cut it, then an automatic weigher, then a drier, followed by a brief quality check instrument, the flavour mixer, and finally, the frier. Once the chips are fried, there is a secondary weigher, followed by a packager.
Now you can see how the process goes...raw potatoes go in one end, and chips that I can eat come out at the other.
So let us take a situation where I want to increase my plants capacity...so I buy a whole new set of funky machines expecting to double output. Two months later, nothing of that sort has happened. I wander down to the factory, and all is clear. The machines are idle, because there are only 2 people peeling the potatoes. Only if I increase the number of peelers, can I increase my output. Now, this shows that my peelers are my bottleneck process.


So, what should I do?
The answer is surprisingly easy, is it not? All you have to do is eliminate that bottleneck, and hire more peelers. This is all the theory of constraints advices, and has what made Mr. Goldratt so famous. Of course, an observant reader will ask, so then what, "Are all my problems solved?" Not really, because once you clear one bootleneck, another will appear, and you will then have to sort the new bottleneck out. And so on and so forth, ad infinitum.

So where does the customer come in all this?
After all, that was in the title of my blog, was it not? Well, I think Mr. Goldratt, or someone else has already thought of this, but in case they have not, here is my take on this. Even if you can solve all your bottlenecks, its really easy to see that it does not mean you can produce all that you want. At the end of the day, you can only produce as many chips as can be eaten. So the final bottleneck in this whole process is your customer. And this is the part that is most uncertain. We have all seen companies with good processes fail. They have finally failed because in spite of all their optimization, they never optimized for their bottleneck constraint, which was customer demand. Thus, any production guy should be given a clear picture of what his product mix demand is likely to be, or he/she is going to be making the wrong moves.

Well, that is it for now...any ideas, as always, comment away.

Tuesday, June 12, 2007

Book Review-- The Reluctant Sorceror

Well, a relief from the barrage of management topics. Today, I would like to review my latest fantasy novel. Its the first in a continuing series by the author Simon Hawke, who is known for his novelizations of such classics as the Jason series....
This is a very light fantasy novel, with the scientist dumped in a magical world as the context. I rather like those, primarily because I like the funky problem solving descriptions that are made. The narrator is a rather verbose chap, who keeps butting in, and this makes the entire thing a lot more interesting.
Overall, worth reading once....but then, I am a diehard fantasy fan, and have recommended practically every fantasy book in the world!

Sunday, June 10, 2007

On Positioning...Branding I could understand!

Branding is a key part of marketing...a subject that sort of dimmed for me when I was told about customer delight rather than customer satisfaction!

However, branding has begun to grow on me, especially after a couple of talks I had with various people about products and value. And today, I notice that I almost exclusively buy branded goods. What makes me trust a Nike Shoe over a shoe that was stitched by me (probably equally skilled) cobbler down the road? Why do I brush with Colgate Toothpaste rather than any other?

Branding attempts to answer these questions. So first question....what is a brand?

Walter Landor, one of the greats of the advertising industry, said:


"Simply put, a brand is a promise. By identifying and authenticating a product or service it delivers a pledge of satisfaction and quality."


Another good definition is given by
www.buildingbrands.com
"A brand is a collection of perceptions in the mind of the consumer."

Now, the key thing that must be pointed out is that a brand need not always mean something positive, or provide any extra value for a product. For example, I could dislike Microsoft, as a result of which, I might refuse to buy their perfectly acceptable software. **

So, now fundamentally, we can say that a brand is a mental thing. It is the perception my product or service has in the mind of my customer and the general public. Again, an important point to note is that it is about perception....not necessarily reality.
So, a brand is more than just a logo, or a catchy tag line. It begins in the mind, passes through your pocketbook, and hopefully never ends! As some chap said, its about the entire experience...not just the product.


Traditional thinking has it, that if you slap a brand on something, you can charge a bit more for it. For example, potatoes sold loose would cost you Rs. 10 a kilo, but once it has been packed in a Spencer's Fresh wrapper, it can cost you Rs. 12. Why is this thinking prevalent?
A brand traditionally provides a degree of trust. And this trust has a cost to it, which is reflected in the higher cost of the branded item. Whether this thinking holds good today when every product is branded is debatable....now a brand has to add value...by enriching your experience rather than merely providing trust! (That previous sentence is an example of manageititis, a debilitating disease that is well nigh incurable).
So, what is the main thing that a brand has to do to succeed? Now, experts have it that a brand must position itself. Now, I found a nice piece on positioning here. But let me try to summarise it.
First, what is positioning?


Positioning is the art of occupying a specific portion of your customers mind, so that he associates you with a particular mood, thought, word, phrase...anything at all that he/she can remember. For example, when I see Kapil Dev, I still think "Palmolive da Jawab nahin!" Or when I hear "Venkatesha Suprabatham, I remember MSS and All India Radio".
Well, that is one question done...next, how is positioning done?
Now that is a much more difficult question to answer...and there is no perfect answer as well.
We can think of a few steps that can be followed to try and position a brand.

Step 1: Be Consistent!


There is a reason this is step 1. Its VERY important. After all, a person cannot remember you if you keep changing your message or your logo. Or if you jump in and out of products...release them, and then forget them. If you are inconsistent about your brand, you will be forgotten


Step 2: Focus and Sacrifice


Positioning means that you will have to focus on one set of customers or public that you want. Of course, human nature being what it is, it means that you will necessarily cause another section of society to hate your guts. Sorry, that is life. As Ries and Trout note: "Sacrifice is the essence of positioning." You can't be all things to all people. That route only leads to failure. An example is the iconic brand, "Harley Davidson". Yup...I love it! But strangely enough, I also know 2-3 people who absolutely despise it!

Step 3: Be the 900 pound gorilla


One of the rules of positioning is that there can only be 1 winner in the battle for a customers mind space. A given segment has only one brand in it. So, its important that you should be a market leader in the segment where you are branding yourself. Only that way, can you grow as the market grows.

Step 4: Innovate, only when you must


This is actually a corollary of Step 1, which is consistency. However, its no fun to be seen as boring, or unchanging. So your branding must keep its differences and still surprise the customer, even though its message must be consistent. Any examples? One that leaps to my mind is the awesome Amul ad campaign, where they have topical cartoons that still deliver the same message, "Utterly Butterly Delicious, Amul". This is a series that has run for almost half a century, but has still not lost its flavour or capacity to surprise.

Step 5: Listen to your customer


This has been said many many times, but is the hardest thing to do....we are all in love with the sound of our own voices. If your customer thinks your product is worthless, the best branding and positioning in the world is not going to save you. Assuming that your customer is a sucker is the fastest way to lose brand equity. It is worth remembering that brands which take their customers for granted tend to overprice the brands to reflect the price that they believe the customer should pay, rather than the brands own intrinsic value. While branding can affect a customers perceptions, consistently shoddy performance cannot be hidden behind a great brand. Strangely enough, the example for that comes from the brand with one of the highest equities. Mercedes-Benz. In the US, it was seen as a top end model, with spectacular reliability. But when a few years later, new management decided to reduce the quality; "the parts are just too good...they don't wear out even after the body of the car itself wears out"***; Mercedes-Benz plummeted to second from last on reliability.
So, a summary:


1. Branding is a mental thing. Its about perception

2. Positioning is about Consistency and sacrifice

3. The customer is not an idiot. Treat him like one at your peril


**I do not dislike Microsoft. I think they make good products!
***That part in quotes was a quote by me....not by a Mercedes-Benz...oops, Daimler-Chrysler person.

Tuesday, June 05, 2007

Why Infosys does not borrow...and Microsoft did not issue Dividends!

Yet another MBA post...inspired by a heated discussion with a colleague (it was friendly though). Now, frequently it has been pointed out in my finance classes that firms try to maximise stakeholder value. This usually means shareholder value, which means stock price!
And the thing that people say is this: if you can manage it, and its not too risky, use debt to raise capital rather than equity.
What does that above statement mean? Stripped of the jargon simply put, it means, "take a loan to expand rather than raising money from shareholders."
Now comes the point...Why is it better to take a loan...after all, you have to pay interest on it.
Let me explain it in this way. Lets say I have a potato farm, which has 10 investors. I make profits of 10 lakhs per year. This means that my shareholders get 1 lakh each. Now, lets say I want to expand, and buy my neighbours farm for 10 lakhs more, which will earn me another 5 lakhs a year. I could do this in 2 ways. Firstly, I can invite 10 new investors to invest 1 lakh each, or I can go to a bank, and at an interest of 10% pa, I could take the loan of 10 lakhs. Let us follow these two scenarios.
In the first scenario, my new profit would be simple. 10 lakhs from my original farm + 5 lakhs from my new farm. Total =15 lakhs. All good. But this 15 lakhs now has to be distributed to 20 people, which means that each shareholder gets only 0.75 lakhs each.
In the second scenario, my profit would be 10 lakhs from my original farm + 5 lakhs from my new farm - 1 lakh in interest payments=14 lakhs. So my profit is lower, but I share this money with only 10 investors, which means that they get 1.4 lakhs rather than 1 lakh they got last year. Of course, my total profits fell, but I don't really care about that...after all, my aim is to get my shareholders rich, and I have achieved that!
Of course, there is a downside, else every company would only borrow money....if there was a drought, and I made only Rs. 50,000, I would still have some money to distribute if I had not borrowed money, and if I had borrowed that 10 Lakhs, I would have been bankrupt, because of the interest costs. So, borrowing money is risky.
Companies which use borrowed money to expand are called Leveraged companies. And conventional wisdom states that if your risks are low (ie: There is not much likelihood of a drought), you should go ahead and borrow money. This would be true especially if your growth return on capital employed (or your profit divided by money invested) is higher than the interest rate prevailing.
The IT industry ought to be a place where leveraging should work then...after all, while bank rates are hardly 12-14%, an industry that grows at 35% should go for loans to grab as much profits as it can to expand. But Infosys has said for a very long time that they do not plan to expand with debt, and they only grow internally rather than taking loans. In fact, they have no debt at all, which seems that they don't reward their shareholders as much as they could.

But here is where I believe that the IT industry is essentially different from manufacturing or agriculture. For my farm which gives me paltry returns, I needed to invest a sizeable amount of money. Typically, a manufacturing plant would invest hundreds of crores, and after a couple of years, profits would be made. But in an IT firm, the investment required is minimal. They really do not need to take loans, because this can be funded out of profits which do not require new shareholders or payment of interest. Here of course, the disadvantage will be lower dividends paid to the shareholders, but this is really the cheapest option, because the shareholders would only get the bank deposit rate from their dividend income, while the company would be growing much faster.
This is the reason for the famous no dividends being issued by Microsoft...they could plow it back into the company and earn far more by growing. And this is why very few IT companies rely on debt and leverage to increase shareholder value. It is no longer very cost effective

Monday, June 04, 2007

Economic Theory for crazies – Part I, Government as a Monopoly

One of the things that I find wonderful about economics is its applicability for the most amazing things. While on the train, I had little to do, except stare at the roof, or listen to the opinionated chap behind me pontificate. So I thought about government.

There are striking parallels between Microsoft and the government. Both of them cannot be challenged (At the moment). And almost everyone agrees that both of them are abusing their powers. Microsoft abuses its powers to make super profits, (while providing great products) and the government abuses its powers by giving us shoddy services (check the state of your roads for verification). Now, I merely use Microsoft because it is a convenient example, and everyone loves bashing Microsoft. But any monopoly could do. Now why is that?

Economics says that when a transaction takes place between a buyer and a seller, in the best case, both the buyer and the seller gain. For example, let us say I go out to buy potatoes (I like them...what can I say?). I would like to pay Rs. 10 for a kilo. At the same time, the friendly neighbourhood grocery store has got potatoes which he is willing to sell at a minimum price of Rs. 6. Now, the two of us meet, and then we bargain, and finally, I will walk away paying Rs. 8 for a kilo. Now I am happy, for I figure that I have saved Rs. 2. And my grocery guy is also happy, because he figures that he has gained Rs. 2 as well.

This 2 Rs gain that I as a consumer make is called the consumer surplus, and the Rs. 2 that the grocery guy got is called the producer surplus. And this works only because I could bargain with the man. Now, let us say that instead of having competition, there was only a single grocery owner in the city...and let us also say that he is a very intelligent shopowner, who is likely to know exactly how much I am willing to pay for my potatoes.

Now, I do not have a choice...if I need to buy potatoes, I will have to buy them from this man...And my shop owner is only interested in maximising his profit, which will be when he charges Rs. 10 for a kilo of potatoes. More than this, and I will go buy beans or something else. Less than this, and he could have made more from me! So, as can be seen, now the consumer surplus drops to Zero, and the producer surplus rises to Rs. 4. So, I am left unsatisfied, and my shop owner can earn super large profits.

Now, how does this relate to government? Government after all can be though of as a provider of services. And since there is only one government at any given place, what happens is that it is a classic case of monopoly. Let us take the example of policing. Since there is only one police force that is possible, and this police force is not really economically penalised for providing sub standard service, they will provide the poorest quality service that they can profitably get away with. If the law and order completely breaks down, then the police will probably be thrown out, so they ensure that that unfortunate situation does not arise. But they will not get more profits or better revenues if their service is better...after all we are a captive customer base. So they will not provide a quality of service that we would like. Instead, they will provide the minimum services that they can get away with.

So, an economic solution (to me) seems to be to bring in competition in the services that government operates. This ranges from basic services such as law and order, right up to the point of framing of laws. What does this mean? It means that the citizen should be allowed to choose the cocktail of laws that he/she will follow. These laws should be enforced by separate forces. Since each person will have different expectations of government, and how much he/she wishes to pay for it, several alternatives are likely to emerge. It would also mean that privacy campaigners can also be satisfied...just choose a set of laws that do not invade your privacy. Of course, certain services therefore will become unavailable to you, but that is market forces for you! What you gain on the swings, you lose on the roundabouts, but as it has already been proved above, our consumer surplus is zero at this current moment, so anything ought to be better!

So economic theory states that a functioning anarchy is possibly the most efficient form of government. Conversely, it now seems obvious that a completely despotic dictatorship is the most inefficient government for the citizens, although it is the best option for the people in power, as they can maximise their gains.

Sounds perfectly fine, neh?

Opinionated B******* --> A lesson for yours truly?

Today, I was traveling back to Chennai...and I was treated (at second hand) to character who unfortunately reminded me...of me!
Now, this chap kept talking....throughout the 5 hours or so that the journey took. His poor co-passenger, was treated to his opinion on everything, from Engineering subjects, to how Unhip and Unhappening Bangalore was. And since he could not seem to have a volume control, the rest of the train was also kept informed about his opinions! For the first 10 minutes or so, it was entertaining, but by the time the 2nd hour had started I was getting a bit weary!
So, a note to self...Shut up when on a train...or at least, speak slightly softer!

Saturday, June 02, 2007

Laziness...at home only.

I just realised how pampered my existence at home is! I do nothing at all, get food, sleep all day, read...and basically laze around. Even at the Hostel, I used to do more, and living alone, I even used to wash all my clothes myself! :)
But at home...zero contribution. I must admit, I almost feel guilty at being such a lazy cretin. But its still only almost!