90% Tax on bonus: Are we being fair?

AIG bonuses has been the top issue in the news for more than a week now. Almost everyone including media, politicians, public are emotionally charged up. There is so much bad blood and negativity out there. Is all this hype & knee jerk reactions justified? I don't think so. We all seem to be carried away by this hype created/fueled by media & politicians and are failing to look at this in a bipartisan and level headed manner.

I agree that careless decisions by some of the senior banking executives led us to this current situation. In reality most of these execs who were responsible for this crisis have already left or have been forced to leave the financial institutions. They have made their money and have got away scot-free. The folks that are remaining are the folks that were working in profitable units of the banks(not involved with crisis), or those that have been hired/charged with fixing this crisis and getting things back in control, or relatively junior folks that merely followed orders. These are the folks that are working hard today to keep the system running, These are the folks that are trying their best to help us recover from this crisis. Is it fair on our part to penalize them?

One of the things that is happening today is generalization, rather than picking out and punishing the folks that caused this crisis, we seem to be indicting the complete banking community and focusing our ire & hatred on them. The politicians that are pushing for the 90% tax on bonuses today are the same folks that legalized & encouraged complex risky instruments like CDS etc in the name of liberalization. Don't they have an equal or higher responsibility for this bubble? Implementing the 90% taxation of bonuses for all bankers is a gross violation of individual rights(failing to pay for the work done/wrongly appropriating the money) and discrimination of banking community. This is no different than racial or ethnic discrimination, in this case discrimination is based on industry. This is also gross misuse of powers by the politicians. I can understand this happening in a Tanzania or North Korea but not in the US. The majority of folks impacted by this law are innocents. I'm surprised that there isn't any level headed person in our political system, that can rise above these silly politics and come up with a bi-partisan, honest and just solution.

Lastly, we seem to be looking at just one side of the coin. Here's a letter by an AIG executive to the CEO highlighting other side of the coin. I hope some of the media personalities and politicians that are fueling this hatred get to read this and realize their mistake.

Pls let me know your thoughts on this issue.

Photo Credits: fintag, hanneorla

Who should be blamed?

Here's an excellent post "Bankers aren't special.. But Banks are" by one of my friends from the banking industry. As part of this post she talks about the double standards where we praise banks/bankers when they generate great returns and slam them when things turn sour. Here's my detailed response to the same.

I agree with her view that bankers get paid more as banks are wealth creation engines. Here are couple of points I would like to add on why bankers are paid more - high level of complexity/highly intellectual nature of their work(similar to IT) and high level of risk they deal with as part of their jobs- higher the risk higher the returns! Rightly so that they get paid more.

Banking industry is all about trust and reputation. One of the reasons why people are upset today is because the trust that people had on the banking system & reputable financial institutions is now broken. Lot of people lost their lifetime savings, 401k's and big portion of their hard earned wealth due to unsustainable/risky investment practices of banks. As a layman a lot of these practices looks way too risky to me. I fail to understand how these smart bankers failed to see the inherent risks/defects in the model.

I feel that banks were focused more on short term profits than long term stability/sustainability. Otherwise how else will you justify the leverages(Investment banks have a leverage of 30-40 times their asset base) and risk taking ability in the system? These days its all about the number game. Most banks/banker's performance is judged by the short term returns they generate and in turn their bonuses are based on the same. This blinded their view on the risks and biased their thinking towards short term profits.

I dont think its a problem with the banks alone, this is an inherent problem with our system (Btw I'm not a socialist, I'm a hardcore advocate of open markets). Who should be blamed for this mess - The Banks? Bankers? Government? or we as individuals who perpetually crave for higher returns? To give you a small example when we are putting our money in a fund/bank most of us by default put our money where there is a higher return and in a normal scenario we hardly care about the risks. When we encourage banks to take higher risk, generate higher return and provide them with our money how do you expect the banks to take the blame?

While i still hold the banks/bankers accountable as it is their responsibility to take the right decisions to safeguard/grow our wealth, we as individuals are equally responsible. We need to wake up to the fact that with higher returns come higher risks and be cognizant of this when we push our bankers to generate higher returns. We as stock holders need to realize that companies/banks cannot keep growing forever and generate unreasonably high returns, we need to take a long term view. To conclude, we need to keep our greed in check and come to grips with reality. End of the day its your money that is lost and you are the one who is affected!

Pls let me know your views/comments on this post!

Photo Credits: Nick.Hider & ilovepiano

How to Survive the Economic Downturn?

I was reading an interesting case study in HBR blogs couple of days back. The case study was about a Home improvement store chain whose sales/profits were going down. The company was faced with a tough decision to cut costs in order to survive. Headcount reduction seemed to be the only course of action. The author lays out the various thoughts of the company's leadership team and employees and asks for our opinion on what is the best course of action.

This seems to be a pretty common occurrence these days with lot of companies facing similar situation. Economic downturns & recessions are an inherent part of capitalism intended to shake up the market and weed out the weak companies. It’s all about survival of the fittest. Companies can either become stronger or weaker based on their response to the crisis and the actions take take during these tough conditions. As part of this blog I've attempted to list down the possible solutions they can adopt to survive and thrive in the downturn. These solutions typically fall under three major categories which are:

Optimization & Cost reduction solutions

These solutions are aimed at reducing wastage in the system and costs.

Solutions for fixing issues/Problems

These solutions are aimed at identifying the root-cause for sales/profit decline & fixing them.

Growth enabling solutions
These solutions are aimed at improving the competitive advantage of companies and enabling them to come out ahead of their competition.

There is no single solution that will fix the issue. Companies need to undertake a combination of all the three major solution categories listed above in order to sustain & emerge stronger from the downturn. Here are top 10 solutions that companies could adopt during tough market conditions:

1. Eliminate excess fluff

Most large organizations as part of their growth create lot of redundant roles, position and non-critical functions. All the roles and functions that are non-critical need to be reviewed and pruned down as appropriate. In addition for each of the functions we need to analyze if there are ways and means in which productivity could be improved thru automation etc and if it can be performed with reduced effort. If feasible some of the people displaced thru this reorganization should be re-trained and deployed in core functions. Companies could also explore options like outsourcing their manufacturing, services etc to low cost locations to reduce cost.

2. Weed out the non-performers

In most environments non-performers are a big drag on the system. They generally are very negative and low on morale. Not only is their productivity impacted they also impact the morale of the good people in the system. Identify the bottom x% of non-performers and weed them out of the system.

3. Reduce Wastage

Wastage of resources is a big drain on enterprises. In normal working conditions these go unnoticed. This is good time to ‘go green’ and reduce wastages in the system. Some of the examples of reducing wastage include – Utilize power saving techniques, Encourage Paper-less office (reduce consumables usage), Reduce T&E expenses (utilize collaboration tools, video-conferences etc), Optimize supply chain (Just in Time, low inventory etc).

4. Renegotiate contract with Suppliers/Vendors

This is a good time to relook at the contracts with your suppliers and see if some of the rates can be renegotiated. Most enterprises get into multi-year contracts with vendors/suppliers and are stuck with the high rates thru the conract. These rates would have looked attractive at the time of signing contracts however due to market pressures they could have reduced later. As an example during the early-mid 2000’s companies that had multi-year contract with telecom service providers realized that as an outcome of dot com burst telecom prices came crashing down due to huge availability of bandwidth however lot of companies were still stuck with old pricing. Some of them pushed their carriers to revise the pricing based on current market conditions.

5. Identify reasons for fall in sales and fix it

This is one of the most important activities that a company needs to do. In a lot of cases companies attribute fall in sales to macro economic conditions and dismiss it. A good indicator for this would be to check how your company is performing w.r.to its industry and some of its key competitors. If the company sales is falling more than its competition it’s an indicator for a problem. Some of the reasons that could impact sales include Product quality, Customer service, Differentiation, Market perception of the company/product, Cost etc. A detailed root-cause analysis needs to be done to identify the problems and appropriate action items need to be taken to fix it.

6. Identify loss making division/products and fix them

In a lot of cases there might be specific products/divisions in the company that might be pulling down the whole company. Identify the non-performing divisions/products and fix them. In case some of these are non-core to the company it may be divest them. It also makes sense to run each of these products/divisions as separate profit centers.

7. Identify what’s core to your company and focus on it

One of the foremost strategies recommended during downturn is to focus on core operations of the company. Over course of time companies tend to deviate off their core offerings and venture into multiple areas. Companies need to clearly identify what is core to their operations and stick to it. In order to be successful they need to have razor sharp focus on their core operations and continuously invest in it to stay ahead of the field. All non-core operations could be spun-off and divested from the company. This would also help to generate much needed cash for running the core operations.

8. Improve differentiation against competition

In order for enterprises to be successful they need to successfully differentiate against competition. Companies need to constantly ask themselves the question - why would customers want to buy their products/services? They should identify unique value proposition that customers would get by engaging the company. Differentiation can be in terms of superior service, Higher quality, Unique features, Customer experience, Better value for cost etc.

9. Invest in Innovation and research

Innovation is a necessity in order to drive sustained growth and market domination over the long term. Companies need to be aggressive and encourage innovation and invest in research to help develop new products and new ways for delivering services to customers. Innovation could also help with operations more efficient thereby driving down cost/Time to Market etc. As an example companies like Google, Amazon, Ebay, Facebook etc kept their focus and invested in innovation and research during the dot com bust and have emerged as the industry leaders today. Similarly American car manufacturers are in the brink of collapse today as they did not innovate for the last few decades.

10. Invest in talent

Challenging market conditions are the best time to hire the top talent in the market. Lot of good talent will be available in the market due to lay-off, company closures etc during challenging times. Successful companies are constantly on the look-out and hire the best talent in the market during challenging times.

I have made the above list generic so that it will fit a wide range of Industries. Pls let me know your views on the above solutions. If you feel that there are other ideas in addition to the ones i have listed above pls feel free to add to this list.

The real crisis? We stopped being wise - Barry Schwartz's speech at TED

This is an excellent speech by Barry Schwartz at TED 2009. In this speech he says that the real crisis we are facing is our loss of wisdom. He talks about the importance of values, virtues etc and says that putting rules and more rules is not the solution. He also says that virtues cannot be taught at school nor can be put as an instruction sheet, it needs to be practiced by people and imbibed as part of our values.

This seems to echo my thoughts on one of my earlier blogs regarding the ethical/moral crisis reg Sathyam.

There are some excellent speeches published in TED website. You could check them out if you are interested.

Layoff by Profitable Companies - Is it Ethical?

Jan 2009 has been a bad month for US with around 598k jobs being laid off. This is on top of the 2.3M layoffs in 2008. One of the trends that we saw during this cycle was lay-offs by profitable companies like Microsoft, IBM, Intel etc. This garnered a lot of press coverage and prompted a big debate on whether layoff's by profitable companies is ethical.

IMHO layoff by profitable companies is ETHICAL. Here's are some of the reasons why i feel it is ethical:

• Shedding excess baggage: Most large companies over a period of time build up a lot of fluff (redundant positions, over staffing etc) in their operations and this typically goes unnoticed when they are growing well and are profitable. When the going gets tough and margins are starting to take a hit they wake up shed lot of these excess baggage, trim down their operations in order to be more efficient & competitive.
  

• Rollback of excess hiring for anticipated growth: It normally takes between 6-12 months to induct a new employee and have him fully productive in a typical enterprise. Lot of companies do anticipatory hiring based on their targeted growth. When a downturn occurs, most companies realize that a slowdown is occurring only when they start feeling the pinch. When growth suddenly starts tapering out and they don't have sufficient work for the folks that were hired ahead of time. Hence leading to lay-offs.

• Declining Demand/Consumption: One of the key reasons for economic slowdown is decline in consumption. People tend to spend lesser due to risks/tough market conditions and this leads to worsening of the condition. A lot of industries take a hit due to reduced consumption/demand. Its only natural that they reduce operating expenses(shutdown factories, layoff workers etc) to remain profitable.
  

• Weeding out the Non-Performers: Weeding out the bottom x% of non-performers is a standard practice in most enterprises. When the going is good the tolerance level in the system is higher and non-performers get more leeway and lesser folks are laid off. Non-performance related lay-offs also get very little attention/coverage. During difficult times, companies utilize this opportunity for flushing out the non-performers. In most Fortune 500 companies the bottom 2-3% itself can be sizable(few thousands). This whole process also gets more press coverage in tough market conditions.

• Protecting share holder interests: One of the key agenda's for boards and CEO's is to maximize shareholder value. These days there is an enormous amount of scrutiny on company performance, operational metrics, profitability etc more so when the going gets tough. We as share holders & individuals also demand better performance and improved value from corporates. Due to this boards and CEO's take a very conservative & precautionary approach during tough economic conditions to optimize their operations, reduce costs and minimize risks. If boards/CEO doesn't take these tough decisions they will be replaced with folks that can take these decisions.
  

In most cases lay-offs are done due to a combination of one or more of the above factors and hence it is ethical. Pls let me know your views on the same. Also if you feel there are other factors in addition to the ones listed above pls feel free to add to the above.

Satyam Fraud - Ethical/Moral Crisis

In my previous post I had covered my analysis of the Satyam fraud. In case you haven't read it here's the link. In this blog I will be covering some of my thoughts on what led to this crisis and what can we do to prevent this in future.

How did we get here?

I read couple of interesting posts in the net that the world is going through not just economic crisis but also ethical crisis with the mis-management of banks & financial institutions, Ponzi schemes, Corporate frauds, Bribes etc. This is very true. While we can have rules, compliance procedures, multiple levels of cross-checks etc, end of the day if someone wants to cheat he very well can find his way around the system. All our systems and processes are built on the basis of trust & ethics. When these fundamental qualities of an individual/organization fails the whole systems comes crashing down.

What happened in Satyam's case is precisely that. It was a breakdown of trust and ethics. Satyam was bound by SEC, GAAP, SOX regulations, they have independent third party audits etc and still managed to get away with their fraud that too for around 7+ yrs (This came from Raju's statements during enquiry). The current society is becoming more and more materialistic and power, greed, fame, market/peer pressure etc are taking over and some of the basic human values are forgotten. As history has shown us repeatedly those who don't operate in a moral and ethical manner will eventually fail as in the case of Satyam/Raju.

What can we do to prevent this?

In the near-term as an outcome from investigations/analysis Govt will come up with more rules, regulations and compliance procedures. These are more like patchwork and will address some of the outcomes of this fraud and add more overheads to the system (similar to SOX regulations in US where businesses spend millions/billions of $'s). However putting more regulations will not address the root-cause of this issue. This whole episode will keep repeating itself time and again till we reach a stage where our rules and regulations become more of an impediment to our businesses instead of enabling them and defining boundaries/acceptable norms. I'm not saying that we don't need rules & regulations just that rules and compliance alone can never be sufficient.

For us to fix this issue each of us need to look within and ask ourselves if we are doing the right thing. Just like there are rules & regulations for the society, each of us need to operate under the boundaries of personal ethics and values. We as a society need to encourage moral values like honesty, integrity, ethics etc and reward people who follow them. The value system needs to imbibed into the future generations through our education systems and by parents setting an example to their children. While this may sound very philosophical it is essential that we fix this as failure of personal ethics and values is root cause of this issue.

We as individuals need to take ownership and drive this change both in us and in our societies. Lets start with ourselves and kick-off this change one at a time!