Srinivasan R

Regulating Platforms

Over the past few months, there have been a lot of disputes between platform businesses, governments, and a lot of these have gone to courts as well. Last Friday (26 August 2016) issue of the Mint newspaper carried an opinion piece titled “the tricky business of regulating disruptors” (read it here). The editorial while labeling almost all platform businesses as disruptors, just stopped short of calling all of them disruptors. In this blog post, I dig deep into the issue of if and how platform businesses need to be regulated with respect to consumer protection, without impeding innovation and thence providing fair business opportunities to businesses (and returns to investors).

Defining the industry boundaries

One of the key determinants of “competitive” behavior is the definition of the relevant industry. What is competitive and what is anti-competitive can depend on how narrow or broad you cast your net while defining the industry. For instance, the Mint editorial explains in detail how in a 1953 verdict on DuPont’s monopoly on the cellophane as a result of “result, business skill, and competitive activity”, despite having over 75% market share in the cellophane market, because the courts defined the “relevant” market as flexible packaging material, and not cellophane, the product. However, in most cases against platform businesses like Uber, the competition commissions and other regulators have defined the market as app-based taxi services, and therefore looked at the market being usurped by monopolies (Didi-Uber combine in China) or a duopoly comprising of Uber and a local operator (like Grab in SE Asia, OLA in India, Lyft in the USA).

Is Uber a competitor or substitute to Taxi?

In a detailed response to Prof. Aswath Damodaran’s 2014 article on Uber’s valuation (read it here), Bill Gurley (a series A investor and board member of Uber) defined three things (read Bill Gurley’s blog post here).

He argues that Uber has since transformed the industry so much that one’s market size estimates based on current taxi market sizes is flawed. In other words, Uber was providing customers with far more value and a very different set of value propositions than a traditional taxi service – quick discovery, easy payment, predictability of service, quality (dual rating of riders and drivers), and trust/ safety. He talked about how Uber’s customers are using it to transport young adults/ children or older parents in the “comfort and safety” of an Uber, rather than a taxi.
He argued that given the economies of scale that arose due to the positive cross-side network effects, more and more drivers and riders adopted Uber, and Uber expanded to more and more geographies, and the prices fell. And the price elasticity contributed to more demand and therefore more network effects. The economics of Uber (and therefore other ride-hailing app-based services) are very different from the city Taxi services.
Uber is not a taxi alternative – it is a car-ownership (or a car-rental) alternative. When the liquidity (availability + density) of Uber vehicles is so high in every geography you want to travel to, you would rather not rent/ buy a car, but use Uber. The convenience and reduced cost of Uber as an alternative to ownership is something that he substantiates with data and analysis.

In other words, Uber was indeed a disruptor, and therefore was entitled to be treated as a separate industry. It is not a competitor to the for-hire taxi, it is an alternative; much the same way Kodak was bankrupted by digital photography (and not by competitors like Fuji).

Creative destruction and Schumpeterian waves of technology innovation

The Mint editorial called for Honorable Judges to not set taxi fares, simply because these disruptors would transform the industry through their technology innovation, and any restraining regulation would hinder these Schumpeterian waves. It is therefore an indirect call for letting these disruptors alone, let the waves of Schumpeterian technology innovation hit the markets, before we arrive at a stability of sorts. Regulation can wait.

Can regulation wait, and allow for a disruptor, in the excuse that the market is a “winner-takes-all” market monopolize the market? The popular arguments against monopolies is that of consumer protection, and that when monopolies rule, consumers suffer – prices rise, service levels fall, and there may be no alternatives. This is exactly the case for another wave of creative destruction.

My primary thesis is that when such disruptions happen on the basis of network effects, leading to economies and scale, and the disruption is based on parameters like improved customer service, lower prices, and transparent/ fair transactions (trust/ safety and the like), monopolies are not necessarily bad. When such monopolies emerge and the customer experiences deteriorate, as dictated by traditional industrial economics theory, the market will be ripe for another wave of Schumpeterian technology innovation. The waves of market entry in the Indian airlines market is testimony to these (1990s – privatization and shake-up leaving two state-owned and two private competitors; 2000s – entry of low-cost carriers leading to the demise/ consolidation of all stuck-in-the middle competitors; 2010s – entry and strengthening of regional airlines, is it?) waves of creative destruction.

Yes, there is space for other competitors, but not so much for Uber replicas. The market is indeed a winner-takes-all market (as I have argued in the past), and therefore there is just enough room for small, losing replicators. Look around the markets for Uber competitors, you do not find any market fragmented. While differentiation and creating niches is the prescription for firms competing with Uber, I request the regulators to begin treating such platform businesses as an independent market and let the inefficient product-markets fail, if required. No one cried when the offline ticket counters of Indian Railways are declining sales, thanks to the volumes garnered by IRCTC (some claim that this is the world’s largest ecommerce platform, is that true?). No one complains about bookmyshow.com garnering huge market shares in the app-based movie seat booking market, claiming that the livelihoods of the ticket clerks are under threat. Why cry about Uber, or for that matter, OLA, Grab, or Lyft?

There is already sufficient discrimination against these disruptors. In a recent visit to San Francisco, I made an extra effort (okay, walked down a flight of escalators) to click a picture at the SFO airport that read, “app-based taxis to pick-up from departures level”. Honorable Judges, please leave them alone, enjoy your ride/ movies/ every other service, contribute to the economies of scale, and let the market be disrupted.

Cheers.

Social Buffering – Is it lonely at the top?

Yesterday (24^th August), I connected three dots. First dot: I met with a couple of my friends from 20 years back (we were batchmates) – one of them celebrated his tenth year of entrepreneurship this week, and another was taking baby steps into entrepreneurship in the last three months. Second dot: I read a piece on LinkedIn on why Samsung cannot be Apple. Third dot: I read an article in the Strategic Management Journal (SMJ) on executive anxiety. And tossing and turning on my bed, late in the night, the three dots connected. Voila.

Dot #1: The entrepreneurial fetish with fund raising

When two entrepreneurs meet with a business school professor, it doesn’t take long for the conversation to veer from business models to fund raising. So it did happen yesterday. The conversation was going towards evaluating if angel investing is better than crowdfunding, and we agreed that the money raised is much less valuable than the insight/ knowledge/ resources/ network the angel investor(s) would bring in. Isn’t that why those investors are called “angels”, as they have some magic wands in their hands? Slowly, bit by bit, I evaluated their business plans and broke the entire fund requirements to an amount that was so small that they would not take money from anyone other than one with an enormous network or experience in that domain. As entrepreneurs, it was extremely important that they realize that money from the right source is far more valuable than the denomination of the currency (or the balance in the bank). The value of the advice and mentoring the angel investors bring in is severely under-rated in today’s entrepreneurial ecosystem. Here’s calling all entrepreneurs to evaluate your list of mentors – what specific insight, learning & knowledge, experience, resources, network do each one of them bring in. Prune/ add ruthlessly.

Dot #2: Singularity

The drive back home from North Bangalore to South Bangalore in the evening traffic is not something I enjoy, unless I have some company or reading to do. Yesterday, I had both. The reading was this LinkedIn post by Anish Behera on Why Samsung will never be Apple? (read it here). If you have returned back to this blog after reading his piece, you know where I got the three dots idea from, right!

His primary argument is that it was important for Steve Jobs and the American culture to be autocratic and not suitable for Korea and Samsung. He argues that American culture of Singularity is more suitable for innovation than the Korean (in fact, he extends his argument to most of Asia as well) culture of Conformity. Though I am glad that he included Mahindra under the singularity dimension, I think it is a slight stretch. But that is a different debate and discussion.

The substance of his argument was that Apple ha(s)d both singularity (one person) and an opinionated (non-conformist) culture that fostered innovation. What it means for entrepreneurs of today is not so much to create a person who is as charismatic (and possibly maverick) as the leaders he quotes, but to have a singularity of purpose that guides decision making. Strong vision, broader search for alternatives, speed of decision making, and discipline in execution arise out of singularity and non-conformity. Both, together; not a preponderance of one over the other. Pure singularity without a culture of non-conformity would result in a narrow search of alternatives and may lead to phenomena like groupthink. Non-conformity without a strong purpose and direction would result in slow decision making and lack of discipline in execution, and may to phenomena like predictable irrationality.

Dot #3: Social buffering

A couple of weeks ago, Apple CEO Tim Cook asked, “Hey Siri, why am I so alone?”. In an insightful interview with The Washington Post (read it here), he talked about a variety of things including not being able to replace Steve Jobs. But what caught my attention yesterday was the statement that “running Apple is sort of a lonely job”. And when I read an academic article on the Strategic Management Journal (yes, that is my primary job) by Michael J Mannor, Aadam J Wowak, Viva Ona Bartkus, and Uuis R Gomez-Mejia titled, “Heavy lies the crown? How job anxiety affects top executive decision making in gain and loss contexts”, (SMJ, 37,9, Sep 2016) the dot #3 emerged. The heavy crown of leadership can lead to significant anxiety in top executives (so beautifully articulated by Tim Cook when he talked about how he prepared for a congressional hearing – have you not read the interview, yet?). An effective insurance against such anxiety is to surround oneself with a team that is supportive of one’s decisions, effectively buffering the executive from threats from the environment. Building such a supportive team, that shields the top executive from the external world without a risk of opportunistic behavior from the buffer themselves is what the authors label as social buffering.

The implications of social buffering (according to the authors) are three-fold. Higher the perceived threat from the external world (and therefore the anxiety of the top executive), more likely the social buffering behavior. Secondly, in spite of the social buffer, it is likely that anxious executives might be more risk-averse than others. And finally, in contexts that represent losses (rather than gains), executives would be more likely to build strong social buffers. For instance, executives leading firms in declining product-markets may build stronger social buffers than those in high growth contexts. To put this in simple terms, the more vulnerable the top executive feels about the environment, the more she will surround herself with supporting team members (who share the same thought processes); it will make her more risk-averse; and more so, when faced with losses (than gains). Given that loss aversion is more pronounced (executives worry more about losses than celebrate equal quantum of gains), this social buffering can become more and more pronounced in malevolent environments.

Connecting the dots

Find an investor who “has been there, done that” + Build a culture of singularity & non-conformity + Beware of social buffering

While it is important that you seek angel investments from someone who brings in a lot of experience, insights, expertise, and a network, it is also imperative that you build a culture of singularity and non-conformity in your organizations. If you do not pay active attention to these details, you may end up surrounding yourself with a social buffer, promoting and highlighting only those in your network who conform to your thoughts and beliefs while letting others go, you run the risk of running your enterprise to the ground with high anxiety, low risk appetite, and conformist thinking. Without an active innovation programme, replication and possibly fast following strategies are likely to dominate the organizational discourse.

Prescriptions

Seek out investments carefully. Do a proper due diligence of your investors’ resources and networks
Keep checks on how your advisors and investors encourage/ dissuade innovation and risk-taking
Make sure that you surround yourself with a variety of perspectives, and ensuring that your social buffer is not counterproductive to your innovation and external orientations

Cheers.

Building your brand

This is not a post about marketing, though it may sound so. This is a post about how entrepreneurs and leaders communicate. This is relevant for brands and firms as well. Read on.

I listened to a very insightful TEDx talk by Simon Sinek on inspirational leaders. Listen to it here. He talked about how inspirational leaders focus on the inner most ring of what he called the golden circle. In the inner circle is the why, followed by the how, and then the what. He cited examples of ineffective communication, when firms and brands and individuals focused on the what to drive the how and why, and how successful people and brands and firms focused on the why first, before highlighting the how, and what. If you have not listened to it yet, please do so, before you proceed.

As we see a tramline of enterprises biting the dust, liquidating/ selling off to powerful competitors/ selling off at a fraction of its past valuations to firms in complementary businesses, this message is becoming far more relevant. Couldn’t resist this contrast …

Yahoo is a guide focused on informing, connecting, and entertaining our users.

https://about.yahoo.com/

Google’s mission is to organize the world’s information and make it universally accessible and useful.

https://www.google.com/intl/en/about/company/

Just take a look at how these two pages are organised – Yahoo’s page flows like this – a statement of what they do – inform, connect, and entertain; how did they start, how is it to work for Yahoo, and what does it offer for developers, advertisers, partners, and research. Google’s page begins with the company overview (that includes their history), who they are (culture and locations), what they believe, and then what they do.

If your communication focuses on what problems you solve (why you exist), and then lead towards how you solve those problems, and therefore what products and services you offer; I am willing to listen to you. On the other hand, there are entrepreneurs and firms that begin with what they do. For instance, early this week, I heard someone talk about building the Uber of Indian tractors for farmers (if the one who talked about this is reading this, don’t take it personally). I had to probe deeper and deeper to understand what problem was being solved and why did Indian farmers needed a mechanisation solution in the lines of Uber.

Virgin’s Richard Branson also wrote today (11 August) about why successful entrepreneurs should seek problems, and create solutions (read it here). Begin with the problem and the opportunity; the business model and the solution will follow; and thence products and services.

So, whatever brand you are building – of yourself, your firm, your products/ services, please begin with the why, the how, and then get to what. Build a robust brand that stands for something, signifies why it exists, and speaks to the ecosystem on why it exists. Remember the arrow that connects A and z in the Amazon.com logo? Everything from A to Z.

And in today’s world, as firms simultaneously diversify and depend on a cluster of complementors to provide (each others’) customers with unique value, it might not be out of place to conceive of your brand as a platform. A simple platform (like how the automobile companies use the word) upon which your complementors and partners could build on, customise, co-develop, co-innovate, and co-create. Brian Monahan’s post titled “More than a promise: Brands are platforms” (read it here) develops this argument very well. Brian’s primary argument is that brands transcend the promise and should allow for other firms and its partners to shape the consumer experience. Imagine brand Android!

Borrowing the idea from Simon Sinek’s talk, leaders communicate why more than the what. How is your brand communication structured?

Would love to listen/ read/ hear about your brand stories.

Obliquity – muddling through in entrepreneurship

Through my travel to the other side of the world last week, I read a couple of books. One of them was Obliquity by John Kay. The subtitle of the book reveals more than the title – why our goals are best achieved indirectly. In this post, I intend to build on my reading of the book, adapt a few ideas, and draw implications for platform-business startups. This is not an exhaustive review of the book – there are a lot of them available online; rather this is a summary of my notes from the book, which I thought was relevant for entrepreneurs.

What do you pursue?

The book builds on an intuitive understanding that relentless pursuit of anything does not take you where you want to go; as much as reaching there obliquely. Happiest people do not pursue happiness, and are happy because they do not actively pursue happiness. They enjoy what they do – their work, their roles, their chores, and are even not sure their activities will lead them to happiness. If you have not yet seen the movie, The Pursuit of Happyness, see it now. It is the experience that matters, not so much the outcome. Successful entrepreneurs startup to solve a world problem, at least something they faced themselves, and not make tons of money/ billions of dollars of valuation. Those that actively play the valuation game – yes I call it a game – do not optimize. Those who are constantly looking for exit options have not been successful. The book is replete with examples of firms whose intent to make money, and how they floundered.

Eudaimonia

Drawing on Aritstotle’s concept of Eudaimonia, Kay classifies three levels of purpose people and firms pursue. The lowest level is those of momentary happiness – like waving at a child smiling through the school bus window; the intermediate level may include a persistent sense of well-being, like a good holiday with family and friends in the Andamans (I have not been there, yet!); and the higher level of pursuit is what is referred to as Eudaimonia, something like the satisfaction of having a patent granted. Something that is fulfilling, achieving something that tells you that you have reached your potential. When I teach strategy introduction sessions, I draw upon vision and mission statements of a variety of (successful) firms to speak about how these statements are actually altruistic and ephemeral, conveying a larger sense of purpose. Consistently, firms that add shareholder value in their vision/ mission statements have faltered, to either rediscover themselves or bite the dust. So, entrepreneurs out there, what is your Eudaimonia? Appreciate that in ancient Greek philosophy (we are approaching the Olympics, right?), “the final end of action is realised in action, and is not a consequence of action. Eudaimonia is a goal set before each agent as soon as he starts to act; it is not chosen and cannot be renounced.” Define why you are in business, and what is your high-level pursuit?

Obliquity in problem solving

Okay, solve this brainteaser for me (cited in page 50-51 of the book). A man sets off walking a mile to his home from his work. As he starts, his dog sets off to meet him on the way, and when it finds him, licks his hand and returns back home. And continues do so (run towards the master, lick his hand and return back home) till the master and the dog reach home together. If the man walked at a speed of three miles per hour, and the dog at twelve miles per hour, how much distance did the dog cover?

You can calculate this distance using the principles of infinite series, but that would be a long-winded calculation. If any of you noticed, the dog was four times as fast as the master, it must have walked four times the distance the master walked in the same time, viz., four miles. This is what Kay refers to as oblique problem solving.

Oblique is simple, direct isn’t. What problems of your customers, partners, stakeholders are you solving? And how – directly, or obliquely? When Tally (www.tallysolutions.com) began selling computerised accounting solutions way back in the 1980s and 90s, their mantra was simple – keep the user experience simple, which translated into replicating the offline processes exactly in the online product. The trial balance looked the same, the ledger entries looked the same, and the end result was that every accountant was already familiar with Tally, when he finished his accounting degree. The “power of simplicity”, which incidentally is their corporate punchline, arose from their intent to not simplify the lives of the accountant, but to exactly replicate. Had they begun simplifying, I am not sure they would have attained this iconic status (and market share) amongst the millions of Indian small and medium businesses (SMBs).

Muddling through

People familiar with academic research on Organization Behavior would have heard of this term “muddling through”, first articulated by Prof. Charles E Lindblom in his seminal paper, “The Science of Muddling Through” (see the paper here). Kay concedes that obliquity is a (better) euphemism for muddling through, and elaborates on how goals, decisions, and actions are different across the direct and muddling through approach (see figure 7 in page 66-67 of the book). A quick summary for the not-so-academically inclined: muddling through represents a state where (a) goals are multi-dimensional and loosely defined; (b) goals evolve over time, in fact, even after the action has begun; (c) the external environment is complex – the structure of relationships is continuously evolving; (d) interactions amongst stakeholders is socially constructed; (e) the external environment is not known, and is uncertain; and (f) the range of events, and therefore the options available in front of the firm/ decision maker is unknown and uncertain. In such a complex and uncertain environment, decision makers engage in “successive limited comparisons of non-comprehensive actions”.

Entrepreneurs do engage in a variety of muddling through. We talked about pivoting and bricolage in an earlier post in this blog (Pelf). As the environment you encounter is uncertain and/ or complex, you are entitled to muddle through! However, do not lose sight of the higher level pursuit, your Eudaimonia. In the absence of the larger sense of purpose, muddling through will remain just that, and not lead you to your ultimate pursuit.

Ex post justification of random outcomes

Kay discusses in detail about how England footballer, David Beckham could “bend” the football, performing multi-variable physics calculations in matter of seconds as he takes a free kick (read a wonderful reporting about it in The Telegraph here). I am not convinced (like Kay) that David indeed did all those calculations, or did Wasim Akram and Waqar Younis, the early exponents of reverse swing in cricket seam bowling, or even exponents of the ‘legal’ doosra or carom-ball deliveries in spin bowling. They had some idea, tried something, experimented, experienced a difference, persisted, perfected and professed (subsequently). Ex post justifications, all of them. A lot of entrepreneurial successes and failures are also subject to the same phenomenon. Now that a famous startup firm has sold out, all the arm-chair analysts will bring out their own analyses on why they saw this was coming. Search on the Internet about the merger of Uber China with Didi Chuxing – you will find a lot of ex post justifications on why this was waiting to happen. There are relatively very few insights/ posts of what that means for other competitors, and how Lyft, Ola, or Grab would feel the impact; or even why Didi Chuxing decided to buy out a competitor so small in size and give its shareholders a share of their own pie. So, when you encounter ex post justifications, just concede to randomness, reflect to learn (you use the rear view mirror of the car to drive forward, right?), and continue forward.

So, in summary, entrepreneurs of today, define what is it that you pursue, what are your higher level goals, and what is your Eudaimonia. Appreciate that obliquity in decision making is here to stay and be prepared to muddle through the environment and indulge in some arm chair ex post justifications of performance.

Shameless self-promotion

By the way, if you are in Bangalore and are available on Saturday, the 6^th August 2016 forenoon (0950am onwards), you are invited to attend a panel discussion I am moderating on “Network Mobilization in Platform Business Firms” as part of the IIMB’s entrepreneurial summit, Eximius 2016. For more details, please visit http://eximius-iimb.com/4startupsnsrcel/. Free, mandatory registration at the website.

Reference class forecasting using pluralism: Fighting single parameter obsessions

Traveling around prestigious Universities and Business Schools in the US this week on an institutional assignment (this post comes from Chapel Hill, NC), one thing struck me in this society, pluralism. I read with interest my friend Suresh Satyamurthy’s piece in yourstory.com (link here) that uses a hangman metaphor for an investor review in the start-up world. In Suresh’s start-up world, the investor is hung-up on a single parameter – scale (pun intended). It set me thinking – any evaluation of performance (more importantly, assessment of future performance) needs to be grounded in as many parameters as possible. In this post, I will introduce Reference Class Forecasting (RCF) as a technique for fighting such biases like single parameter obsession. Drawing on research on behavioural economics, I attempt to provide guidelines for entrepreneurs and investors to make better forecasts of future performance.

Intent-outcome relationship

This is possibly the first and the most obvious starting point of any assessment. Start with what was the intent in the first place. If the stated intent of the platform was to transform the industry, please define what is industry transformation and measure those, and not start harping on profitability. Not every business needs to show the same kind of performance on the same parameters. Take the example of baby products company, firstcry.com. The founders’ motivation to start-up arose from the difficulty in finding products for their own children – availability, variety, poor quality, and certain international products/ brands not available in India (read their interview here). So, the best performance metric for assessing the performance of firstcry.com would be to see if they have been able to “make a wide variety of good quality international products and brands available to parents”. The performance metrics would therefore be (a) number of outlets – online and offline, (b) inventory size and variety, (c) number of brands, (d) number of products uniquely available at firstcry.com, at least in a specific geography, and (e) number of parents reached. Scale here would mean growth in number of customers, brands, products, and channels. Not GMV, not anything else. Yes, profitability is important, but not the first parameter of success.

Constructs, variables, and measures

Hmm, I may sound like a research methods teacher, but I think this is important to understand. Everyone (at least those reading this blog post) understands that everything could be measured in a variety of ways. A construct is an attribute of a person/ entity that cannot be observed or measured directly, but can be inferred using a number of indicators, known as manifest variables. For instance, entrepreneurial success is a construct that is measured by a variety of variables ranging from firm performance, firm growth, market power, firm’s influence in industry standard setting, pioneering innovation, to even investor wealth creation (or exit valuation) at sell-out to a large corporation. Each of these variables could be measured using different measures; see for instance, the number of measures we identified for firm growth in the context of firstcry.com in the last section. Can you see a decision–tree like structure here?

Indices

So, when I think of multiple parameters, I am reminded of indices. Indices like Human Development Index (HDI) as a measure of economic development, or a Consumer Price Index (CPI) as a measure of inflation. Each and every of these indices are prone to discussions and debates about what constitutes these indices and why; and in what proportion/ weights. Take for instance HDI that is a composite of life expectancy (personal well being), education (social well being), and income per capita (economic well being). Why only these? What about social and racial discrimination? What about ecological sustainability? Similar is the case with consumer price index (CPI), which is calculated using prices of a select basket of items, with price data collected weekly, monthly, or half-yearly for specific items. Again, why should tobacco products prices be included in CPI calculations? Or we could debate of how the housing price index is calculated for inclusion in the CPI. Does age composition of the household matter in calculating the CPI basket? For a relatively young family, would the basket of goods not be different than those families with more elders than children?

So, to cut my long argument short, please refrain from creating indices that just simply represent a mish-mash of parameters to evaluate a start-up.

My recommendation: Use reference class forecasting

Reference class forecasting (RCF), sometimes also referred to as comparison class forecasting is a method recommended to overcome cognitive biases and misplaced incentives. My favourite article on this appeared in The McKinsey Quarterly (see here). Let me elaborate the theory first.

Nobel laureate Daniel Kahneman and Amos Tversky’s work on theories of decision making under uncertainty is the starting point for understanding RCF. They described how people make decisions that are seemingly irrational while dealing with probabilities and forecasts using Prospect Theory (see an insightful class by Prof. Schiller, another Nobel Laureate, on YouTube here). Summary relevant to us: people are more concerned by smaller losses than equivalent gains; and people round off probabilities of occurrence to either zero or one, when it is close to either, and in between, exaggerate.

Let us understand how an entrepreneur could use this theory to manipulate his capital provider. She shows some initial success, and likens her business model to an already successful model somewhere else, in some other context; and gets the investor to exaggerate the probability of her success. For example, I know a friend wanted to build the Uber of toys in India. Why buy toys, just rent them, let the child play for a week, and return it back to the library next week to issue a new set of toys. Sounds exciting? Just that the economics did not work out the cost of damages to the toys small children could do, that would render it useless for the next borrower (like breaking one car wheel). The entrepreneur kept the rentals high enough to account for such losses, and soon her customers realised that the rentals were working out far more expensive than buying new toys, notwithstanding the child refusing to part with his toys at the end of the week. The entrepreneur continued to convince his investors to keep investing in her, luring them to wait for the economies of scale to kick-in and she could have enough bargaining power with toy manufacturers to directly import from the North of Himalayas, but that never happened and the investor exited the firm at its lowest valuation.

These biases manifest themselves in the form of delusional optimism, rather than a clear understanding and detailed evaluation of costs and benefits, even when hard data is available.

Steps in using RCF: A field guide

RCF helps forecasters and planners overcome these biases by situating the reference point outside of the subject being assessed. In order to forecast (or assess future performance) a business, investors need to identify a reference class of analogous businesses, estimate the distribution of the outcomes of those firms, and benchmark the enterprise at an appropriate point of the distribution. Firstly, the investors should identify appropriate reference class for the enterprise. These reference classes need to be identified using a variety of parameters that match the enterprise. The next step is to analyse the performance of the firms in the reference class and map them into a probability distribution. There may be clusters of firms that may emerge during this distribution-mapping exercise; there may be instances of only extremes of firm performance observed (say in winner-takes-all markets); or there could be continuous distributions.

The next task is to use pluralism in the parameters to position the enterprise in the distribution. Here is where multiple parameters would help in an reliable estimate of the position. For instance, an Uber for toys in India would only work when the marginal costs of renting out a car (wear and tear) is negligible compared to the fixed (sunk) costs of buying the car. Whereas in the toys market, the marginal costs of a child playing with the toy is a significant proportion of the market price of the toy, and therefore this enterprise would not be subject to the same evolutionary direction as Uber. However, if the enterprise was repositioned as a toy library (as my friend ultimately did), it would work – look at how the cost structures of library and toys work. It provided her a benchmark on only buying those toys that would be durable, held the customer’s attention for only short periods of time, and were very expensive to buy. Typical examples were multi-player games, which no child wanted to own independently (given the small size of families today), but would rent out during the weekends/ birthday parties for a small proportion of the cost of the game.

So, hers is calling entrepreneurs and investors to overcome such cognitive biases and forecast better.

Comments and feedback welcome.

Breaking the Uber-Ola duopoly?

Okay, after a week’s break for personal reasons, the blog is back up. Writing from Berkeley, CA today.

The Karnataka Government (of whom Bangalore is the capital city) recently announced that it would like to have more private players in the ride-hailing app market, not just an Uber-Ola duopoly. Read the Transport Minister’s interview here. Which got me thinking, will this market sustain multiple competitors, if at all?

A classic winner-takes-all market is defined by three conditions – presence of strong network effects, high multi-homing costs, and the absence of any special needs. Let us first analyse if ride-hailing is a WTA market, and then talk about what kind of resources would another player require to compete in that market (remember Taxi-for-sure sold out some years back).

The ride-hailing app market enjoys strong cross-side network effects from both sides – more the drivers on the road, more the riders adopt; and vice versa. Simple. What are the multi-homing costs for the riders – just the real-estate on her phone for installing multiple-apps; and possibly any loyalty rewards, including maintaining her rider-rating. The multi-homing costs for the drivers are higher, though. He needs to affiliate with multiple firms; maintain multiple devices and payment/ banking information; and more importantly ensure sufficient rides taken on each of the platforms to sustain his incentives. Given the way Uber India and OlaCabs provide incentives (based on the number of rides per day), it would become increasingly difficult for him to multi-home. There are only two segments of customers in the ride-hailing app market: those who take them regularly (say 15-16 rides a week), and those who use them sporadically (say 2-3 rides a week). And both of these segments have the same preferences – low prices, high convenience, quick access to cars, and good customer service. So, this market seems like a WTA market, in the absence of a strong differentiation.

Differentiate

So, how does a new competitor differentiate? There are four options – long rides (say for instance, airport drops in a city like Bangalore); more variety of cars (larger vehicles for the big Indian family/ friends network); short/ weekend holiday trips; and rental cars (for self-driving by the riders).

Not that these needs are not being served – specialised competitors like Meru Cabs and Mega Cabs serve the airport market. In fact the Bangalore International Airport Limited (BIAL) has not authorised either OlaCabs or Uber to pick up passengers from the airport. Even in San Francisco, I saw a sign today morning, that said “all app-based cabs can only pick up from the departure level”! Some agreements need to be signed between the airports and the aggregators to ensure seamless experience for the riders. And this is true of a variety of airports across the world. Here is where, entrenched competitors like Meru can make a difference.

The large vehicle/ variety of vehicles was the forte of the neighbourhood taxi operator. The operator (or sometimes a local aggregator) would have on his list a variety of cabs ranging from the smallest hatchback to the large 15 seater van. You signed up on a hour-km base rate and a topup rate for exceeding either (time or distance, or both). Here is where a new ride-hailing app can begin differentiating. Take the example of Lithium cabs in Bangalore, which is appealing to the environmentally conscious consumer, by deploying only electric vehicles in the fleet (read here). Similarly, there could be specific apps for off-roading, mountainous trails (think the Manali-Leh highway – don’t forget to see the map in Earth mode), or for biking/ trekking/ hiking trips.

The short weekend holiday trips are possibly the most underserved market in India. A lot of small families would drive out their own cars, leaving at least one member of the family super-tired and unable to enjoy the holiday as much as the others. Especially if the road is not very good, and the car is not in the best of the condition, it can be treacherous ride rather than a enjoyable holiday. Some may argue that the drive itself was the enjoyment, but that is a different discussion. Here is an opportunity for ride-hailing apps to easily extend their services. The daily office-going commuter is not on the roads during the weekends, and the cabs are being under-utilised. Here is a win-win for both the drivers and the riders. OlaCabs has just began the Ola Outstation service for serving just this need – it is early enough to get more drivers (and bigger cars) to get on the roads on weekends, but I am sure they will get there sooner.

The car rentals (driven by the riders, as in Hertz in the USA) has its share of competitors – Zoomcar is a good example. For someone on a day trip to a familiar city, such rentals would be a great service, providing flexibility, control, and convenience. However, these rentals have not attained sufficient scale for the network effects to kick-in as these are asset intensive (the cab aggregator has to own all the cars); caught in regulatory conundrums (is it a private vehicle or a taxi – white number plate or a yellow number plate, or black/ yellow); how is insurance managed; and the coordination costs are very high (see how the airport pickup from Bangalore airport works, including the limited number of drop-off locations – serious limitations on the last mile to home).

Address the special preferences

In summary, in order to fulfil the Karnataka Government’s wish to break the monopoly, we need competitors to differentiate. We need the airport taxis to become cheaper, more efficient, and provide better customer service; we need the taxi/ cab aggregators to not just include more and more variety in their cars – from electric vehicles to sedans to SUVs, but differentiate on the value proposition; expand the capacity utilisation of their cars during the weekend by serving the weekend holiday trips market; and car rentals to expand their network significantly (four drop-off locations in Bangalore when you take a car from the airport, seriously?).

Cheers and happy weekend.

Pelf: Is venture capital money for startups evil?

A common discourse these days in the print and social media is the persistent rant by “old school” economists and businessmen about how easy access to venture capital and private equity for startups have spoilt the ecosystem. And any failure is attributed to this easy access, any news in fact. In this post, I throw open three challenges for the startup ecosystem.

First things first, definition of pelf. The word has disappeared from a lot of English-speaking countries, but still survives in India, at least in my mind. It refers to money and wealth, which is ill-gotten, or through a dishonorable way. For the more lexicologically inclined, here is a link with more details.

As the startup economy generates any news, like Jabong being on sale; or ANI Technologies (the firm that runs OLA Cabs) reports losses, I scroll down to read the comments. And a large majority of them are rants about how these young twenty-something entrepreneurs have so much access to easy capital, that they do not care about business failures. I would imagine it is very fashionable to say – yes, failure is good and you should encourage failures, but fail with your own money (bootstrapping is okay; VC money is not). On the other hand, entrepreneurs would argue for the need for sufficient capital to invest in developing the ecosystem (low internet penetration, poor logistics and last-mile connectivity, inadequate payment infrastructure, and heightened competition from MNC subsidiaries like Amazon.in). Platform-businesses need capital to kick-in network effects, including subsidizing users (like Uber); so do a lot of infrastructure-dependent businesses that need patient capital before all pieces of the ecosystem fit with each other (PayTM).

The first challenge I pose to the entrepreneurs is to communicate the nature of your business model to your stakeholders very well. What is the source of your network effects? In just the last week, I heard at least four entrepreneurs pitching to investors, using the platform word in their first slides of the presentation, without ever talking about when and wherefrom network effects would kick-in. If you need capital to kick-in network effects, elucidate. Over the last few years, enough has been written about platform business models and network effects, a simple Internet search would educate you enough. Please put up at least a pictorial representation on your website (most of the websites have pages titled, how it works, which are craving for such content). For an example, please visit the homepage of Tarnea Technology Solutions (disclaimer: I advise them).

The second challenge is about pivoting. Entrepreneurs (ab)use this term a lot, that quite a lot of times, I am left wondering if the business had any specific plan in mind at all. When one thing does not work, it is natural to seek another business. When a large plan does not yield great results, it is important to seek business results from whatever succeeds in the overall scheme. But to use the word pivoting with a sense of pride is unnerving. I would urge entrepreneurs to take pride in whatever you do, fail, bounce back. But to pivot with pride, I am not sure. You may have used entrepreneurial bricolage (making do with whatever is at hand) to build your business, nothing wrong. The classic (okay, my favorite) academic paper on entrepreneurial bricolage is here. Bricolage explains how entrepreneurs recombine their limited resources at hand and create unique products/ provide unique services that challenge institutional norms. For examples of digital bricolage and what it entails for new age entrepreneurs, read this latest article at HBR.org.

The third challenge (may be a request) I pose to entrepreneurs is to provide credible estimates of performance. The old age firms, especially the ones listed in the stock market need to provide the (Wall or Dalal) street and analysts with performance expectations. Yes, forward looking statements. The stock market penalizes firms who do not provide reasonable estimates of performance, or fail to perform in line with estimates. Entrepreneurs, even though you do not have the retail investors and analysts chasing you with quarter-on-quarter performance expectations, it makes for good governance to keep stakeholders informed. Please provide us with credible forward looking statements. It is actually good time-pass these days to initiate conversations with OLA and Uber drivers about when and if at all these firms will ever become profitable. Neither the drivers, nor the riders have a clue to the way forward, and it is good fun listening to various viewpoints. I am very impressed with Snapdeal founder Kunal Behl’s collaboration with Ashvin Vellody of KPMG to publish this report on the Impact of e-commerce on SMEs in India. Not so much the report (it is definitely well written and contains insightful analysis), but the act of writing itself is commendable for me.

To summarize, entrepreneurs in the startup world, if you want to change the perception that all your startup capital was easily obtained, is pelf, and therefore not justified, I challenge you to

Explicitly communicate the source of your network effects
Don’t pivot; use entrepreneurial bricolage
Provide credible estimates of performance

Cheers.

Flipkart Ads – Is there a shift in online advertising economics?

Yesterday, I read an interview with Sanjay Ramakrishnan, Senior Director & Head – Business development & Marketing, Flipkart Ads in Advertising Age India (read it here). It set me thinking, why is Flipkart into advertisements? Is it competing with Amazon or with Google, Facebook, and Apple as well?

Though I am tempted to label this development as the advertising market becoming a contestable market, I will refrain from doing so. Let me first explain what is a contestable market (in simple terms, of course, let me try; and in the context of platform business models), and then proceed to analyze if the success of Flipkart Ads is a source of worry for other platforms whose principal business model is based on advertising revenue.

The theory of contestable markets originated from the works of Baumol as early as 1982 in this seminal paper (available through JSTOR here). He (and his co-authors in subsequent papers) defined a contestable market as one with absolutely free entry and costless exit. Which implies that such a market would be vulnerable for a hit-and-run entry, i.e., by any competitor with no need for any specific assets, process capabilities, or differentiation.

A key characteristic of these markets is that the new entrant takes the prices prevailing in the market (of the incumbents) as given, and enters with the same price. In a perfect competition, any new entrant will increase the supply in the market, and should lead to a reduction in prices. Even when the market shares of incumbents and new entrants change, the industry price levels should ideally fall with increase in supply. In contrast, in a contestable market, the new entrant could enter the market with the same price as the incumbents. The justification for this assertion could be based on two arguments, that the new entrant enters the market at such a small scale compared to the incumbents that there is no visible change in the total market supply to warrant a price correction. The second argument is founded on the thesis that the incumbents cannot retaliate with sufficient speed to counter the threat posed by the new entrant, due to their systems and processes that bind them to a particular cost structure and a positioning in the market. In such a case, the new entrant could enter the market with a prior contract, preferably a long-term contract, at least as long-term as it takes for the incumbent to respond. In perfect competition or monopolistic competition, incumbent firms will adopt limit pricing strategies (if profitable for them) to keep new entrants at bay, i.e., as the incumbents sense the threat of new entry, they would reduce the prices to a level where it would be profitable for the incumbents and not for the new entrant. Take for example, when cola firms entered the bottled water market in India, the incumbent, Bisleri International embarked on a strategy of keeping market prices so low that it took a long time for Coca Cola Company, and Pepsico to break even.

The second aspect of contestable markets is the absence of any sunk costs whatsoever for both the incumbent and the new entrant. If any upfront fixed costs were to be incurred by a competitor either prior to entry (including in studying the feasibility of making money in that market) or at entry (like setting up manufacturing and distribution capabilities), the costs of entry will prevent this market from becoming contestable. Let me provide an example. In today’s world, setting up an online store entails no sunk costs for any retailer. The domain registration and hosting, website design, payment gateways, and fulfillment are all functions that are unbundled and offered as independent services (as SaaS) by different vendors, which makes all of them variable costs, rather than fixed costs. Such costs are neither fixed nor specific – one could use the payment gateway for any other online transaction, should this venture fail. Such markets with no sunk costs result in no barriers to entry and exit and therefore, are contestable. Contrast this with our previous example of Coca Cola Company and Pepsico entering the Indian bottled water market – this is a market that requires significant bottling and distribution capabilities. Though the cola firms enter this market with significant synergies from their core business, there were certain unique capabilities that the bottled water market required – sourcing of good quality water and plastic bottles, bottling lines that were specific to water, unique branding, and wider distribution networks.

The third characteristic of contestable markets is that the products are absolutely non-differentiable. That means, the new entrants can enter the market and imitate the products/ services offered by the incumbents at the same costs or even lower, and therefore maintain the same price levels. It is also possible that the new entrants enter with lower prices, and offer the same ‘standard’ products or provide additional features at the same or lower prices. Such standardization is highly visible in the context of platform services, like a C2C marketplace. In the absence of any product differentiation between competitors (any new feature is imitable quickly and is almost costless to do so), Quickr.com and OLX.in entered the market and took market share from incumbents like Sulekha.com or asklaila.com.

In summary, a market can be (or become) contestable when either of these conditions are met – no changes in prices (no limit pricing by incumbents), no fixed sunk costs, and no differentiation in products and services offered.

Is digital advertising becoming a contestable market?

For digital advertising market to become (and be) a contestable market, it has to allow for costless entry and exit, no sunk costs, and no differentiation. In the case of Flipkart Ads, I would argue that it would have cost Flipkart next to nothing to build the platform. The ecommerce store was in any case dealing with sellers, and all that they had to do was to extend the relationship to brands. And remember, in the Indian market, a lot of the brands had their own ecommerce retail operations and some of them were already on Flipkart as sellers. For instance, when I searched for the Prestige brand of pressure cookers on Flipkart, I found about 40-odd sellers including TTK Prestige, the brand owner.

And when Flipkart entered the digital advertising space, did Google and Facebook respond with limit pricing? I am not sure they did. A Feb 2015 LiveMint article that announced Flipkart and SnapDeal’s entry into online advertising space gave Google ad revenues as US$55bn compared to Amazon’s US$1bn (read it here). Given these sizes, it is unlikely Google and Facebook would have felt the need to respond to their entry by lowering prices.

Developing the advertising platform would possibly not involve any sunk costs for Flipkart. There is sufficient traction in terms of relationships with sellers and brands, the technology platform costs next to nothing to build, transaction costs are variable (including cloud storage and payment gateways), and even brand building is costless (as they are extending the same brand – Flipkart Ads).

It is the third condition of contestable markets that protects the online advertising market from becoming a contestable market, i.e., lack of differentiation. In the case of online advertising market, differentiation is created and sustained by superior targeting of advertisements to the right users. Measuring and monitoring engagement of the audience is the key in data collection; deep understanding of the consumer behavior and decision-making process is critical in analyzing this large volume of data; and close relationships with a wide variety of advertisers is imperative to ensure narrowcasting of advertisements to specific audience profiles. Here is where the product differentiation kicks in – the kind of browsing habit data that Google has access to is very different from the ‘buying intent’ that Flipkart can derive out of its customers’ behaviors. And especially in the context of mobile apps, the Flipkart app has access to other information like the person’s location, WiFi/ data connection information, and even his contacts; all of which could be useful to provide targeted narrowcasting (or even unicasting) of advertisements. Such shrinking of segments and the ability to serve what the marketers call ‘the segment of one’ customer can differentiate the new entrant, Flipkart’s services from the incumbent ‘Google’ and ‘Facebook’.

So, what are the implications for entrepreneurs?

First, evaluate if your market is indeed contestable, or is likely to become contestable. If there is a likelihood of your primary market being or becoming contestable, consider one of the following options:

Change your business/ business model (pivoting is a fancy word these days in the startup ecosystem)
Erect barriers to entry and exit – use regulation if you must (see how Airport Taxis in Bangalore are competing with OLA and Uber)
Differentiate – even if it is not the most significant of your product offerings, focus on those value creation opportunities that involve sunk costs
Wait for a new entrant and bleed him to death with limit pricing (you better have easier access to capital than the new entrant)!
Wind up, sell out, and take your family (if you have one) on a holiday to Seychelles! And don’t forget to thank me!

Digital disruption – drivers, symptoms and scenarios

My students, colleagues, and leaders in firms who I mentor have been asking me to share my views on digital disruption of businesses. In this post, I try to define the contours of digital disruption and what it holds for the future of businesses, in my opinion.

What is digital disruption?

Disruption refers to a fundamental change in the value proposition of the business. When digital technologies form the basis of such a change, I call it a digital disruption.

Drivers of digital disruption

There are three primary drivers of digital disruption (adapted from this article). First, is the maturity of digital tools and technologies that uncover inefficiencies in traditional business models. Take for instance the sharing economy characterized by business models like Airbnb.com and Uber. These business models highlighted the underutilization of fixed assets in residences and cars, and shifted the consumer behavior from traditional business models of exclusive hotels and owned cars to shared residences and cars. A recent example of this sharing economy is www.flightcar.com, that allows for individual car owners to rent their cars parked idle in airports to other visitors to that city as self-driving cars!

The second driver of digital disruption is the increasing evaluability of performance parameters. In a traditional business like car hiring services, it was difficult to evaluate the quality of cars. In the sharing economy, ratings/ reviews/ recommendations from other users can help evaluate various parameters of the products and services. Uber allows for mutual rating of drivers and riders, alike. Such improvements in technology that increase the evaluability of parameters, hitherto not evaluable can significantly contribute to unique customer value addition.

The third driver of disruption is the increased dominance of mobile apps. What the transition from traditional PC-based software applications to mobile apps contributes is lower costs of customer adoption, richer data collection by the apps leading to better customization of experience, and mobility. Imagine using Uber through only a PC-based or a browser-based communication!

When do you know your business is being digitally disrupted?

The following table describes the characteristics and symptoms of digital disruption with some examples (adapted from this article).

Symptoms	Examples
A proliferation of free or nearly free digital technologies in the value creation process	Digital photography eliminating paper photography
Such technologies are provided by multi-sided platform firms	Products like Gmail eliminating the need for organizations investing in their own email servers
Conscious shifting of value creating activities outside the firm, including open and user innovation processes	Evolution of 3D printing enabling democratization of design and prototyping
Rapid prototyping and product development/ market entry made possible as a result of user/ open innovation	Proliferation of platforms and forums like tech-shops that enable businesses and consumers to rapidly prototype and customize their products in low volume production contexts
Use of direct and indirect network effects to leverage economies of scale and scope	Evolution of aggregators and marketplaces like Alibaba.com that leverage network effects for economies of scale and scope

Most digital disruptions are visible when the industry/ market is characterized by one of more of the above symptoms. If any of these symptoms are visible in your business context, organizations beware. Begin preparing to face/ counter these forces.

Planning for the digitally disrupted future

Prof. Mike Wade from IMD, Lausanne describes four scenarios of digital disruption (read the full report here).

The global bazaar – industry and geographic boundaries blurring due to internet and mobile
Cautious capitalism – data security concerns limit firms’ ability to monetize consumer data
Territorial dominance – regional industry boundaries persist, with tight regulation
Regional marketplaces – world divided into regional clusters with their own rules and governance, innovation fostered in regions with little or no international competition

The following figure summarizes the four scenarios with examples of firms that will dominate their respective markets.

As you can see, these are just my preliminary thoughts, and I would strive to develop on them subsequently.

Comments, feedback, and experiences welcome.

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