6 AM Pacific

YouTube vs Viacom: The Return of the King

The old adage “Content is king” doesn’t seem to be borne out by the post-bubble resurgence of new media. The three companies that have benefited by this resurgence the most are Google, Apple and YouTube, which is now part of Google. None of them create content. More »

The Fortress IPO

The IPO of Fortress (NYSE: FIG) on Friday closed at $31 or 70% above the IPO price on the first day of trading. It was the largest first day jump in a while. The fact that the forward P/E is now at 40x speaks to the frothiness of anything associated with hedge funds and private equity. But another interesting question that needs to be asked is – should a hedge fund be a public company? More »

A Tale of Two Techies

Taking up from where I left off last week. Based upon the analysis it appears that the dramatic growth in the IT Services industry in India is the primary force in shaping the Indian techie. The Indian techie is a bright person who did well in college, but even after a few years in the industry, is low on technical depth. Before he can really sink his teeth into something, he is pulled into project management. Not because Indians or Indian companies don’t care about technical depth, but because if they have to meet demand and grow, they have no choice. And to paraphrase Gordon Gekko in the movie Wall Street – Growth is good.

A study in contrasts is that other techie – the American techie. More »

Runaway CEO compensation

Directors of US public companies can’t seem to get a break. First it was Sarbanes-Oxley. Lately, it has been options backdating. And now, with the Democrats controlling the legislature the volume on CEO compensation is so high, it could shatter eardrums. Runaway CEO compensation is certainly an issue, but knee-jerk legislation is not the right way.

Bob Nardelli’s recent departure from Home Depot adds fuel to the fire. Last week newspapers reporting his resignation, very typically, simplify the headline to such an extent that it distorts the truth. The directors of Home Depot apparently gave him a $210 million severance package after he did very little to the stock price in the 6 years that he was CEO.
More »

The Rise and Rise of Private Equity

This week rumours were rife about what could be the biggest private equity deal ever – the buyout of Home Depot. The company later quashed the rumours that they were talking to private equity firms.

These are sweet times for private equity. The deals are bigger and more numerous. Capital is easy to raise. So is debt, that is needed to leverage the buyouts. A recent Fortune article paints a very rosy picture of the private equity business. Here’s a different perspective on it from NPR (audio).
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Any Press is Good Press: Tell that to Dell

You may have heard of this adage - Any press is good press. In this new world where news is not news until the blogosphere gets a hold of it, I propose that we retire it. Its a quaint idea but its time is past.

On August 14th Dell announced that it would recall 4.1 million lithium ion batteries made by Sony. Then news weighed heavily on the already drooping stock price of Dell and seems to have had some impact on Sony’s as well. More »

The Worth of a Job

It’s been a long time since my last post. Perhaps too long. Things have been busy at Gridstone Research, the startup I work for and blogging had to take a back seat for a while.

So to make up for it, here’s a meaty subject. Why do people in different professions get paid what they get paid? It’s an interesting subject and I thought I would find some research on it on the internet, but I couldn’t. There’s a lot of data on what people get paid in different professions, but the question we are trying to answer is why.

Let’s first clarify the question at hand. We are not dealing with executive compensation here, although that is quite an interesting (and topical) subject in of itself. We also know that in any profession the higher you sit in the organization chart the more you get paid (generally). What we want to compare here is compensation in different professions - investment banking or software sales or retail bank front office – taking out the effect of position and years of experience. We will ignore stock option related windfalls, which are anyway becoming rare. And for this piece, we assume that we are comparing professions in the same city, so there is no cost of living impact on wages.

After all the assumptions in the last para, you are still left with a significant variation in compensation both at entry level (out of college or business school) or at any time marker after that. The question is why? What makes some jobs worth large amounts of money while others are so-so?

Here’s my hypothesis. If the person in a job can directly impact the company’s profit in a significant, measurable way that job will get paid more than someone in a job that doesn’t.

That sounds almost like a truism. But let’s examine more closely what it means. An example will make it clearer.

Take the job of a Portfolio Manager (PM) at a Mutual Fund. The PM decides which stocks to buy, hold or sell for the Fund. He almost entirely determines how the Mutual Fund performs. If the Fund performs well, its shareholders make higher returns than other comparable funds. The word spreads and more money pours into the Fund swelling the management fee that the Fund Management firm charges. The average mutual fund in the US had assets of $1.05B and expenses of 1.25% in 2005. A 25% increase in assets increases the firm’s fees by over $3 million which should largely drop to the bottom-line. As you can see, the correlation between the PM’s decisions and the business outcomes are very high. Also, and importantly, there are few if any other things that matter. Unlike in a manufacturing company where many people contribute to the value and quality of the product, the PM might depend upon the recommendations of the Fund’s Analysts who research companies, but he makes his own final decisions. Random events or luck play a minor role, especially if these events impact the benchmark as well.

The PM’s job therefore fits our criteria perfectly. He directly impacts the firm’s profits in a significant, measurable way. Not surprisingly, the Portfolio Manager for a Mutual Fund in the US is a highly paid job. Many of them take home over $ 1 million.

Sales people in most industries that sell to businesses tend to get paid more. What predictions can one make about compensation in the Sales profession using my hypothesis? A Sales professional will be paid more when Gross Profit (or Contribution) per Sales professional is higher (significant impact to profit). A salesman for Boeing should therefore be one of the highest paid salesmen in any industry. Also Revenue Producers will be paid more in the Professional Services industries where the Partner or the Banker is the product himself. The client often knows and trusts the Partner or Banker and will give him the deal because of him and not the company he works for (direct impact). Therefore, Management Consultants, Lawyers and Investment Bankers all get paid oodles of cash.

A school teacher’s job is a tough one. They mold young minds. A good teacher can be a glorious thing for a young student. What can be more important than this job to both individuals and society? Yet school teachers are paid very little in almost every country. I have often struggled with this paradox. Why wouldn’t we pay school teachers more and get the best we can for our children?

Let’s take a school teacher’s job and evaluate it against the criteria in our hypothesis. A school teacher definitely directly impacts the outcomes for particular students. This impact can be undoubtedly significant. You might decide to become a writer because of a superb English teacher, or totally lose interest in Biology because of lousy one. However, a school teacher in the US typically works for a public (government) school and not for a business. And the outcomes for students discussed above are not exactly measurable outcomes. So a school teacher’s job doesn’t fit the criteria in our hypothesis on a couple of counts. So school teacher salaries will predictably be low, attracting average talent and with lower incentives to excel.

On the other hand, consider the teachers in Delhi’s IIT coaching classes. Their outcomes are very measurable – the students’ JEE rank. The students’ JEE rank drives both the enrollment in the coaching classes and the fees per student. No wonder these teachers can take home as much as Rs. 15 lakhs a year, a salary that an ordinary school teacher in India can only dream of.

I think the hypothesis in general works. But like most things in the complex world of business, it’s hard to make rules stick. There are always eddy currents that produce exceptions. If you find any, let me know.

The Virtue of Simplicity

The airlines business is a complex one. The pity is that most airlines
reflect the complexity in their business onto their dealing with passengers.
Passengers like me hate it.

I am planning a trip to the East Coast (I live in the San Francisco Bay
Area). The trip is a 3 city trip over 4 days. I generally prefer to do my
own travel planning. When I was at Infosys, I would talk to our company travel
agent.  Now, in a startup, I find it easier and cheaper to  do my own
travel bookings on the internet.

So far, all my trips to New York have been on JetBlue. They have convenient flights and low prices. This time I
need to go to Boston and Chicago as well and so JetBlue won’t work. So
I go to Expedia.com and check out the flights. My conclusion after 45 minutes
of research and copious note-taking - if I want to minimize my travel cost, I
will have to travel on 3 different airlines and fly in and out of different New York airports.

For most airlines, pricing is a game of revenue maximization. Here are some
tricks of the trade:

1. If you book your travel early you get a cheaper fare. Everyone uses this
one, including Southwest Airlines.
2. Refundable tickets cost more than non-refundable. Again, very widely used.
3. Take a hub, dominate traffic in and out of it and charge the earth for it. New York to Boston round
trip from two different New York airports can be $200 or $600 based upon the competition on that sector.
4. Round-trip fare is heavily discounted versus point to point.
5. Saturday night stay-over reduces the fare quite a bit.

There are countless other tricks that are all designed to maximize revenue.
Optimization engines and pricing rules in the innards of airline pricing
systems are some of the most complex you’ll find in the business world.

As a passenger I hate this whole system. I hate it that it takes me 45
minutes to do my tickets. I hate it that even after that, I don’t know if I
made the right choices. I hate it that I can’t travel back on a different
airline that has more convenient flights without paying a hefty premium for it.
And I cannot develop a trusting relationship with an airline who charges my
$600 when an equally good (or equally bad, depends on your perspective) airline
is charging a $200 fare for the same itinerary.

So here’s my question to these airlines. Do their fancy price optimization
algorithms put any value on what I can only call torturing the customer? I’ll
bet they don’t because they have no way to measure it or put a value to it. The
reason simplicity in business is so rare is that there are no good ways to
measure the cost of complexity. And so your finance types in the company can’t
put it into their cost-benefit analysis spreadsheets.

Complexity costs. Customers like simple products - simple to use, simple to
understand. They like simple pricing models where the price is linked to the
value they receive. This is not just true about simple-minded consumers. Business
buyers like simplicity as well.

Southwest Airlines is a company that I truly admire. The genius of Southwest
Airlines is in how they have become the most important airlines in the US by
simplifying it for their passengers and for themselves. In the morass of
complexity that is the American airlines industry, Southwest Airlines is a
shining beacon of hope. Not only is their pricing dead simple, everything about
the airlines is that way. They fly only Boeing 737s. This simplifies, crew
scheduling, training, aircraft maintenance and spares. They have only one class
- coach class. There is no seat assignment. It’s first come first serve. And
their frequent flier program is a tribute to simplicity – 8 round trips and you
get a free roundtrip to anywhere they fly. You would need a full book to fully
document the frequent flier program of United Airlines.

No wonder Southwest Airlines has delighted customers and a growing business.
Its market cap at $12.64B is way above much larger airlines like American
Airlines and United. They understand the virtue of simplicity. They understand
that it not only makes for happier customers, it also makes operations run
cheaper and faster.

Now if they’d only fly to the airports I need them to fly to.

Garage-Sale

In big business the phrase ‘cost of doing business’ is often employed to justify a cost that is deeply embedded or can’t be justified on an Return on Investment basis. Sometimes it truly is necessary. Often it is just handy management jargon to keep something from being cut by the accountants.

In a startup, on the other hand, the cost of doing business has a very real meaning. It in fact means exactly how it reads - the cost of running the startup. In management speak this is often referred to as the ‘burn rate’. And I am here to tell you, that the cost of doing business for a startup is going down fast.

There are many trends that impact the cost (and ease) of doing business for a startup. The two  that I think are particularly pertinent to the cost of technology are - open source software and usage based pricing. Sometimes both these things get combined.

Let me give you an example. As an ex-head of Sales, I believe in a company acquiring good habits on Sales process early. Ergo, we use a CRM system at Gridstone. When making the choice for a CRM system we never even considered licensed software. If we had, I suspect it would have cost us several thousand dollars per user per annum, for something with the functionality that we need. We probably would have needed outside consultants to implement it adding more to the cost and time to value. Most startups nowadays don’t even consider that option.

The next option, which is very popular today is salesforce.com which is a hosted internet application. The company is very successful and is growing like a weed. Their price for the Enterprise edition - $900 per user per annum. Simple to implement. Good service. Works like a charm.

We were almost going to go with salesforce.com when we heard about this open source CRM software called SugarCRM. SugarCRM is also a company. I think the way their business model works is that they, and outside collaborators, work on the open source version of Sugar, which of course is free to use and comes with the source code for others to tinker with. But SugarCRM the company also develops add-on modules like Sugar-Outlook integration that are not open source and are priced per user per month. Sugar also offers hosting and training services around SugarCRM. If we wanted to take the full hosted solution with add-on modules, we would get an excellent CRM system that matches salesforce.com in functionality for the price per user of $480 per annum.

Now SugarCRM is open source and anyone is free to use it themselves or host it for others for a fee. There are dozens of hosting service providers who will host SugarCRM for you. Some of them even have add-on modules. And you won’t believe the prices. The service provider we finally went with charges us $5 per month. Not $5 per user per month. $5 per month period. For the usage it allows, for us it practically means unlimited users! Plus the price includes hosting for a few other applications as well. It’s a brave new world!

Now technology costs are not the only costs for a startup. All costs related to people, office space aren’t going down. But tech costs are a major component of the costs especially for early stage startups. For two guys in a garage, the quintessential valley startup, their runway is now much longer than it used to be. In the future more  tech companies like Flickr will be going straight from garage to selling the company. It is ironic that this should be happening in an environment where venture capital is so abundantly available.

Street Power

The recent fiasco in France holds many lessons for democracies everywhere.

France has this strange combination of a thriving corporate industry and high unemployment especially amongst youth. The culprits here are France’s rigid labour laws which make it almost impossible to dismiss or layoff employees. Companies therefore prefer not to hire. If they have to, they use temporary workers. Since older employees can’t be fired easily, unemployment hits the youth. Much of the unemployment is among the children of immigrants which ultimately was the cause of rioting in France a few months ago. People with no jobs are more likely to riot - they have time on their hands and nothing to lose.

The government in France, with the best of intentions, decided to fix some of these problems to regenerate employment amongst youth. But they could not suddenly change labour laws across the working population. If layoffs were permitted across the board, sure, growing companies would start hiring young people, but there would also be a lot of older workers laid off and out of jobs. So the government decided to make it easier to fire only young workers in the first two years after they join.

Big mistake. Within days, massive student and youth protests were organized across the country. Colleges shut down because all the students were in the streets protesting against what they were calling a law unfairly targeting young people! The government first said it was willing to negotiate the time period - make it 18 months instead of 2 years. In the end, Jacques Chirac just withdrew the bill, in effect dashing the Presidential hopes of his trusted luitenant Dominique de Villepin who was the author of the bill. So were all students against the new bill? No. Last week they were interviewing a law student from the Sorbonne on BBC. The student was being asked about the law and the protests. She was against the protests and for the law. She didn’t like the fact that the colleges had been shut for the past 4 weeks and who knows what would happen to her final exams. But more importantly, she thought that the new bill would generate employment for the youth! She also said that none of the economics and law students of her university were in the protest marches.

I think the new bill would have worked. Not that the French government didn’t deserve the shellacking it got. They have nobody to blame but themselves for making France into an insular, inflexible place to do business. But really, this bill didn’t have a chance. Why? For two reasons:

1. The rationale for the new law is not easy to explain. It is not obvious that making it easier to fire young workers will result in higher employment among the same workers. I can imagine myself trying to explain that to a 3rd year medieval history student. Even if I knew French, I don’t think I could. On the other hand, the opposition can easily spin it the other way portraying it as an evil law designed to protect older workers or even designed to keep immigrant youth from keeping good jobs. Here I don’t just mean the Opposition in Parliament. Every change has opposition to it simply because someone is going to get hurt by the change.

2. The opposition to the law had Street Power. The people who were in favour of the new law like the Sorbonne law student and her friends, did not.

Cut to India. Labour flexibility, for decades, has been the one reform that no politician wants to touch. It is hard to believe that if you are the owner or manager of a company, your company can make losses, go bust and lose its entire net worth, but you can’t restructure your workforce. Capital treads softly where labour is inflexible. There was a time when there was talk of an Exit Policy for sick companies. A very unfortunate choice of name, if you ask me. The opposition (trade unions) quickly positioned the Exit in Exit Policy to be the exit of employees. ‘Hire and fire’ was another colorful phrase they used. The government had to bury the whole thing.

But its now resurfacing. You hear snatches of statements made by the PM and FM about the need for labour flexibility. Although they’ve picked a better name this time, I don’t like the government’s odds of passing any substantive legislation on this matter. Why? because of the same reasons that the French government failed.

How do you explain the rationale of labour flexibility to Mr. Godbole who is a teller in a bank? Mr. Godbole, we plan to make it easier to fire people such as yourself because this will encourage capital investment which will generate more jobs. I can just see Mr. Godbole’s eyes glazing over. Before he gets angry. Even Mr. Godbole can understand that making it easier to fire him is not good for his pension. Self interest is a great motivator. When it comes down to Godbole’s job security vs. more employment in the country, Godbole knows which side of his toast is buttered. And finally, Godbole is part of a union. He has Street Power. His union can call a strike, do a dharna and if it comes down to it, burn a few buses. The stakes are very high. And a burning bus is an arresting sight on TV.

The challenge of sound economic policy making is that often doing the right thing benefits a silent majority, but hurts a vocal minority. In some cases the vocal minority can make their voice heard. In others they can take their campaign funding elsewhere. You need money to run elections. You need votes to win them.

I do think that one of the most important reforms that the Indian economy can benefit from is bringing labour flexibility. This is the best time to do it when economic growth is strong. But I won’t be holding my breath waiting for it. Not while the govenment depends upon the support of CPI(M).