Lehman and Ernst & Young

The repo sleight of hand at Lehman was an atrocious piece of work. For those of you who haven’t been paying attention here’s how it works.

Lehman had a boatload of assets on its balance sheet supported by a thin slice of equity. To hide their huge leverage, they did deals with counterparties which were essentially short-term (like a week or two) loans against collateral (which they had plenty of). Except, that they didn’t show these as debt on the balance sheet against collateral. Instead they showed them as sale of assets so that the balance sheet at the end of the quarter wouldn’t look as leveraged as it was. Terrible, terrible stuff. The accounting magic may not have been at the scale of Enron, but the end result was the same – a once proud company, bankrupted, it’s shareholders left with nothing.

With all the noise around it, it is almost certain that Dick Fuld, the former CEO will be prosecuted. But what I am unable to fathom is why Ernst & Young gets away with it. Enron brought Arthur Andersen down. Of course they did a lot of other bad stuff like trying to shred the evidence. But does that make so much of a difference to E&Y’s culpability? If the shareholders of Lehman bring a class action lawsuit against Ernst & Young, that could be worth billions in damages.

But that doesn’t seem to be the case. If anyone has a better understanding of this, please leave a comment.

Update: I think I found the answer to my question. From the New York Observer:

Indeed, the problem when Lehman invented Repo 105 early last decade was that it couldn’t get an American law firm to sign off on it. It finally got the O.K. from Linklaters, a member of the small group of top British firms called the Magic Circle. So Lehman would send over its Repo 105 assets to England, where its European wing handled them. “These firms clearly shop jurisdictions all the time for the most favorable rule set, and there’s nothing wrong with that,” the second executive said.

Also read Felix Salmon’s post on Wall Street bankers still living on a different planet.

Why are Non-Fiction Books so Boring?

I read a lot of non-fiction. But I seldom finish the book. I find that as the book goes along, the incremental insight gained per chapter keeps reducing, till it is no longer worth my time to keep reading.

For a while I thought that this was my problem. I do know that my reading speed is generally less than my friends. My wife reads at twice the speed that I read, for example.

But that is not the reason. I have compared notes with others who read non-fiction. And most people don’t finish their non-fiction books, especially if they read a lot of non-fiction and there’s another book waiting for them. The problem is widespread, if not universal.

I have a hypothesis for why this is so. Non-fiction books are typically written around a set of concepts, notions, historical perspectives etc. Often these concepts, while original, can be concisely written in the form of an article in a journal or a magazine. Or just a blog post. However, there is no model to monetize that other than the ridiculously low fee the print media industry, itself under threat, might pay you.

If you think that your ideas have power, the only way to monetize it in any substantial way writing about them, is to write a book. A book has certain definitional boundaries. It has to be say a hundred pages or more. The fatter it is, the more justifiable is the price of $20 or $30 or whatever. So you end up writing page after page, chapter after chapter on ideas that don’t really have the legs to go that far. In the process you make a book that can’t hold the reader’s interest till the end.

I am being a little foolhardy in bringing this up right now, when I am writing my maiden book myself. It’ll be a business book, and I can just hear you say, “Well let’s see what your book turns out to be, Basab.” Well, Gaurav and I are hoping it will be packed with insightful goodness and will hold your attention till the end. And now that I’ve put this post out there, it gives us a goal – get the reader to finish the book.

Online Education is Coming, And Fast

An in depth piece in the New York Times magazine looks at an effort to improve teacher quality through training. While this particular initiative may be better than the hundreds of other such initiatives, I find myself wondering if teacher training is indeed that big systemic change that the school education needs. Is it just tinkering with the edges when what we need is seismic shifts?

There are a whole host of problems facing the school education system in the US. Teacher training is just one of them.

The sheer number of teachers required and the low pay almost ensures that the average school teacher will not be anywhere near the best that American colleges turn out. If you think about it, isn’t a school teacher’s job, in whose hands we leave our children’s education, much more valuable to society than a lawyer’s or a banker’s. Unfortunately, society puts a really low price on it.

More

An Indian Passport and Indianness

M. F. Husain surrenders his Indian passport and takes up Qatari citizenship. As the drama plays out and now peters out in the media an interesting question to ask is what is it that makes one an India.

Now one could write a book on this subject (not me, I’ve already got a gig going but someone, I’m sure) but here’s a short blog post.

Whether you have an Indian passport or not is a terrible way to look at it. From the Husain media circus, it appears that surrendering the passport was really the event that made him unIndian. In spite of his protestations to the contrary, Barkha Dutt (link to NDTV above) seemed to think that was the case. It so happens that India does not permit dual citizenship. The OCI is not the same as citizenship. If like many other countries like the US, India did permit dual citizenship then Husain could have added the Qatari passport and no one would have cared.

I have many friends who live in India but hold a US passport. I think they would consider themselves Indian.

What about residency? Is that a good criterion? But then there are all kinds of Non Resident Indians. Short stays, long stays, those that are waiting for the kids to go to college to return. And then there are those who don’t intend to go back but still feel very connected to India.

I think that its just silly to try to draw these boundaries, and affix labels. Let’s just celebrate a shared culture with great diversity within it and fuzzy boundaries at the edges.

And it is downright hypocritical to celebrate Sunita Williams as one of our own, but decry M F Husain surrendering his passport as abandoning his country.

What I Am Upto

While things keep me occupied on the personal front, I have been refashioning my professional work to fit it. And it’s been going surprisingly well.

First, I have started taking on consulting work. Most of it is strategy and business performance related work and it is quite energizing and interesting. Most of it is of course in the Offshore Services industry where I can bring my experience to bear upon problems that managements are facing as growth levels off in the industry and companies really have to compete for business.

Second, I am writing a book. Some people want to be able to bungee jump before they die. For me it was writing a book. “Regret minimization”, to paraphrase Jeff Bezos.

The book is going to a business book about the Offshore Services industry. Not a history, more of a guide or a how to book on the market side of the business. My co-conspirator on the project is my good friend Gaurav Rastogi. (Check out his recent posts on Afterlife – thoughtful, creative stuff.)

The reason we are writing this book is that we feel that for a $50 B industry there is little out there in terms of a body of knowledge on the Offshore Services industry. Sure, there’s a lot on software engineering and quality, but not on how to run the business itself. We hope to make a contribution to that body of knowledge.

Anyway, details will follow as we make some progress. If anyone is willing to contribute their ideas or just anecdotes, we’re very keen to talk to people outside our circle of acquaintances which naturally is skewed towards Infosys or ex-Infosys people. Any ideas on publishing – in India and in the US – will also help.

Reuse is Like Cutting Consumption in Half

If you are like me you don’t send Fedex packages too often (not yourself, at any rate). I happened to do that a couple of days ago and was quite tickled to see a simple change that Fedex had made to their envelope. You know, the one made out of stiff cardboard which looks like it can stop a bullet if need be to save the two sheets of paper inside.

Well, Fedex is doing its bit to save the planet. What they’ve done is they made the foldover (“lip”?) on the envelope longer and put two strips of adhesive instead of one. The first time you use the lower strip to seal the envelope. The receiving party opens the envelope using the handy “opener” (?) embedded into the fold. After opening it, there still remains one strip of unused adhesive which can be used to send out another fedex package.

I thought it was very ingenious. But the tubelight went off only after I had assiduously used both strips of adhesive to make doubly sure that my super important package was sealed shut!

Photo by hyku

Kindle Doesn’t Quite Work for Non-Fiction

Felix Salmon writes

I’ve come to the clear conclusion that it simply isn’t suited for reading the vast majority of non-fiction. You might not even notice it when you’re doing it, but when you read a non-fiction work like this one, you tend to flick backwards and forwards a lot, skim past the bits you already know about, re-read earlier passages in light of later ones, that sort of thing. And that’s prohibitively difficult with the kindle, which is designed primarily for reading narratives where you start at the beginning and make your way steadily to the end. Truly narrative non-fiction a la Krakauer is fine, but “learn about the crisis” nonfiction just doesn’t lend itself to being read on the kindle at any price. If you’re the kind of person who reads footnotes, you will get very annoyed very quickly with the kindle whenever they start appearing.

I have come to the same conclusion and have started ordering dead tree books when they are non-fiction. Any book where illustrations are important gives you a suboptimal experience on the Kindle. And as Salmon says, skipping chapters or going back and forth is just very difficult in a Kindle.

But this is not inherently a problem with an e-book. It’s just that Kindle hasn’t addressed the issues involved. One is about laying out a book specifically for the Kindle. Today it is laid out for the actual book and that is essentially sucked in for the Kindle. No doubt the variable font settings on the Kindle make this challenging, but the problem can be solved. And with color e-ink displays coming, there shouldn’t be the wide gap between the layout of non-fiction books and their e-book counterparts.

The other issue is with usability. The big question that I don’t have an answer to (but somebody does) is – can an e-ink display have touch capabilities? If it can, the Kindle reader can easily flip back and forth within a book. The experience might be different from a real book, but much better than today’s Kindle.

Europe is Getting Less Secular

The latest flap over halal meat served in a restaurant in France

A French fast food chain’s decision to serve only halal meat in eight restaurants with a strong Muslim clientele has sparked a wave of criticism from politicians decrying the step as unacceptable.

Quick, the restaurant chain, is also not serving any pork products in these restaurants.

Right wing politicians are making hay out of the incident. But to anybody not blinkered by religious prejudice, there is absolutely no logical argument that you can make against Quick’s decision. Quick is free to tailor their product to suit individual or group preferences. Customers who don’t like halal meat, even though it tastes identical, are free to go elsewhere for their meals. Customers who would like pork in their meals could also follow suit.

I would spend a little more time on searching for a grain of logic in the arguments of the critics, but that would be a waste of time. What is clearly happening is that Europe is seeing growing pressure against its secular principles. Switzerland’s minaret ban vote is another case in point. France itself is pretty close to banning the burqa, which I have to admit is not as illogical as the tirade against halal only restaurants, but is fueled largely by political calculations and an anti-minority sentiment.

When jobs are scarce, people turn against immigrants. Most of the Muslims in Europe are immigrants from North Africa or South Asia. Add that to the fact that some people can’t separate terrorists from the religion itself and you have a situation ripe for exploitation by politicians like Jean-Marie Le Pen.

This movie still has a few reels left.

My Son and Asperger’s Syndrome

Autism is in the news. My Name is Khan was released last weekend. The movie takes on some important topics (Asperger’s, religion based profiling). The movie was very average, but any movie with SRK in it is automatically big news.

The other big news is that the American Psychiatric Association has recommended that Asperger’s Syndrome (AS) be dropped from the DSM (Diagnostic and Statistical Manual of Mental Disorders). Asperger’s Syndrome will be subsumed under Autism and will disappear as a separate diagnosis altogether.

The reason for this change, from an op-ed in the New York Times:

The change is welcome, because careful study of people with Asperger’s has demonstrated that the diagnosis is misleading and invalid, and there are clear benefits to understanding autism as one condition that runs along a spectrum.

Several NYT readers have written in, most of them against such a move.

Elsewhere, a new movie about Temple Grandin, an autistic inventor and writer was released by HBO this month.

All in all, a very active month for Autism. Which is good. My son, Naren, has Asperger’s Syndrome. We welcome the light that is being shone on Autism and AS. Autism is not well understood in schools and by the general public. Since the most important deficiencies among Aspies (as they are called) are social deficits, and the incidence of Autism is the highest it has ever been, society benefits from a better understanding of Autism.

In the US today, 1 out of 150 kids get a diagnosis of Autism. That is a very high incidence of a disorder of any kind. In fact, there is some thinking that the genetic traits that are responsible for Autism are far more widespread than we think. In many people, the compulsive need to create order is actually a symptom of a muted Autism trait. Tyler Cowen an economist has a book out which is partly about the need for Autistics to impose order on a disorderly world. The question arises as to how Autism traits could be so widespread in the face of evolution and natural selection. The answer, some people suspect, is that in some ways Autistic traits can offer benefits and therefore increase evolutionary “fitness”.

Undeniably, there are many talented and famous people who, it is thought, were Autistic. Albert Einstein and Emily Dickinson, for instance. Vernon Smith, a Nobel prize winner in Economics, considers himself to be autistic. A five minute interview of Smith on CNBC is here.

That Autistic children can be talented is not something I need convincing about. My son Naren was identified very early as a GATE student (gifted program in California). In eighth grade, while he was having all his problems at school, he was still pulling straight As in his Honors courses. He writes with clarity and maturity [the link was wrong. fixed now]. And he is a talented musician. He plays the piano, the trumpet and the guitar and has composed four delightful pieces for the piano. Here’s one.

Harpsichord Hero

We are so proud of Naren’s achievements. But Naren also has problems. Like most autistic children, he doesn’t automatically learn the norms of social interaction. He stands out in a group of children. His interests – music, DC comics, manga – are deep and narrow. He has no interest in sports. It’s tough for him to make friends.

In middle school, Naren also started showing behavior problems. Teenage and Asperger’s didn’t mix well for him. Many things now frustrate and anger him. Last year he started having anger outbursts. The problem grew to where the school district didn’t think he could continue in mainstream education. We disagreed and are negotiating for the placement we think he deserves.

We know Naren will get better and be successful. He is of course, getting the inputs he needs – doctor, therapy, group work and a lot of love and support from his family. But most importantly, Naren himself, really wants to get better.

Till very recently, we never got a definitive diagnosis of AS from any doctor. Naren’s AS is typical in many ways, and atypical in others. But now, a clear AS diagnosis from both his doctor and neuropsychologist is actually a relief. That is the power of a category, or a label. Naren can now be told that he is an Aspie. He and we can now relate his condition to thousands of other Aspies. We are now part of the AS community. The resources – treatments, therapies, books, online support – available to AS kids are now available to Naren. As a descriptor – Autism is just too broad and fuzzy. On the other hand, Asperger’s is a single word that gets you very much in the neighbourhood of where Naren is.

Which is why we will keep calling it Asperger’s regardless of what they do with the DSM. I suspect most people with AS will too. People want to identify with a group with shared characteristics, which is why the group is formed in the first place. If those characteristics are shared weakly, the strength of the group identity weakens too.

We took Naren to see MNIK. In the first 15 minutes he said “I’m not like him at all.” But at the end of the movie he said “This was the best movie I have ever seen. It was all about me.”

Is Offshore Services a Scale Business

Earlier this week I wondered why Indian Offshore Services companies weren’t “bulking up” – basically acquiring companies just like themselves – just smaller and with perhaps lower P/Es.

A reader left a thoughtful comment :

I guess one of the common reasons for M&A (to add bulk) is to achieve economies of scale. Indian IT outsourcing is services business. In services industry, (compared to manufacturing industry) the economies of scale flatten out relatively fast. The profit/revenue per employee for a 10,000 employee company may not necessarily be better than a company with 5000 employees. After all its all about humans, not machines.
So a large company (Infy,Wipro etc) doesn’t gain much by acquiring a smaller size company. Their own brand name is already so powerful, that they don’t need much help in that department.

The comment makes a lot of sense and it would be hard to disagree with the fact that the IT Services does not have the economies of scale that a steel manufacturer does (ergo, Mittal acquiring every company in sight). But there are important economies of scale at the top of the range. Let me explain.

If you look at the financial metrics of an IT Services company, it is almost entirely a variable cost business. Both capital intensity (capital investment required to produce a unit of revenue) and fixed costs are low.

Also, IT Services revenue tends to be sticky. Especially, if the revenue is of the kind that “runs the company” rather than “changes the company”.

So you have an industry where you can get into business with very little capital. You breakeven fast because the fixed costs are low. And the revenue you have is relatively immune to competition. Which explains why you have so many small companies in the industry.

But you also have giants in the industry – IBM, Accenture, Infosys, TCS. There must be something that makes the giants grow faster than the guys at the bottom of the range.

There are indeed. Some things like Overheads and Sales costs could both be more efficient (lower % of revenue) and more effective (cover more industries, more countries in the world) with size. But these aren’t that major factors. The important one is the economies of scale related to branding.

Outsourcing large scale IT or BPO, more often than not, comes down to a matter of trust. A C level executive at a Fortune 1000 company is making a huge bet that can make or break his career and perhaps even a few quarters for the company. And while a part of that trust is derived from the service provider’s representatives working on the deal. A big part of it comes from that intangible – the brand.

And when it comes to branding, size matters. It’s not just that you can spend much more on advertising if you are bigger (like IBM or Accenture). Your brand automatically benefits from your larger presence. You have more client references (who have hopefully had good experiences with you). The analysts know you, the deal consultants know you. You are public. You are in the news. You are automatically on every short list.

Branding also matters at the other end of the value chain – in hiring. Employees like to join large established companies and will often forgo a higher paying job at a smaller company. (Silicon Valley may be the one exception to the rule and even here, things have changed). So Infosys is basically getting the cream of the crop at a lower cost than their competitors. Is that worth a few points on the margin? You bet.

Here’s the nub. There are several companies around $1B that are well run companies, but they run the risk of becoming marginalized, of losing the mindshare game to the big guys. In a market where growth may be harder to come by, they will have to compete harder against bigger brands, if they want to keep shareholders happy. Inorganic growth (acquisitions) can be one plank of your strategy in such companies. Obviously, it can’t be the only thing you’re doing.

That said, gaining economies of scale is not the only reason to bulk up. It has to make financial sense. Relative stock valuations, cash on the balance sheet – those are the table stakes.