It has been a while since I last posted, and since then I have shifted cities, companies and the type of work that I do. And yes, have married and become a father as well. And most of those things have ensured that writing posts has become fairly rare. This week, I have some time and wanted to restart with an idea that has been floating around in my head for some time — The relationship between customers, employees and shareholders and how we can use this to analyse an industry.
The Components of an Economy
The standard economics books I have read say that a marketplace is made up of buyers and sellers, all seeking to maximise their overall value. But if we look at the world around us, the “market” does not seem to have much negotiating of overall value. Sure, the famous “invisible hand” is supposed to be working to ensure this, but it seems fairly invisible to me!
Instead, I have been trying to see economic principles with respect to three components of the economy that I see in daily life whenever we buy (or sell) something.
One, the person who buys the goods, who is called the buyer, customer, client, sucker….depending on the industry you are in.
Second, the shareholder of the company, or the proprietor of the firm who is selling you the stuff that you are buying
Thirdly, the employee who actually delivers the stuff that you buy. In some cases, like my local barbershop, the employee may be the proprietor. In other cases, like my bank, there may be many employees who deliver the product to me.
Most economic textbooks take the employee as one of the costs of production, and then say “TaDa….standard buyer seller model!”, and they are probably right. However, it may be interesting to take all three components and work to see what sort of dynamic evolves when you have a perfect market.
The Example — Telecom in India
The context and industry overview
One of the more interesting examples of this interaction was seen in the Telecom Industry between 200-12. For various reasons, which need their own blog post to discuss, there were a very large set of telecom service providers in India in this period. While 10-15 service providers does not a perfect market make, in the oligopoly that is telecom, this is not at all common. As a comparison, most developed markets have 2-3 major players in mobile telephony and maybe 1 or 2 minor competitors. So 15 service providers is quite a large number in the relatively low margin telecom world in India.
As most economic theories would tell you, when you have a larger number of sellers, this would ten to drive down prices and make companies try to grab customers any way they can, and that is exactly what happened. Indian mobile phone tariffs plummeted, with already low call charges dropping to the lowest in the world.
Analysis — A free for all, and what ensues.
One of the things that I expected was that telecom service providers would start differentiating themselves in this crowded market with solutions that were tailored to individual market segments. This would mean that one of the service providers would capture the corporate data market, while another would be targeting the low margin, but high volume retail voice market. In other words the world of Telecom would start to resemble the world of soap sellers, with one group saying, 20% moisturizing milk and the other group saying, “the soap of the stars”.
But that did not happen….at least from my perspective. Instead, tariff plans across the board seemed to converge in a pure price battle, as if all the businesses had no other alternative.
So you had this weird situation, where there were 15 mobile service providers but none of them were any good. Customer service was a joke, and any kind of customization that was requested was inevitably met with “Our Policies/systems do not allow this” My first instinct was to say that these companies are stupid. Why are they not investing in building a differentiated model? It would make so much sense!
But these companies are being run by smart and knowledgeable people who know way more about the business than me, As an example, one of my classmates at my Business School (who is definitely at least as smart as me, and is more hardworking too!) is working for one of those telecom companies. And as top management, I was sure that Sunil Mittal, and Arun Sarin (at the time) were no mugs either. So why could they not figure it out?
So, i changed my assumptions. What if they had figured it out, but something was stopping them? It could not be management quality, so what could it be. The other two alternatives are people, and capital. And now things became a lot more understandable!
Results — The unfortunate trio
First, some context. Any company needs to return cash to its investors (and certainly its lenders). There needs to be some amount of revenue that HAS to be set aside to ensure that capital providers are remunerated. And in telecom, the major expenses are spectrum fees (one time, usually financed with debt) and employee costs. I am deliberately excluding network costs and tower costs, which are not insignificant, but which muddy up the waters in this analysis.
So once you pay the debt holders (which should be non-negotiable), you have to distribute profits among the shareholders and employees. However, the hyper-competitive nature of the industry meant that nobody was making a lot of money. So companies could not pay their shareholders very much….and even though there was a lot of demand for telecom employees because of the number of companies, the sheer cash crunch at companies meant that employees were not getting paid that much! So employees at these companies were not happy at all. Wage hikes were below their expectations, and work hours seem to stretch longer and longer!
“What about shareholders?”, you may ask. Well, shareholders were suffering too. From what I could see, Vodafone India was not making enough money to break even, so Vodafone Plc needed to invest in India. Bharti Airtel, decided to try to diversify its holdings by moving out of India, which needed a lot of debt, which in turn has depressed their earnings per share. Reliance Communications tried playing the volume game, and for some time was the largest telecom company in India by subscribers (maybe it still is, but I don’t think so). But because its subscribers did not really make it much money, it also had to take on a huge pile of debt. Tata Docomo, which started the fare wars in India with its famous 1p per minute tariffs is yet to make a profit (I think).
Now customers should have had a great deal! But that does not seem to be true either. Sure, the number of subscribers shot up dramatically, but I have yet to meet a satisfied telecom subscriber! Service quality across the industry has suffered, and network congestion means that signal drops are (relatively) common across all service providers.
None of the three stakeholders in the industry are entirely satisfied with the status quo. As shareholders go, three of the smaller competitors seem to have disappeared (with some help from the courts). With the reduction in competition, we are now seeing a more traditional competitive landscape (though how long it lasts is a question mark). Companies are reducing debt and raising equity in an effort to ensure that risks in their capital structure are reduced.
At the same time, customer tariffs are beginning to rise, though tariffs in India are still among the lowest in the world. But as a result of the risks taken in the 2007-12 period, data tariffs rates which are too high for the average Indian ensure that data is yet to drive the profitability of these companies meaningfully. The road to providing differentiated services to customers is still not taken.
And employees? They are usually the last to benefit in any business cycle, and my own guess is that wage hikes and addition of hires would only begin after profitability of the companies improves significantly.
Competition is supposed to be an unmitigated good. However, the telecom industry does not seem to accept this, and globally we tend to see that the industry is captured by 2-3 players. There are multiple and complex reasons for this. The jargon terms here tend to be network effect, regulation, spectrum auction policies and stuff like that. Whatever the reasons are, the impact of having multiple players is not an unconditional good.
In later blogs, I shall try to use the three party stakeholder system of economic analysis on other industries to see if any conclusions can be drawn. But this example is one that makes me wonder whether free markets are actually a stable equilibrium state, or is like a tripod, which can be tipped over with an imbalance from any side?