Tag: transaction cost

Meetings from home

For the last eight years, I’ve worked from home with occasional travel to clients’ offices. How occasional this travel has been has mostly depended on how far away the client is, and how insistent they are on seeing my face. Nevertheless, I’ve always made it a point to visit them for any important meetings, and do them in person.

Now, with the Covid-19 crisis, this hybrid model has broken down. Like most other people in the world, I work entirely from home nowadays, even for important meetings.

At the face of this, this seems like a good thing – for example, nowadays, however important a meeting is, the transaction cost is low. An hour long meeting means spending an hour for it (the time taken for prep is separate and hasn’t changed), and there’s no elaborate song-and-dance about it with travel and dressing up and all that.

While this seems far more efficient use of my time, I’m not sure I’m so happy about it. Essentially, I miss the sense of occasion. Now, an important meeting feels no different from an internal meeting with partners, or some trivial update.

Travel to and from an important meeting was a good time to mentally prepare for it, and then take stock of how it was gone. Now, until ten minutes before a meeting, I’m living my life as usual, and the natural boundaries that used to help me prep are also gone.

The other problem with remotely being there in large but important meetings is that it’s really easy to switch off. If you’re not the one who is doing a majority of the talking (or even the listening), it becomes incredibly hard to focus, and incredibly easy to get distracted elsewhere in the computer (it helps if your camera is switched off).

In a “real” physical meeting, however, large the gathering is, it is naturally easy for you to focus (and naturally more difficult to be distracted), and also easier to get involved in the meeting. An online meeting sometimes feels a bit too much like a group discussion, and without visual cues involved, it becomes really hard to butt in and make a point.

So once we are allowed to travel, and to meet, I’m pretty certain that I’ll start travelling a bit for work again. I’ll start with meetings in Bangalore (inter-city travel is likely to be painful for a very long time).

It might involve transaction cost, but a lot of the transaction cost gets recovered in terms of collateral benefits.

Hanging out on Hangouts

The covid-19 crisis has fundamentally changed the way we work, and I thikn some things we are not going to get back. For the foreseeable future, at least, even after official lockdowns have been lifted, people will be hesitant to meet each other.

This means that meetings that used to earlier happen in person are now going to happen on video calls. People will say that video calls can never replace the face-to-face meetings, and that they are suboptimal, especially for things like sales, account management, relationship management, etc.

The main reason why face-to-face interactions are generally superior to voice or video calls is that the latter is considered transactional. Let’s say I decide to meet you for some work-related thing. We meet in one of our offices, or a coffee  shop, or a bar, and indulge in pleasantaries. We talk about the traffic, about coffee, about food, do some random gossip, discuss common connects, and basically just hang out with each other for a while before we get down to work.

While these pleasantaries and “hanging out” can be considered to be a sort of transaction cost, it is important that we do it, since it helps in building relationships and getting more comfortable with each other. And once you’ve gotten comfortable with someone you are likely (at the margin) to do more business with them, and have a more fruitful relationship.

This kind of pleasantaries is not common on a phone call (or a video call). Usually phone calls have more well defined start and end boundaries than in-person meetings. It is rather common for people to just get started off on the topic of discussion rather than getting to know one another, cracking jokes, discussing the weather and all that.

If we need video and phone calls to become more effective in the coming months (at least as long as people aren’t stepping out), it is imperative that we learn to “hang out on hangouts”. We need to spend some time in the beginning of meetings with random discussions and gossip. We need to be less transactional. This transaction cost is small compared to the benefit of effectively replicating in-person meetings.

However, hanging out on hangouts doesn’t come easily to us – it’s not “natural”. The way to get around it is through practice.

On Sunday night, on a whim, I got onto a group video call with a bunch of college friends. Midway through the call I wondered what we were doing. Most of the discussion was pointless. But it gave us an opportunity to “hang out” with each other in a way we hadn’t for a long time (because we live in different places).

Overall, it was super fun, and since then I’ve been messaging different groups of friends saying we should do group video chats. Hopefully some of those will fructify. Along with the immediate fun to be had, they will also help me prepare better for “hanging out” at the beginning of my work meetings.

I think you should do them, too.

Moving towards a cashless economy

In any transaction, the process of payment is a pain. It is a necessary step, of course, in that payment is what completes the transaction, but the process of payment is not something that adds any value to the transaction. If money could be magically be transferred from buyer to seller at the end of a transaction, both transacting parties would be happy.

In this context, any chosen method of payment, be it cash or credit card or cheque or bank transfer, involves some degree of pain for the transacting parties.

In case of cash, there’s the problem of counting out the money, cross checking it, finding exact change, being able to handle currency without the fear of being robbed, and making sure the currency is not counterfeit. Cheques have a credit risk, since they can bounce, not to speak of the time it takes to write one, and the time it takes for the money to get transferred.

Bank transfer requires parties to have bank accounts, and the ability of transacting parties to tell each other their account details. Credit cards have the most explicit pain of transaction – the transaction fees the merchants need to pay the acquiring bank – apart from the time and pain of swiping, entering the PIN, etc.

The reason India has so far been a primarily cash economy is that the pain of transacting through cash has been far lower than the pain through other means. Apart from the pains mentioned above, cash also has the advantage of anonymity, speed of transaction and ability to hide from the tax authorities.

So if we have to turn India closer to a cashless economy, as the current union government plans to do, we need to either increase the pain of transacting in cash, or reduce the pain of transacting through another means. The Unified Payments Interface (UPI), which was launched with much fanfare earlier this year but has spectacularly failed to take off, seeks to reduce pain of cashless transactions. The government’s efforts to get people open bank accounts through the Pradhan Mantri Jan Dhan Yojana (PMJDY) also seeks to reduce pain in non-cash transactions.

The government’s recent effort to withdraw legal tender of Rs. 500 and Rs. 1000 notes, on the other hand, seeks to increase the cost of transacting in cash – 85% of the current stock of cash in India needs to get banked in the next 50 days. This, however, is not a repeatable exercise – it can simply remove confidence in the rupee and drive people to alternate (formal or informal) currencies.

So what can be done to move India to a more cashless economy? The problem with small change has already played its part, with most auto rickshaw and taxi drivers in Mumbai supposedly willing to accept payment in digital wallets such as PayTM. If the stock for the new Rs. 2000 and Rs. 500 notes released is low, and most people have to transact using Rs. 100 notes, that will again increase the pain of transacting in cash, since the cost of handling cash might go up.

Perversely, if crime and robberies increase, that will again make people wary of handling cash. In fact, as this excellent piece in the New Yorker claims, the reason Sweden has moved largely cashless is that people got scared of handling cash after a series of cash robberies a few years ago. The cost of higher crime, however, means this is not a desirable way to go cashless.

It’s been barely three days since the new Rs. 500 and Rs. 2000 notes have been released, and there are already reports of counterfeiting in these notes. Given the framework I’ve proposed in this blogpost, it is not inconceivable that these rumours have been planted – when people become more wary of receiving large currency (thanks to the fear of counterfeiting), they want to reduce the use of such physical currency.

It’s perverse, I know, but nothing can be ruled out! As I’ve repeatedly pointed out, increased use of cash has a fiscal cost (in terms of printing and maintaining currency, apart from people not paying taxes), so the government has an incentive to stamp it out.

 

 

Landmark mismanagement

Yesterday’s Landmark Quiz in Bangalore was a major waste of time. No, I’m not talking about the quality the quiz here – the prelims was among the better Landmark Quiz prelims I’ve sat through, and given that we just missed out on qualification for the finals (AJMd, as we say here in Bangalore) I didn’t sit through the finals though I was told the questions there too were pretty good.

I’m talking about the transaction costs of attending the quiz. The overall management of the event left much to be desired. First of all, we had to show up at the venue at 11:45 for a quiz that was supposed to start at 1:45 pm. Teams with confirmed seats were let in at around 12:30 and only around 1 o’clock were us “waitlisted” teams let in. There too, the organizers did a major show of letting in waitlisted teams, calling them in order and taking over half an hour to let everyone in.

The point is that even after all the waitlisted teams had been let in, there was plenty of room in the auditorium. This makes me wonder about the wisdom of waitlisting so many teams, and then making such a big show of letting people in. Given that the total turnout was much smaller than the hall capacity, things would have been much simpler if people had been simply left in, with volunteers only ensuring that the seating was efficient (without leaving gaps).

Before the quiz yesterday i started writing a blog post on how the quiz registration process was itself flawed, and gave incentive to people to register zombie teams because the option of registering a team came free. So while the hall had been theoretically filled up many days ago, most of these registrations were zombie registrations thus leading to a long wait list and thus calling people early. Given that the quiz doesn’t have an entry fee, I can’t currently think of a good way to price this option.

But reaching the venue early was not the only waste of time. The written prelims of the quiz finished around 3 pm, including calling out the correct answers. The results, however, weren’t announced till close to 6 o’clock. In the interim time period there was the finals for school students, but that still doesn’t explain why they had to wait until 6 o’clock to announce the results of the senior quiz.

The way I see it, it was sheer disrespect on the part of the organizers of the time of the participants. Yes, Landmark might be a much sought after quiz, rated among the best in the country. Yes, most people come there for the questions and not just to win – and so stay on to watch the finals even when they haven’t qualified (it is indeed commendable that Landmark quizzes have managed to be great spectator events while not dropping quality). Yes, many participants have traveled from other cities and so having traveled the cost of their time might be “cheap” – in that they have little else to do in the rest of the day.

Even taking into account all these, the wastage of 5 hours of each quizzer’s time (2 hours for early reporting; 3 hours gap between prelims and results announcement; 4 if you consider that watching the Junior finals wasn’t a waste of time) is not a done thing. Given the quiz’s unparalleled reputation it is unlikely that market forces are going to tell the organizers that they are wasting people’s time, but the message has to go through.

Liquidity

In economic theory, outside of capital markets, “liquidity” is a topic that isn’t spoken about as much as it should. While I’m no academician to set this right in theoretical circles, I’ll make an attempt to help my readers what the fuss is all about.

Well past midnight, when you exit a mall after having just watched the “second show” of a movie, you will find a bunch of auto rickshaw drivers who accost you. Without exception, each of them is likely to quote an exorbitant price to take you home. As the night goes on, there is a reasonable chance that some of these drivers will have to move away from the mall, unable to have found a customer for the night.

Two months back, I was looking to purchase a high end laptop. I walked the high streets of Bangalore, going to every big and small computer store I came across. Each brand had a maximum of one laptop that fit my requirements. I ended up purchasing the laptop I’m typing this post on in the US (got a cousin to bring it in for me).

In London in 2005, a sandwich at Subway cost less than two pounds, while a Masala Dosa at a half-decent restaurant cost at least seven or eight pounds. In Bangalore today, a first rate Masala dosa won’t set you back by more than thirty rupees, while a standard unexceptional “sub of the day” at a subway costs over twice that amount.

All the above cases of pricing anomalies or market failures can be ascribed to “lack of liquidity”. In financial literature, liquidity is defined as an asset‘s ability to be sold without causing a significant movement in the price and with minimum loss of value (source: Wikipedia). From a practitioner’s standpoint, liquidity is positively correlated with the amount of activity that is happening in the market – the more the buyers and sellers for a particular security, the less the “transaction cost” you incur in selling it.

Auto rickshaws in the middle of the night, dosas in London, subs in Bangalore and high end laptops in India – they are all examples of markets that (by the above definition) are highly illiquid. In each of the above markets, the number of buyers and sellers at any point of time is low (relative to other comparable markets – such as auto rickshaws in the evening or dosas in Bangalore). Thanks to that, the “bid ask spread” (my apologies for continuing to use financial jargon. Bid ask spread refers to the price between the highest price a buyer is willing to pay and the lowest price a seller is willing to accept) is high, and consequently, buyers end up paying a high price, or in some cases, sellers end up not realizing a high enough price for their good.

Now, why should this happen? Doesn’t it sound counterintuitive if I say that “there isn’t much demand for subs in Bangalore, hence the price is high”? The fact is that when I say that “there isn’t much demand” I omit saying that there isn’t much supply also. This calls for further explanation.

Let us imagine a world where it is impossible for a buyer and a seller to interact directly to conduct a sale (this sounds like dystopia, but let us imagine a situation like that). In this world, there are a bunch of “specialists” called “market makers”, whose only job is to buy and sell goods. So if you are the seller of a particular good, instead of finding a buyer, you sell it to a market maker, who takes the risk of holding on to your good (carrying cost, possible damage, risk of sudden fall in value of that class of goods, etc.) until he has found a seller. Similarly, if you want to buy something, you only contact a market maker.

When there are a large number of buyers and a large number of sellers for a particular good, the costs of making markets is low. Due to the number of buyers, the average length of time a market maker has to hold on to the good is low, which automatically reduces the risk of making markets in this particular good. Since the cost of making markets in this good is low, more market makers will want to make markets for this particular good. Their competition lowers the bid-ask spread (refer to definition above), and thus both buyers and sellers will realize a price that is close to the true market clearing price.

Now what happens when there are few buyers and sellers for a good? Very few market makers will want to trade in this good, since the risk of holding on to these goods is significantly higher. Consequently, there is less competition among market makers and the bid ask spread remains high (while it is a fact that the cost of market making is also high for these goods, the lack of competition in market makers further pushes up the spread). As a seller, you now have much less choice in terms of buyers for your good, so you end up accepting a rate much lower than true market clearing price. Similarly, as a buyer, you end up paying exorbitant prices.

Now let us get back to the real world where buyers and sellers can actually interact. It can be seen as being similar to the above world, but with the change that buyers and sellers are their own market makers! The cost of making markets comes into play here. As a seller of auto rickshaw services outside a mall past midnight, you know there is a risk of not finding a buyer for your services. You try and price in this risk in the price you quote, and you end up asking for more than the market clearing rate, and there is a good chance there will be no takers for that rate, until you get desperate about finding a customer and quote something below the clearing rate. If you are looking to hail a rickshaw outside a mall past midnight, you are wary of being stranded there without a ride home, so you end up paying much more than the true clearing price.

Several examples of this nature abound. Like how real estate prices are “sticky”, and builders refuse to drop prices in the face of falling demand (note there that real estate brokers are not market makers – they don’t take on the risk of holding on to the asset). Like how I get suboptimal rent for the house that I own in Kathriguppe in Bangalore, only because there aren’t too many people who want to rent a 3BHK independent house. And how apple products are almost a fourth more expensive in India than in the US.

Moving briefly from micro to macro economics, GDP grows when there is more economic activity, or when there is more trade. One way of increasing GDP is to foster trade. However, a large number of goods and services that people need, or that people want to provide, are “illiquid” (that includes Quant consulting –  which is what I do. There aren’t too many of my ilk around, and no too many organizations interested in buying these services). One way of fostering internal trade, and thus economic growth, is to reduce the cost of market making. When it comes to goods, VAT, in that sense is a step in the right direction since at each step it is charged only on the marginal value added – and thus the presence of an intermediary doesn’t increase the total cost by too much. Stamp duty on real estate, however, is a bad idea. By charging a full tax on every transaction, it dissuades market makers in the sector, and thus keeps markets illiquid and opaque. The worst of all, though, is Agricultural Marketing, where by law the APMCs have monopoly in making markets in agriculture. Now you know why the farmer continues to suffer even though retail prices of agricultural products have been going through the roof.

Ok I end this post with that digression into macroeconomics. However, I do hope that I’ve been able to explain to you why illiquid products are costlier (if you’re a buyer that is)! Let me know in case you have any questions.

Update

This post came about as a result of a twitter conversation earlier today with Dhiren and Pavan. Giving credit where it’s due