Poor Economics – A review

July 17, 2011 Leave a comment

I had the opportunity to read this book Poor Economics by  Abhijit Banerjee and Esther Duflo. The book provides excellent insights into the life of poor. The main objective of the book is resolve the conflict between the two solutions for global poverty. One of the solution being is to do nothing and allow the market to evolve in poor countries and other being to fund them until the markets are mature enough to take care on their own.

The authors try to emphasize the fact that there is no one fixed approach to solving the poverty problem. But through RCT (Randomized Control Trials) which many researchers and authors have conducted, the authors try to show that how simple policy changes to existing programs can make it more effective.

For eg. take the example of child vaccination. The authors inform us that in certain poor areas in rural Rajasthan even when vaccination is free, people tend to avoid the program for a variety of reasons. One being superstitious beliefs against vaccination and other factor is time inconsistency. Time inconsistency affects the rich and poor but in the latter’s case the consequences are much more drastic. Here the poor understand that vaccination might be better for their children’s future just like we understand that eating healthy foods will prevent heart-attack in the future. We keep postponing our habit of eating healthy foods, the poor who have other immediate problems to take care (like the next meal) keep postponing their decision to take their vaccinate their kids. Now when the vaccination program made a small change of adding an extra provision of providing 2Kg dried lentils with each vaccination, the program saw a significant jump in % of children getting vaccinated. The authors explain that the superstitious beliefs though prevented vaccination, it was not rooted strongly in their minds. And by adding the free lentils to the program the poor could come to the camp, get vaccinated and go back home and need not worry about the next meal at least for that day.

The authors also show that poor, in contrast to the popular view that they are lazy and spend irrationally have a lot of factors going against them. For example the middle class society takes many things are granted. For eg. Vaccination: Once the child is born, the hospital immediately provides vaccination. An other example the authors cite is drinking water, we need not worry on water being treated with chlorine to prevent certain water borne diseases, the government does that for us. But for the poor, the water sources (wells, ponds) in their case needs to chlorine treated, else they are susceptible to infections. The poor need to take decisions constantly for their next meal, medicine, money for their business etc and at each step they face more problems than a typical middle class person.

The authors cover the following topics of health, education, insurance and loans (MFI, banks etc) for the poor. In each case they provide insights on why certain policies work and certain don’t and how significant achievements in reducing poverty can be made even within existing political structures. Well researched and an useful book for anyone who wants to understand about global poverty.

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NUMMI plant and GM

January 5, 2011 Leave a comment

Recently came across an article which mentioned that NUMMI plant at Fremont, California was closed by Toyota this October. That came as a shock as NUMMI factory was the first plant of Toyota in US and which showcased Toyota Production System to the world. It was also the subject of numerous case studies, books and research. It changed the way how american factories were run, a major revolution since the assembly line production system started by Henry Ford.

This American Life audio talks about NUMMI, how the impossible partnership came into being and provides wonderful insider view into the partnership of GM and Toyota who were rivals at that time and still are. Some of them will are incredible like gambling, drugs and even sex was available in the NUMMI factory before Toyota entered the picture. The audio has many commentaries from people who worked in NUMMI before and after the Toyota partnership and they explain how Toyota transformed the plant into an efficient factory, the task which was considered near impossible. The audio goes onto explain how GM failed to learn it lessons which eventually lead to its bankruptcy and also provides a twist in the end. Wonderful podcast which provides important learning in the area of operations and organizational behavior.

Can Business Ethics be taught ?

December 14, 2010 Leave a comment

The social responsibility of businesses is to increase its profits: – a quote from the economics nobel prize winner Milton Friedman, a believer in the efficacy of free markets. The strong underlying assumption made is that if businesses go wrong in their actions, we have the three forces of law, market and society that are always available for correction. But that may not always be the case. We as business administration students are taught how best to analyze industries, make profits and sustain them. But along the way there are roadblocks – cultural, social, legal, ethical among others. Take the following hypothesis : Assume that the Wall Street like wrongdoings are the outcome of a few inherently unethical people who too have passed the hallowed corridors of the best MBA schools and yet committed those crimes. Then it makes no sense to teach business ethics in schools, as such people will commit crime anyhow. But if the hypothesis does not hold good, then we ought to make that effort to help good people not make such mistakes. The  2 examples cited below are illustrations of where business people (may) forget to be humane in the quest for profits and the correcting forces fail

The Bhopal (India) Gas Tragedy at the Union Carbide plant in Dec,1984 is a live example of what happens when law fails to control businesses. On the night of Dec 2nd 1984  poisonous gas fumes of Methyl isocyanate (MIC) exited from the plant at Bhopal, immediately killing about 5000 people, permanently disabling 100000 and injuring 500000 more. The ideal compensation would be the present value of someone’s potential  lifetime earnings (dead and permanently disabled included). The final settlement in 1989 including interest was $470 M which gives us an average of $4500 per life (not including the injured). The obvious question: Is it enough ? Well seems enough for an Indian life, at least by law. The value of an American life in a similar disaster would be no less that a million dollars.  Although we can cast our judgements till the end of time, the parent company UCC and similar MNCs have one bias they cannot deny of. The West Virginian of UCC plant had far better safety and warning systems in place for a similar production facility. Not to mention the fact that MIC, which was earlier imported for use at Bhopal was now being stored inhouse  in spite of the lack of storage space and maintenance training. It just made economic sense. Why not shift production/storage/disposal of hazardous materials to low labor cost countries when it costs just $4500 per life. Well that’s a B+. The A+ answer would be, to find a region where it could be done in $450.

The reaction of the Union leader when told that the Carbide plant would be shut down immediately was now why after taking our lives, would you also want to take our jobs ? Regions where the difference between your daily expenses and earnings is marginal, a job is equivalent of life. Could you give be a better instance of an industry faced with a supplier power lower than this ?

Nestle started testing its infant milk formula in the interiors of Africa by dressing local women in white clothes and promoting the product as samples to new mothers. There’s no substitution to breast milk according to any research, but the problem just starts there. Mothers in these countries do not even have access to clean drinking water or the facilities to boil water easily, which apparently the infant formula needs to be mixed with before feeding. Also, such is the biological development of an infant that when it gets used to a particular taste, it is very difficult for a mother to shift it back to breast milk. Well, when you launch such products for testing and then make the babies almost addicted to it, you cannot have a case of lower buyer power. What would a mother as a consumer not do to save her baby ?

We as budding managers may never know the end results of our actions. The examples above clearly show that a maintenance manager at Union Carbide or a product manager at Nestle may have done his/her duties to the best of his/her ability, yet those a collection of those very acts may have resulted in an unethical business output. A few people at the top thrive on the fact that they are able to separate the conscience from the act of an employee down on the floor or field. The whole motive behind concentration camps for the Jews was to separate the solider’s conscience from the act of killing. Otherwise how difficult it is to shoot an unarmed person point-blank. Each person in the Nazi Army did his job to perfection, be it driving trains, filled with people , on time to the camps or making them work at the sound of whiplash or pulling the plug on the electric chair. They never felt responsible for the final result.

It is responsibility of the strong to protect the weak. We as managers of tomorrow do not only control our destiny, but the lives of many others and hence it is our moral obligation to evaluate the result of our actions. We live in a society where laws can be interpreted in a million different ways, markets can be manipulated and societies can fail to protect the weak. No longer then is the final goal of businesses to make profits.

Disclaimer: This is a brief summary of one of the lectures on Competitive Strategy that I attended at the Business School. The professor is a well respected authority in the field of Business Strategy.

Categories: Business Strategy

The sixth force in Porter’s five

October 3, 2010 Leave a comment

My recent foray into the world of strategy has been all but uninteresting. It has been a standard practice for consultants and students of management to start their industry analysis by exploring the structure with the five forces. The overall structure tries to find the positives and negatives in the structure with the intention of reinforcing or suppressing them respectively. The ideal scenario for an industry to be highly profitable would be to have high barriers to entry with low threat from suppliers and buyers as well as minimal incumbents (the classic coke-pepsi situation). This minimizes firms competing on prices which is almost inversely proportional to the profitability of the industry. The one thing you would never see is pepsi vs. coke ads based on pricing. But all works well inside a mature industry with threat from substitutes being minimized either my  higher investment in R&D and advertising or diversification into alternatives by the incumbents.

The case just differs a little when you have forces like the government coming into picture, which is more the case in emerging industries than in the mature ones. The sixth force is – th power of complements. To define a complement, it is a good or service that increases your profitability without featuring in your cash flows. For e.g. cars and roads/ financing could be complements. It is very important to understand in what context is complement taken as tyres could feature in the cash flow of a OEM during manufacturing of an automotive but act as complements in the after sales market.

A good example of the power of complements could be the case of the Lincoln Highway in the early 1900s. Carl Fisher (the creator of the Indy 500 track) with the help of the automakers laid this first road running across America from SF to NYC. The automakers then knew that to promote the sales of their vehicles they needed good roads which were few and far  in between. Bitter rivals Ford and GM who were going tooth and nail in product competition realized that government intervention would be necessary to compete against the streetcars or trams as well as the railways. They built small parks along major highways where they would let people test drive their vehicles and in the end hand over petition papers for public’s signature asking the government to fund construction of roads. The government yielded and the Lincoln Highway was thus formed. The first transcontinental convoy on the road was of none other than the army. One of the young Army officers in the convoy was Dwight David Eisenhower, then a Lt. Colonel, who credited the experience when supporting construction of the Interstate Highway System when he became President of the United States in 1952. Thus, the demise of  the tram network was plotted. The Interstates also led to the underdeveloped train routes in the United States.

 This example illustrates how important can complements be when shaping an industry and hence their effect is regarded as the SIXTH FORCE.

Categories: Business Strategy

Imagination in Healthcare

September 7, 2010 1 comment

My chemistry teacher in school, while introducing us to organic chemistry, used to half-joke that man’s invention of distilling process before the invention of soap was proof that his need for intoxication was greater than his need for hygiene. I do not know if the facts were right, nor do I agree with the judgment, but that is an interesting thought that I recall when I think about our priorities. This must be the reason why I am not surprised when I see that we have low cost and highly reliable models for retailing FMCGs, but not a similar model for delivering healthcare or education. To quote a friend’s (slightly exaggerated) status message on Facebook, we can get a pizza delivered to our house in 20 minutes, but a person in a medical emergency will not get an ambulance to take him to hospital in 20 minutes. I strongly believe that a low-cost healthcare delivery model is essential if India is to make any progress. I also strongly believe that this model can survive the test of free markets – the government need not be the only spender on healthcare facilities for the poor.

The facts are as follows: Majority of India’s population still does not have access to decent healthcare; 75% of India’s hospitals are in urban areas and 70% of the hospital beds and facilities are in the private sector; penetration of medical insurance is very low; public expenditure on healthcare in India was 0.9% of GDP while China spent 1.9% and USA a whopping 5.8% (World Health Report, WHO, 2005). So where do we start making a change? It is only reasonable for private hospitals to target the upper middle class in India. After all profit-making is a legitimate objective in a free economy. Discussions about public expenditure on healthcare tend to spiral into capitalist vs socialist debates. That is not the objective of this piece, but I firmly believe that the government should spend on creating basic infrastructure that provides entrepreneurs a chance to serve the needs of the market, if not directly providing healthcare facilities by itself.

But in this case, whatever ideology we choose, it is pretty obvious that India grossly under-spends on healthcare. Then again we cannot expect a government that is struggling with huge budget deficits and a zillion other problems including education, power and inflation to suddenly drop everything and match USA’s public spending on healthcare (even as a percentage of GDP). To rectify even one of the unflattering facts mentioned above the government has to resolve a dozen underlying issues. Take, for example, the problem of medical insurance. There are issues of high costs, high claim ratios, non-transparent procedures, etc. which can only be solved through painstaking, sustained and coordinated efforts from multiple agencies. It calls for regulatory and attitudinal changes and awareness among the public.

What I am getting to is the classic ‘Fortune at the Bottom of the Pyramid’ argument. The private sector in the healthcare industry is expected to be a $35 billion industry by 2012. Whether the government is successful in providing meaningful healthcare for millions of its citizens will depend on whether it will be able to create infrastructure and incentives that attract private investment in rural healthcare. The private sector on its part has been guilty of lack of imagination in addressing specific needs of India’s vast untapped market. However in a country where healthcare is a fledgling industry and the vast upper middle class has not yet been tapped fully, it will be slightly over-optimistic to expect the private sector to think too seriously about the rural or poor among the population.

There has to be serious thought put in by the government, pharmaceutical companies and private hospitals chains about innovations in operating models. Why not use a build-operate-transfer (BOT) model? How about a hub and spoke model? Thousands of deaths in India happen from easily preventable diseases – how about very large hospitals that specialize in providing fairly straightforward treatments (thus achieving economies of scale) and small specialized hospitals for tertiary and quaternary care? I don’t know if these will work, but I am not sure if there has been sufficient discussions about these possibilities.

Most companies in India now accept that the next big spurt in revenue will happen when they master the art of reaching out to rural India. This is true for the healthcare industry as well. Then why are they holding back? Surely some smart guy in these private hospital chains would have realized that there is a huge market waiting to be served. Again the problems are manifold – they feel hesitant to compete against highly subsidized government hospitals. The talent pool is limited and most private hospitals would prefer to assign them to higher-value healthcare services as is the case now. There are no clear long-term policies laid down by the government regarding healthcare. There is no proven solution yet to the problem of reaching highly dispersed rural population.

To sum up, what needs to be done can be broadly listed down as:

  • Perseverance: resolve the issues of huge shortfall of doctors nurses (#1 priority), poor infrastructure and low penetration of medical insurance
  • A little far-sightedness: set long term policy on healthcare, especially with regard to private investment so that some of the uncertainty about investing in capex-heavy healthcare projects will be reduced
  • A little imagination: work out cost-efficient methods of operation which ensures access to a dispersed population

Pour in your thoughts in the comments on what else could be done.

The new Supply Chain

July 8, 2010 2 comments

Recently I came across a Tech Crunch article on Apple’s tight integration between its hardware and software and the way it manages its Supply Chain. This made me think about the dynamic nature of supply chain in the electronics industry. Let me give a primer on how traditional supply chain worked and how Apple is changing the game.

Let us take the automobile industry. It has a highly decentralized supply chain meaning no single entity controls the entire supply chain. It is fair to say that at the least a thousand companies are involved in making a car to roll out of the final assembly. The supply chain has become so dispersed that even say movement of parts within a factory is handled by a different company claiming that they are specialist in this particular function. Now this kind of supply chain is fairly common in almost all types of industry right from automobiles to electronics where hundreds of companies are involved in manufacturing a single product.

But this was not the case during the days of Henry Ford. At that time Ford was a vertically integrated. It controlled the management of almost all functions from extraction of ore to parts manufacturing to final assembly. This was to promote efficiency and tight control of resources. In today’s world where new products are developed in record time, companies need to emphasis on innovation rather than efficiency in functions and so companies leave it to the specialists to come up with innovation for new products.

The Tech Crunch article suggests that Apple is taking the Ford approach to its supply chain. Recently it bought a chip manufacturer which means that Apple is going to more in control of its product than any other company unlike Android, Nokia which are dependent on others for satisfying their hardware and software requirements. This means it can add optimize its hardware chip and have more DRM control. Most importantly it can have hassle free user interface which other manufacturers are trying hard to achieve. By being vertically integrated Apple also has all the know how within its fold.

Apple though moving towards a vertically integrated supply chain understands the power of a horizontal supply chain which other manufacturers are following. For example, it gets to see the technology road map of suppliers of other cell phone manufacturers to see if it matches with Apple’s long term strategy. Even though Apple has its own chip manufacturing unit, suppliers of competition readily comply with Apple’s requests because of the huge iphone market. Only Apple can wield such power over the entire supply chain.

Vertically Integrated Supply Chain can succeed if it matches the innovation speed of the supplier. Apple a leader in the traditional supply chain is more capable than any other company to change the rules of the game and be a trend setter in the area of supply chain too.

Piracy is illegal?

Most of us are law abiding, peace-loving citizens. We speak of ‘other people’ who commit crimes with barely concealed contempt. However that does not stop us from committing a crime that is no different from stealing when we use pirated digital content, whether in the form of movies, music or software. However, most of us don’t feel guilty about it, in spite of knowing that it is illegal. When asked to explain the apparent clash between our law abiding nature and the act of piracy, we often justify it with the non-affordability argument or by taking the moral high ground in the fight against the evil big corporations. However, the real reasons are different.
First of all, there is the difficulty in tracking all transactions, the ease of availability and the very low probability of punishment. These are some of the simplest explanation for most people using pirated content, but the last we will admit as our real motivation. Obviously there is nothing heroic about buying pirated movies because you are very unlikely to get caught. But there is something definitely heroic about taking a stand against the big corporations who are out to do evil. This is manifested in the non-affordability Argument. This argument goes like this: “The movie DVDs are so expensive that I cannot afford to buy them. The big studios have overpriced the DVDs so much that movie fans like me can watch only pirated movies. So blame the extortionist movie studios for piracy, not me. Through piracy, I’m
taking the fight to the studios.”
To understand why this argument is flawed, just replace movies with cars, studios with auto companies and piracy with stealing in the above statement. Of course cars are not softwares, but the logic is the same. Pricing is the prerogative of the company selling a product/service in a free market (subject to monopoly laws) and hence cannot be used as an excuse for using pirated content.
A far more important reason why piracy is considered acceptable is the distance of the victim. If I were to contemplate stealing an Audi, I can be pretty sure that the owner of the Audi would be mighty pissed about his missing car. He would complain to the police and seek justice. However if I were to copy a movie from my friend, he would not have to give up anything in the process and I would get a perfect copy of the movie. The only victim is the movie studio which is far far away and has no clue about the transaction that just happened. Not only is it easier to commit a crime if I don’t see my victims, but also much easier to convince myself that there is no victim at all. Even if I know there is a victim, I could even convince myself that he doesn’t mind this small crime. And since nobody has any special love for the lone victim (the Big Corporation) nowadays, some might do it just for the pleasure of sticking it to the man and gain appreciation from his peers for doing so.
Digital content has been around for a very short time. Whatever be the field, laws take notoriously long time to evolve. The conflict that happens before laws finally gain widespread acceptance is actually good. Whatever be the reasons for piracy, there must be some legitimate concerns of users of data that must be addressed while framing any law. Similarly, there are legitimate concerns of creators of content that must also be addressed. The conflict is the only way in which we can arrive at a compromise between the two parties. Laws do not mean anything unless most of the society accepts them. Therefore, anti-piracy laws will be difficult to enforce unless large sections of the society agree that it safeguards the interests and is fair to all parties. Once that happens, people will start accepting the fact that there is a real victim of piracy whose rights need to be safeguarded. It will become easier to enforce a law that is acceptable and availability will go down. Till that happens, companies will continue to wrestle with new technologies and innovative revenue models, and pirates will continue to try their best to outsmart the companies.