Emerging markets were going to weather the storm … but will they survive the hurricane?

Source: http://www.dbresearch.com/
The financial breakdown of the west has spilled over to the emerging economies and these economies face a sharp economic contraction, led by :

• declining FX reserves,
• battered financial systems,
• a pronounced weakening of real economic activity.
• sharply slowing exports,
• plummeting commodity prices and
• sizeable capital outflows

The global financial dislocation has also exposed financial vulnerabilities in a number of smaller EMs, forcing several of them to request IMF financial support:

At the beginning of the crisis, the EM-6 had enough official FX reserves to cover their 12-month external financing requirements. This is generally regarded as a comfortable position.
However, this metric does not capture

1. all potential sources of balance-of-payments pressure
2. equity liabilities,
3. off-balance sheet liabilities related to cross-border derivatives transactions
4. resident capital flight.

Nonetheless, the comfortable external financing positions theoretically mean that as long as the authorities refrain from “financing” these types of outflows by drawing down their FX reserves, the countries will have sufficient funds to stay current on their debts falling due over the next 12 months, albeit at the risk of substantial currency depreciation in the event of, for example, substantial resident capital flight.

Two important sources of balance-of-payments pressure have weakened since the onset of the crisis.

1. The value of foreign portfolio holdings in the EM-6 has declined substantially on the back of large Q4-2008 outflows,
2. dramatic equity market correction and/or significant currency depreciation; and losses related to off-balance sheet transactions seem to have been largely realized.

Further EM-6 FX liquidity has stagnated or declined in recent months, only Mexico’s 12-month financing requirements now exceed its FX reserves (but only very slightly).

Resident capital outflows in the EM-6 should remain manageable as the risk of a sovereign default or a systemic banking crisis is low – and as long as the authorities devalue the exchange rate and allow domestic interest rates to rise.
This also applies to Russia, where FX reserves have fallen most, the current account is being hit the hardest and which has seen the largest resident capital outflows.

A scenario of how the (near) future will pan out for the EM-6
In a typical crisis, capital inflows recover after a while, allowing EMs to avoid drawing down all their external assets.
Uncertainity:

• But what if this time is different and the EM-6 only have very limited access to external capital markets over the next 12-24 months?
• What if capital-constrained financial institutions and spooked investors in the advanced economies remain reluctant to lend to EMs?
• What if banks that have tapped government bail-out programmes encounter significant political opposition to extending funding to EMs?
• What if the huge amount of expected fiscal-stimulus and bail-out related sovereign and sovereign-guaranteed debt issuance in the developed markets leads to a diversion of funds away from EMs?

One possible consequence of any of these / or a combination of these uncertainity panning out is :
Some combination of sizeable FX reserve buffers, bilateral swap agreements and access to the IMF’s short-term liquidity facility should provide the EM-6 with enough time to adjust their current account positions by way of a further (substantial) currency devaluation and a further (sharp) slowdown in economic growth.

The EM-6 economies are being battered and are already seeing a sharp deceleration in economic growth. The economic slowdown could become even more pronounced, should they remain shut out of international capital markets for longer than expected and be forced to adjust their balance-of-payments more drastically on the current account side. The recent Brazilian and Mexican sovereign bond issues have raised some hope that this can be avoided. However, under either scenario a systemic financial breakdown looks unlikely.
But no one knows if it will.

Strategy Curves - Industry Structure - Strategic Context

Source: http://www.mckinseyquarterly.com/Using_power_curves_to_assess_industry_dynamics_2222

The power law, where the extreme and the rare have a disproportionate impact

Winner take - all extreme concentration
The probability of finding value in the extremes is much greater that probability of finding value close to the average.
Power law mathematical notation - scale invariance:

1. f(x) = a (x)^k
2. f(cx) = a (cx)^k
3. c^k f(x) is proportional to f(x)

The curve is characterized by a short “head,” this depicts a small set of companies with extremely large incomes, and drops off quickly to a long “tail” of companies with a significantly smaller incomes.
The relationship is simple: a variable (for example, net income) is a function of another variable (for example, rank by net income) with an exponent (for example, rank raised to a power).

Power curves across Industry
Surprisingly the more labor- or capital-intensive sectors, such as chemicals and machinery, have flatter curves than intangible-rich ones, such as software and biotech.


Thus scaling by a constant simply multiplies the original power-law relation by the constant c^k called the scaling exponent.
Thus, all power laws with a particular scaling exponent are equivalent up to constant factors, since each is simply a scaled version of the others.
This behavior is what produces the linear relationship when both logarithms are taken of both f(x) and x, and the straight-line on the log-log plot is often called the signature of a power law. Notably, however, with real data, such straightness is necessary, but not a sufficient condition for the data following a power-law relation. In fact, there are many ways to generate finite amounts of data that mimic this signature behavior, but, in their asymptotic limit, are not true power laws. Thus, accurately fitting and validating power-law models is an active area of research in statistics.


A plot of distribution of net income of the global top 150 corporations does not yield a bell curve. Thus there isn't an even spread of net income values across the mean value. The representation is a power curve - implying that most values (of Net Income) are below average.
Power-law relations are predominantly found in nature and phenomenon that are naturally occurring.

• Gravitation and the Coulomb force, are power laws, (inverse square)
  
• Area of circle - quadratic law

A wide variety of probability distributions have tails asymptotically that follow power law forms.
This 'asymptotically long tails' observation is connected closely with the study of theory of large deviations (also called extreme value theory), which considers the frequency of extremely rare events like stock market crashes and large natural disasters.

Interesting Observations, Examples & Arguments

• Wealth -- social & natural -- seems to obey the power law.
• Number of earthquakes, behavior of piles of grains, population dynamics - behavior and characteristics - exhibit close similarity to the power law.
• Number and the magnitude of 'Solar Flares' the x-ray signature of black holes - exhibit power law characteristics.
• The observed random distribution of digits from 1 to 9 (Benford's Law),
• Benford Law : American astronomer Simon Newcomb noticed that in logarithm books, the earlier pages (which contained numbers that started with 1) were much more worn than the other pages. Newcomb's published result is the first known instance of this observation and includes a distribution on the second digit, as well. Newcomb proposed a law that the probability of a single number being the first digit of a number (let such a first digit be N) was equal to log(N+1)-log(N). The phenomenon was rediscovered in 1938 by the physicist Frank Benford, who checked it on a wide variety of data sets and was credited for it
• The impact of forest fires
• The 80-20 rule applies to the distribution of wealth - the top 20% of the population holds 80% of the wealth in a society.
• The 80-20 rule also applies to major motion pictures.
• Admissions at Ivy League / to colleges follows the 75-25 rule --> nearly three quarters of the undergraduate students at Harvard and other so-called "most selective" universities and colleges come from the top income quartile.
• Applied to financial markets and as repeatedly pointed out by Benoit Mandelbrot and Nassim Nicholas Taleb, "just 10 trading days represent 63% of the returns of the past 50 years".
• The power law also applies to concentration of market capitalization to the shares of a small number of publicly traded companies (e.g., the 80-20 rule approximately applies to the market value of the FTSE 100 compared to all shares traded in London), the size of hedge funds, and a number of other areas in finance.

Analysis - Business Context
An analysis of the top 30 US banks and savings institutions in June 1994, 2007, and 2008, measured by their domestic deposits.
This inequality has been increasing from 1994 (when the number-ten bank was roughly 30 percent of the size of the largest one) to 2008 (when it was only 10 percent as large as the first-ranked institution). It also shows how in 2008, the financial crisis accelerated the growth of the top five compared with the other banks in the top ten as the largest financial institutions took advantage of their relatively healthy balance sheets and absorbed banks in the next tier.
Regulation could put a damper on this crisis-driven acceleration of inequality, but power curve dynamics suggest that it will not reverse the trend.
There are observed long-term patterns of increasing inequality in size and performance in a variety of industries and markets - using metrics such as market value, revenues, income, and assets to plot the size of companies by rank.
Thus the power curves are becoming steeper - i.e., the inequity is increasing. In analysis -

• An industry’s degree of openness and competitive intensity is an important determinant of its power curve dynamics.
• It would be expected that a bigger number of competitors and consumer choices to flatten the curve, but in fact the larger the system, the larger the gap between the number-one and the median spot. (why?)
• After the liberalization of US interstate banking, in 1994, deposits grew significantly faster in the top-ranking banks than in the lower-ranking ones, creating a steeper power curve.
• Greater openness may create a more level playing field at first, but progressively greater differentiation and consolidation tend to occur over time, as they did when the United States liberalized its telecom market.
  

Power curves are also promoted by intangible assets—talent, networks, brands, and intellectual property—because they can drive increasing returns to scale, generate economies of scope, and help differentiate value propositions.
Surprisingly the more labor- or capital-intensive sectors, such as chemicals and machinery, have flatter curves than intangible-rich ones, such as software and biotech.

The fact that industry structures and outcomes appear to be distributed around “natural” values opens up an intriguing new field of research into the strategic implications. Notably, the extreme outcomes that characterize power curves suggest that strategic thrusts rather than incremental strategies are required to improve a company’s position significantly.
Consider the retail mutual-fund industry, for example. The major players sitting atop this power curve have opportunities to extend their lead over smaller players by exploiting network effects, such as cross-selling individual retirement accounts (IRAs), to a large installed base of 401(k) plan holders as they roll over their assets. The financial crisis of 2008 may well boost this opportunity further as weakened financial institutions consider placing their asset-management units on the block to raise capital.

Application of Power curves in strategy setting
As executives set strategy, power curves can be a useful diagnostic tool for understanding an industry’s structural dynamics.
In particular, there may well be commonalities across sectors in the way these curves evolve, and that might make it possible to gain better insights, based on the experience of other industries, into an industry’s evolution.
As the importance of intangible assets increases across sectors, for example, will power curves in media and insurance resemble the currently much steeper ones found in today’s intangible-rich sectors such as software and biotech? Power curves could also benchmark an industry’s performance. Curves for specific industries evolve over many years, so the appearance of large deviations from a more recent “norm” can indicate 1.) exceptional performance, on one hand, or 2.) instability in the market, on the other.

Unlike the laws of physics, power curves aren’t immutable. But their ubiquity and consistency suggest that companies are generally competing not only against one another but also against an industry structure that becomes progressively more unequal. For most companies, this possibility makes power curves an important piece of the strategic context. Eclectic Antidote to the Power Law predisposition

Power law is a useful paradigm & tool for studying many natural & social phenomenon that are consistent with that model. As a descriptive ('positive' in philosophy of science speak) framework, the power law is often superior to the 'normal' distribution and should be adopted and utilized more widely.

From a normative, prescriptive however, the logic of the power law could easily be abused (just as the 'bell curve' has been). To any person of both intelligence and conscience, it is not a laudable nor a desirable thing to have 20%, 25%, or some other percentage of small concentrated elites or 'hits' crowd out higher quality competition and, even, endanger meritocracy and democracy.
The negative consequences of a predisposition to follow and mould activities as per power law can be mitigated by using a long tail strategy by focusing on asymptotic populations, of encouraging eclecticism and accommodating niches.
The power law can then become a useful and desirable framework to identify and tackle problems in business, finance, policy making, and culture.

Role of IT in Reducing Carbon Emissions

Source:http://www.mckinseyquarterly.com/Data_centers_How_to_cut_carbon_emissions_and_costs_2255

Greenhouse gas emission can be attributed to emissions related to ICT - s/w laptops, PC's, data centers, networking, telecommunications & mobile phones. (ICT is overtaking aviation in terms of impact on environment.)

There are 2 sources of contribution to environmental impact:
1. Embedded s/w - energy & material used for production, transport & disposal of ICT
2. Energy used during the life-time of the ICT components - device & s/w

Examples -
1. PC's the major part of emission is in production as the PC's are idle during most of their lifetime.
2. For data centers, emissions is more a part of their working lifetime and less as compared to its manufacturing.

Geographically the growth in emissions from ICT is happening in emerging economies, India, China. Application wise, data centres will be growing the fastest followed by growth in workplaces as more and more of knowledge workers come into the workforce across the globe.

Within ICT the greatest opportunity to reduce emissions are:
1. Making ICT greener - i.e., making hardware more efficient, making larger more efficient data centres. Management initiatives - Productising infrastructure, virtualizing technology, industrializing the production of ICT.

2. Using ICT to make business processes more efficient, example - in energy production and energy distribution managing data better, having sensors to create relevant data and smart grids to ustilize the algorithmised data for efficient operations.The manner in which ICT can improve manufacturing or reduce energy usage is for example:

• In automotive production just knowing the carbon footprint across (global) supply chain.
• In private homes, making homes smarter to reduce carbon footprint of the private household.
• Optimizing of logistics & transportation to avoid congestion and waste of fuel, by looking at efficent less obstructed ways.

Net cost to companies for optimizing their energy usage and optimizing their processes using information technology (ICT) - The business process optimization case is more positive in terms of abatement as it looks at effcient usage of resources, better data capture and processes makes processes more efficient directly impacting organisations costs.

Provider and user end of technology receive these messages differently. The users (Banks, transportation, IT, aluminum production co's) are more open and excited to use ICT as a means of creating internal efficiencies as well as reducing carbon footprint while the providers (hardware and software providers) are more apprehensive / sceptical.

Dematerializing certain business processes (such as telecommuting, using more video-conferences) has limited impact, changing processes that can enable reduction on travel and other means, ICT would have major impact on the abatement potential.

2009 - What it holds for entrepreneurs and small businesses

Source: http://money.cnn.com/galleries/2009/smallbusiness/0901/gallery.smallbiz2009.smb/index.html

The year 2008 ended on a bleak note for all industry, specifically the small industries faced issues such as slow sales, frozen credit from banks, costs related to healthcare soaring and the credit card debts getting higher. What does 2009 hold :

1. 2008 saw the cost of healthcare rising (by 5.7% per employee), and healthcare costs were the top issues for small and medium business enterprises. This year (2009) it is expected that healthcare reform takes center stage - President Obama is endorsing the forming of national health insurance fund that small businesses can have access to. These pools can negotiate better rates (as a collective) vs individuals. 2009 will see a beginning with more impact to be observed in 2010.
   
2. As a fallout of the credit crisis, access to credit for even credit worthy businesses became an issue. Businesses responded cutting back on expansion plans , downsizing staff and focusing on other ways to increase the cash flow. The loan-guarantee program backed 30% fewer small business loans in 2008 than it did the year before. Banks profit not only from the interest on the loans they give, but by bundling these loans in the form of 'asset backed securities' which are traded to investors. With the value of many 'asset backed securities' dropping last year, the demand for this instrument declined, with no secondary 'Asset Backed Securities' market the banks stopped making even primary loans. This year (2009) it is expected that TALF (Term Asset Backed Security Loan Facility) which is instituted by the federal reserve, aims to make TALF (loan) available to 'Asset Backed Security' buyers, with the hope of spurring demand for 'Asset Backed Securities'.
   
3. Tax cuts as a means of stimulating spending. Though the tax cuts were to expire this year (revert to pre bush era), president Obama will hold off on raising the taxes, instead would give tax break on income (the earners share only and not extended to employer share).
4. Layoffs & hiring. Last year small businesses were the last to layoff. Last year large firm announced massive layoffs and these are expected to continue this year as well. While small businesses did not initially lay off until October when the recession became worse. From a small business point of view, layoffs mean, letting go of family members, relatives and longer working hours for the people that are left in the job.
5. Credit card. Last year as the credit crisis worsened, card companies began to reduce exposure limits and increase interest rates to very high levels. The federal agency stepped in with new regulations safeguarding the credit user against certain credit card company practices of increasing rates on existing balances and charging late fee without notice.
   
6. Commodities and Oil. Oil was on a roller-coaster last year seeing highs and lows in extremes. Iron & steel saw a surge in price by up to 30% while food grains also saw increasing prices. During the year a sharp decline in prices of corn, coffee and non-precious metals was also seen. this year these fluctuations are expected to continue while oil is expected to stabilize to more sustainable levels (for oil co's). Dollar is expected to fall against the yen and euro this year, due to low interest rates and the extensive U.S. government borrowing that will be necessary to cover the costs of the 2008 bailout packages. For companies that do business overseas, a falling dollar leads to increase in costs, and thus the price of raw materials in the U.S. tends to move opposite the direction of the dollar, which means more price hikes may be looming for commodities.
7. The share of the dollar. Reduced credit availability (both consumer and institutional) and rising unemployment concerns, led to curtailed spending. So it may seem that Americans are for the first time saving & not taking more debt. Consequently holiday retail sales took a major hit as spending reduced. This year the story would continue and consequently we would see a large number of businesses (retail) shutting down, the ripple effect will impact store suppliers and also impact small businesses adversely.
   

Airlines - showing distinct signs of shrinking

Source: http://www.iata.org/NR/rdonlyres/250BD608-E428-4A49-B833-20C0E5B99344/0/industry_times_january2009.pdf

• International airlines saw a fall of 13.5% in cargo traffic in November and a drop of 4.6% in passengers as business shrank across the industry, the carriers' grouping IATA said on Tuesday.
• This has been the sharpest decline since 9 /11.
• The airline industry sees revenues tumbling & hundred of thousands of jobs being at risk.
• With the drop in passengers (in actual terms) the airlines are operating at 73%.

And this scenario is expected to intensify.

• Further in America - which includes the United States, Canada and Mexico - carriers saw a decline of 14.4% in cargo and 4.8% in passengers.
• Europe recorded an 11% slump in cargo and 3.4% in passengers as the major markets for its airlines - intra-continental, the North Atlantic and Asia - all sunk deeper into economic woes.
• Despite the fall in oil prices and a low demand scenario for oil that will keep the price of oil soft, the industry is estimated to generate losses to the tune of US$ 2.5 billion in next year.

Upside of a Downturn

With an objective to look into the future with intent and focusing on the possible upside of this downturn, the following seems to come to mind quite naturally. The present global economic downturn has its share of positives, some more apparent than others, and these would surface in different forms and stages, in the journey out of this downturn.

1. Spurt in entrepreneurship
2. Re-surfacing of the systemic view and future - option portfolio approach
3. Protecting of Growth Initiatives - Elevate, consolidate & redirect innovation funding
4. Refocusing on value and what it means to, / the customer
5. Demand & supply balance
6. Opportunity for creating changes - long term impact
7. Focus and emphasis on renovation and repair
8. Re-skilling of oneself
9. Rationalization - Balance of credit to cash from a consumers perspective
10. Opportunity for people to collaborate remotely (work and social)
11. Reduction in office space - focus on increase in productivity
12. A closer scrutiny of the functioning of the corporate & board governance
13. Re-modelling of business to take long term strategic positions
14. Improve Cost Discipline
15. Enhanced fiscal discipline awareness & emphasis on drivers of growth, cash flow & value
16. Organizational restructuring (not rationalization) for efficient focus on Cash, Core People (not Processes), Delivery and Growth

From an individual & firm perspective these are the positives that the downturn has to offer

The Upside to the downturn

1. Spurt in entrepreneurship
2. Re-surfacing of the systemic view and future - option portfolio approach
3. Protect Growth Initiatives - Elevate, consolidate, and protect innovation funding
4. Refocusing on value and what it means to, / the customer
5. Demand & supply balance
6. Time for structural changes - long term impact
7. balance of credit to cash from a consumers perspective
8. renovation and repair
9. Re-skilling oneself
10. rationalization
11. people to collaborate remotely
12. reduce office space - increase productivity
13. corporate & board governance - under scrutiny
14. re-modelling of business and take long term strategic positions
    
15. Improve Cost Discipline
16. Reduce Cost of Goods Sold & Use, not General & Administrative Spending
17. Incorporate capital costs into SKU cost reduction

Retail in India

Source:http://retail-tech.blogspot.com/2008/09/organized-retail-in-india-to-form-14-18.html

Unorganised Retail & Organized Retail
The advent of organized retail has impacted the unorganized retail. But the unorganized retail is showing remarkable resilience and is all set to challenge the organized retail with innovative business models, hybrid formats, in-store operations focus etc.
The organized retail is where most of the focus has been and a lot of metrics have been floated that talk of very high growth rates. Information on unorganized retail is sketchy thus the possible ways of their resilience & responsiveness are not known.
But a closer study of metrics tells that focusing on revenue per square foot & area under retail, as levers of growth and value might not be the whole story and may not be entirely accurate.
And for the unorganized retail the relevance of these metrics might be very different (or in a different manner) than what it would be for organized retail.
If we look at organized and unorganized retail as the two extremes of formats, operations, consolidation etc. there is an opportunity to explore multiple, innovative forms of retail that can exist / co-exist profitably within these 2 extremes.

A scan of recent activities in the retail market shows some initial indicators for the same (even if it is at one end of the extreme...):

• Retailers, realty cos’ form partnerships to beat slowdown - Revenue sharing rental based model with minimum upfront payment emerging – without minimum upfront guarantee.
  

• Vishal Retail is in early stage discussions with some top developers to enter into a revenue sharing-based rental model,Megamart has signed a few large stores on revenue sharing-based rental model ,Brandhouse Retails.

• Big retailers not keen to anchor new malls (future group plans to open stores along with other retailers so that it doesn't have to go through a long gestation period to reach optimum sales).