Finally it is Friday - going to be long day - not just because of classes, which go on till 4:30, but also because of the last Friday party we have tonight. Prof. Tushman was so worried that he literally begged the class to come on Saturday.
The first session was on outsourcing, off shoring - the differences and the benefits.Quick summary of the differences:
- Outsourcing:
- Work given to different company
- May be done by same employees, but most often different employees
- Usually from same country, but may be different as well
- Off shoring
- Can be done by the same company, if not it is outsourcing
- Almost always done by different employees
- Done in different countries
While the savings is quite apparent to the outsourcing company, how do we calculate the NPV of the savings ? As we do this, we have to keep in mind two parameters: wage differential reducing over a period of time and tax impact on the outsourcer. And these can have massive impacts. Just consider the following example:
- Case 1:
- Assumptions : Offshored 3000 jobs, wages $56 in US, $12.5 in offshored country, 10% discount rate, 34% taxes for outsourcer, 2% inflation/year.
- NPV of savings : $1.155 billion
- Case 1 (modified)
- Assumptions : Offshored 3000 jobs, wages $56 in US, $12.5 in offshored country, 10% discount rate, 34% taxes for outsourcer, 2% inflation/year.
- Assume that US wages goes up by 2%/year and wages in outsourced country goes up by 6%/year
- NPV of savings : $0.515 billion
Typically, when one company does outsourcing, all others are forced to do so. Why ? Because some of the savings are passed back as savings to customers, it puts pressure on the cost structure of the whole industry. However, outsourcing is not just about cost savings, it is many times about competitive advantage and in some cases it is about survival.
Mckinsey did a study and based on some assumptions (some of these could be questionable), concluded that it is a win-win for both the countries - in this case US and India. The conclusions were as follows:
- Value potential accrued to US from US $1 of US spending offshored to India was $1.14
- Value potential accrued to India from US $1 of US spending, was $0.33
Which means, in effect both countries together have gained by $0.47. The biggest assumption here is that 70% of the displaced workers find a job with at least 70% of the last pay. According to the study, this assumption is credible based on past data. Two issues comes to mind: this study was done in 2003, is it still relevant ? Secondly, the same benefits may not accrue to a country in Europe, where the jobs are not so easily available. Is this the reason why Europe offshores much lower than what the US does ? Food for thought.
The Mckinsey Study can be found here: http://www.mckinsey.com/mgi/reports/pdfs/offshore/Offshoring_MGI_Perspective.pdf
The session on Strategy was interesting becuase it was about Whirlpool, which was trying to renew itself. Why do strategies become less impactful over a period of time. It is because of both internal and external reasons:
- External threats
- Competition is aware of what you are doing
- Internal barriers
- Perception
- Motivation
- Inspiration
- Coordination
And all these need to be tackled to get there. Organizational structure, systems and processes play a big role. And sequencing of steps can make or break the effort to change a strategy. There are trade-offs between moving too soon to change a strategy and moving too late. What options are available to overcome internal barriers:
- Perception: Foresight to see problems before they become crises
- Motivation: Ability to paint a picture of the future that clarifies the need for change
- Inspiration : a direction that inherently fires up the whole company; this can be motivating too
- Coordination: Personal credibility, a comprehensive plan, a good sequencing to bypass resistance if needed
Strategy academics agree that the toughest is to change a strategy than to create one in the first place.
The last session was on Japan - extremely complex to understand why they are not growing. Post WW-II, they had miracle growth. In fact they were set back by 20 years because of the war - the GDP in 1952 was the same as in 1932. The country had extremely good skills at building complex systems - Battleship Yamoto is a good example of the capabilities. (http://en.wikipedia.org/wiki/Japanese_battleship_Yamato). The real GDP growth was 10.1%/year for 17 years - this is the highest in world history.
During the period 1971-91, the average GDP growth fell to 4.4%/year. Still not too bad. But post 1991, they had five recessions. In order to boost economic activity, Bank of Japan reduces interest rates from 6% to 0.5% over a period of time. Still no one borrows money, as they don't need it. This phenomenon is called the "Liquidity Trap". In Keynesian economics, this is a situation in which the monetary policy cannot stimulate the economy - either through lowering interest rates or by increasing money supply.
What does the BoJ do now ? They tried Quantitative Easing - where they increase the money supply - still no impact. Then they try fiscal policy changes by a stimulus package - which has some impact. Japan has many issues to deal with, specifically:
- Poor corporate governance structure with very few outsiders
- Education, which is still based on rote learning
- Women are not seen in the workplace and less so in boards
- Politics has been wrecking havoc - they need a strong political leader; from Map 2006 till date they have had 5 Prime Ministers !
- Demographics - they live much longer than in other countries, resulting in an aging population; their birth rate is low and with no immigration, the population is expected to go down by 2050
With lack of political leadership, there is a logjam in the country. Sad, indeed.
We had a special session today by Prof. David Moss on the topic, "Understanding the Financial Crisis and its Consequences". Before we get into the topic, a little bit about Prof. David Moss.
David A. Moss is the John G. McLean Professor at Harvard Business School, where he teaches in the Business, Government, and the International Economy unit. Moss graduated from Cornell University (B.A., 1986) and went on to earn an M.A. in economics (1988) and a Ph.D. in history (1992) from Yale University. He joined the Business School faculty in July, 1993.
Prof. Moss's research focuses on economic policy and especially the government's role as a risk manager. He has published three books on these subjects: Socializing Security: Progressive-Era Economists and the Origins of American Social Policy (Harvard University Press, 1996), which traces the intellectual and institutional origins of the American welfare state; When All Else Fails: Government as the Ultimate Risk Manager (Harvard University Press, 2002), which explores the government's pivotal role as a risk manager in policies ranging from limited liability and bankruptcy law to social insurance and federal disaster relief; and A Concise Guide to Macroeconomics: What Managers, Executives, and Students Need to Know (Harvard Business School Press, 2007), a primer on macroeconomics and macroeconomic policy. He has published numerous articles, book chapters, and case studies, mainly in the fields of institutional and policy history, financial history, political economy, regulation, and comparative social policy. One recent article, "An Ounce of Prevention: Financial Regulation, Moral Hazard, and the End of ‘Too Big to Fail'" (Harvard Magazine, Sept-Oct 2009), grew out of his research on financial regulation and regulatory reform for the TARP Congressional Oversight Panel.
Firstly, this was a sub-prime crisis. How did it become a financial crisis ?
- Large financial institutions which has participated in the various forms of MBS (Mortgage Based Securities), held many of these outside their balance sheets. On the balance sheets, they were leveraged by over 30%, but put together with what had off-balance sheet, the leverage was over 50% or in some cases it was 70%
- So, if the asset price falls by about 2%, the leverage they have violates the fed rules. So that have two choices : raise equity or sell the assets
- Since only some could raise equity, most were forced to sell the assets in a downturn
- As they sell, they drive asset prices further down, which forces them to sell more
- Overnight it became a financial crisis - and Friday Sept 12th Lehman Brothers were denied support by the Treasury Secretary Paulson. On Monday Sept 15th, Lehman filed for Bankruptcy.
- During the same weekend, on Sunday Sept 14th, AIG approached the Fed for $40b, which was promptly denied. But on Monday, after the Lehman bankruptcy and on the news that AIG failed to secure private funding, the Fed extended an emergency credit to AIG
- It is rumoured that Treasury Secretary was so stunned by the issues on hand , and combined with the stress and lack of sleep, was under severe personal pressure.
- Now the issue is a full blown financial crisis
But how did a financial crisis turn out to be an Economic crisis ?
- Financial crisis resulted in a credit crunch even for the good guys
- It became a crisis of confidence - which meant people were not spending
- And it soon became a classical Keynesian Recession
Financial crisis and Economic crisis are linked as they have interdependency's. Mark-2-Market accounting turned out to be one single policy which affected the market. EU abandoned this and the market improved. US also abandoned it, but was late in doing so. The biggest downside is, it may hide a lot of issues which can blow up later. Hence the need to get back M2M sooner.
The US disbursed $2 trillion and guaranteed another $12 trillion, which is the largest in history. And all of them, if called the government would have gone broke ! They did it to restore the crisis of confidence, bail out the TBTF (Too Big To Fail) companies like AIG, Bear Stearns, Fannie and Freddie, and purchase securities.
TARP - Troubled Asset Relief Program, was $700b to buy assets to stop the panic selling. But it turned out to be different - buying the equity instead of assets. Why ? Because many economists felt it is more efficient to buy equity instead of assets and secondly there was uncomfortable feeling in using tax payers money to buy assets at a high price.
In between there was a fire in the money market. And the government wanted to guarantee the MM funds. Fortunately someone in FDIC saw the problem and prevented it - because such a move to guarantee MM funds would have led a collapse of the banking sector. All bank accounts were secured only for $100k, which means people will pull all money from the banks and move it to MM funds. The policy was modified to guarantee only old MM funds and not the new ones coming to the market.
In retrospect, in the short term a financial system meltdown. But in the long term, we created a moral hazard. Why ? Because in all this creditors were the only guys who were not hurt. They are supposed to be the conscious keepers of the capitalist markets - by monitoring the risks and adjusting the interest spreads accordingly. In future, they may be inclined to take higher risks, no longer playing the role of a conscious keeper.
How to prevent next crisis ?
- Reduce leverage - especially of large financial institutions like investment banks
- Rating agencies regulation
- Regulation of retail lending
- Not allow off-balance sheet items
Prof. Moss believes that it is good to refer to history for solutions. Every 15 years there has been a crisis, but after 1933 there has been no major failures for over 50 years. What was done in 1950 was to aggressively regulate the biggest systemic risk, which was commercial banking then. And have low regulation for others. Similar logic should be applied now - aggressively regulate the investment banking and have low regulation for the rest of the market. Are the Fed's listening ?
After a long day of heavy stuff, most people were getting ready for the Friday night party. I was down under the weather and could not participate - and I understand I missed a lot of good clean fun - music and dance - well into the night. After all, it was time to let your hair down, after seven long weeks. More later ...........
No comments:
Post a Comment