I was handed an interesting link by bloggerazzi about a part of economics that I had never heard about till date, called Transaction Cost Economics.
previously, the inefficiencies of a manufacturing system were found on the assembly line. So, if a production line slows down, or if extra material is machined, then you know where to pin the blame on! Catch the worker on the line, and improve the process!
But that only worked to an extent, and todays economies are now somewhat different. How, you might ask?
Firstly, todays production lines are not solely dependent upon the worker. They also depend on the supervisor, the inventory scheduler, the middle manager, the stores guy, the accounts man, and half a dozen lawyers to boot.
Basically, a transaction where the only trade is in intellect and services is subject to several unique features. First, is of course, how do you bill the transaction. Second, and linked to one, is measuring the effectiveness of the transaction.
For example, if you were performing a machining operation on a lathe, you could work out to the nearest penny how much it costs to produce a component. Right from the power consumed, and the cost of the interest on the loan for the lathe, to the wages the underpaid lathe man gets paid, everything is accountable.
But how do you rate the effectiveness of a manager? Or judge the utility of a lawyer? Most of the time, they seem useless…but trust me, when you are hit with a lawsuit, you will wish you had a good lawyer (And good accountants too).
Transaction Cost economics tries to quantify these things and come up with numbers that denote their worth. But at the same time, some interesting points come up! Firstly, we see that as an operation becomes more complex, there are more transactions needed to complete the job perfectly.
From this we come to the old one about the factors of production. We all know 3 factors of production. They are
1. Land
2. Labour
3. Capital
But there is a fourth factor which comes up, and transaction costs best defines the fourth factor of production, which is, Management.
In short, Management can be defined as the factor by which the transaction costs that determine the other three factors can be reduced. I do hope that last sentence made sense, because it is the crux of the next point.
Management is also about handling information efficiently. And today one of the points that has been made is that management requires information instantaneously. This has been the reason why IT investments have frequently been justified. They are supposed to reduce the transaction costs made due to lack of information. But IT investment adds another transaction layer to the entire system, and must justify itself. Also, it is seen that the amount of information gathered creates yet more transactions in information processing. This is one of the reasons why IT implementation frequently is seen as a failure. The initial gains that are promised are all used up in the implementation of the IT system itself.
So, one of the things that anyone interested in designing IT solutions should be doing is to map the transactions that take place in any process. Then, identify the transactions that can be reduced or eliminated. Third, quantify the costs that will be saved by reducing these steps. The last process is the one that is truly difficult. And that is to anticipate the additional transactions that will ensue from bringing your IT system into place.
One of the reasons why designing an IT system is not the same as simply automating the process. And why IT consultants earn their fat pay packets too!
Transaction Cost Economics and IT Infrastructure Tuesday, Jul 31 2007
IT and Management IT, Management, Transaction Cost Economics 11:18 am
Harry Potter — The saga ends Tuesday, Jul 24 2007
Book Reviews 1:54 pm
I have to admit it. Along with my sister, I was one of those many people who bought books 5 and 6 on day 1. For the first time since the series came out, my sister and I were in different cities, so could not buy 1 book on 1st day. The solution was therefore obvious….2 books for two people!
Well, I managed to start the book only on early sunday morning, but had managed to finish it off before noon! And I have to say, I felt handily vindicated by the book. It is no longer children’s fantasy, now definitely in the young adult category; but that in no way means that it was bad. Sure, it was a VERY standard fantasy ending…but heck, i like standard endings.
While it would have been very poetic for Harry and Voldemort to die together, I much prefer it this way, where the hero gets to live!
All in all, nice book…though there were no Quidditch descriptions. Ah well, you can’t have everything.
Well, now that the saga is ended, it looks like Bloomsburry is going to have some serious worrying about future cash flows to do!
Privacy and security Tuesday, Jul 24 2007
security 12:19 pm
There are literally thousands of emails and articles written which talk about email security, and how you should not reveal data about yourself online, such as your birthday, or the colour of your eyes. Why? Because, if you do, people can steal your identity, and then steal all your money from some bank.
The first time I saw these emails/articles, I agreed wholeheartedly. Of course it is right that we should protect these details from malicious hackers. And then I realized exactly what it was that I was protecting. After all, I like presents, so I widely publicize my birthday to one and all anyway. And anyone who wants to steal my identity is surely going to have enough initiative to see my photo to check the colour of my eyes. There are enough of those lying around in the world!
What it seems to me is that the companies which are being affected by identity theft are trying to pass the buck here. Why on earth do they not have better security systems. After all, its easier for them to blame the poor customer than it is to make sure that problems don’t crop up in the future.
So, I am going to be a lot more suspicious when someone asks me to hide my birthday on my orkut profile.
Die Hard 5.0 — Bruce Willis is dead. Long live Rajnikanth Monday, Jul 23 2007
Movie Review 10:06 am
Hollywood needs Rajnikanth. And Bruce Willis is doing his best to satisfy them. What with using cars as a sort of hyper large bullet with which to blow up helicopters, and various other such physics defying stunts, even Rajni would have his eyebrows as high as they could go.
And another thing….why is it that good looking computer hackers who also moonlight as kung fu master mercenaries are found only in movies? Well, my companion at the movie was more interested in the good looking computer hacker guy who can moonlight as a gun toting mercenary as well as getaway car driver, but in my humble opinion…no way…the girl was waaaaay cooler.
So, all in all, it was an amazing experience. And with Rajni’s latest film having him sport the hairless look, its no surprise that by the end of the movie, I was not sure who was playing who.
Bruce…If Hollywood does not let you do Die Hard 5.0, join the Tamil film industry. I guarantee that you will find success, and bullet dodging roles galore.
Of overcharging Taxi Drivers, and all of their ilk — Sub optimal Economic Equilibrium Friday, Jul 20 2007
Economics and Management Economics, Management, Taxi Drivers 9:50 am
Yesternight, a friend of mine was attempting to hail a taxi at Salt Lake in Kolkata. Of course, no taxi guy seemed to be willing to take him for anything under 10 times the actual price, so he had to walk in the end.
But this got me thinking. According to definitions, perfect competition would exist when it is very easy for people to enter and exit the market. By that definition, taxi drivers in Salt lake should exist in perfect competition. But clearly, because prices have not fallen, it seems as if there is no perfect competition here. Why is that so?
Now, at first I thought it could be cabals or unions that distort the free market…but that did not make enough sense. So here is an alternative explanation for why taxi and auto guys charge so much…even though due to competition they ought to offer cut rate prices.
Let us take a hypothetical case where there are 1o taxi drivers. In most places, such as Bangalore, or bombay, there would be a plethora of customers, and the taxi driver would have choices, as does the customer. Also, because most of the customers are locals, knowledge of the locale is also assumed. In this case, it seems to me that the perfect competition model ensures that the lowest prices will be guaranteed.
However, in a place like Salt Lake and Gurgaon, the case would be slightly different. Firstly, the local populance is unlikely to travel by taxi. In salt lake, this is probably due to familiarity, and lack of places to go to. In the case of gurgaon, it is because those who live there are likely to have their own private means of transport like a car or a bike. Therefore, the only people who are likely to hail a taxi-cab are going to be people who are not locals. Also this subset is definitely smaller than the superset of all the people living in the area.
So to summarise, problem is
1. Information Asymnetry
2. Finite customer base.
So, let us take a hypothetical case of 10 taxi drivers, and only 2 customers. While it seems counterintuitive that the prices should go up, here is why they will. In order for the taxi driver to make ends meet, he will have to get revenues of say Rs. 200 a week. Whether he gets it by taking 1 fellow 5 times or taking him once is immaterial to him. Therefore, now these 2 customers will now pay 400 between them. Now, while only 2 taxi drivers benefit, averages say that the next day, another 2 taxi drivers will get 200 and the first 2 will go without clients at all. So, all in all, in a 5 day week, all the taxi drivers will get paid, and the total income would be Rs. 2000. (200 a week per taxi driver)
What would happen now if 1 guy undercuts to a more realistic fare…say Rs. 30. Remember, this is a price inelastic market, so the number of customers won’t really go up. So he might get 2 more passengers added to the market. Now, by perfect competition laws, every other taxi driver should also lower his prices down to 30. So now, the total revenue made by all the taxi drivers now is 4×30x5= Rs. 600. This means that every taxi driver now gets only Rs. 60 in a 5 day week.
So we have a perfectly logical explanation for why taxi guys overcharge in certain places. Its market demand a and supply based, after all!
But there is a neat little corollary here. This is in reality a vicious cycle, because the assumption that is made for this to work is that the demand is inelastic with respect to price. This assumption was made with respect to mobile phones when they first came to India. The rates were incredible, with prices going as high as Rs. 27 per minute. Obviously there were not many takers for that sort of price. But once TRAI mandated changes to pricing, companies were busy complaining that they were going to make huge losses. But to their surprise…they did not…the market got them new customers….and that began the price war that led to perfect competition (practically).
The analogy of course with autos and taxis is this….someday, someone will cut the price and address a market of locals as well…then the traditional elastic demand and supply economics will triumph!
But till then, if you live in Salt Lake or Chennai…prepare to get fleeced by the local private transport providers!
Mumbhai! Monday, Jul 16 2007
General stuff 10:48 am
I was in Mumbai on Friday and Saturday for NIMITT 2007, SP Jain’s management fest. First off, a compliment…a brilliantly organized event, with some wonderful hospitality displayed by the gentlemen and ladies of SP Jain. They did a spectacular job indeed, and deserve every accolade that they are going to get.
But the city itself! I have to admit, I was not a big fan of the place. But like a skin disease, the city grows on you! Now, I have to say, I really love the city. Sure, it has lots of warts, and the lousy traffic is nothing to write home about, unless you want to write a horror story; but the life in the city, and not last, Marine Drive itself makes for a place that is simply awesome.
It helps that I met friends whom I had not met for some time, and spent a couple of very enjoyable days as well. All in all, a wonderful weekend.
So, anyone who wants to hire me….remember, a job in Mumbai would be good. Of course, I would also appreciate a pay package that lets me live the life I want in Mumbai! 
Why are Chennai Buses the way they are? Wednesday, Jul 11 2007
General stuff 11:05 am
Up to now, I have been (mostly) laudatory about Chennai. But now its time for a crib session. I have been travelling by the buses of Chennai for enough time now to start criticizing them. While the buses routes are extremely well covered, and you can travel from one place to another by bus, the downside is the crowds.
The buses are ALWAYS crowded. This is distinct from any other city, where there is a rush hour, and then the pressure falls. Primarily, this seems to be because there just are not that many buses. I visited the website of the organization, which claims they have 2000 buses. 2000 buses for 7 million people in a city where the distances are huge! That is just ridiculous. Even Bangalore has more buses than that…and the routes don’t take two hours to cover. Which also brings me to my next point. Buses wander all over town! The average bus seems to take the LONGEST possible route to get to the destination, taking twice as long as any other method.
And the ridiculous pricing….the prices are cheap…and so are the services. The buses themselves are in terrible condition, barring the odd exception. Truly, when you pay peanuts, you get quality even monkeys will question!
Ah well…enough of this diatribe. The main reason that it was brought on is because my knees have been beaten up sitting in a space that even a midget would have trouble fitting into!
Biofuels– Agrofuels. Whats in a name? Wednesday, Jul 11 2007
Biofuels and Economics 10:08 am
Today, I thought I would enter the biofuels debate. After all, every Tom, Dick and Harry wants to enter the debate. So why not Balasubramanian?
Biofuels are the common name given to anything that provides energy that comes from agricultural sources. This could be ethanol, power produced from bagasse, jatropha seed juice, even methane from cowdung.
So why is everyone interested in it now though? After all, these things have been around since the dawn of time, practically. Heck, I remember watching programs on biogas when I was a kid, and Doordarshan was the only Channel available!
Well, the answer is simple. 10 years ago, a barrel of crude oil used to cost $12-14. Today, it is about $76. Economics says that if prices go up, demand for the product goes down. But Oil is a strange commodity. Like food, the modern world cant seem to live without it. Thus, a situation in economics called inelastic demand sets in, where demand is somewhat independent of price. But even though the demand stays constant, now there is a desire for substitute sources. And this is where biofuels comes in.
Burning Ethanol in the car engine has been around since Gerald Ford made the first Model T. After all, it was a car designed to run on alcohol. But who would like to go through the lengthy process of growing a crop, and then waiting for it to grow, and finally produce alcohol fuel, when you get high grade petroleum oil practically coming out of the ground for free! So alcohol was abandoned. But when oil hit $50 a barrel, the interest was rekindled. After all, the cost of sugarcane is not too much, and alcohol could now be substituted. And besides, after all the hoopla about green energy and global warming, producers can get labelled as good guys even while they rake in the money!
But can there ever be a perfect deal? Unfortunately no! What you gain on the swings, you lose on the roundabouts. Ethanol is produced from three major crops; sugarcane, corn and sugar beet. But sugarcane requires fertile and irrigated land. And even if we take the entire cropland in the world and grow sugarcane on it, we probably would not be making enough ethanol to supply our needs. At best, ethanol is a partial substitute. Also, the diversion of land from food crops to sugarcane leads to a situation where food prices will become a serious problem. This is especially because the crop is grown in countries which are not precisely rich; Brazil, India, Africa, and the likes.
So the lobby against biofuels is slowly building itself up. But this is a debate that will probably be decided by the Financial officers and the bean counters at an office rather than in the streets and farms. But the end result may well be seen in the economics classrooms when people discuss case studies on substitute products!
Haircuts! Tuesday, Jul 10 2007
General stuff 12:01 pm
Those who have seen me over the last few months have noticed that my latest attempt at disguise involved hiding my face behind an unruly mop of uncut hair.
Chennai’s heat finally persuaded me to finally go for a haircut. And I was treated to a display of family tradition at the barbershop, with 3 generations, from a patriarch to the grandson, learning his trade.
End result is me, with far less hair, and almost unrecognizable (according to my boss).
Strategic HR–That elusive creature Friday, Jul 6 2007
Human Resource and Management 5:24 pm
Human Resource in every company is much vilified. It is claimed (sometimes justifiably) that they are useful only for 3 things, recruitment, payroll, and vilification.
But todays HR professionals feel that they are being short changed. In the party where the marketing guys ruled, and the finance guys were feted, the poor HR fellows looked a little bit out of place, standing at one corner, dipping into the drinks cabinet now and then.
Times had to change, and suddenly a divine light dawned….and the enlightened HR professional came up with the golden words, and it was called “Strategic HR”.
HR guys suffered from quite an inferiority complex. Whenever a fin guy was asked to deliver his results, he could say, hey i lowered your debts by 90%, and saved you a tonne of cash. And marketing, “Heck, where would you be without your star who got you 50 new clients?”. But poor HR…”Sir, I hired 2500 new employees who are going to cost you Rs100 crores….and most of them will leave by next week.” Not guaranteed to bring a smile to that CEO’s face.
Strategic HR tried to turn things on its head. It said, “Phsaw…these balance sheets are all past data. and all those sales happened yesterday. Our stock prices depend on tomorrow…and for that, we need future growth.”
And of course, future growth was measured by whether you had the right people doing the right job, at the right time, at the right place. This was strategic HR’s idea. To pick the best people for the best job at the right time. And all this would be based upon a company’s nebulous vision and mission statement.
Today’s HR profs and executives are big believers in Strategic HR. Whether it works is still a matter of conjecture.
Mind you, I do not denigrate HR. Any company with Bad HR is doomed to devastation and ruin. But I am just a little bit suspicious about Strategic HR. Its fine in theory. But in practice, it frequently means work…which no one likes doing.
