If it were a school debate, the subject of the topic would be ‘Sodexo coupons – A boon or a curse. Discuss’.

Fortunately most of us are past that stage of life where we need to debate such issues in front of other school kids. Unfortunately though, unless we discuss and debate, we would lose money on a transaction like this. Let us look at the bare bone facts of the Sodexo business and try to draw some conclusions.

The perquisite valuation rule (Sodexo/Food coupon is a perk) (Fringe Benefit tax) governing the issuance of Food coupons states (Rule 3(7)(iii)) -

(iii) The value of free food and non-alcoholic beverages provided by the employer to an employee shall be the amount of expenditure incurred by such employer. The amount so determined shall be reduced by the amount, if any, paid or recovered from the employee for such benefit or amenity:

Provided that nothing contained in this clause shall apply to free food and non-alcoholic beverages provided by such employer during working hours at office or business premises or through paid vouchers which are not transferable and usable only at eating joints, to the extent the value thereof either case does not exceed fifty rupees per meal or to tea or snacks provided during working hours or to free food and non-alcoholic beverages during working hours provided in a remote area or an off-shore installation.

If you didn’t have the patience to go through the rule, here’s what it states in summary. The Employer cannot pay more than Rs. 50/- per meal during working hours. Assuming a reasonable 2 meals per day and 22 working days in a month, it works out to Rs. 2200/- p.m food coupons (which is the limit that most of us get) (the max. anyone can get is Rs. 3000/-). Of course, since the Employer cannot pay more than Rs. 50/- per meal, the maximum value of any one Sodexho coupon cannot exceed Rs. 50/-. Hence the denominations are always Rs. 50/- or lower (usually they are Rs. 50/-, Rs. 35/-, Rs. 20/- and Rs. 10/-).

These coupons are useful for different parties in multiple ways. There are four parties involved in any food coupon transaction as illustrated below (along with Sodexo’s business model):

Employee: The Employee is usually very excited with any prospect that saves him a little tax. And so is the case with Sodexo coupons too, where availing the Sodexo coupon opportunity will make the food coupon amount tax free. For employees in the highest tax bracket (30%), this would save tax of Rs. 660/- p.m (or Rs. 7920/- per year). Of course, if you didn’t opt for the coupons, you would get Rs. 1540 as deposit in your bank account (Rs.2200/- after tax deduction). But did the food coupon craze take off in huge numbers just because an Employee could save some tax and buy food from his office canteen? Absolutely not. The reason it took off was because the retail chains (FoodWorld, Spencers, Foodbazaar, Big Bazaar, MK Retail, Total, Reliance etc.) started accepting the coupons for anything and everything that you purchase at their store. Employees jumped at the opportunity (and most people mentally classify these coupons as free money than hard cash – look at some stuff they buy using the coupons. They would never buy it with hard cash).

Company: Most companies started this perk out as a differentiator to employees (and marketed it as ‘it’s actually extra money in your pocket since it’s tax-free). And then all companies started offering it. From a nice-to-have feature, it has now turned into a must-have feature in the pay package. Companies don’t make or lose any money on this transaction (apart from the administrative headache).

Retail Store: Initially, the retail store used to accept Sodexo coupons only for pure food item purchases. It was a pure sales/marketing tactic from thereon – to attract more customers and to wean away customers from other competing chains, they started accepting Sodexo coupons for anything and sundry (which apart from increased sales, also increased customer loyalty). Eventually, competitive destruction happened and the retail chains till Dec 31st, 2011 accepted Sodexo coupons for all purchases. They redeemed their Sodexo coupons with Sodexo for a 5% discount (and they used to receive cash only after 20-30 days after submitting the coupon; credit card companies credit the retail store within 24 hours usually). It’s almost become mandatory for retail chains to accept Sodexo, else they risked losing customers to other retail chains and very fast (the cornershop marwariwala lost his business this way, till of course he also started accepting Sodexo!). Of course, to cover up the lost 5%, people usually concur on the fact that retail stores usually mark up the prices of certain items (although this cannot be corroborated with any data available).

Sodexo: Who exactly is Sodexo? This link gives more information (and this one in more juicier detail), but in summary, Sodexo is a French multinational corporation Sodexo is one of the largest food services and facilities management companies in the world, with 380,000 employees, representing 130 nationalities, present on 34,000 sites in 80 countries. They are the biggest beneficiary in this transaction. Since this is almost like a parallel currency, they have to invest a lot of money upfront to get the govt. machinery working in passing certain laws. They make money in three ways:

a) They receive Rs.100/- worth of coupons, while give back only Rs. 95/- in cash, netting a straight 5% gain.

b) Sodexo coupons usually come with an expiry date (think of it as a currency with expiry date *shudder*). Once its expired, no retail store would accept it and it becomes null and void. However, Sodexo had already received the money from your Company when they issued the coupon (and hence a 100% profit!). There is a complex process through which you can get new coupons issued, but most people would not have the time or the patience to go through the process for getting the new coupons.

c) The biggest of them all. They get money at 0% interest. Have a look at the diagram once again. Day 1, they receive Rs. 100/-. Day 24-34, they give back Rs. 95/-. That is, they have had the money for a full 20-30 days without paying any interest. In fact, till the coupon is used, it is practically free money (and they can lend this money at interest, thereby making money).

So, if this was a win-win-win-win arrangement for all the folks involved, why did the retail store chains suddenly stop taking Sodexo coupons in lieu of items?

There is no clarity on what exactly happened, but here are the news items floating around -

a) They have increased the brokerage from 5% to 9%. That is, the retail chains used to get back Rs. 95/- of their money, but in the revised scenario, would get back Rs. 91/-. Already under pressure for margins, this was not acceptable by retail chains. Presumably, they formed a clique and stopped taking the coupons across the table.

b) The number of days in which cash conversion happens has gone up from 20 days to close to 60 days, thereby impacting the cash cycle of organizations

thereby, resulting in a clique where the retail chains have closed ranks and have decided to put up a fight with Sodexo – to i) reduce the brokerage rate below 5% (and they’ll eventually settle to the original 5% figure) and ii) reduce the cash conversion cycle (and settle back on the 20-30 day figure).

Sodexo certainly has to negotiate and accede to the demands of the retail chains, simply because without them, Sodexo ceases to exist. Retail chains will also join the negotiating table because they will have too much to lose (the corner stone marwariwallah is still accepting Sodexos, and more probably, there is always a possibility that one retail chain breaks away from the clique to grab customers quickly). All in all, this is bound to be a temporary situation (max of 1-2 months), and as usual, the employee is being inconvenienced for the greater good of the mankind or some such.

My personal opinion is that the entire Sodexo tamasha is not worth the administrative hassle that most companies undergo (the big IT firms have everything automated, but all other firms are not). Why not give Rs. 2200/- as a food perk straightaway as cash instead of this circuitous food coupon route? Or tax it at the minimum rate? This whole hassle could have been avoided. But then again, there are vested interests at play here and I am not even a micro-bit player in the rational minority.  (As an aside, I always wondered about an active secondary market. For example, you get Rs. 2200/- worth of coupons and you save Rs. 600/- in tax. Which essentially means, you would be willing to sell the coupons for cash for anything above Rs. 1600/- thereby making a neat, tidy profit. I am almost sure this is illegal, but I just wonder!). Also, Sodexo coupons involve a lot of paper. They can shift to card based system (if at all this system has to exist) and save a lot of money (IT firms usually give out cards, but try using a card in any retail chain – nada for now!).

Disclosure: I don’t subscribe to Sodexo coupons. My wife does and hence have a vested interest liquidating the Sodexo vouchers

P.S: I can also see a govt. conspiracy here Sodexo coupons out of circulation means Employees will not subscribe to them January end (or future months). Which means, more taxable income and which means, more taxes. Government #FTW

P.P.S: I explained a scenario above where a Employee can technically make a profit by selling the coupons at a discount. One enterprising person actually tried to sell these coupons at a premium on an internet site. Why would anyone pay hard cash (say, Rs. 105/-) in exchange for Sodexo coupons (worth Rs. 100/-). Beats me. Not too sure what the guy who posted this was thinking though

Make a prediction about anything. Just about anything. The trick lies in making an outrageous prediction and not just a normal prediction. For example, you can predict that Bangladesh is going to win this year’s World Cup. Or the stock market is going to touch 25000/12000 by this year end. Or Manmohan Singh will actually clamp down on corruption. At this stage, you may or may not state reasons for your prediction. If you are a well-known person, publish your prediction is some journal/magazine/newsletter. If you are not, there is always the workplace-colleagues group, family etc. But someone other than you should clearly and loudly hear that you’ve made a prediction, an outrageous one at that.

There are two results which can happen from the instance you’ve made the prediction. The prediction might actually turn out to be true in which case you are a celebrity and the person with crystal-ball gazing ability. Of course, now that your prediction has come true, you can always state reasons (hindsight vision 20/20) as to why you thought this was the only outcome possible. Again, if you had published your prediction, more offers in terms of articles, op-eds, seminar talks would come your way. If you are not, you’ll atleast be held in high-esteem by your colleagues/family.

On the other hand, your prediction may not come true (most cases!). The advantage here is that almost noone will remember your outrageous prediction. In a world where there is a lot of information overload, who is going to remember things which have failed? Almost noone.

You don’t believe me, do you? Let me state some examples –

a)      On the eve of the 1996 cricket world cup, different ex-cricketers were asked about the probable winner. Richard Hadlee said Sri Lanka. I don’t remember which other ex-cricketer said which team would win. Sri Lanka went on to win the World Cup. Richard Hadlee subsequently was asked before almost every World Cup (TV shows, Marketing events etc. – making him a lot of money!) since 1996 about the probable winner and we are reminded of his crystal ball gazing ability since then. He went on to say India, England, South Africa for the next 3 world cups and each of those predictions turned out to be false (Australia won all 3). Did anyone chide Richard Hadlee for his stupid prediction? Absolutely not. He was recently reminded of his prediction of the 1996 world cup winner, and was asked the probable winner of the 2011 World Cup.

b)      Arjun Murti, a Goldman Sachs banker had predicted Oil would touch $100 when it was languishing around $40 a few years back. It was an outrageous prediction. Oil subsequently went on to hit $140 and is back to $90 levels now. Once Oil crossed $100, Arjun Murti was hailed as one of the most prolific commodities banker and was probably given a ton of bonus for his prediction. He went to predict that Oil would hit $200 very soon. Till date, Oil hasn’t (and this prediction was 3 years back). Did anyone notice? Did anyone care? Did anyone say ‘Yo Arjun, what’s with the foolish prediction?’ Absolutely not.

c)      Closer home, Rakesh Jhunjhunwala predicted that Sensex would touch 20000 by 2008 in 2003. Sensex did cross 20000 in 2007 itself. Rakesh was hailed as a visionary who could predict markets at will. Rakesh was subsequently asked of the next target. He said 40000 by 2011. We are nowhere close to that (in fact, as of today, not even half of that). Did anyone question the sanity of Rakesh Jhunjhunwala of his prediction? You know the answer by now.

That in summary, is the effect of the Theory of Outrageous Prediction. Limited to zero downside and unlimited upside.

You might say, ‘Hold on, why not just make any prediction? Why do I have to make an outrageous prediction?’ Well, the answer to that is, noone would care to remember your normal prediction. Worst case, they might just boil it down to sheer luck than anything else (For example, let’s say you predict Obama is going to win 2012 elections. Well, noone cares about your prediction because that is an expected outcome (or most probable outcome). However, if you predict Sarah Palin is probably going to sweep the 2012 election, you are onto something. Imagine if that event turns out to be true (god forbid!). You can state reasons ranging from disgruntled-US-employees to sweeping-demographic-changes-influenced-by-social-media or some such!).

One caution though. You need to use this theory sparingly. Else, people might just ignore you for silly talk and posturing (the success ratio of outrageous predictions is abysmally low. If you predict every other day, you are bound to be branded a failure).

P.S:  Any attempt to copy the name of my theory will lead to a trademark violation. You’ll hear from my lawyers almost immediately

In this post, I attempt to demystify the reasoning behind valuations of each of the IPL players that will go under hammer tomorrow. Before that, a brief of some basic rules are in order –

• Each franchise needs a squad of players, with 11 playing at any one time.

• Only 4 players at any time are allowed to be non-Indian.

• The franchises bid on the basis of the salary they are prepared to offer the player.

• The salary offer is valid for three years, although there is the possibility of player transfers in future years.

• Each team must also have four under 22 players.

• Each bid starts with the base fee fixed by the IPL (based on the band), and there is no upper limit.

• Players were grouped into different bands (5 bands) within the auction based on the  expectations of the organisers that they were of similar experience and  ability.

• Each of the IPL franchises can retain up to 4 players in advance of the player auction. Out of these, 3 could be Indian.

• A franchise can bid for up to 10 overseas players. However, during a game, only 4 of these can be on the field while the rest have to be Indian cricketers only.

• There is a maximum limit of $9 million for each franchise to spend at the IPL 4 auction. This means that a franchise which retains 4 players will have less spending money ($4.5million) for other players.

• The maximum size of a franchise team is 30 players.

• Sahara Pune Warriors and the Kochi teams were allowed to sign up to 4 players prior to the auction from a list of players who were not on any team during the previous IPL seasons.

The auction of IPL players is a classic English auction where the franchisee with the highest bid for the player gets the player. It is a simple auction process, with no complications and slimy strategies. However, we cannot just keep bidding for all players. So, what can be a strategy?

The strategy is essentially to have a list of 50 players (the maximum size of a franchise is 30 players, and on average over the past 3 IPL seasons, teams have had 18-24 players in their squad), classify them depending on various factors like batting, bowling, all-rounder etc and then rank them. After the ranking is done, we need to set the minimum and maximum prices that we can pay for each player and move down the list depending on the cash remaining (unless of course, the owner wants a particular player at any cost – in that case, all calculations go out of the window and the remaining players get short changed).

Classification based on batting, bowling or all-rounder is very basic. We all know who ‘bats only’, ‘bowls only’, ‘bats but also bowls’, ‘bowls but also bats’ and ‘genuine-all-rounder’. This requires no further elaboration.

Ranking them though is the challenge. How do you rank one player above the other in each of the classifications? What are the factors that can lead you to quantitatively rank one player over the other? Here is where I think Statistics and Regression models play a large part (in determining which variable is significant towards calculation of a value, what variables to-gether contribute towards the valuation etc.). However, as stated earlier, I will skip this part and probably go for a guesstimate of these variables. More quantitatively inclined folks can compare if these variables were indeed significant over the valuation in the previous auction (seasons). The variables, in no particular order are (as you would observe in the variables, we consider a split within variables: one for ODIs and the other for T20s. This is because of a lack of statistically significant player history for T20s. As we go along in T20 matches, only the T20 variable can be considered) –

a)      Experience – Quite a basic variable, in the sense that a great Test player may not be a fantastic T20 player. The number of T20s that a player has played is one of the variables. Here, Experience consists of two variables – one for T20s and the other for ODIs

b)      Batting Strike Rate – This is for ‘Batters’ classification. Many players across the world might not have played a lot of T20s (domestic/international). Therefore, this Batting Strike Rate variable needs to be split into two. We need to consider the Batting Strike Rate1 of T20s and also consider the Batting Strike 2 of ODIs.

c)       Batting Average – Again for ‘Batters classification’. Again, there is a Batting Average 1 for T20s and Batting Average 2 for ODIs.

d)      Composite Batting Variable – This may or may not work, and can be tested for statistical significance. The hypothesis is that Batting Strike Rate 1 * Batting Average 1 = Batting Composite Variable 1 along with Batting Composite Variable 2 should be easier to rank than each of variables mentioned in b) and c) and then reclassifying them.

e)      Bowling Strike Rate – Same as Batting strike rate, but for Bowling.

f)       Bowling Average – Same as Bowling average, but for Bowling.

g)      Composite Bowling Variable – Same as Batting variable, but for Bowling

h)      Indian Player – Hypothesis here is that an Indian player will fetch more value than an overseas player although the ratio of available positions in the side to the number of overseas players is low. I believe this variable is significant only because the Indian players can be used for extensive marketing within the franchisees across India hence bring in more revenue rather than the overseas players.

i)        Controversy-ridden – Hypothesis here is that the audience is more interested in the drama of a player rather than just the player value per se. For example, an affair with a film actress, the slap-scandal, monkey business and various other characters in the player community would fetch a better price than a normal staid player (a normal staid player but oozing with talent is a different issue which will be taken care by variables b-g).

j)        Players under 22 years – These players will get a premium over players with similar performances (variables b-g) but with age > 22 due to the simple reason that demand outstrips supply. There are only so many eligible and good players < 22 years of age and the demand is of atleast 4 years under 22 (with 10 teams, you need 40 players under 22. Do we have so many decent players at all?)

k)      Popularity – Popular/exciting players are bound to get a higher price than players who have similar performance (variables b-g). For example, a player like a Sachin/Dhoni (both of them have been retained by their franchisees though) are bound to fetch a higher price just because of more avenues for marketing and pulling in the crowds.

l)        All-rounder capability – I am not really sure how we can model this variable. As I thought through all these variables, this is probably the most difficult variable to model. How do we blend the batting composite and bowling composite variables and in what proportion? Do we need to blend them with different weights for a batting all-rounder versus a bowling all-rounder? Anyway, I do think all-rounders would add a great deal of value to all the IPL teams and they would be bid at a premium.

Those are probably the 12 important variables to fit into a regression equation,

Price of player = f(12 variables)

The only remaining valuation variable is the range that we’d like to come up with. That’s easier said than done and probably can be commented on once we solve the regression equation (probably attaching different level of confidences to each price would solve the problem – not too sure, haven’t thought this through).

End of analysis.

Do let me know if this analysis made any sense at all (or was helpful in anyway), and if there was any variable that I left out. Also, kindly shower brickbats on this blogpost (and demand that I don’t write such posts in the future if it doesn’t suit your tastes).

P.S: Oh yes. Happy New Year and all. May the farce..er…force be with in 2011 (Vulcan sign)

]]> http://kirandhanwada.com/2011/01/07/ipl-2011-player-valuation-and-analysis/feed/ 3 http://kirandhanwada.com/2010/11/16/retrospective-determinism/ http://kirandhanwada.com/2010/11/16/retrospective-determinism/#comments Tue, 16 Nov 2010 09:32:54 +0000 Kiran http://kirandhanwada.com/?p=470 *Jargon alert. Loosely called ‘Hindsight bias’.

How often have we looked at past events, somehow saw/derived a pattern from these connected events and concluded that the final eventuality had to happen? Many a time, we indulge in this process known as retrospective determinism.

Let me explain.

 a)      The US govt. looked at all the events leading up to 9/11, post 9/11. All agencies in the govt. started seeing patterns in the information available(the terrorists taking airplane training, certain phone calls to the Middle East etc) and concluded it 9/11 could have been prevented, if not for the intelligence failure. At home, back in India – the 11/26 attacks in Mumbai. Charges have been leveled across agencies that information was not shared and hence attacks which could have been prevented were not.

 These are classic cases of retrospective determinism. Consider an intelligence agency’s information pile, every single day. Every day, a ton of information from all parts of the world flows through an agency. Multiple events happen on a daily basis and no one sees a pattern, unless another 9/11 or a 11/26 takes place – and everyone starts seeing them again to assign blame. These were not cases of ‘could have been prevented if such and such was followed’; the odds of such an attack could just not have been predicted, nor could a pattern seen.

 b)      The Stock Market – Seemingly, everyone and their uncle’s grandson predicted the economic collapse. In India, by the looks of experts on media, almost everyone seemed to have predicted the stock market top out at 21k in 2008. Subsequently, when the collapse did happen and retail investors were languishing with stock market at 8000, the same experts started offering reasons why the stock market fell thereafter (retrospective determinism alert) and will fall further. Yet, the same experts are predicting all sorts of nonsense (30k in a year, 5k in a year and so on and so forth) when the time has come when the stock market has inched towards 21k again this time. Somehow, nobody wants to indulge in prospective determinism. Looking at the past and expounding on a pattern and foresight has indeed become a national past time.

c) Multiple cases in corporate life. CEOs of most companies proclaim to have seen the future when a product of their company becomes a runaway success. They list out major factors which contributed to their product’s success. However, what is usually not said is this one particular product might be a part of a portfolio of 10 products, 6 of them which spectacularly failed. Somehow, the CEOs couldn’t see the future in these failed products.

Another example – The success of Google as a company seems to be a story every publisher wants to publish. Authors write eloquently on factors which contributed to Google success – precocious entrepreneurs, loads of talent, hardwork etc. Yet, these are the same factors that were a part of Altavista (the best search engine of the 90s), Excite.com and approx. 10 other search engines in the 90s. So, why did Google succeed and all other search engines with similar factors fail? Derving reasons from hindsight and proclaiming them to be success factors is the worst case of retrospective determinism.

Cases of retrospective determinism abound in personal life. You only have to look at different stages in your life and we all would have exhibited this behavior multiple times. (Update: Just browsed a book titled ‘Double life of Ramalinga Raju’. The author seems to point out that the case of fraud was evident from the beginning of Raju’s meteoric rise from 1997. I wonder why this outrageous insight didn’t occur to the author before 2008, the year of Raju’s arrest? Retrospective determinism is a harmful being – stay away!)

The question though is, what is wrong with retrospective determinism? What is wrong in seeing patterns and learning from them? Learning from the past is very useful, and maybe necessary in most cases. However, indulging in searching for patterns in cases of pure randomness would lead to dangerous conclusions and leading to yet more hazardous measures to prevent a random occurrence (like structuring yet another agency to overlook other intelligence agencies (a case of who will audit the auditor arises again!), getting in more experts who were right last time to predict stock markets instead of avoiding prediction altogether etc, writing about success factors that the naive ones might lap up). A case to avoid retrospective determinism is an easy sell and we would do better to refrain from it as much as possible.

Let me explain.

The heart of economics deals with incentives. Incentives shape the behavior of an individual. These incentives need not necessarily be monetary. They can be non-material forms like love and respect among others. It is my personal belief that Incentive theory can be applied almost to any field with success.

Incentive theory has been more widely known as the principal-agent problem, especially when applied to the corporate world. In the corporate world, the principal is the employer and the agent is the employee. The theory states that the interests between the principal and the agent may not necessarily be aligned, and hence the agent might not wholeheartedly pursue the interests of the principal. Various mechanisms have been devised to align interests like commissions, profit sharing, stock options, efficiency wages and even a disincentive like firing. All the above mechanisms and many more try to address the principal-agent problem. Extending the theory to the world in general, I call it the Incentive theory.

My general and overarching principle states that people change their behavior according to the incentives/disincentives available. My exposure to this principle came through to me primarily in the corporate world. Once I understood this principle, it became very easy to extend this framework to other subject areas leading to conclusions with immense predictability. I did play back this principle/framework with multiple people and almost all agreed to the notion that the theory of incentives works in all subject areas, including love.

Situations are many. I will quote just a few examples -

1) Corporations – This is an easy one, easily extended from the principal-agent problem. Sales professionals are usually the paid the highest, since their incentives (commissions) are tied to the sales they bring in and hence leads to the growth of a company. Employees working in IT care not so much for the sales numbers, but to the number of errors/bugs they generate since their incentive is tied to superior code. The employee on a car assembly line works towards number of cars he can work on, since his incentive is tied to that particular element of his job.

 2) Work – All incentives need not be monetary. For example, people wanted to work for Google way back in 2000-2004, not necessarily because of monetary incentives but because it was a ‘cool’ place to work for, a place where all ‘smart’ people worked. Every computer science engineer worth his salt wanted to work for Google. Similar was the case with Microsoft in the early 90s. Eventually, people made money – but that’s not the point. The primary motivation to join Google/Microsoft was not money but ‘coolness’ and ‘smartness’.

 3) Dating and Love: It is plain amazing what people do during dating/love. The incentive here is to feel happy by pleasing the other person and more often than not, expect reciprocation of the affection/warmth/love that you had exhibited. As much as ‘Be Yourself’ is the mantra, people tend to adjust their behavioral patterns (and in some case, sleeping patterns) to get along with their partner. I have personally known a total non-reader reading up on her partner’s favorite authors, a frequent drinker becoming a teetotaler etc. Yes, these actions may not be permanent, but they are temporary enough for the other partner to reciprocate their love/warmth.

 4) Blogging – Why do people blog? Why do I blog? What is my primary incentive? There might be many incentives – fame, sounding intelligent, leading to a book, impressing a girl, making friends in the blogging world, networking and so on and so forth. Multiple bloggers have these and many other incentives, each onto his own.

 All this is commonsense – don’t you think? I certainly felt so, but only after I started thinking in this mode. I call it a ‘mode’ because living life by constantly thinking about incentives/disincentives will drive people crazy. We are inherently built to act according to our incentives and so it shall be, whether we like it or not. I stated this theory to lay out a framework of thought process that one has to consciously imbibe, so as to understand and appreciate the world and the wonderful, but incentive-driven human beings in it. Ask yourself for any situation – What is my incentive here? What is his/her/their incentive here? How do I modify the incentives to create a win-win/win-loss situation? You’d be surprised at the number of things you’ll learn once you start applying this principle/framework in day-to-day affairs. I definitely was.

Signaling, as per Wiki, is defined as

In economics, more precisely in contract theory, signaling is the idea that one party (termed the agent) conveys some meaningful information about itself to another party (the principal).

(Advanced economics students might want to classify this under behavioral economics).

Back in 1974, Nobel laureate Michael Spence introduced the notion of signaling in economic thinking. According to him, when information is imperfect, individuals who possess strong qualities will send signals to distinguish themselves from the others. He takes education as an example. Suppose there are two types of individuals called, for convenience, the ‘dafts’ and the ‘defts’. Employers cannot say who is who. It costs to the dafts more time and effort to become educated than to the defts. Spence shows that, if education is sufficiently costly for dafts and cheap for defts, only defts will invest in education, thereby signaling their higher productivity to potential employers.

Like it nor not, we all use signaling in our day-to-day lives. If I exaggerate a wee bit, it is used probably at every moment and with everyone. For example:

a. Business: Suppose you come up with a product – let’s say ‘Ketchup’. This Ketchup might be the best ketchup available in the country, if not the entire world. However, shouting-from-rooftops about this ketchup being the best in the world in various advertisements wouldn’t help much, since the Ketchup marketplace is already a crowded one. ‘Tastier than Heinz’ is one approach – relative comparison which customers will quickly catch on to – that’s one type of signaling. The second type of signaling might involve money back guarantees, public tasting guarantees or tying up with a food chain and offering your ketchup as a free add-on. Positive signaling to increase your business.

b. Corporations: This theory works very well during or near Quarter result declarations. Statements like ‘Retail sales are holding’, ‘Economy has been weak’ implies that earnings would not meet expectations. As also, is the case with dividends (giving out dividends consistently may be taken as stable company but no growth prospects), insider buying (when management of the company starts buying shares, it is usually a signal that the company is and will be doing well in the foreseeable future), insider selling (opposite of the previous item) and various other corporate actions – each signaling or telling us what is about to come. They may not be 100% reliable, but works most of the time.

c. Money: How do you let the world know that you are rich? One way, although incredibly crazy would be to print out your bank statements and put it up on a billboard. More often than not, in this case, you are sending out a positive signal for kidnappers! On a serious note, flaunting a Louis Vuitton bag, driving a Porsche car, building a huge house etc. are signals to indicate you are rich. You need not say anything, but your actions speak for it. That’s signaling.

d. At work: ‘Pretending to be busy’, ‘Blocking calendars’ and ‘looking perturbed and disturbed’ are all classic signals to indicate that you are someone important, your time is important and you deal with multiple issues in the corporation, even though you might not be. Trying to hang out with superiors is also a classic signal that you intend to move up the ladder. There are about a million examples of Signaling theory at work.

e. Relationships: Last but not the least, signaling theory works brilliantly in relationships. Does ‘Silence’ ring a bell? ‘What happened dear?’ might be a question posed to you. If you are silent or even worse, say ‘nothing’, then it’s a classic signal that you are pissed off at something he/she had done. I presume almost everyone in a relationship would have a gone through this exact example. That’s signaling at work – indicating to him/her that he/she better not repeat the act again.

Since this was only an introduction to the signaling theory, I restricted it to very simple and straightforward signals that we observe in daily life. There are more nuanced signals and then there are counter-signals in almost every walk of life, through which we can learn a lot about a business/corporation/person/relationship. I will try to point to certain examples and explain these signals in the near future.

As I was walking down one of the aisles in Wal-Mart the other day, I noticed a wide range of cornflakes – some new brands placed alongside the older ones. This led me to think about the Marketing Management course that I had studied in my MBA, especially the AIDA concept espoused by Philip Kotler.

AIDA is an abbreviation for

A – Awareness (for eg., that a iPhone exists)

I – Interest (that iPhone has n features and its good to have)

D – Desire (I totally want to own a iPhone)

A – Action (I buy a iPhone)

AIDA framework is generally used in the field of products, services and advertising. I extended the concept here to relationships in my overdrive.

That translates to -

A – Awareness that you exist

I – Interested in you. I gotta check compatibility and stuff, but in general conversations etc, I like you and am interested.

D – The entire set of checks and balances, due diligence, compatibility etc. done from my side. I totally desire you and want to be with you.

A – Action, essentially, Proposing.

So, how does this framework work out? Let me explain with an example.

Awareness is the easiest part. I know her. She knows me. For simplistic purposes, let’s assume we meet once in a while and have each other’s phone numbers through which we converse regularly.

Interest is where I try to determine whether she is a good fit or not – in terms of emotional and compatibility issues, interests, general view of life etc. A relationship can only go forward if both parties (that is, me and her) are atleast in this phase. If I determine that the girl is not interested in me, nor do I have a chance in hell in the future, I can cut my losses by not investing any more of my time and effort in further pursuing this girl. At any rate, even if she says ‘I don’t know’, I will atleast know that I have a chance if I can invest time and effort to convert the ‘I don’t know’. People usually jump from Interest to Action, a critical mistake and in which case success rate might not be that high.

Desire – For a relationship to be successful, atleast one of the parties should quickly move to this phase. This is a necessary but not sufficient condition for the relationship to go forward. In this phase, one party would have invested pretty heavily and hopefully he would have had the girl in the ‘I’ phase. Pursuing her through the right means will lead her into ‘D’ phase. Subsequently, move in to the ‘A’ phase.

Action – As much as you think she is in ‘D’ phase, proposing would take guts. Apart from the minute fear of rejection (rarely, unless you have misread her to be in ‘D’), there is also a factor of how, when and where to propose. Easier said than done, but not as ambiguous as the ‘I’ and ‘D’ stage. This along with Awareness stages are very clear in terms of expectations and results.

]]> http://kirandhanwada.com/2009/06/04/aida-in-relationships/feed/ 3 http://kirandhanwada.com/2009/06/01/quantum-relationships/ http://kirandhanwada.com/2009/06/01/quantum-relationships/#comments Mon, 01 Jun 2009 05:35:26 +0000 Kiran http://kirandhanwada.com/?p=253 I was talking to my friend the other day when he mentioned that he was in a ‘proxy relationship’. On enquiring further on this inter-galactic phrase, he explained that he didn’t know whether ‘he was in love’ or ‘he was just friends’ with this girl [which actually meant that he is interested but is shit scared that the girl might say 'Oh, but we are just good friends']. Obviously, till date, he never asked the girl how she felt. As I was thinking about this relationship and many other relationships I have seen go down this path in the past, I was reminded of Quantum Mechanics. Yeah, quantum mechanics! Let me explain.

1) The relationship that my friend quotes is not in a single state. It is a combination of multiple states. If the probability of ‘I am in love’ in p, then the probability of ‘I am just friends with that girl’ is (1-p). The relationship that my friend states is obviously a combination of the two states, p and (1-p). The dilemma of my friend is obvious that he doesn’t know what the value of p is. All he knows is 0<p<1. This state is called the quantum state (yes, you can quote Schrodinger, Heisenberg, Feynman et.al here).

2) The problem is exacerbated by my friend not wanting to disturb the quantum state by measuring it. The only way to measure is asking the girl. What happens if the girl also thinks that the relationship is in a quantum state? Assuming a generic scenario that all girls are sensible, we might have to ignore this possibility lest the equation becomes too complex. The crux of quantum theory kicks in at measurement – the moment you measure this relationship and assuming the girl is sensible, the quantum state comes crashing down and settles into a steady state of either ‘romance’ or ‘friends’ – just like quantum mechanics (determine position, velocity is impossible to calculate etc.)

3) Extending the concept personally – If I see a hot and/or pretty girl at work or at a party or as a school friend or anywhere else (wink), two thoughts cross my mind. Should I pursue her with all my heart or should I just assume that I am too late in the game and she is already taken and has a boyfriend already? Or should it be just a stone in the dark kindaa situation (throw a stone in the dark – if it hits something you are lucky, else, you have just lost a stone)? Obviously the quantum state arises due to the superimposition of two states – probability of winning her (p) and probability of she having a boyfriend already (1-p). Asking her, would bring down the quantum state crashing down. Pursuing her with all the heart and getting turned down increases the costs dramatically and not trying at all would just not be me. On the other hand, asking a girl upfront “whether it is ok to consider her romantically, need to think about it” would just end up as a slap on my face. The superimposition of states continues.

Ah, life’s a mess!

]]> http://kirandhanwada.com/2009/06/01/quantum-relationships/feed/ 7 http://kirandhanwada.com/2009/04/27/know-brainer-no-brainer-series-part-3/ http://kirandhanwada.com/2009/04/27/know-brainer-no-brainer-series-part-3/#comments Mon, 27 Apr 2009 05:19:04 +0000 Kiran http://kirandhanwada.com/?p=234 This Guru-Shishya series started here.

1) Guruji, welcome back after a long time. I trust your vacation went very well. I had a few fundamental questions regarding inflation while you were out on vacation. You had mentioned in this post that inflation would go down to zero – and miraculously it did. And yet the prices of rice, pulses and wheat have gone up. Weren’t rice, wheat and pulses part of this inflation calculation Guruji? Is the Govt. trying to mislead people by quoting low inflation numbers, thereby indicating reduced prices and trying to rig the election?

ANSWER: Shishya, that is a very good question. Inflation (which is close to 0% nowadays), that is quoted,  is based on an index called the Wholesale Price Index (WPI). In India, under WPI, food items (rice, dal, vegetables etc) account for only about 15% of the total weightage of the index. The other part (which is the majority) of the index is consumed by fuel, crude oil, manufacturing etc. However, if you base inflation on another index called Consumer Price Index (CPI), the inflation would be around 10% and not close to 0%.  The reason for this  is while CPI gives 47% weightage to food items (rice, dal, vegetables), WPI gives only 15%. However, WPI is a better indicator of inflation than CPI.

2) But why Guruji, if the prices of food items are increasing, and the common man is feeling the pinch, isn’t it right to base our inflation on CPI rather than WPI? Why indeed is WPI better than CPI?

ANSWER: WPI and CPI are equally important and each serves a purpose of its own. However, WPI is a better indicator of inflation. Let’s take an example. Let’s say, X’s income is around Rs. 10,000. What do you think would be the amount he would spend on food items? Compare this vis-à-vis other major expenditures like fuel (for the vehicle), fuel (LPG), rental/EMI expenditure, clothing etc. Food would not cost X more than 10-15% of his income but other items (fuel, clothing etc.) will cost a lot more. WPI reflects exactly this detail (as you would observe around you, rental prices have reduced, fuel prices have come down, large discounts on clothing items are being offered etc) while CPI allocates more of its weightage to food items and hence is hardly the right indicator to the actual inflation. The actual inflation should always be based out of WPI.

3) Thank you for that enlightening conversation Guruji. Last question for the day Guruji. I have read that most of the US banks declared much better numbers than expected in Q1, 2009 (including Wells Fargo, Citibank etc). Have they finally got their act to-gether? Is this the end of recession as we see it? Or is media creating a much ado about nothing?

ANSWER: Shishya, media is bound to create much ado about nothing. That’s their job. I would actually quote from one of the best blogs in finance I have come across recently to answer your question succinctly and I quote -

“AIG, knowing it would need to ask for much more capital from the Treasury imminently, decided to throw in the towel, and gifted major bank counter-parties with trades which were egregiously profitable to the banks, and even more egregiously money losing to the U.S. taxpayers, who had to dump more and more cash into AIG, without having the U.S. Treasury Secretary Tim Geithner disclose the real extent of this, for lack of a better word, fraudulent scam.”

Remember how AIG was ‘saved’ and the US taxpayers pumped in huge amounts of money (insanely, $175 billion) into AIG alone. Now, you exactly know where this money went and how come these banks suddenly declared better results than expected. Fraud, scam, cheating – it’s all very ugly out there and someone is making truckloads of money. Well, that’s how the world is Shishya.

The stupendous blog on finance is Zero Hedge. Sometimes, extremely technical, but most of the time brilliant. Spend some time on it Shishya, and you would gain a lot more wisdom than listening to those quacks on CNBC all the time. As Jim Cramer would say, ‘They know nothing, they know nothing’.

That is it for this week Shishya. I will see you some time later once you have more questions up your sleeve. Be well.

Now that we are done with the excitement and enthusiasm of ushering in the New Year and all that, let’s look at what 2009 has in store for us.

With the hypothesis of ‘data doesn’t lie’, let’s look at some of the news across the world and India before meshing in our conclusions depending on the data  -

a) RBI has cut key lending and borrowing rates, esoterically called repo and reverse repo rates (Simply put, these are rates banks pay to borrow from the RBI and get from the RBI for keeping cash there). Repo stands at 5.5% and Reverse repo stands at 4%. RBI cut interest rates for the fourth time since October and has unveiled thousands of crores of stimulus package. If this doesn’t amount to ‘measured panic’, I don’t know what is.

b) In September-October 2008 timeframe, inflation was 12%. It is around 6.6% now. (Inflation, as a simple concept, is rise in prices). Since inflation has reduced from 12% to 6.6%, it is a good thing, no? Actually and worrisomely not. In usual circumstances, reduction in inflation is good for the economy. However, we now have a serious risk of deflation where it might touch 0% or go negative. Economics 101 will tell you that reducing inflation is a slightly easier job than pulling out an economy out of deflation, or even worse stagflation (Lots of jargon like inflation, deflation and stagflation used. Our dear friend Wiki has loads of explanation on them).

c) If Indian economy was on the rise over the past 4-8 years, Real Estate in India was on cocaine. Simple example. In 2003, a 2 BHK (bedroom-hall-kitchen) in one of the very good localities in Hyderabad cost Rs. 17 lakh. In 2007, the same flat costs Rs. 50 lakh. That’s close to a 200% increase. I am not sure any of our salaries rose by 200% in the same period, barring a lucky few. If income doesn’t keep up with investment avenues (or is it the other way round), sooner or later, that particular investment avenue has to be disbanded. Now that we hear that prices are coming down (drastically in some places), speculators will go out of business which will lead to a further spiral. My call is that real estate should correct itself by atleast 20% if not more by end of 2009.

d) Other general news in India includes

- Investments being drastically cut down by manufacturing and service companies.

- Risk of layoffs (massive in some places) to calibrate supply and demand (the offshoot of this being that people would be fraught to take home loans where EMI is more than 1/3^rd their net income and hence further reduction in real estate demand)

- Good startups would find it difficult to find funding, and hence many a innovative idea would die a death for now.

- With banks not reducing interest rates in line with RBI reduction (although they had no problems increasing it immediately when RBI was increasing the rates), discretionary spending will drastically reduce. Small businesses will have difficulty getting working capital (Wiki again!) to sustain their business in this difficult economic scenario.

e) Globally, US has cut interest rates close to zero percent, while Japan magnanimously has reduced interest rates from 0.3% to 0.1% to stimulate the economy. US, UK and Japan are already in a recession, while I believe Asia will be truly hit by a recession in 2009. Asia’s biggest revenue generator is exports. With worldwide spending clampdown, exports have already taken a hit and are expected to take a bigger hit in 2009. US’s economic stimulus package – $850 billion, China’s stimulus package – $585 billion. Aren’t those numbers just plain awesome. I think they are avoiding mentioning a ‘trillion’ since it sounds a big number. In fact, I forget the number of zeroes in a billion or trillion now. South east asia’s manufacturing and shipments are down dramatically and expected to continue over the next half year. I wonder what’s up with Antarctica?!

By now, you would have arrived at a conclusion that I am extrapolating at a doomsday scenario. Not really. The end of 2009 will see some light, although recession is going to continue well into 2010.  IT service providers especially will benefit due to the strong dollar-rupee equation along with increased outsourcing from US and UK companies. The health sector is not cyclical and will not be affected by the recession. There are some stocks which you can really buy cheap (although, for the risk of repetition, the word ‘value’ is being bitch-slapped around in media for any and every stock). As Buffett says, ‘I don’t know what will happen 1 year down the line or 5 years down the line. The only thing I know is if I invest in good businesses, they will give me a decent return over the long run’. The advice is valid both for stockmarkets as well as life.

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