I claim to be a good cook. I indulge in this passion occasionally. But when I do, I will also invite few friends so that I can show-off my culinary skills. I select some exquisite dishes from the collection of cookery books that my wife maintains. I will then ask my wife to get all the ingredients and get the maid to do all the cleaning, cutting and chopping. Then later in the afternoon after a nice nap, I will land up in the kitchen to commence my artistic composition of various ingredients to an exquisite rhapsody! At every point I will have my wife and the maid extending various implements to assist my operation like the nursing staff in an operation theatre. After the various concoctions find their way to the microwave, baking oven, refrigerator (as the case may be) I will leave it to the minions to take them at prescribed time period and present them for the consumption of the invited guests. Of course it is the job of the maid to remove all dishes and clean-up. I will almost fill the conversation during the dinner with the art that goes behind each of the dishes. What an excitement for me!
On the other hand I remember my Mom’s cooking. We had no gas supply and no gadgets like microwave, cooking range etc. Five of us were in colleges/ schools. One in medical college, two in Engineering Colleges, another one in regular college and the other in school. From breakfast, to packed lunch to evening snacks and the sumptuous dinner; all fresh from the kitchen, day in and day out, in addition to the teaching the kids, mending cows , and other chores of household.
My cooking is an occasional event, an aberration; primarily for my excitement and glory and not to help anybody’s hunger. Whereas my Mom’s cooking was meant to ensure that none of us went hungry. No ceremony. Just rigorous execution, just-in-time management of inventory, tight planning of cash flows, total customer satisfaction with outstanding social networks.
Unfortunately, it is the heroism that often gets recognised and not persistence and perseverance.
I remember the story narrated by an IAS officer about his tenure as the district collector of an inflammable district which often flared up at times of religious festivities. He used to take enormous efforts to get the occasion go without any incidence. There was a neighbouring district manned by his colleague, which also had similar explosive settings. The major difference used to be that at least once in a year there used to be a conflagration that hit the headlines which the collector had to manage with great difficulty. The credit naturally went to the second officer and very few could see the difference made by first one.
This happens in many private sector organisations too. The guy who solves a problem (which is often created by the same fellow) gets all the credit; but the guy who worked hard to prevent problems day- in and day-out and worked to bring about continuous improvements is seldom noticed. The credits and the bonus to the former, naturally encouraging high-profile project launches and other short-term strategies. We saw the impact of this short-termism in the meltdown of global financial markets.
What we need for sustained progress more is the discipline of my mother’s cooking (for that matter most mothers) than my heroism in cooking. As the proverb goes “success is 10% inspiration and 90% perspiration”.
Monday, August 17, 2009
Monday, August 10, 2009
To be or not to be - Part 3; Of Controls and Decontrols
Penicillin is the first antibiotic that was discovered. Over the years, penicillin and its derivatives became one of the most important drug families to fight infectious diseases in a very cost effective manner. The way in which the Government of India tried to manage price and supply of this drug makes an excellent case study on the impact of micromanagement of resource allocation by government.
In view of the criticality of this drug, the Government of India (GOI) set up facilities in two Public Sector Undertakings [PSUs] to manufacture penicillin. Within a short span of time, the capacity of these production facilities was incapable of meeting the demand. Even at Rs 1200 per unit (as against an international price of about Rs 600 per unit) these PSUs could just about meet the cost of production.
The government needed to keep the price low, keep the inefficient PSU afloat and also manage the shortage. A complex problem of optimisation!
The scene was perfect for control, corruption, privilege postings and bulk gratifications; sacrifices in the name of providing healthcare for the poor and needy. Now the government came out with a bizarre plan to manage price and supply of the drug in the domestic market without compromising the sustainability of the PSUs.
The department of Chemicals and Petrochemicals, the operating ministry for managing this complex social challenge of such national importance, in the beginning of the year would ask the industry players what their expected demand for the drug was for the oncoming year. Then they asked the PSUs how much they expected to produce during this period. Now the ministry officials, after significant deliberation even at the level of the secretary made allocation of domestic production to the buyers on some ratio of their expected demand and last year consumption. The ministry also fixed the price of penicillin to about Rs 1200 per unit. The government also ensured that no new licenses were given to produce this in India. Then to manage the demand these buyers were allowed duty free import in proportion to what they bought from domestic market.
The domestic suppliers were often unable to keep up with the supply they promised and although the price was fixed and the suppliers were PSUs the buyers were overcharged by demanding interest free deposits and other charges euphemistically called packing and forwarding charges. Even after all this, every month the buyers visited with begging bowls like supplicants. Once the buyers managed to buy from the domestic suppliers then they rushed for the import license; filling in bundles of forms that had to be pushed from table to table. The industry players had special skilled staff to manage this ‘logistics’. Once they got the import license, they had to woo the egos and line the purses of the customs department to clear the goods although it was duty free. Industry had specialists employed for this too.
A total waste of time and resources; but for some it provided opportunities for privileged postings and corruption. All for the benefit of the poor! Finally sense prevailed and such draconian controls on import and domestic production were lifted. Penicillin became available in the domestic market at less than half the price.
The story was similar for many more products. Cement is another excellent case in point. I remember standing with a begging bowl at the district collector’s office for allocation of cement to build our house. The construction activities had to be synchronised to match the erratic supply of this precious commodity. In fact almost at the end, when I wanted few more sacks of cement I had to buy the same from black market at three times the price.
Why am I remembering these past horrors?
One reason is to remind that there are still many areas where the policy makers appear to be micromanaging; supposedly for the larger good of the public. But in the end it just adds to corruption and inefficiency. The Air India kept alive on ventilator is a case in point.
More damaging outcome of such policies is that very small interest groups are able to influence policy makers to create market distortions and enrichment of the select few. Amartya Sen has beautifully described how the agriculture pricing policies destabilize market, fail to benefit the deserving farmers or the guy on the street and distort farming practices. As per him “The overall effect of the subsidy is more spectacular in transferring money to medium and large farmers with food to sell, than in giving food to the undernourished consumers” (For a detailed discussion on this, refer to “The Argumentative Indian” by Dr Sen page 212 to 215)
Even the free electricity to the farmer is the same story. The poor farmer gets no benefit as he can’t afford even a pump and the electricity board is in perpetual red!
Reminiscing of this past becomes even more relevant today when we hear cries for more government intervention and control on account of recent failings in the markets.
But I think the problem also lies in our basic feudalistic culture. I have had many opportunities to be associated with projects where the so called non-bureaucrats appear to be in positions that require them to be involved in areas of public policy. It was almost hilarious and shocking to see them changing their colour so fast. They suddenly wanted absolute control and were even worried whether the democratic process and market forces can be depended on for balanced development.
It is worthy to remember that as Garry Hammel noted in his famous book "Future of Management” democracy with its checks and balances and markets with its invisible hand are two of the few institutions in this world that have sustained for centuries.
We have few examples in India of right policy interventions revolutionising industry sectors. As Dr Ajay Shah noted in his article "Flying on One Engine” “In the story of India’s economic reforms, the revolutionary changes on the equity market stand out with respect to the magnitude of the change which has come about from 1993 to 2003 despite concerted political lobbying in trying to prevent change”
It is true that at times markets will fail. We need to try to correct the failure and not to abolish the market. What is needed when the market fails is to correct irresponsible behaviour for which rules have be in place and the regulators will have to intervene. But what we need is course correction and policy nudges and not wholesale nationalisation or control. Infants should be nurtured; but also exposed to the reality of the competitive world else they grow up to be spoiled brats. (Take a look at "Devastation of world financial markets - A case of Policy Reversals in India?” and "Checks & Balances - Who checks and Who balances” for some thoughts on this.)
It takes imagination and ability to think through the ground realities and to come up with policy framework that nurtures healthy competition and incentivise responsible behaviour instead of creating ‘tables with a value’ in government offices. What we need today is administrative reforms that would compel and encourage policy makers to be adept in this than become feudalistic despots.
In view of the criticality of this drug, the Government of India (GOI) set up facilities in two Public Sector Undertakings [PSUs] to manufacture penicillin. Within a short span of time, the capacity of these production facilities was incapable of meeting the demand. Even at Rs 1200 per unit (as against an international price of about Rs 600 per unit) these PSUs could just about meet the cost of production.
The government needed to keep the price low, keep the inefficient PSU afloat and also manage the shortage. A complex problem of optimisation!
The scene was perfect for control, corruption, privilege postings and bulk gratifications; sacrifices in the name of providing healthcare for the poor and needy. Now the government came out with a bizarre plan to manage price and supply of the drug in the domestic market without compromising the sustainability of the PSUs.
The department of Chemicals and Petrochemicals, the operating ministry for managing this complex social challenge of such national importance, in the beginning of the year would ask the industry players what their expected demand for the drug was for the oncoming year. Then they asked the PSUs how much they expected to produce during this period. Now the ministry officials, after significant deliberation even at the level of the secretary made allocation of domestic production to the buyers on some ratio of their expected demand and last year consumption. The ministry also fixed the price of penicillin to about Rs 1200 per unit. The government also ensured that no new licenses were given to produce this in India. Then to manage the demand these buyers were allowed duty free import in proportion to what they bought from domestic market.
The domestic suppliers were often unable to keep up with the supply they promised and although the price was fixed and the suppliers were PSUs the buyers were overcharged by demanding interest free deposits and other charges euphemistically called packing and forwarding charges. Even after all this, every month the buyers visited with begging bowls like supplicants. Once the buyers managed to buy from the domestic suppliers then they rushed for the import license; filling in bundles of forms that had to be pushed from table to table. The industry players had special skilled staff to manage this ‘logistics’. Once they got the import license, they had to woo the egos and line the purses of the customs department to clear the goods although it was duty free. Industry had specialists employed for this too.
A total waste of time and resources; but for some it provided opportunities for privileged postings and corruption. All for the benefit of the poor! Finally sense prevailed and such draconian controls on import and domestic production were lifted. Penicillin became available in the domestic market at less than half the price.
The story was similar for many more products. Cement is another excellent case in point. I remember standing with a begging bowl at the district collector’s office for allocation of cement to build our house. The construction activities had to be synchronised to match the erratic supply of this precious commodity. In fact almost at the end, when I wanted few more sacks of cement I had to buy the same from black market at three times the price.
Why am I remembering these past horrors?
One reason is to remind that there are still many areas where the policy makers appear to be micromanaging; supposedly for the larger good of the public. But in the end it just adds to corruption and inefficiency. The Air India kept alive on ventilator is a case in point.
More damaging outcome of such policies is that very small interest groups are able to influence policy makers to create market distortions and enrichment of the select few. Amartya Sen has beautifully described how the agriculture pricing policies destabilize market, fail to benefit the deserving farmers or the guy on the street and distort farming practices. As per him “The overall effect of the subsidy is more spectacular in transferring money to medium and large farmers with food to sell, than in giving food to the undernourished consumers” (For a detailed discussion on this, refer to “The Argumentative Indian” by Dr Sen page 212 to 215)
Even the free electricity to the farmer is the same story. The poor farmer gets no benefit as he can’t afford even a pump and the electricity board is in perpetual red!
Reminiscing of this past becomes even more relevant today when we hear cries for more government intervention and control on account of recent failings in the markets.
But I think the problem also lies in our basic feudalistic culture. I have had many opportunities to be associated with projects where the so called non-bureaucrats appear to be in positions that require them to be involved in areas of public policy. It was almost hilarious and shocking to see them changing their colour so fast. They suddenly wanted absolute control and were even worried whether the democratic process and market forces can be depended on for balanced development.
It is worthy to remember that as Garry Hammel noted in his famous book "Future of Management” democracy with its checks and balances and markets with its invisible hand are two of the few institutions in this world that have sustained for centuries.
We have few examples in India of right policy interventions revolutionising industry sectors. As Dr Ajay Shah noted in his article "Flying on One Engine” “In the story of India’s economic reforms, the revolutionary changes on the equity market stand out with respect to the magnitude of the change which has come about from 1993 to 2003 despite concerted political lobbying in trying to prevent change”
It is true that at times markets will fail. We need to try to correct the failure and not to abolish the market. What is needed when the market fails is to correct irresponsible behaviour for which rules have be in place and the regulators will have to intervene. But what we need is course correction and policy nudges and not wholesale nationalisation or control. Infants should be nurtured; but also exposed to the reality of the competitive world else they grow up to be spoiled brats. (Take a look at "Devastation of world financial markets - A case of Policy Reversals in India?” and "Checks & Balances - Who checks and Who balances” for some thoughts on this.)
It takes imagination and ability to think through the ground realities and to come up with policy framework that nurtures healthy competition and incentivise responsible behaviour instead of creating ‘tables with a value’ in government offices. What we need today is administrative reforms that would compel and encourage policy makers to be adept in this than become feudalistic despots.
Sunday, August 2, 2009
Learn to count- both Blessings and Failures
In my previous posting "E = MC Squared” I had written about the three drivers of operational excellence that we focus on. They were Measurement, Continuous improvement and Customer focus. This posting is a little more detail on the framework of measurement that we try to institutionalize. There no rocket science here; just one of the ways for structuring and prioritizing various matrices.
The Information Technology (IT) and Service industries, in spite of their exposure to data handling, data mining and their familiarity with money value of transactions, often messes up in the discipline of systematic measurement for operational efficiency. Their operational measurement discipline is not yet matured because the glamour and focus in these industries are still ‘cool functions’, “exciting features” and “latest gadgets’ than boring pursuit of efficiency gains.
So we turned for some lessons to process industry; especially hazardous chemical industry. The reasons were manifold and can be summarised as below.
1. The process industry has been around for hundreds of years and has matured over period of time whereas IT and Services industries are quite young and still evolving.
2. Many of their product lines have been commoditized with very low operating margins unlike the IT and Service industries which still enjoy significant margins arising out of novelty and innovation. This meant that the process industry has to squeeze out efficiency wherever possible.
3. In chemical process industry the cost of process breakdowns and safety breaches are often fatal and therefore the extent of public attention, scrutiny and audits is quite severe.
4. In process industry mostly the processes are integrated end-to-end with less control and knowledge of what is happening inside the pipes. This necessitates strong monitoring and control.
The framework of measurement we evolved has thus been helped a lot by the learning from the process industry. The three key elements of this framework are the following.
1. Flow management (Micromanagement)
These are matrices that keep track of each of the inputs to ensure that it passes through each process/ sub-process it was meant to traverse and that too without error. This becomes even more critical when some of the processes are quite new and evolving because in such cases the exceptions gets to be the norm and tend to get ignored; especially in computerised processes.
These errors lead to customer discontent and even revenue leakage. I remember long ago when many people received a letter from one of the large banks which admitted that they had not tracked the credit card transactions correctly and enjoined the recipients to make a payment on the basis of their own bills. (I am not sure how many actually paid. This is not a made up story either).
One of my friends who provide transaction billing solutions to large number of banks and telcos shared with me the extent of leakage he is able to unearth when his system is introduced first time.
2. Capacity Management (Macro management)
These are matrices that track the capacity of processes, people, service providers and machines. We try to establish and evolve measures for trends in capacity utilisation of each element to avoid surprise bottlenecks.
This continuous monitoring is even more critical in computer based operations as many of the computer systems and network equipments are shared resources for multiple processes and the utilisation is build up for each of the processes would be different. Very often the process managers give scanty attention to the capacity requirement of their processes and how this capacity utilisation varies with volume.
In computerised processes there is another often neglected component of capacity grabber. The queries needed by the business or regulator. These queries on one side use the same production capacity. On the other end very often these queries are prepared by the junior most programmers who often develop quite in-efficient queries that hog resources. Mostly these onetime queries become a norm and end up quietly eating up resources.
Another area which eats up capacity is the weakness in the design itself. For most of the programmers, the kick is in developing features. Once the features are up and running he has lost his interest and is keen to move to the next project. At the time of feature development these cool cats seldom give importance to program efficiencies and once they are developed they are too lazy (and often don’t even know) to spend the time and effort to fine-in my experience there will be scope for at least 100% improvement in process efficiency in most of the bespoke programs.
3. Service Levels
The best way to ensure focus in measurement and improvement is to have clearly defined service levels that we are willing to commit to our customers. We call it the Customer Service Commitments (CSC). These involve commitments on Turn-Around- Time (TAT), Quality and Cost.
We try to build time-series data of these parameters at every key process and service provider level. This time series data provides early triggers in terms of trend shifts and unusual volatility.
We also try to have a separate team (other than the team responsible for operation) to track the commitments to the ultimate customer.
What Next?
The next thing to having data in place is how we use the data. I believe that is the more difficult part because it involves change in habits and practices of human beings. And that is not easy! Very often the data tracking reports are seen and used as measures for compliance or to satisfy whims of the bosses.
Excitement is in trouble shooting, exception handling and heroism. Not in prevention of trouble. It is more interesting to fix people than systems.
What we continuously try is to inculcate a spirit of looking at data as a tool for continuous improvement by everybody at all levels. To make this a culture and not a ritual.This is because we believe that we can scale-up and excel only when each of us learn the art of decision making that is founded on data.
“Give the people the facts, and they will do the right thing??”
The Information Technology (IT) and Service industries, in spite of their exposure to data handling, data mining and their familiarity with money value of transactions, often messes up in the discipline of systematic measurement for operational efficiency. Their operational measurement discipline is not yet matured because the glamour and focus in these industries are still ‘cool functions’, “exciting features” and “latest gadgets’ than boring pursuit of efficiency gains.
So we turned for some lessons to process industry; especially hazardous chemical industry. The reasons were manifold and can be summarised as below.
1. The process industry has been around for hundreds of years and has matured over period of time whereas IT and Services industries are quite young and still evolving.
2. Many of their product lines have been commoditized with very low operating margins unlike the IT and Service industries which still enjoy significant margins arising out of novelty and innovation. This meant that the process industry has to squeeze out efficiency wherever possible.
3. In chemical process industry the cost of process breakdowns and safety breaches are often fatal and therefore the extent of public attention, scrutiny and audits is quite severe.
4. In process industry mostly the processes are integrated end-to-end with less control and knowledge of what is happening inside the pipes. This necessitates strong monitoring and control.
The framework of measurement we evolved has thus been helped a lot by the learning from the process industry. The three key elements of this framework are the following.
1. Flow management (Micromanagement)
These are matrices that keep track of each of the inputs to ensure that it passes through each process/ sub-process it was meant to traverse and that too without error. This becomes even more critical when some of the processes are quite new and evolving because in such cases the exceptions gets to be the norm and tend to get ignored; especially in computerised processes.
These errors lead to customer discontent and even revenue leakage. I remember long ago when many people received a letter from one of the large banks which admitted that they had not tracked the credit card transactions correctly and enjoined the recipients to make a payment on the basis of their own bills. (I am not sure how many actually paid. This is not a made up story either).
One of my friends who provide transaction billing solutions to large number of banks and telcos shared with me the extent of leakage he is able to unearth when his system is introduced first time.
2. Capacity Management (Macro management)
These are matrices that track the capacity of processes, people, service providers and machines. We try to establish and evolve measures for trends in capacity utilisation of each element to avoid surprise bottlenecks.
This continuous monitoring is even more critical in computer based operations as many of the computer systems and network equipments are shared resources for multiple processes and the utilisation is build up for each of the processes would be different. Very often the process managers give scanty attention to the capacity requirement of their processes and how this capacity utilisation varies with volume.
In computerised processes there is another often neglected component of capacity grabber. The queries needed by the business or regulator. These queries on one side use the same production capacity. On the other end very often these queries are prepared by the junior most programmers who often develop quite in-efficient queries that hog resources. Mostly these onetime queries become a norm and end up quietly eating up resources.
Another area which eats up capacity is the weakness in the design itself. For most of the programmers, the kick is in developing features. Once the features are up and running he has lost his interest and is keen to move to the next project. At the time of feature development these cool cats seldom give importance to program efficiencies and once they are developed they are too lazy (and often don’t even know) to spend the time and effort to fine-in my experience there will be scope for at least 100% improvement in process efficiency in most of the bespoke programs.
3. Service Levels
The best way to ensure focus in measurement and improvement is to have clearly defined service levels that we are willing to commit to our customers. We call it the Customer Service Commitments (CSC). These involve commitments on Turn-Around- Time (TAT), Quality and Cost.
We try to build time-series data of these parameters at every key process and service provider level. This time series data provides early triggers in terms of trend shifts and unusual volatility.
We also try to have a separate team (other than the team responsible for operation) to track the commitments to the ultimate customer.
What Next?
The next thing to having data in place is how we use the data. I believe that is the more difficult part because it involves change in habits and practices of human beings. And that is not easy! Very often the data tracking reports are seen and used as measures for compliance or to satisfy whims of the bosses.
Excitement is in trouble shooting, exception handling and heroism. Not in prevention of trouble. It is more interesting to fix people than systems.
What we continuously try is to inculcate a spirit of looking at data as a tool for continuous improvement by everybody at all levels. To make this a culture and not a ritual.This is because we believe that we can scale-up and excel only when each of us learn the art of decision making that is founded on data.
“Give the people the facts, and they will do the right thing??”
Monday, July 27, 2009
Will we ever learn?
Last week I was chatting with one of my friends who is based in New Jersey. He is a senior executive of a multinational bank and a key player in the high-stake game of Wall Street. (Like many members of this club, he often pretends to know all the answers and I am willing to listen to him!) The topic of discussion turned to recent financial market turmoil and how the survivors are surviving. The record quarterly profit of Goldman Sachs and huge bonus they plan to payout naturally popped up.
“The turmoil has kicked out many players. The bailout package has ameliorated extreme trauma of the remaining few. Now with reduced competition to feed the demand, the surviving bankers are up to their same old tricks. They even enjoy better margins these days” My friend explained to me. I was a bit surprised. So soon? Is the memory so short? Don’t we learn some lessons? Is it just a cynical remark of a jealous banker?
I logged onto the net to see what more renowned experts had to say on this. The following quote from Paul Krugman in the article "The Joy of Sachs” he wrote in the New York Times summarised it all. (Do take the pain to read the whole article. It is illuminating.)
“First, it tells us that Goldman is very good at what it does. Unfortunately, what it does is bad for America.
Second, it shows that Wall Street’s bad habits — above all, the system of compensation that helped cause the financial crisis — have not gone away.
Third, it shows that by rescuing the financial system without reforming it, Washington has done nothing to protect us from a new crisis, and, in fact, has made another crisis more likely.”
This brought to my mind a completely contrasting story. The story of Darbary Seth of Tata Chemicals. Soda Ash, the chemical that his company produced and marketed was under price control and one day the government removed the price control. Instead of trying to take advantage of the freedom that this decontrol offered and increase price, he actually reduced the price. To the surprised colleagues and frustrated competitors he quipped, “When there is decontrol, we should have self control”
These are two ends of the spectrum. On one end we see the corporate governance that limits itself to being technically correct and compliance to the letter of the law. On the other end we see a visionary leadership who recognizes the larger role played by every business enterprise. The world around us is a mixture of both and what lies in between. The balance keeps shifting from one extreme to another. Sometimes the crisis, that was triggered by the excesses lead to stronger shareholder activism and trigger correction mechanisms as new acts and regulations.
In the last few years the pendulum appears to have been more to the side of ‘profit at whatever costs’. More so in the areas of financial innovation or rather the how these innovations were exploited.
How do we ensure that the balance tilts more towards more responsible corporations? Is there a need to bring about some regulatory intervention? Will it help?
I agree the rules cannot be the solution. But when the financial innovations significantly expanded product options and as Krugman noted “directed vast quantities of capital into the construction of unsellable houses and empty shopping malls which increased risk rather than reducing it, and concentrated risk rather than spreading it” there appears to be a definite case for some tweaking of regulations to ensure that the checks and balances are built with no/ minimum conflicts of interest. (Refer to my posting Checks and Balances - Who checks and Who balances” for some thoughts on this)
Don’t get me wrong. I am not advocating a return to license and control raj. My limited point is that we need to strengthen our institutional framework further and the regulators should improve the quality of their team so that they can clearly discern what is right and what is fair and don’t let the political expediency rule their judgement; especially when the market participants get caught in a spiral of short-termism and incentive structures that could be disastrous to the society in the long term. On the other hand a little more of introspection in the board rooms and among managers could also help.(Take a look at "Devastation of world financial markets - A case of Policy Reversals in India?” for some different perspectives on this)
“The turmoil has kicked out many players. The bailout package has ameliorated extreme trauma of the remaining few. Now with reduced competition to feed the demand, the surviving bankers are up to their same old tricks. They even enjoy better margins these days” My friend explained to me. I was a bit surprised. So soon? Is the memory so short? Don’t we learn some lessons? Is it just a cynical remark of a jealous banker?
I logged onto the net to see what more renowned experts had to say on this. The following quote from Paul Krugman in the article "The Joy of Sachs” he wrote in the New York Times summarised it all. (Do take the pain to read the whole article. It is illuminating.)
“First, it tells us that Goldman is very good at what it does. Unfortunately, what it does is bad for America.
Second, it shows that Wall Street’s bad habits — above all, the system of compensation that helped cause the financial crisis — have not gone away.
Third, it shows that by rescuing the financial system without reforming it, Washington has done nothing to protect us from a new crisis, and, in fact, has made another crisis more likely.”
This brought to my mind a completely contrasting story. The story of Darbary Seth of Tata Chemicals. Soda Ash, the chemical that his company produced and marketed was under price control and one day the government removed the price control. Instead of trying to take advantage of the freedom that this decontrol offered and increase price, he actually reduced the price. To the surprised colleagues and frustrated competitors he quipped, “When there is decontrol, we should have self control”
These are two ends of the spectrum. On one end we see the corporate governance that limits itself to being technically correct and compliance to the letter of the law. On the other end we see a visionary leadership who recognizes the larger role played by every business enterprise. The world around us is a mixture of both and what lies in between. The balance keeps shifting from one extreme to another. Sometimes the crisis, that was triggered by the excesses lead to stronger shareholder activism and trigger correction mechanisms as new acts and regulations.
In the last few years the pendulum appears to have been more to the side of ‘profit at whatever costs’. More so in the areas of financial innovation or rather the how these innovations were exploited.
How do we ensure that the balance tilts more towards more responsible corporations? Is there a need to bring about some regulatory intervention? Will it help?
I agree the rules cannot be the solution. But when the financial innovations significantly expanded product options and as Krugman noted “directed vast quantities of capital into the construction of unsellable houses and empty shopping malls which increased risk rather than reducing it, and concentrated risk rather than spreading it” there appears to be a definite case for some tweaking of regulations to ensure that the checks and balances are built with no/ minimum conflicts of interest. (Refer to my posting Checks and Balances - Who checks and Who balances” for some thoughts on this)
Don’t get me wrong. I am not advocating a return to license and control raj. My limited point is that we need to strengthen our institutional framework further and the regulators should improve the quality of their team so that they can clearly discern what is right and what is fair and don’t let the political expediency rule their judgement; especially when the market participants get caught in a spiral of short-termism and incentive structures that could be disastrous to the society in the long term. On the other hand a little more of introspection in the board rooms and among managers could also help.(Take a look at "Devastation of world financial markets - A case of Policy Reversals in India?” for some different perspectives on this)
Monday, July 20, 2009
It makes Sense – Part 4: SEBI asks Mutual Funds to go light on entry
Investment in stocks has its share of risk. When I participate in the market, what is the sensible way to reduce my risk? Do good research and have a diversified portfolio. Both these need some amount of time and resources to commit. So investing in mutual funds is the next best option for me.
I know for the benefit of diversification, expertise in fund management and diversification of portfolio the AMC offers me I need to pay a price. So the funds are allowed to charge a certain management fee.
But then there is charge that the funds take from me that they call the entry load which is in the vicinity of about 2%. A good part of this goes as the commission to the distributor. I, as the investor, have no right to decide what I pay the distributor who helps me to make this investment. But when I invest in the stocks directly I can decide what I want to pay my broker. Today he charges me a very small fee of 35 to 50 basis points compared to almost 200 basis points that the fund distributor charges. In addition, the distributor gets to share a part of my return every year as the trail commission. (The rumor in the market is that sometimes these commissions get shared by some decision makers). I feel that the total effort that the broker spends on me when I buy shares in the market is much more than the effort that the fund distributor spends on me even though the ticket size of each of my transaction is much larger when I invest in funds.
The question that SEBI has now asked the AMC is precisely this. Why shouldn’t the brokerage for my distributor be decided by me? In addition it reduces the incentive that the distributor has to make me switch in and out of the funds more often. Further when the incentive to the distributor is paid for by the fund house he is not my advisor who looks after my interest; his loyalties will naturally lie with the fund house. Sometimes the poorly managed funds are able to get my investment because they have been able to influence the distributor with a more lucrative incentive.
Surprisingly it is not just SEBI who is asking question. The regulators in UK and Australia are also thinking along similar lines. In fact SEBI has advised that the new charge structure should be in place from August 2009.
The fund houses are not amused. It reduces the leverage they had with the distributors. Naturally they point out that the incentive structure is more skewed in the insurance industry where many of the insurance products are more of fund management solutions and less of insurance. But SEBI can regulate only the mutual funds. They cannot wait for the whole world to clean up before they clean their backyard. Can they?
It makes enormous sense for the investor; but not for the fund house.
I know for the benefit of diversification, expertise in fund management and diversification of portfolio the AMC offers me I need to pay a price. So the funds are allowed to charge a certain management fee.
But then there is charge that the funds take from me that they call the entry load which is in the vicinity of about 2%. A good part of this goes as the commission to the distributor. I, as the investor, have no right to decide what I pay the distributor who helps me to make this investment. But when I invest in the stocks directly I can decide what I want to pay my broker. Today he charges me a very small fee of 35 to 50 basis points compared to almost 200 basis points that the fund distributor charges. In addition, the distributor gets to share a part of my return every year as the trail commission. (The rumor in the market is that sometimes these commissions get shared by some decision makers). I feel that the total effort that the broker spends on me when I buy shares in the market is much more than the effort that the fund distributor spends on me even though the ticket size of each of my transaction is much larger when I invest in funds.
The question that SEBI has now asked the AMC is precisely this. Why shouldn’t the brokerage for my distributor be decided by me? In addition it reduces the incentive that the distributor has to make me switch in and out of the funds more often. Further when the incentive to the distributor is paid for by the fund house he is not my advisor who looks after my interest; his loyalties will naturally lie with the fund house. Sometimes the poorly managed funds are able to get my investment because they have been able to influence the distributor with a more lucrative incentive.
Surprisingly it is not just SEBI who is asking question. The regulators in UK and Australia are also thinking along similar lines. In fact SEBI has advised that the new charge structure should be in place from August 2009.
The fund houses are not amused. It reduces the leverage they had with the distributors. Naturally they point out that the incentive structure is more skewed in the insurance industry where many of the insurance products are more of fund management solutions and less of insurance. But SEBI can regulate only the mutual funds. They cannot wait for the whole world to clean up before they clean their backyard. Can they?
It makes enormous sense for the investor; but not for the fund house.
Sunday, July 12, 2009
E = MC Squared
For us in NSDL, establishing a world class depository was a challenge in itself. Once we did a decent job of this, we proceeded further to figure out what our core strengths are which could act as the foundation for our growth. We did not want to limit ourselves as a player in capital market alone.
We now see NSDL as a total solution provider Covering Information Technology, Process Design, Operations, Legal & Administrative infrastructure and Integrating multiple agencies to Manage very large databases and large volume transactions in a Secure and Efficient manner.
With this diversification we want to ensure that the organization does not get too unwieldy and non-responsive in our service delivery. We want to make the passion for excellence a habit and not an exception.
To achieve this, a host of areas needs attention. We sat down and assessed our immediate challenges in the projects we are on and the core strengths around which our growth strategy is built. This posting briefly describes our operational strategy that is still evolving.
One of the first things that we have taken up is to structure a simple model that could direct our prioritization. We call it E = MC2; which summarizes our belief that Excellence can be derived from a culture that Measures each and every drivers of performance and strives for Continuous improvement with a Customer focus. Let me explain each of these in a little more detail.
Measurement
Measurement and MIS are integral parts of all management processes. But often these measures and reports hide more than what they reveal. As a cynic observed “Statistics is like bikini; what it reveals is interesting, but what is hides is the most critical’
We decided to have a “bare it all” culture when it comes to measurement. When we measure we try to remind ourselves “No Pads Please”. We realize that the matrices that we chose and measure could change our behavior, help to make the performance visible, improve control and help in decision making.
This is most easily preached and more difficult to practice. So we try to establish rituals to make this a habit than response to the big boss’s whims. We have also developed a framework that drives our measurements. (I shall discuss this in details in another posting)
Continuous improvement
The measurements help us to know where we are and where we appear to be going. It also helps us to identify trends and exceptions and then get to the root cause(s). This helps us to identify and anticipate in advance potential pitfalls and take preventive/ proactive actions and not just react to emergencies.
Customer Focus
Measurement and Improvement can be distractive and could lead to enormous waste of resources if we don’t have focus. We attempt to inculcate in each of us a belief that the most powerful factor that provides a ‘right focus’ is the customer.
We developed (and continue to develop) a series of measures which we call “Customer Service Commitments” (CSC). This is fundamentally different from the service level agreement (SLA). SLA is a commitment on the minimum below which we will try not to go. But CSC is what we try our best to deliver; a level much above SLA.
Footnote: These are foundations on which our operations are built. This, as you would see, is not a static model. It is a virtuous cycle of that continuously up the bar and helps us to achieve our vision of establishing ourselves as the First Choice Information Utility in India which offers the Optimum solution at the Optimum price.
We now see NSDL as a total solution provider Covering Information Technology, Process Design, Operations, Legal & Administrative infrastructure and Integrating multiple agencies to Manage very large databases and large volume transactions in a Secure and Efficient manner.
With this diversification we want to ensure that the organization does not get too unwieldy and non-responsive in our service delivery. We want to make the passion for excellence a habit and not an exception.
To achieve this, a host of areas needs attention. We sat down and assessed our immediate challenges in the projects we are on and the core strengths around which our growth strategy is built. This posting briefly describes our operational strategy that is still evolving.
One of the first things that we have taken up is to structure a simple model that could direct our prioritization. We call it E = MC2; which summarizes our belief that Excellence can be derived from a culture that Measures each and every drivers of performance and strives for Continuous improvement with a Customer focus. Let me explain each of these in a little more detail.
Measurement
Measurement and MIS are integral parts of all management processes. But often these measures and reports hide more than what they reveal. As a cynic observed “Statistics is like bikini; what it reveals is interesting, but what is hides is the most critical’
We decided to have a “bare it all” culture when it comes to measurement. When we measure we try to remind ourselves “No Pads Please”. We realize that the matrices that we chose and measure could change our behavior, help to make the performance visible, improve control and help in decision making.
This is most easily preached and more difficult to practice. So we try to establish rituals to make this a habit than response to the big boss’s whims. We have also developed a framework that drives our measurements. (I shall discuss this in details in another posting)
Continuous improvement
The measurements help us to know where we are and where we appear to be going. It also helps us to identify trends and exceptions and then get to the root cause(s). This helps us to identify and anticipate in advance potential pitfalls and take preventive/ proactive actions and not just react to emergencies.
Customer Focus
Measurement and Improvement can be distractive and could lead to enormous waste of resources if we don’t have focus. We attempt to inculcate in each of us a belief that the most powerful factor that provides a ‘right focus’ is the customer.
We developed (and continue to develop) a series of measures which we call “Customer Service Commitments” (CSC). This is fundamentally different from the service level agreement (SLA). SLA is a commitment on the minimum below which we will try not to go. But CSC is what we try our best to deliver; a level much above SLA.
Footnote: These are foundations on which our operations are built. This, as you would see, is not a static model. It is a virtuous cycle of that continuously up the bar and helps us to achieve our vision of establishing ourselves as the First Choice Information Utility in India which offers the Optimum solution at the Optimum price.
Sunday, July 5, 2009
Setting up the depository - An attempt to transform a hundred year old heritage
On 8th November 1996, when Shri. P. Chidambaram, the then Honourable Finance Minister of India, inaugurated National Securities Depositories Ltd. as the first securities depository in India, in front of a packed audience of the luminaries of the Indian financial world, assembled at Nehru Centre, Mumbai, the feelings that bubbled in the minds of the spectators were mixed. For those who used to squirm at the international rating of the Indian settlement infrastructure as the worst in the world, this was a dream come true. For the cynics who had very little faith in
This article is not an attempt to narrate the brick-by-brick progress of a yet-to-be completed monumental institution; but rather a case study about managing a transitional process of systems & procedures and habits & practices of each and every player in the capital market including issuing companies, their R&T agents, custodians, clearing houses, brokers, institutional investors and even retail investors.
While most of the recent efforts in establishment of scripless trading in many markets have been by means of an executive fiat, the Indian policy makers, attempting to liberate from the inefficiencies of legal monopolies, provided options to the companies to link with NSDL, eligible entities to join as depository participants and investors to use the system. Although this policy framework evoked considerable skepticism, the progress achieved by NSDL by eliciting support of each of the affected segments and by relevant policy interventions from the regulator, clearly demonstrates the potential for a model based on consensus building and incremental growth with each step designed & tested for stress resistance.
The first challenge for NSDL, after it commenced operations in November 1996, was to convince the issuing companies to make their securities available for dematerialisation. This also meant active support to their R&T agents in establishing systems & procedures and computing & telecommunications infrastructure required to ensure the superior service standards envisaged in the depository system. In the first year, about 100 companies forming about 40% of the aggregate market capitalization had connected with NSDL. This has, since then, increased to 300 companies forming about 73% of the market capitalization.
The second challenge was to convince various eligible entities like banks, custodians and brokers that investment in establishing themselves as DPs was a meaningful growth strategy. This was quite critical, as without a nation wide DP network, NSDL could not take a single step forward. By the end of the first year, NSDL had managed to have 37 DPs providing services from about 102 locations. Today, this has increased to 76 DPs giving services at about 600 locations in 160 cities/ towns across the country.
The third challenge was to garner the support of a significant part of the users of the depository like brokers, custodians, both domestic and foreign institutional investors and retail investors spread all across the country. This turned out to be the most challenging of all due to a variety of factors. These include:
· unlike in the case of issuing companies and the DPs who joined NSDL, the users of the depository like brokers, custodians and fund managers needed answers to many questions about the potential impact of this system in their main line of business (in addition to the visionary thinking on the part of their management);
· although there was an in-principle understanding about the benefits of scripless trading, absence of a proper framework to quantify the benefits of this system and the hitherto unfamiliar custody and settlement costs in the depository, stood in the way of evolving a convincing cost benefit balance;
· the completely new way of holding and dealing in securities itself evoked a fear of the unknown and needed a lot of clarifications for the users to feel comfortable, particularly about safety features, potential pitfalls to guard against, and visibility of holding;
· the change in the rules of the game necessitated a retraining;
· the fear about potential loss in competence in this high technology environment;
· the extensive due diligence requirement of foreign institutional investors and their custodians to feel satisfied about the inherent strength of the new system; and
· the resistance of those who saw a potential revenue/ profit loss in a cleaner and more efficient system.
NSDL’s response in the face of such a challenge, was a strategic initiative that went beyond conventional marketing tools of mass media advertising, addressing these varied issues in a systematic fashion. As per this strategic plan, the initial focus was towards the major players in the market like institutions, active brokers and custodians. In this direction, NSDL embarked upon a series of measures:
0 to organize detailed exposure program to educate the major broking members, their staff, fund managers, their back office staff and staff members of the custodians about the new rules of the game;
0 to directly work with all levels of the institutional decision making processes to address their concerns and to help them develop a proper framework for cost benefit analysis satisfying the rigors of their approval processes;
0 to proactively assist the foreign institutional investors and their custodians in their due diligence process, so that they feel comfortable about the capabilities of NSDL to meet their exacting standards;
0 to organize a nationwide investor awareness program to educate investors about the operations of the system; and
0 to fine-tune the system itself towards better efficiency and safety.
All these initiatives started showing early results. Within less than a year of operations, many of the major domestic and foreign institutions opened their accounts with NSDL and dematerialised a part of their holding valued about Rs 10,000 crore. In the meantime, Morgan Stanley, a US-based custodian, recommended its clients to use the NSDL system, after it satisfied its due diligence as per the requirement of
However, trading and settlement in the dematerialised form was yet to be taken care of. This was due to the problem of illiquidity of dematerialised securities. This was due to the creation of a pre-verified pool of securities in the depository system, which itself is a basic design requirement needed for avoiding the ills associated with paper based settlement system.
The success of NSDL in attracting participation of a variety of users and establishment of a nationwide depository participant network, gave confidence to the regulator to initiate a series of policy changes that would address the issue of liquidity of dematerialised securities. These included:
+ mandatory settlement of trades in the dematerialised form for institutional investors with respect to a select list of eight securities from 15th January 1998, which has been gradually increased to 300 by February 1999;
+ one way integration of physical and dematerialised segments allowing delivery of dematerialised securities in the physical market;
+ mandatory settlement in dematerialised form with respect to a select list of 12 securities for all segments of investors from 4th January 1999. The list has been increased to 60 securities by April 1999.
Addressing the liquidity problem by these policy measures dramatically increased the participation by all segments of investors. But NSDL did not see this policy intervention as a magic wand ensuring success. It recognized that without a sustained effort in educating the investors at large and ensuring quality in client servicing, these policy initiatives would come to a naught. Accordingly, the marketing efforts were taken to a higher tempo in addition to the strategies already in operation.
ù The broker exposure programs were extended to cover brokers of regional stock exchanges like DSE, BgSE, CSE, LSE, MSE in addition to about 1500 brokers and their staff from NSE and BSE, who where trained in the fist leg.
ù Two media campaigns supplemented by special incentives from DPs were undertaken. One in April 1998, when demat delivery was allowed in physical segment and one in November 1998, when mandatory settlement in dematerialised form for all segments of investors was announced.
ù A variety of educational material were developed including video films in eight languages, NSDL web site and materials addressing issues of various segments like brokers, sub brokers and retail investors.
ù The reach of the investor awareness programs was further extended.
All these efforts yielded encouraging results. The investor accounts with NSDL grew by December 1998 to 141,000 from about 1550 cities and they hold about Rs. 65,000 crore worth of securities in their accounts. The settlement in the dematerialised form in the premier stock exchanges has also reached a level of about 40%. Further, seven major stock exchanges have established connectivity with NSDL.
Now that the most active segments of the investors have been exposed to this new system, NSDL is refocusing its strategies in two major directions:
å The first one is essentially to broaden the scope of the marketing efforts so as to cover the less active segments of the investors so that they are also brought in to the system smoothly. The efforts in this direction envisage Investor Depository Meets (to offer opportunity to retail investors in all major cities/ towns to directly interact with depository officials), media campaigns, surveys to understand the problems of investors, etc.
å The second one focuses on enhancing the quality of client servicing. Towards this direction, NSDL has initiated a Branch Empowerment Program to upgrade the quality of the personnel in the branches of the DPs involved in client servicing. This is further scheduled to graduate to a Certification Program that would insist on having at least one certified professional at each of the branches of DPs.
The ultimate goal that these strategies are directed at, is a transformation of the Indian Capital Market towards “Complete Scripless Trading by the 21st Century.”
Tailpiece: As all of us are aware, the success of the depository in India is a foregone conclusion. Today the trading and settlement in Indian capital markets happen only in the demat form. However I have reproduced the article of 1998 because I feel that the flavor of hope, aspiration and conviction when the success was still a hope is a is good case study to anybody who is involved in transformational projects.
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