Wednesday, July 28, 2010

On Regulatory Zeal

By Saleem Husain.

Regulatory Zeal, along with India’s economy, is the great growth story of our time. I am alternately reminded of two very different campaigns - the “Got Milk?” campaign, focused on the absence of an essential ingredient and The Crusades, aiming for zealous universal correctness.

Let me explain in the context of my current time in India after a long stint on Wall Street, NY. Regulatory bodies in India find any and every occasion to congratulate themselves in public and private. To me this is akin to transport authorities feeling happy about low accident rates - by outlawing motorcars! Because that is what the financial regulatory framework in India is - and where the West is headed.

As in the “Got Milk?” campaign, one should focus on the absence of flexibility in broker dealers in India and see where that leads. A simple example is the Total Return Swap (TRS). It is by far the cleanest way of renting balance sheets out - which is the bread and butter of Indian banks. It is basically an instrument where the client pays a spread over LIBOR and gets the return (gain or loss) of an asset (usually an index or a collection thereof). Simple? Yes. Easy to price or hedge? Absolutely! So, sir, can I trade it…? Are you out of your mind!! But you can have corporations window-dressing their earnings at quarter-end, conning simple investors who ultimately lose money. The situation is akin to using a motor car to cut butter and a butter knife to tune an engine.

My larger point is that regulators’ ruminating on possibilities - while ignoring the possibility that the person involved may have the intellect to make an informed decision - only leads to a society where horse carriages still ferry around people; with the incumbent problem of dung several stories high, as was prevalent in NY at the turn of the century.

A person in need to sell volatility will find a way to do it. Be it under the cover of “capital origination” or by altering the company’s holding structure to permit it to do so in a location that allows it. A case in point - most CDS (credit default swap) contracts on Indian names are traded in London. If I was to round the circle, these CDS contracts may be used to create synthetic bonds on corporate debt and these ‘bonds’ could provide a proxy secondary market of corporate bonds. Interesting, except that secondary trading on Indian corporate debt is thin and illiquid.

Where does that leave us? Clearly, all markets are not created equal. Any market is a function of trust - not just between the participants and their faith in the market’s fair play but also, conversely, of the market's trust in the maturity of the player. We will have to live with differences in market structures across national boundaries and societies. However, I believe a guiding principle for regulatory bodies across markets should be that: the strength of an entity is measured not by how ferocious an attack is by a "virus" – but rather by how resilient the response is.

Saleem Husain is Director, Citigroup, New York. He earlier worked with Booz Allen Hamilton and Ernst & Young, and holds an MBA from New York University (Stern). He is currently based in Mumbai, India, and travels across the globe carrying his Kindle loaded with an eclectic set of books.

Saturday, July 24, 2010

To Predict or Not to Predict?

By Dr. Israr Qureshi.

Should we stop predicting?...because of the fear that such attempts may not succeed.

Should we choose less uncertain (or to stretch it further, "certain") scenarios to predict what will happen in future? The fun (and utility) of predicting lies in the fact that the business environment is very uncertain.

Going back to the issue of prediction raised in an
earlier post at Strategy and You, let's take the example of the football (soccer) world cup. If we take a probability approach, then predicting each match would be quite difficult as there are infinitely different combinations of passing the ball towards the goal post - when we factor in the presence of so many players in the ground, and each player can take multiple attempts at the ball in each passing sequence.

If we take a capability approach, then also it is difficult to predict, as not all players are equally replaceable (substitutable). Moreover, they play in unique synergistically mutually reinforcing combinations. For example, Muller was made to sit-out in the crucial semi-final with Spain. Now, no one could predict, which player will be made unavailable (either due to injury, or red card (for the same match) or yellow card (for the next match)). Absence of Muller made Klose less effective and resulted in the loss of a crucial match for Germany.

However, does that mean we cannot and should not even try to predict... (and rely on coincidence of random picks, as shown by Paul the Octopus)... my answer is a big NO. Here is why...even though some of us may not have predicted precisely about the Winner, most of us would agree that weaker teams were out of the competition sooner than the stronger teams (e.g. exits in first round). Irrespective of Germany's loss in the semi-final, most of us would agree that they played well, so they have the capability, and they would perform well in coming years (though there will be some chance factors such as the yellow card to Muller). Spain has consistently preformed well past couple of years and they deserved the world cup victory and they will continue to do well in next couple of years.

Thus, what I am trying to point out is that we may not be good in predicting top winners (their exact relative positions) but we are good in predicting broad winners and pathetic losers based on analysis of their relative capabilities.

Does that mean we do not need refinement in our analytical tool-box? Sure, we do need to refine our analysis. We do need to take into account the context, such as disturbing effect of "vuvuzelas", cold weather in South Africa (during this time of the year), high elevation of some match locations, so on and so forth. At times we need to factor in some uncertainties, such as the yellow card to Muller and his subsequent unavailability in the next (crucial) match. However, these conditionalities should not desist us from our endeavor to use all our knowledge, analytics, and wisdom to see where are we heading and how best we should land there.

*Dr. Israr Qureshi is an Assistant Professor in the Department of Management and Marketing at Hong Kong Polytechnic University. His recent research has appeared in MIS Quarterly, European Journal of Information Systems and several other prominent outlets.

Friday, July 16, 2010

The “i” vs. the “Phone”: Why Apple Will Not Recall iPhone 4

By Dr. Hari Bapuji.

I am tempted to predict what will happen in the Apple news conference today, though as Nassim Nicholas Taleb (author of The Black Swan) says, it is indeed difficult to predict business phenomena.

First, Apple’s news conference at 1 pm ET will be covered widely by the media of all hues. Second, Apple will not “recall” its iPhone 4 but will offer some fix. In the same breath, let me also say that what Apple does today is going to reveal whether it will remain the company of the future or not.

It is clear now that Apple’s iPhone 4 has a problem of signal interference. In layperson terms, it does not work as a phone when it is held in a certain way. It has also been established by now that it is a design flaw, which is integral to the features of a product as opposed to a deviation from design specifications, which would have made it a manufacturing flaw. The solutions offered by others for this range from wearing gloves while using the phone to covering it with duct tape.

Apple’s reaction to the reports of this problem was far from generous – Steve Jobs asked consumers to “stop holding it that way”, while the company said the problem is perceived because the bars indicating signal strength are not accurately representing the actual signal strength. So, they offered a software fix. Obviously consumers were not convinced because they were not reporting fewer observed bars (a matter of perception), but lost reception (an actual problem faced). This strategy of dealing with consumers is what makes me wonder if Apple which overtook Microsoft only recently is on the way to losing it. The reason I think so is because of the kind of problem that occurred in iPhone 4 and the manner in which Apple is dealing with it.

When it was launched, iPhone 4 garnered record sales because it could do a number of cool things, including making it easier to take pictures of oneself. It wasn’t surprising at all that Apple would equip its newest gadget with fancy features because it prides itself on its design excellence. This is reflected in the facts that Apple is perhaps the only company which prints on its products “Designed in California; Made in China.” At some level, Apple seems to have taken design to be more about fancy features and looks. That is, they seem to have focused more on form than functionality. Or, simply put, Apple perhaps forgot that iPhone is first a phone and then all other things. Otherwise, it is unfathomable that a company would not conduct enough tests to make sure the primary function of its product is well in place.

That Apple perhaps gives more importance to form than function is also a reason why it was unable to accept the problem in the first place – the problem relates to iPhone’s metal antenna which distinguishes it from earlier versions (by looks) and is supposed to contribute to its looks. So, Apple could not have compromised on this feature by admitting a problem with it and thus making changes to it.

While the problem is one thing, the reaction of Apple is another even more important issue. It has not been open to admit the issue, let alone discuss it. This is very typical of Apple – secrecy is a necessary ingredient of their strategy. However, a surprise is good only when it is pleasant. Likewise, secrecy is fine only when everything goes well; but openness is needed when thing are not going well. This where Apple seems to be missing the point. If we were to go to our marketing fundamentals, Apple’s handling of its customers’ concerns would likely be called “product myopia” and our experience suggests that it does not work, at least forever.

No matter what Apple does, it is not going to be called a recall simply because the Consumer Product Safety Commission (CPSC) will not be involved in it. The CPSC gets involved only in cases where the flaws in a product pose danger to consumers, but not when the product doesn’t meet quality expectations. Therefore, Apple will not “recall” iPhone 4, but will offer some fix.

The nature of fix that Apple will likely announce is important because it will tell us whether Apple will respond to its consumers and make the “Phone” work better or if Steve Jobs would simply say that “it is a phone because I say so.” In other words, it will be interesting to see whether they will focus on the “i” or the “phone” in the iPhone. That focus will give us hints about whether Apple will maintain its leadership or not.

Friday, July 9, 2010

Of Black Swans and Octopuses: Brazil, Soccer and Why We Just Can’t Predict

By Dr. Suhaib Riaz.

I was in Rio de Janeiro for the Academy of International Business conference when Brazil played Chile in the soccer world cup and won 3-0. Everyone at Copacabana beach, where the FIFA Fan Fest Screen showed the game to over 10,000 people, had such confidence in the team that “goal” shouts erupted on each occasion before the actual goals happened. And yet Brazil is out. And so are other favorites, such as Argentina and Germany. Two teams that have never won the soccer world-cup before will battle in the final. Why can’t we predict outcomes from such a controlled environment, where the regulatory framework (rules) are well known, the resources and capabilities of teams are well known, and the only strategy dynamics are how to move a handful of players to push a ball into a goal post? And if we can’t predict even these simple outcomes, how about more complex real world business environments?

By sheer coincidence I’ve been reading and ruminating on Nassim Nicholas Taleb’s “The Black Swan” (the second edition is out with a new section on robustness and fragility). Taleb doesn’t mince words, calling it a ‘scandal of prediction’ in most disciplines, particularly in the social sciences: “We are suckers for those who help us navigate uncertainty, whether the fortune-teller or the “well-published” (dull) academics or civil servants using phony mathematics.”

Such suckers in fact, that our latest prediction-obsession (fueled by the media) is with an Octopus named Paul in Germany that seems to predict Germany’s soccer outcomes better than any human judgment. Octopus Paul apparently has picked 6 out of 6 correct outcomes for Germany in the world cup. Any explanations?

Could it be that it’s simply drawn to the red on the flags, which would easily account for 4 picks of German wins against non-red flags, and two picks of losses against flags with more red than the German flag? I have no idea at all if Octopuses can even see that much colour, but here’s what Taleb might say: the real comparison would be if we consider a large number of random octopuses and see how many of them get it right: perhaps one or two will, just due to randomness, and Paul happens to be that one: “The reference point argument is as follows: do not compute odds from the vantage point of the winning gambler, but from all those who started in the cohort.” He calls this “the problem of silent evidence”, and it is widespread in our disciplines as various forms of survival bias – we only look at the ones that got it right, or survived, not at the failures.

Taleb’s larger point is of course that “we just can’t predict”, particularly given the presence of outliers or Black Swans in all social science phenomena. Particularly vexing is his refusal to accept a clear demarcation between Risk and Uncertainty – to him, the idea that risk is the situation where we can calculate probabilities means nothing. He seems to suggest that in social sciences there are no real world situations where you can calculate probabilities – and thereby predict risks; there is just uncertainty.

Which brings me back to uncertainty in the business world. Can we predict how the Brazil economy will look in 10 years? Can we predict what the leading companies will look like? I doubt it. Even a short visit there reveals the complexity of predicting such phenomena. Brazil’s institutional framework is under transformation. There are innumerable socio-economic variables that could change (say, for example a different type of political leader; or a new generation from the Favelas that is now apparently sent to school 7am to 7pm to keep them away from the drug lords); firms and their capabilities that are typically embedded in such complex environments could see sudden changes; Brazilian firms’ interactions with firms from the rest of the world could thus change; in all, the role that Brazil and its companies would have in the global economy is largely unpredictable. Only with a lot of “ifs” and “buts” can we say something, and most likely we would have to later blame our wayward predictions on factors “exogenous” to our analysis that we obviously couldn’t have seen coming.

Taleb, or NNT as he refers to himself in the book, has many more gems, but more on that later – here’s just one on a favourite theme:
“Don’t ask the barber if you need a haircut- and don’t ask an academic if what he does is relevant.”

Incidentally, I was presenting a narrative on the debt crisis, mostly after the events of the financial crisis, as is the bane of social science academics. The paper drew a surprisingly positive response for what I thought was really a work in progress. Perhaps because even at this point in the 'post-crisis crisis', there were few works on even trying to explain the largely unpredictable events that happened.

The question for us is: What kinds of organizations and strategies can we conceive of, for a world where we just can’t predict? Any takers? Or should we get an Octopus as CEO?  

Monday, July 5, 2010

Energy and Bottom of the Pyramid in Canada: Book Club for Manitoba Hydro

Dr. Hari Bapuji

Recently, I facilitated a book club in which Manitoba Hydro executives discussed the book “Fortune at the Bottom of the Pyramid: Eradicating Poverty through Profits (FBoP).” This book, written by late CK Prahalad, makes a simple, but very powerful argument – this world is inhabited by over 4 billion people who earn less than $1,500 an year and strive for a better life. Collectively, their purchasing power is in trillions of dollars. So, companies can make profits by selling to them and by innovating new products/services in a process of co-creation with the poor. In doing so, companies not only can make profits, but also eradicate poverty.

Prima facie, the book FBoP is not relevant to a public sector organization operating in a developed world. But, the participants were very quick to realize that the ideas in the book can help transform organizations anywhere in the world. As one participant noted, although “the examples in the book are from the developing world, it is evident that energy is at the core of those examples. So, it is relevant to Manitoba Hydro.” In other words, if we think of the past and the present, FBoP is not appealing, but is highly useful if we think of the future that we can imagine and create.

The discussion was centered around five themes: (i) identifying new markets, (ii) protecting existing markets, (iii) increasing energy efficiency, (iv) creating new energy forms, and (v) improving organizational systems and processes. Each of these themes revealed several interesting insights.

I was very surprised to learn that there are communities in Northern Manitoba that are not connected through the grid and use diesel-generated power. The group on new markets shared ideas on how those markets can be served with alternative power sources because laying transmission lines is an expensive proposition. There was also a question on whether anyone living in this part of the world can be considered poor given that their income may be more than $1,500 an year. But, the group soon agreed that it was important to focus on the idea than go by strict definitions: “this is our bottom of the pyramid” said the group.

The discussion on protecting existing markets was very challenging given that Manitoba Hydro is in a monopoly situation. However, situations can change dramatically and drastically (contrast the current situation of MTS/Bell with that they faced a few years ago). Not surprisingly, the group talked about how their markets (particularly those outside of Canada) may be served by companies offering alternative and off-grid power.

The most interesting dilemma was raised by the group that discussed the issue of increasing energy efficiency. Prahalad argues that companies need to deliver products and services at a low-cost, yet at the highest quality (in doing so, he challenged the price-quality equation that we have grown accustomed to). But, Manitoba Hydro already sells power at the lowest rates. As a result, the users may not have any incentive to conserve energy. In other words, this group raised the possibility of an unintended consequence of low-price and high-quality: high consumption. So, companies need to find a way to make sure that consumption is reasonable. Otherwise, the products/services aimed at poor may make the planet unsustainable. Prahalad partially acknowledges this possibility and asks that the products/services aimed at the bottom of the pyramid be highly sustainable.

The group on creating new energy forms discussed about various alternative energies, such as wind, solar, battery, and bio. These energies could supplement the conventional energy sources, thus providing more and more cleaner energies.

To do more with less, organizations need to really rethink their systems and processes, argued the group that discussed organizational systems and processes. They raised some processes (even minor processes) that need not occur in an organization as frequently. Also, they argued that doing more with less would involve higher co-ordination and trust among the units. It was very evident from this discussion that companies in today’s era of global competition need to continuously re-design their systems and processes to eliminate waste and reduce inefficiency.

Overall, the discussion was very useful and generated many insights. I felt that if we had more time, the discussion could have further moved into areas like (i) markets outside of Manitoba, (ii) using non-profit partnerships to improve energy efficiency, and (iii) new products that could improve energy efficiency. That said, the purpose of discussion in a book club is not to go into particular areas or generate highly useful solutions, but to set off thinking in the directions that we do not normally think of. To that extent, it was an enriching experience for me.