The Derick Parry management paradigm

Before you ask, Derick Parry was a West Indian cricketer. He finished his international playing career before I was born, partly because he bowled spin at a time when the West Indies usually played four fearsome fast bowlers, and partly because he went on rebel tours to South Africa.

That, however, doesn’t mean that I never watched him play – there was a “masters” series sometime in the mid 1990s when he played as part of the ‘West Indies masters” team. I don’t even remember who they were playing, or where (such series aren’t archived well, so I can’t find the score card either).

All I remember is that Parry was batting along with Larry Gomes, and the West Indies Masters were chasing a modest target. Parry is relevant to our discussion because of the commentator’s (don’t remember who – it was an Indian guy) repeated descriptions of how he should play.

“Parry should not bother about runs”, the commentator kept saying. “He should simply use his long reach and smother the spin and hold one end up. It is Gomes who should do the scoring”. And incredibly, that’s how West Indies Masters got to the target.

So the Derick Parry management paradigm consists of eschewing all the “interesting” or “good” or “impactful” work (“scoring”, basically. no pun intended), and simply being focussed on holding one end up, or providing support. It wasn’t that Parry couldn’t score – he had at Test batting average of 22, but on that day the commentator wanted him to simply hold one end up and let the more accomplished batsman do the scoring.

I’ve seen this happen at various levels, but this usually happens at the intra-company level. There will be one team which will explicitly not work on the more interesting part of the problem, and instead simply “provide support” to another team that works on this stuff. In a lot of cases it is not that the “supporting team” doesn’t have the ability or skills to execute the task end-to-end. It just so happens that they are a part of the organisation which is “not supposed to do the scoring”. Most often, this kind of a relationship is seen in companies with offshore units – the offshore unit sticks to providing support to the onshore unit, which does the “scoring”.

In some cases, the Derick Parry school goes to inter-company deals as well, and in such cases it is usually done so as to win the business. Basically if you are trying to win an outsourcing contract, you don’t want to be seen doing something that the client considers to be “core business”. And so even if you’re fully capable of doing that, you suppress that part of your offering and only provide support. The plan in some cases is to do a Mustafa’s camel, but in most cases that doesn’t succeed.

I’m not offering any comment on whether the Derick Parry strategy of management is good or not. All I’m doing here is to attach this oft-used strategy to a name, one that is mostly forgotten.

More optionality in startup valuations

Mint reports that Indian e-commerce biggies Flipkart and Snapdeal are finding it hard to raise more money at the valuations at which they raised their last funding rounds. One line from the report:

Despite Morgan Stanley’s markdown in February, Flipkart is still approaching investors asking for a valuation of $15 billion, but it hasn’t had any takers yet, the first two people cited above said.

The problem with the valuations is that it includes significant option value. It is common in startup funding to include implicit options in favour of the new round of investors to protect them from the downside of any future decrease in valuation.

Typically designed in the form of “ratchets”, when the firm raises a fresh round at a lower valuation, the investors in the previous round will get additional shares so that their overall share in the investment remains the same (won’t go into the exact mechanics here). This downside protection allows investors to be more aggressive on their valuations of the company, and the company is able to report higher headline numbers.

Ratchets have two problems, both of which are illustrated in the difficulty of Flipkart and Snapdeal in raising more funds. Firstly, optionality in funding means an automatic markdown of funds held by investors in progressively earlier rounds. This is not explicit, but a ratchet is basically existing investors writing an option in favour of the new investors. While the cost of this option is not explicit, it is the earlier investors who bear the cost.

So Series C (and earlier) investors bear the cost of the optionality given to Series D investors. Series B and earlier investors bear the cost of Series C’s optionality. And so on. Notice that this telescopes, so the founders (original owners of equity) have written options to everyone who has invested (of course they also benefit from the higher overall valuation).

Now, if a “down round” (funding round at lower overall valuation than previous round) happens, this optionality gets immediately gets “paid out”. So if the Series D valuation is lower than Series C valuation, Series B and earlier investors (and founders) immediately “pay” the difference to the Series C investors (these options are American, and usually without an expiry date). So Series B and earlier investors (and especially founders) will not like this round. And they will hunt around for offers that will ensure that they don’t have to pay out on the options they’ve written. I suspect this is what is happening at Flipkart and Snapdeal now.

The second problem with ratchets is that stated valuations are inflated. A common share in Flipkart (don’t think one exists. All investors in that firm are effectively either long or short an option in the same stock) is not valued at $15 billion, so that valuation is essentially a misnomer. When Morgan Stanley says on its books that Flipkart is actually worth $11 billion, it is possible that that is the “true value” of the stock, without accounting for the optionality that latest round of investors receive. In other words, the latest round of investors invested at a price, which if extended to all stock, would value the company at $15 billion. But the rest of the company’s stock is not the same as the stock these investors hold! 

The problem, though, is that the latest “headline valuation” (inclusive of optionality) is anchored in the minds of founders and other earlier investors, and they see any lower price as unacceptable. And so the logjam continues. It will be interesting to see how this plays out.

With IPO being way too far off an event for determining if a company has “arrived” I propose a new metric, with shorter horizon. A company can be declared as having arrived if it manages to raise a round of equity with no embedded options. Think about it!

Maximum Retail Price is a conspiracy by FMCG companies

A few months back, Anupam Manur, a colleague at the Takshashila Institution, had written an Op-Ed in The Hindu that the Maximum Retail Price (MRP) mechanism is archaic and needs to be shelved.

Introduced in 1990 by the Department of Civil Supplies, this regulation governs that the maximum price at which packed goods can be sold be printed on the packet, and makes any transactions at a price higher than this price illegal. This was intended to be a mechanism to protect consumers from usurious shopkeepers (remember this was introduced just before economic reforms were launched), and Anupam’s piece also treats the intention as such.

Having now briefly lived in a country with no such regulations (Spain), I must say that my entire perspective of how retail works has been turned upside down (and this, having spent a year consulting for a major retail chain in India).

The existence of the MRP in India means you tend to look at everything in retail from that perspective – the manufacturer/packager, for example, can set margins (a percentage of the MRP) that each segment of the supply chain can earn. As a consequence, players in the chain have little leverage on what prices to charge – at best, they can forego a part of their (usually tiny) margins in order to drive sales.

Without the existence of MRP, however, the (power) equation is turned upside down. Two supermarkets close to my home in Barcelona (about 200m from each other), for example, charge €0,79 and €0,96 respectively for identical cartons of milk (of the same brand, etc.). This price difference (17% or 21% the way you look at it) of a retail commodity between two nearby stores would be impossible to see in India.

Given the broad similarity in these two supermarkets, it is unlikely that there’s too much difference in what they would have paid to procure these cartons of milk. In other words, one supermarket makes a far higher margin selling this milk (which is possibly compensated by the other’s higher sales).

In other words, in a market without MRP, the manufacturer/brand loses control over the pricing once he has sold products down the chain – it is up to the respective player in the chain to determine what he will charge for from his buyers, and thus manage his own revenues. While free markets mean that prices of products broadly converge across stores, the manufacturer/brand can do little in order to dictate them beyond a point.

With this kind of pricing power missing from retailers in a market like India (with MRP), the retailer is at a greater mercy of the manufacturer. The manufacturer can allow the retailer some leeway in pricing, for example, by setting an artificially high MRP, but the question is whether the manufacturer wants the retailer to have this leeway.

Under the current system (MRP), the retailer is mostly at the mercy of the manufacturer. The manufacturer has bargaining power over how much stocks to distribute to the retailer and when, and there is little leeway for the retailer to manage his stocks intelligently. In fact, for some products, manufacturers even control discounts and don’t allow retailers to sell below a particular price (threatening to stop supplies in case they do so). Without the MRP, this kind of coercion on behalf of manufacturers will be significantly reduced.

In this context, it is useful to look at the MRP as a tool that shifts the balance of power in the packaged goods supply chain in favour of the manufacturers/brands and away from the retailers. As Anupam has established in his piece, customers don’t necessarily benefit from this regulation. They are merely an excuse for manufacturers of packaged goods to exert bargaining power over the retailers.

In other words, the MRP is a conspiracy by the FMCG companies, who stand to benefit most from such regulations (at the cost of retailers and customers).

With the current union government supposedly enjoying support of the trading community, there is no better opportunity for this MRP regulation to go.

Uninspiring startups

The other day I suddenly wanted to check out what the “startup scene” is like in India, and so went on to VC Circle, looking at companies that have raised (Series A or B) funding in the last few months. I looked at the last 20 such companies, and quickly got bored. Most of them were in businesses that seemed absolutely uninspiring and banal.

A week ago I was mentioning this to a friend, who chided me for wasting time on VCCircle doing such “research” when Tracxn has it all in one place. And so yesterday, when I was once again in the frame of mind where I wanted to see what’s going on in the startup world. I logged on to Tracxn.

So I couldn’t log on immediately. The site asked me for my “work email” before I could see anything, and when I supplied an email ID that can pass off as a work ID, I got a mail saying it will take some time before I can actually log on. That time turned out to be five minutes, after which I got a message asking me to log on, and I started browsing the section on Indian e-commerce companies.

The experience wasn’t very different from what I had on VCCircle the other day, though evidently this was much quicker and more organised, meaning I could browse more companies with fewer clicks. So I probably got past a hundred startups, not all of them funded (VCCircle reports funding events, so it is biased that way). The tracxn database contains name of company, sector, what their business is, who the founders are (including background), any funding and so forth.

I’m unaware if any biases have crept in to the Tracxn database in terms of listing, but after some cursory viewing, there was a dominant pattern that emerged. And I must admit this is not a pattern that I might have fully appreciated.

So what I found based on the Tracxn database is that most of the startup founders are very young, aged less than 25 (guessing based on their school graduation year). Not too many of them have much in terms of academic pedigree (a few recent IIT graduates here and there, but more the exception than the norm), and not much in terms of work experience (obvious, if you’re starting up before you are 25).

Again the Tracxn data might be biased, but I didn’t find too many technology companies. Most seemed to be of the on-the-ground-getting-things-done kind of businesses. And then there were copycats.

It is not hard to believe, but every time a particular sector gets established or becomes “hot”, it attracts all and sundry. And justifiably so, for the company that might ultimately make money from the sector need not be the pioneer. In fact, there might be a last mover advantage, since the later entrants can learn from the mistakes of the early entrants and set themselves up to succeed better. In that sense the copycats are justified.

But the thing to note is that a large number of such “copycat” companies are getting funded. Some of them might have raised from angels, or small investors, rather than from established Venture Capitalists, but they have obtained financial backing for sure.

Anyways, after my session of looking at startups and analysing them yesterday, the one big insight was that the market is currently rewarding risk taking ability at the cost of all other kinds of abilities. Hot money is chasing startups, so anyone willing to work with a remotely viable idea is able to raise money. How these companies will fan out going forward is anybody’s guess!

 

The finiteness of the global advertising market

In this excellent post on social media companies, Aswath Damodaran articulates something I’ve long wondered – about the finiteness of the global advertising market. Given the number of companies that come up with new mechanisms to match advertisers with consumers, one can be forgiven for believing that the market for advertising is infinite. That the more avenues you create for serving advertisements to people, the more the advertising that will flow, and there won’t be a let up anywhere.

This picture here is from Damodaran’s blog (which I recommend you subscribe to, since every single post is worth reading). Based on the numbers that Damodaran presents here, the overall growth of the worldwide advertising market seems rather low.

Source: Aswath Damodaran (http://aswathdamodaran.blogspot.in/2014/11/twitters-bar-mitzvah-is-social-media.html). All numbers in billions of dollars

The number to take away for me from this calculation is the shrinking pie of non-digital advertising. Based on these numbers, the total non-digital advertising market in 2008 was $468 billion. In 2014, going by the same numbers this is down to $400 billion. This de-growth is significant and holds important lessons for other sectors that are dependent on advertising.

So far, the flow of advertising capital has been taken for granted and the number of business plans made (in both old and new economies) with an assumption on advertising growth is endless. If you want your local bus utility to make more money, you rent out advertising space on buses. If a low-cost airline wants to make more money, they put advertisements on the back of seats (a very good idea since it gets undivided attention for the duration of the flight). It is a surprise that insides of toilet stall doors (which again get undivided attention) haven’t fallen prey to advertisements yet.

The point here is that while it is all well and good to plan businesses based on advertising income, what we need to keep in mind is that the advertising pie in the long term grows at the same rate as the global economy. Sooner or later the waters will recede to the natural level, and then we will know who is swimming naked!

 

Marketing

I’m in a conversation with a friend on marketing my consulting services and he gave me a most genius piece of advice

You can say you do supervised learning instead of saying regressions.

Last month I was at this big data conference. Everyone I met said they were into big data or analytics or some such. The follow up question would always be “and what exactly do you do?” Followed by a laugh about how these are much abused terms.