Amazon's takeover of Whole Foods might not work

I don't judge business events by stock market reactions, as stock markets can be absurd and have a logic that I can't fathom. That is why, I am questioning the logic of Amazon's buy-out of Whole Foods in spite of the seemingly massive stock market approval and also the jubilation among the proletariat. Stock markets have loved Enron till the day before the scam was disclosed and the general population beliefs have been massively wrong before. I don't claim that this marriage WILL fail, but I think there are many risk factors that are not being considered and because of them this COULD fail.

The Amazon and Whole Foods marriage, to be successful, would need to create synergies. Maybe if a few Amazon or Whole Foods warehouses can be closed without an impact on sales, the buyout would make sense. Or, if Amazon could push its products through Whole Foods (or vice versa) without an increase of cost, it would also make sense. In both these scenarios there has to be some level or merging of strategies or information between the two firms. Not withstanding the study from Harvard Business School that said that 70 - 90% of mergers and acquisitions do not achieve their goals, I raise some questions on the ability of Amazon to create synergies with Whole Foods. 

Let us start from the general business strategy. One of the reasons Whole Foods works is that they are essentially 'local'. So, a store manager can make purchasing decisions without head office approval - like buying potatoes from a local farmer. Their distribution is very decentralized because of such local buying. There are large regional teams with significant autonomy. Of course such operations cost more and so Whole Foods ensures a 30%+ gross margins. Amazon by contrast is centralized, regimented and highly synchronized. The key skill of an Amazon manager is being able to follow the process and not independent thinking. So, the first set of questions - is there any possible synergy between Whole Foods and Amazon? Can the people of these two companies work together? Would a Whole Foods store manager be okay to give up his autonomy? Would an Amazon manager have the competency to be autonomous? 

It is not just about the managers' autonomy. Whole Foods is known to have have 12 different inventory management systems -  they also have autonomous inventory management systems. Whole Foods is trying to reign this in by creating a cloud based solution with Infor, but such attempts in previous firms have had limited success. Whichever ways, Amazon will either inherit a blind system or an Infor based system about which it has very little expertise. Will it be possible to seamlessly integrate Amazon and Whole Foods inventory systems? Will Amazon ever have the same granular level information about Whole Foods stores that it has about its own DCs?

Let us look at it from the customer front. Whole Foods is essentially a bit like a cult. Because of local buying, Whole Foods has fresher produce. Also, such local buying is good for the community. These two differentiators have created a following among a specific class of consumers who are ready to pay the high prices of Whole Foods. What happens to this 'cult' if Whole Foods centralizes the produce? Will consumers still be loyal to Whole Foods? 

The list of questions can go on. Whole Foods has only around 400 stores in the USA. Walmart has more than ten times as many. Will it be possible for a small specialty store to compete with the might of Walmart? Let us say Whole Foods goes on a store opening spree - will it still be able to create the cult among customers with that high rate of expansion? 

I don't have answers to my own questions. But, I do have these and a few more questions. In such times of a general jubilation I know there is a danger of me and my questions being labeled as cynical or old economy, and I am fine with that. I just hope to trigger a few thoughts among some people who can go beyond the general jubilation and think of an alternate - even if for only a few minutes. 

Flipkart eCommerce valuations

I am not against eCommerce. Just that I am confused by the real business of Flipkart and its lot. I am writing this blog hoping that some intelligent reader will enlighten me. Okay, to start, the total investment in Flipkart has been around $2.3 billion dollars. And yet the value of the firm is supposed to be more than $15 billion. If we create a time value for the various investments the rate of return would be astronomical.

Where has all the 2.3 billion gone? Assuming Flipkart has leased 3 million sq ft of warehouse space, and a lease rate of Rs. 20 per sq ft the costs come to around $12million per year. Assuming they employ 16000 people at an average of Rs.15000 per month the salary bill would come to be $48million per year. The company has been in existence for 8 years and it has grown rapidly only in last couple of years, so you can do the math of the total expenses. Ohh yes, this is expense as (to the best of my knowledge) Flipkart has leased all its its warehousing space and not invested in creating its own infrastructure.

In May 2014, Flipkart bought Myntra reportedly at $320 million. Myntra had 2014 yearly revenue of around $160 million and probably no profits at all. Interestingly Tiger Global and Accel Partners are involved with both Flipkart and Myntra. So its like this, the two investors invest in Flipkart, who then buys Myntra, who then pays off its investors. Amazing circle of life. Note that the total investment into Myntra has been only around $100 million.

(All my numbers are from internet based magazines and newpapers and could be completely wrong)

Hmm.....my confusion. Whats happening here?

Okay....let me predict the future. Flipkart will indulge into more acquisitions at astronomical rates. And by coincidence both Flipkart and the acquired company would have the same set of investors (directly and indirectly) .

Customer service through operational metrics

The first thing business mantra that we are supposed to learn and believe is that “Customer is the king”. Unfortunately in real life customers are those set of beleaguered individuals who are forced to wait infinitely for their service and make do with inferior products. In most cases there are no ways for customers to formally complain, no individual manager would lose a KRA point because of customer mistreatment or no CEO would ever have a customer service as a metric in business dashboard. 

Take the case of HDFC Home Loans. It is very easy to get a new loan as the sales personnel would probably visit your office or residence at your convenience. For a query on an existing loan you would have to wait for around an hour at the firm’s office.  The firm’s message seems to be that new customers are important and existing customers are not. Same is the case with all mobile service providers. Most of these places also do not have a formal complain mechanism where a customer gets a tracking number and thus be able to trace the resolution.

It is clearly the CEOs who are to blame for this. So, Mr. Deepak Parekh is the culprit for the case of HDFC bank. Sales is a metric that I am sure he would be measuring. Am assuming that sitting in the head office Mr. Parekh would routinely examine the achievement of weekly or monthly targets of disbursements. Thus it becomes imperative for his managers to achieve the numbers. Like the entire household gets interested in humouring the tantrums of an cranky child, the entire HDFC structure would probably be fixated on achieving Mr. Parekh’s obsession with sales numbers.

Now think, the waiting time for customers at the HDFC Home Loan branches is not at all measured. Nor is the satisfaction of customers with the resolution process. Essentially these are toys that Mr. Parekh would most probably not be interested in playing with. Hence the entire rank and file of HDFC Home Loans deems it unnecessary to work on and improve these parameters. Faster and better service at branches would definitely be possible. But, no manager would ever get a carrot or a stick for performance on service to existing customers. There is thus a completely lack of action and existing customers are forced to meekly accept shoddy service.

Point one of the blog is that customer centric behaviour is to a get extent dependent on the metrics that the Chief Executive uses to control and manage the organisation.

Why should Mr. Parekh even think of improving service to existing customers? For all my criticism, HDFC is probably a lot better than its competitors and among the more humane financial businesses. Every delay is a mark of inefficiency in the organisation. Every customer who comes into the branch with a query is a pointer to a flaw in the process. All these weakness create costs in terms of excess manpower requirements, reprocessing, lost documents, etc. These activities are shrouded within routine work and their horrendously damaging impact is rarely uncovered.

Fast process dictate that the firm be devoid of all wastes. They force efficient performance. A 20 year old wooden bodied truck can easily be driven on the highway where there are no minimum speed parameters. That one truck can easily delay the movement of many other vehicles. Now image that the highway has a minimum speed limit of 60 kmph. Suddenly all vehicles on the highway would be forced to be efficient. The fuel efficiency would go up and all other operating costs reduce. For those who feel that high speed could cause more accidents, well, India with among the lowest average highway speeds has among the highest accident rates.

Point two, business heads should invest him time in monitoring these operational metrics as it will create an overall much leaner and better organisation.

A simple way to achieve excellence on any parameter would be to continuously measure them. Branch level operational metrics need to be given importance at the corporate level. HDFC could start with measuring the average turnaround time for customers. They could also have a simple metric of how satisfied the customers were with the interaction. A best Branch Manager award could be instituted on the basis of performance on these parameters. At a back end level a simple Pareto chart on the nature of complaints and queries could generate a good understanding on where the improvements are to be directed.

One of the easiest ways to control crime rate is to not register complains or make the task of registering complains difficult. Mr. Parekh needs to avoid such behaviour to keep a tab on the operational issues before they blow out of control. (Even now, I am pretty certain that HDFC Home Loan has high costs of managing Branches and the firm is pretty unhappy with their ability to get data from Branches). There has to be an easy way for customers to communicate with top management. Not only must the complaining be easier, a better way would be to motivate customers to give feedback.

The last point, CEOs could well include the Branch level operational metrics in the corporate dashboard and allow customers to reach out to them.

A disclaimer here: I repeat that HDFC is probably among the better of all private financial institutions in the country. I am using the name of HDFC and Mr. Parekh as this idea of this blog came from a poor interaction with their branch.     

Analytics - a tale of two movies

The first movie is of course 'Moneyball' and the second is 'Trouble with the curve'. Both movies are about recruitment of players in baseball. But both movies take a completely different route for this. This article seeks to point out the extreme difference and I seek views of all of you readers.

In Moneyball, Billy Beane (Brad Pitt) is a the General Manager of a poor Oakland Athletics team. He develops a statistical model for player selection with a Yale economics graduate. The focus of selection is numbers and not intuition and experience of the scounts. Gus (Clint Eastwood) is an aging scout for Atlanta Braves in Trouble with the Curve. He has a very weak eyesight. He rejects a star prospect based on the sound of the bat hitting the ball. This is in spite of his amazing statistics. In the end Gus is proved right.

The debate is between using analytics and individual insights for decision making. In the movies both seem to work. In real life a lot of importance is given to the brilliance of an individual manager who seems to be able to make better decisions. Books by Kahneman and Taleb negate the role of intuition and seem to suggest a role for random luck. They support the decision making with numbers view.

What would you do? How much importance would you give to decisions taken on the basis of analytics versus the gut based decisions of an experienced manager?

The Mumbai dabbawallah myth

The Mumbai dabbawallahs seem to be a stuff of fantasy. Every supply chain conference and training seems to be incomplete without a mention of their supposedly fantastic performance. Their par six sigma performance is a dream achievement for every supply chain professional. They have seemed to have achieved an iconic level of excellence with 'uneducated' operators and no technology.

Let me make my position clear. Yes, the dabbawallahs have surely achieved operations excellence. But, they have been able to do so because of some benign business conditions. Most other business are not blessed with the simple and stable pattern existing in the dabbawallahs business. Thus the dabbawallahs are able to excel in Operations without strategy, technology or any type of documented processes.

The same dabbawallah visits the same houses every day at the same fixed time. He collects the lunch box (dabba) and relays it through the same train to the same office at the exact same address. The dimensions of the products are also more or less the same. This 'same' based operation continues every single day. The only variation is that a customer may not have a lunch to deliver on some days. No business enjoys such luxury of stability.

The arrival of customers, the time taken to serve the customers and the type of service or products demanded by the customers all vary in 'normal' businesses. Without variation, or with low variation, business is easier to plan. With stable conditions a business can easily avoid all excess inventory, excess resources and product stock outs.

Let us assume that a beauty salon has exactly one customer coming every ten minutes for exactly the same style of hair treatment and that the treatment takes exactly 30 minutes. In this case the salon can easily employ a staff of 3 people and deliver excellent customer service with very high level of resource utilisation - leading to six sigma operations with high profits. 

An average FMCG firm would have hundreds of SKUs for customers to randomly choose from. The distribution network with multiple independent profit making entities would also have their own buying pattern and behaviour. And, of course, the customers have no compulsion to order in a stable pattern. Thus these businesses are considerably more difficult. The dabbawallahs do the same thing every day. Thus they can easily work from memory. Since businesses have a high number of variables, they need the support of technology to make decisions.

The dabbalwallahs would be very praiseworthy if they were picking up lunch from different houses every day as per some random pattern and also if the delivery addresses were different. To add to the fun it would be wonderful to have the trains running at varying time tables. What the dabbawallahs have achieved is good but nothing incredible. Their model of operation may be a benchmark for abnormal conditions of stability, but is absolutely useless in normal business conditions.

Stampede - an Operations failure

Operations failures that cause a loss of lives and are avoidable without much difficulty are very painful. Here lives are at stake and not merely excess stocks or breakdowns or some other performance metrics. Take the lastest stampede in Madhya Pradesh: http://bit.ly/1p7f9yf. 

As of now 10 people have been reportedly dead.

The number of temple stampede deaths in India are unprecedented. Take this data:
October 2013: Madhya Pradesh, 115 dead
February 2013: Allahabad, 36 dead
November 2011: Haridwar, 16 dead
January 2011: Sabrimala, 102 dead
March 2010: Kunda, 71 dead
August 2008: Himachal Pradesh, 162 dead

The list can go on. These are all stampede events with relation to some religious activity. The data has been sourced from wikipedia.

All places of religious importance have a significantly higher than average rate of human density. This makes the system highly susceptible to failures. An electric fire at home may at most cause a fire and in a worst case death of a few people. In a dense area, an exactly similar event can lead to very grave outcome. A small spark may ignite a chain of events leading to an enormous tragedy. The first point being made here is that tragedies of similar nature in domestic and public locations have a much greater impact in public places.

At homes, or even in offices the people in the system are more or less constant. All those people generally have a long term stake in the well being of that place. Thus, in a majority of cases, minimum safety standards are ensured. In public places, in spite of the religious connection, the situation is very different. Pilgrims may not always be as careful in ensuring a risk minimizing behaviour. That there are so many other pilgrims may create a condition where no individual takes the onus.

A third point is about the concept of risk probability. Say an office has 100 people and each of them is capable of causing a catastrophe with a probability of 0.01%. The chance the there will be a catastrophe in the office is still lower than 1%. In a gathering of 10,000 people the chance of a similar tragedy would be more than 60%. Simple statistical calculations point to the fact that the probabilities of tragedies caused by human failure are significantly higher in public places.

Some religious places have a spurt of pilgrims on some specific days of a year only. This spurt can increase the number of pilgrims by more than a thousand times. With pilgrims the entourage also includes shopkeepers, beggars and similar people. Most places are not designed to handle this sudden increase in the number of people. Thus the system is in a shock and very susceptible to failures. 

There can be more reasons. But, the point remains, that in places with high human density, like the places of worship, the probability and the impact of a tragedy are both very high. It thus makes sense that temple management and the staff of such public places give more than average attention to safety issues. There has to be some sort of paranoia for tragedy prevention.

One way to create such systems is of course by the rule of law. Temples and other religious places could be forced to have a set of safety based policies and the temple management could be made directly liable for any deviations or failures. The fear of punitive action might force attention on this ignored issue. However, it is common knowledge that forced compliance based system rarely result in intended outcomes. People would always find ways to subvert the rules and thus there would be no major improvement in the behavior.

I am not clear to the exact nature of the solution. But, I am clear that every place of religious gathering would have to evolve their own ways of safety procedures. Temple management and staff must be educated and thus motivated to create safety policies. A temple would never have a deity that is unclean. Something should be done so that unsafe practices are a similar anathema. Every human is an incarnation of the divine. Thus, ensuring safety of humans is probably as big as any other offering made to the almighty. 

Imagining the future of Retailing

Sunil Chopra and Aditya Jain had this article in the Economic times: http://articles.economictimes.indiatimes.com/2014-08-13/news/52768197_1_online-retailer-blue-nile-zales

They talk about merging the concepts of online and offline retailing with overall benefits for everyone, the consumers, retailers and etailers. As a concept no one can doubt on such win win scenarios. But, as a matter of practice, the article says nothing, and uses completely wrong examples to prove their point.

There is a comparisons of the costs of an online diamond firm Blue Nile with an offline firm Zales. Of course their cost structures are going to be different. For that matter the cost structures of Toyota and Mercedes Benz would be different, that of Walmart and Macy's would be different. To compare and then try and derive some relationships is perverse academics.

Online and offline are very different businesses. So an online business is bound to have higher revenue per dollar invested in infrastructure. But, the aim of business is surely not to maximise the revenue per infrastructure dollar. For all our enthusiasm for etailing, Amazon is still losing money.

In the Costco and Amazon example, Amazon's high transportation costs cannot be used to justify the better performance of Costco. The low variety model of Costco is great, but the profit margins of Wal-Mart are significantly higher than Costco. Here it seems that the authors have been selective in giving their pre-meditated examples so that they can prove a point.

Online and offline are very different models. As of now, 'touch' is an important part of shopping for many items. Who knows, the evolved customer may not need need to feel. Also, this concept may vary with the category of material. Last mile is surely a major cost for online models, but collaboration with offline for this may not be the only way. Online businesses may create mini warehouses inside cities. Similarly, offline businesses may not be limited to being a demonstration center for products that are ultimately bough online. They will have their own needs and create their own purpose. There also might be some form of collaboration, but not necessarily in the model that Chopra has proposed.

When I read an article by stalwarts like Chopra I expect articles with more imagination and not such mundane discussion that is part of every run of mill SCM seminar. But I guess the pressure to get something in print seems to be taking a toll of even the best among us.

Using Operations to improve customer service

Way back in 1969, Wickham Skinner had written an article in the Harvard Business Review saying that if designed, manufacturing can be a potent strategic weapon for firms. The key was in making manufacturing decisions, or in other words operations decisions, a part of corporate strategy making. Almost 45 years after the article was written, I was sad to see that a firm like Shoppers Stop had completely ignored basic operations principles in ground level operations. So, while operations parameters surely do not seem to be a part of strategy, they are not even a part of routine operations.

July 2nd, 2014 was the first day of supposedly a special sale for their First Citizen members of Shoppers Stop. Obviously they must have expected a higher number of customers as the sale proposition mentioned in the advertising was fabulous. As expected, the customers were surely higher and the number increased towards the evening. There were no major problems in the store, the culprit were the checkout counters.

When the number of customers are expected to be higher, the checkout, which would usually be the constraint, should have been designed to be as fast as possible. The number of customers would be more, and the number of SKUs per customer would also he higher. This one single factor could be a huge factor in realising the sale, as with larger queues, customers could just walk off.

And this was precisely what was happening. It was not a hoard of customers walking off, but a few surely were. The checkout time at around 5:30 pm was more than 25 minutes and it was getting worse. There were loud, irritating discussions in the queue about this.

The long checkout time had many reasons:

1. The discounts were being manually entered. The problem was not just the entry, but since it was manual, the customers had lots of queries. Many were checking the calculations with the counter staff to confirm the discount amount. It is normal for customers to trust manual calculations lesser than automated ones.
2. There was a confusion with the fine print of discounts. There was a 5% additional discount for something and as per the new policy the discount would not be given as cash, but would be added as points. Customers were inquiring about the timing of this policy change, the reason and lots of other things that were in no way helping increase the speed of checkout. 
3. Because the discounts were not cash (but points) a few customers were spending a lot of time at the counter debating if it was worth buying the material. Thus they were using up valuable time at the bottleneck process. 
4. The concept of cash back on credit cards is clear. But, many customers did not know about this and again had loads of queries. 
5. A few items had the bar codes missing. Though this was rare, even one item with a missing bar code could take up around 5 - 10 minutes to locate and clear.
6. The invoice was another classic document. Though it was correct, it was cryptic. You needed a good head in mathematics to match the discounts mentioned to the actual value. Customers would obviously ask questions on this.

There were many other minor reasons. Like one customer debated about the VAT. Another did not trust the manually written product code and insisted to see a similar product. One genius customer was calling someone from her mobile phone to decide on the purchase.

My point is that none of these reasons are radically new. Shoppers Stop has been in this business for around 20 years now. They should have seen through this. Designing for quick check outs is no rocket science. For some reason however businesses routinely ignore the operational issues that arise out of some marketing actions and do not take adequate actions to manage performance. I could hear a lot of talk among sales people in the Shoppers Stop store about their huge targets during the sale period. There was no talk about the queue at the check out counters. Yes, the counter staff were very courteous and patient, almost all the counters were open, but the clear lack of attention to the customer flow through was clear. Come on Shoppers Stop, you can surely do better!!

The other side of large retail in India

I am amazed by the vociferous opposition in the media to the AAP's proposal to ban FDI in multibrand retailing in Delhi (http://timesofindia.indiatimes.com/business/india-business/AAPs-decision-on-FDI-in-retail-irresponsible-Commerce-minister/articleshow/28785884.cms). Newspapers are full of articles of potential losses of billions and also of more than 10 million job loss (http://timesofindia.indiatimes.com/business/india-business/Blocking-retail-FDI-to-rob-India-of-1-crore-jobs/articleshow/28807283.cms?). There is also a lot of talk of how big box retail will improve everything wrong in our country. The opposition may not be completely valid.

The reason that we have high wastage in agriculture is not the lack of systems. It is in fact the existing infrastructure bottlenecks. The cold chains can't operate profitably because of the lack of reliable electricity supply. The truck speeds are slow because of pathetic road conditions. There are high prices and variable quality in the produce because of the fragmented nature of the farm ownerships. All these are crucial issues which if solved would automatically impact the efficiencies of the retail business. The FDI is for direct retailing business. It will have no impact on the infrastructure. As it is the FDI route for cold chains has been open, without many takers, for quite some time now.

There is a difference between the type of jobs created by large retail and the small mom and pop stores. With Mom and pop stores there are entrepreneurs who employ one to four low wage helpers. They are served by entrepreneur distributors and entrepreneur vehicle owners (sometimes with bicycles). Thus the job quality and the level of income is higher for a majority of people. In organised retail, the salary structures and job quality are highly skewed. The super rich but small number of top management would have an extremely high salary as compared to an army of shop floor drones who would barely be able to survive. The salaries of Target and Walmart CEOs are more than 500 times the average salary of their employees (http://money.cnn.com/magazines/fortune/fortune500/2012/ceo-pay-ratios/).  

Such type of income distribution is never good for any economy. High growth and increase of consumption can only happen in markets where the income structures are relatively level. The type of jobs in multi brand retail are thus not likely to create a favourable impact on the economy. Plus of course there is a possibility that the large retail may cause a job loss in the existing set up.

Proponents of large retail in India are demanding proof to show that if the existing large stores have caused any job loss as of now. However they avoid questions on the issue of the supposed benefits of large retail. Have large retail in India benefited farmers in any way? Have they led a significant price decrease for customers?

Efficiency does not always mean low price. Low prices of cigarettes could possibly cause havoc in the economy. Efficiency calculations with a smaller set in considerations are usually wrong and cause something what is called as 'local optimum'. For an alcoholic (or a cigarette smoker) low prices of his vice would be a great proposition. So, if we limit are efficiency calculations to the immediate satisfaction of the person, the prices must be as low as possible. However, if we extend the calculation to his lifetime, higher prices that lead to lower consumption could be better. (Am assuming that consumption is related to price and in cases of alcohol and cigarettes this could be wrong, but the the point is the nature of example and not the exact relationship).

Thus the low buying prices for the consumer could surely create a short term advantage for her. However in the long term, when the focus of efficiency is shifted from the buying transaction to the entire country, the effects of large retail could be very different. The documentary 'Wal-Mart: The high cost of low price' clearly shows that the public health care benefits that the Wal-Mart employees use are a huge drain on the tax revenue. Thus the low buying prices could be nullified by higher taxes.

I am of course assuming here that the large retailers are honest citizens. There have been multiple cases of policy manipulation (though lobbying) and corruption against most large retailers. Being super large they have a clout to conduct such activities unscathed, but this could be the issue of another article. 

It is disturbing that the media savy and educated section of the Indian population are not even willing to consider the other side of the debate. News papers and TV media cannot be relied on so much to frame and base our opinions on such important issues. They have their own agendas. My appeal is for people to think on their own, to read alternate views, to go beyond 'popular' opinion and then  decide. A society that is led by opinions manufactured by mainstream media can be a very dangerous place to live in.

Nano savings and other such dumb fables

I am never able to understand some acts of the corporate world and from my limited means of understanding find them to be absolutely stupid. One such news is the grand announcement by Go Air in today's Times of India -

GoAir opts for female crew to save fuel

http://timesofindia.indiatimes.com/business/india-business/GoAir-opts-for-female-crew-to-save-fuel/articleshow/20805888.cms

Let us look into this issue. They say that every additional kilo costs the Rs. 3 per flight hour. So, for a Mumbai Delhi flight (accounting for the congestion) the cost would be Rs. 6 per trip. A male purser according to the article weights around 20 kg more than a female purser. Assuming a flight has 4 male pursers and replaces them all, the benefit would be Rs. 480 per flight. Assuming a cost of Rs. 4000 per ticket and 180 passengers per flight, the saving would be 0.07% of the revenue. The fuel savings from reducing magazine pages would be even lesser.

The airline hopes to save Rs. 2.5 crores - 3 crores using this. Assuming the Rs. 480 savings per flight and 360 days in a year, the savings would require Go air to have around `175 flights of 2 hours each everyday. This is almost double their existing flight plan.

My first objection is that these supposed inefficiencies have been brought into focus because of the rupee depreciation. A Non Value Adding activity is a Non Value Adding activity irrespective of the rupee price. Even if this fairy tale of savings was true, that it was not done earlier is a mark of inefficient management team at Go Air. Why wait for the dollar to be worth Rs. 60 to reduce the potable water tanks or install sharklets? These items would have served the firm in reducing costs irrespective of the rupee dollar exchange rate.

In terms of cost reduction by reducing assets, it is important to understand the behaviour of costs. For the fight pursers, there is of course the cost of their salary and benefits. But, there is sometimes a much higher cost for their control and management. There are a set of people who create the schedules for these pursers, people who monitor them, people who train and recruit them, etc. In a hypothetical situation that a flight can be managed without the pursers, the cost benefit would be significantly higher than the Rs. 3 per kg per flight hour or the direct salaries of the pursers. This is because the entire set of activities related to the flight pursers could be junked.

All other cost reduction would be very minor and have a very limited impact on the cost performance of the firm. Given that the complete elimination of the activities would not be possible, the focus must then shift to maximising the impact of the activity. The airlines would save a lot of money from eliminating the inflight magazine. But, if that cannot be done, it might be prudent to increase the pages of the magazines, increase customer satisfaction, and thus increase the load factor.

All the savings being talked here are what i call nano savings. To expect these nano savings to save the firm would be very amateur. However the business world has always been fond of such hypothetical fables. Even if one customer chooses not to use the service because of such measures the benefit from days of such nano savings would be lost. One social media savy customer who does not get water to drink may cause a huge PR mess for the firm. The point - especially in times of recession, such nano savings are not at all worth the risks they create. Creating higher customer satisfaction and retention should be given much higher importance than such nano savings.

Extraordinary Maruti results? Where art thou common sense?

Going by the mainstream media reports, Maruti Suzuki seems to have achieved an extraordinary increase of profits in a subdued market. This is as per the quarterly results of March 2013. In spite of a reduction in sales Maruti Suzuki has been reported to have an 80% increase in net profits over the previous year. Business journalists have been going head over heels on this announcement. The success is attributed to better product mix, lower discounts, price hikes, localisation and favourable price of yen. Truly amazing indeed.

The major and only contributor to the high profits is the reduction in cost of materials. There is a direct 7% reduction in cost of material consumer. The cost of material consumed has fallen from being 21.4% of sales to 18.3% of sales. In the quarter ended March 2012, an average car would have Rs. 2.46 lakh worth of materials. In 2013, in spite of inflation and in spite of a higher proportion of larger cars being sold this cost has come down to Rs 2.39 lakhs per car. Larger vehicles would clearly demand more material and thus this cost should have increased. Surprisingly, the cost choose to come down.


Let us first try to understand the imported materials. An average of weekly prices from April 2012 to March 2013 is Rs. 1.52 for one yen. For the previous year in the same period this was Rs. 1.64. This is around a 7% depreciation of the Yen versus the Rupee. Maruti Suzuki imports around 25% of its raw material and of this around 80% is from Japan. Applying this formula to the cost of material consumed, the imports from Japan for quarter of March 2012 would be Rs. 177,482 lakhs. A 7% reduction to this, because of currency depreciation by 7% would create an import bill of Rs. 165,058 lakhs. If we apply the formula (80% of 25% of the total cost of material consumed) to the quarter of March 2013 we get a remarkably similar actual value of Rs. 164,514 lakh. This is less than half a percent off the predicted value. We can safely assume that the yen depreciation has caused a 7% reduction in the import bill. Also, we must note that as the Yen rises this saving is bound to vanish. (In fact the Yen has already appreciated by around 5% in April 2013)

Since the total material cost reduction was 7% over the two quarter, it means that there has been an equal 7% reduction in the domestic procurement of the year. When prices of metals (steel and aluminium) have remained more or less steady, this 7% reduction seems hard to believe. There is no definite word on how this 7% cost reduction has been achieved without a corresponding reduction in the prices of basic inputs. Maruti Suzuki attributes this to reduction of suppliers and other techniques which have been standard industry practices for decades. To attribute the dramatic reduction to such standard techniques seems highly improbable. And if it was actually due to these techniques, that Maruti Suzuki avoided doing this for so many years also points a finger at the ability of the management. 

Obviously the financial reporters have not cared to question the company and have not done their homework. They merely choose to report directly from the company data and for reasons best known to them, create a feeling of exuberance, when no reason exists for the same. The future for Maruti Suzuki seems quite bad to me. The appreciating Yen would hit the imports hard. It would also not be possible to keep the local procurement costs low when the input costs are rising or at best steady. 

The quarter ending June 2012 was a very poor one for Maruti Suzuki. Any decent performance for the quarter ending June 2013 would thus again show a significant increase in profits. However, given the skills of financial engineers within firms, it would not be correct to base company analysis on the data and information supplied by the company itself. Analysts must dig deep, get a thorough understanding of the firm's business, ask relevant questions. Only after this, should any kind of analysis be submitted.  My prediction for Maruti Suzuki is that I do not see a significant change in the profits over a year. What do you feel? 

The issue of low truck speeds in India

It is very well known that the average speed of trucks in India is only around 20 kmph. There are estimates of a loss of Rs. 60,000 crores because of this. The Global average speed is said to be 60 - 80 kmph. These numbers point to a significant cost reduction opportunity in logistics.

The toll plazas, checking points and the poor road conditions are the familiar culprits for this ailment of low speed. Firms have been pointing fingers at the government and are painting a picture of them being in a helpless position. However the frequent truck breakdowns, vehicle overloading and poor driving discipline are also major causes of this low speed. These factors can easily be regulated and are in complete control of the firms. 

A two lane road (with one lane for each side) with all vehicles moving in an exact straight line can easily have vehicles travel at a very high inform speed. There are many assumptions in this statement however. The first assumption is that all vehicles are moving at a uniform speed. Because of over loading and also poorly maintained vehicles the speed of a very few vehicles is at around 20 kmph. Especially in cases of two lane highways such vehicles can easily slow down all the other vehicles. Given that only about 14% of the national highways have 4 or more than 4 lanes, this problem affects more than 85% of the Indian National highways.

In most cases the truck drivers are also least likely to follow the discipline of lanes. For four lane roads (with two lanes for each side), if all the slow vehicles could drive in one lane, the other lane could accommodate fast moving vehicles. Because the truck drivers choose to use the lanes that they deem fit at the spur of the moment, the entire highway network is slowed down.

Frequent breakdowns are also a major cause in slowing down the vehicle movements. For various reasons we have had poor maintenance management in professional as well as the owner driven vehicles. The high average age of vehicles (debated to be around 12 - 15 years) is also partly to be blamed for the high rate of break downs. Like the issue of a slow moving vehicle mentioned above, a vehicle breakdown would also cause a reduction in speed for all traffic on that route.

The altruistic answer to this problem would be for all firms to pay attention to vehicle maintenance and driver training and also ensure that all instances of overloading are avoided.  Easier said than done. Low margins in business are forcing logistics firms to minimise the immediate expenses on maintenance also to resort to over loading and such tactics. It would seem that any firm that stays 'honest' would obviously not be able to survive. The honesty and survival issue are topics for another blog.

The main point here is to get the industry to work on the same set of rules that minimise road disruptions and thus lead to high overall speeds. Such industry wide change can only come by forcing the application of the relevant laws in earnest. Instead of lobbying for easier rules, Organised firms should in fact push for strong rules and strict application. Given their expenses, it would be close to impossible for single truck owners to survive without overloading. Such changes would easily throw the unorganised players out of business and allow the organised players to expand their business footprint. That such strict rule implementation could also improve vehicle speed and thus profits would of course be an extra added advantage 
 

Accidents are cheap and safety expensive

There was a blast in the Tarapur unit of Aarti Drugs Limited at the Tarapur MIDC yesterday. Five young people lost their lives. It seems these young people were screaming with pain for 2 - 3 hours before giving up the struggle.

http://timesofindia.indiatimes.com/city/mumbai/5-dead-as-reactor-blast-brings-building-down/articleshow/19137728.cms

This is not the first incident of an accident at Aarti Drugs Limited. As recent as October 2012 a major boiler blast in the Dombivali unit of Aarti Industries had led to three people being hospitalised and more than 125 others treated for vomiting, burning eyes and breathing problems. Coming back to Tarapur, this is just one of the many incidents which have been reported from Tarapur MIDC. In December 2012 a reactor blast in Sunrise Process Equipment had led to injury of four people. In September 2011 a hydrogen sulphide gas leakage at the Sequent Scientific plant at Tarapur had caused death of 4 employees.

Tarapur is not a town secluded from the mainstream. It is less than 100 kms away from Mumbai and has the Atomic Power station. The industrial town also boasts of organisations like Tarapur Management Association (TMA) and Tarapur Industries Manufacturers' Association (TIMA). Such frequent accidents do not show these organisations, factory owners and professionals working in Tarapur in a positive light. 


Why is it that the accident rate is so high in the Tarapur MIDC and also a few select companies like Aarti Industries? The only possible reason is that it is cheaper to manage accidents and more expensive to prevent them.

The low probability factor

Human minds are known to ignore all risks that have a very low probability of occurrence. That is why people avoid wearing helmets and seat belts. Even though the impact of a traffic accident is high, possibly death, the extremely low probability makes the human mind think - it can't happen to me. This is precisely why these firms, their owners and the senior professionals have a lax attitude towards accidents.

What they fail to understand is that a series of low risk situations would lead to a high risk probability. For example, assume that one process has a probability of failure as 1%. If five such processes are kept in a series, the cumulative probability of failure would be higher than 60%. This is a very simple probability calculation and I do not think that the firm owners are oblivious of this fact.

Accident prevention is a mindset. It starts with not tolerating even the slightest deviation from the operating norms. Equipments have to be maintained as per some fixed processes. Piping and valves have to be changed routinely. People working in the plants have to be trained continuously for safety procedures. But, all these activities are very expensive. It is probably easier to 'manage' a boiler inspector rather than shut the firm and have a honest boiler inspection. Same could be the case with pollution inspectors who are generally 'considerate'. As it is, it very rare for a business owner to get jailed for such acts of wilful murder.

Is it Tarapur and Aarti alone?
Of course not. The lax attitude towards industrial safety seems universal in India. A major automobile OEM has different safety standards for its own and contract employees. It is rare to see a worker on scaffolding in industries and around new constructions wearing safety belts. There are many offices in Mumbai where adequate fire protection  measures are avoided and extinguishers even when present are past the due date.

May be, the government authorities who are responsible to monitor and the business owners who are responsible to provide have both enough incentives to not do their jobs. At such times it is the professionals and professional organisations (like TMA and TIMA) who are responsible towards highlighting lax procedures and forcing firms to implement safety procedures. Businesses surely have to run to create profits and every action of businesses would be directed towards creating higher returns. However, human life should be above all such calculations. It might be okay to work around excise, transport and all such officials. But, anything that could even have the smallest probability of impact on human life must be non negotiable. 

Disclaimer
There of course will be some exceptions. I am sure that some plants in Tarapur and such industrial clusters have a very elaborate safety mechanism. But at the same time, there would possibly be a large number who would consider safety as an unnecessary burden. The article is directed towards these firms.

I do not have data of accident rates at other locations and I consider even a single occurance of such accidents as an untoleratable act.

Question of Scale in Indian retail

An issue very close to my heart has brought me back to blogging. It also gives me an opportunity to say - "I had told you this". It was the news in the Economic Times dated 19th March, regarding Office Depot and Staples putting a halt to their India plans.

http://economictimes.indiatimes.com/news/news-by-industry/services/retail/office-depot-staples-concede-fight-to-kiranas-pack-up-retail-plans/articleshow/19055125.cms

 It is very clear that the large format retailers have a significant overhead and would need a huge scale to be able to sustain their business model. The MD's salary for Shoppers Stop is around 0.15% of the total revenue. For Walmart, this percent is 0.000045%. Well there are lots of difference between WalMart and Shoppers Stop, but the differences in the proportion mentioned above are too large to be ignored. (WalMart does not reveal the salary expenses and based on newspaper reports the remuneration for Mike Duke has been assumed to be 20 million USD). To put this into perspective roughly one third the gross margins (not profits) of one Shoppers Stop store are expnesed in paying the MD's remuneration. With only 53 stores this is way too much money spent on one person. (The expenses of Shoppers Stop considered for Gross Margin inclde the COGS and the employee costs)


According to a report, 90% of Americans have a WalMart within 15 minutes of their house. It is only with this huge scale and the superlative use of technology that WalMart makes the money that it does. For a population around 2 million, Dubai has six super stores of Carrefour. Thus there is one Carrefour for every three hundred thirty three thousand (333,000) people. Mumbai metropolitan area which is about the same size as Dubai and a population of around 20 million has six Big Bazaar stores. This makes it around one Big Bazaar store for 3.3million people.

Again, it is debatable if Mumbai and Dubai can be compared. The idea here is to indicate the stark difference and the lack of scale among Indian retailers. Overheads like salaries, IT expenses, etc are not very linear to the scale of Operations. Shoppers Stop is not even 0.1% of the size of Walmart in terms of revenue, but the compensation to the Shoppers Stop MD is around 3% of the WalMart CEO compensation.

Unless these large retailers in India plan for scale, it will be impossible for them to sustain. They have to have planned growth that has a significant multiplier effect to the number of stores. Shoppers Stop has managed 53 stores in 20 years, and in ten years Big Bazaar has managed 214 stores. That they still have such a small footprint does not seem right. Walmart has 3000 stores in the US. Even Toys "R" Us has around 875 stores in the US. Tesco has 471 super stores in UK which is 80% of the size of Maharashtra. In all formats combined Tesco has almost 3000 stores in the UK. France, which is just around twice the size of Maharashtra has 1200 super and hyper markets of Carrefour. Across formats the number of stores is more than 5500. An Asian country like Taiwan, which is around 12% of the size of Maharashtra has 70 Carrefour stores.

It is clear here that scale is an essential component for survival in organised retail. And, this scale is more about the stores in the same retail format than across formats Given this common knowledge the behaviour of Indian retailers is surprising. McDonald's India has managed to create around 250 restaurants in 15 years and now they plan to double the number in West and South India in the next two years.The message here is that it is okay to have a lower number of outlets now, but without a significant increase in capacity the survival of the organised retail market in India is questionable. 

Is it really the Kirana?

Foreign FDI has been blocked in multi brand retail on the pretext of protecting the small kirana (mom and pop) stores. Sometimes I wonder if this is the real reason. I strongly believe that the restriction is actually to help the large Indian organised retailers. They are the ones to be first affected by the direct entry of Wal-Marts and Tescos of the world in retailing.

The typical design of the large foreign retailers is that they have a very strong but investment intensive back end. In order to get good returns from their investments, the stores have to be necessarily large formats. In addition, in one given market there have to be a high number of stores.

The high lease rates in urban areas of India make it impossible for retailers to have many large stores inside the city. The Wal-Mart model of having the store outside the city would be difficult given the traffic and road infrastructure bottlenecks. In rural areas the scale of operations is generally very low. Indians typically do not have a spend oriented culture like the Americans. So, it would be difficult for a retailer to set up and sustain a large store in a Tier 3 city.

The kirana stores in India have created a very low cost selling model. A pan shop could sustain itself at a monthly profit of around Rs. 5000 only. This number could be much lower in rural areas. This was not the case in the USA. These players can never be threatened by the foreign retailers. The existing so called organised retailers in India would probably have the most to lose.

Indian organised retailers are still in an experimentation mode. They hastily set up the front end and are now trying to make the back end work. Most have poor systems. Some companies have closed down and most of the rest are not making money. They have tried to copy the IT systems in foreign retail as this can be easily bought. But, the human systems and discipline needed are sadly missing.

By getting the government of India to form rules banning the foreign retailers, the organised players seem to be creating space for themselves. Foreign companies wanting to enter India would be forced to tie with the existing Indian players. It clearly seems that the rule has been created in the first place to benefit these large Indian retail players.

Now suddenly there is a talk about relaxing the rule. Nothing has changed for the small kirana owner. But all the large format foreign retailers have already been subdued to partnerships with large Indian firms – this includes Wal-Mart, Tesco, Woolworths, etc. Having done this, and needing more investments, it seems that the large Indian players are now getting the government to allow more direct investment in multi brand retail.

of Margins, Profits and Collaboration

A manufacturer needs a retail store to sell its products. And, a retail store needs a good agile manufacturer. While this is common knowledge, supply chain practice tends to suggest otherwise. Look at this article in Economic Times:

http://lite.epaper.timesofindia.com/mobile.aspx?article=yes&pageid=1&sectid=edid=&edlabel=ETD&mydateHid=11-03-2011&pubname=Economic+Times+-+Delhi&edname=&articleid=Ar00100&publabel=ET

The Electronic retailers want the manufacturers to raise the margins by 4% from the current 8 -10%. The manufacturers say that the organised retailers give them a lower throughput than the smaller mom and pop stores and hence they can't increase the margins for modern trade.

Gross margin is defined as the buying cost subtracted from the selling price. For all practical purpose, this number is very different from profits. A high margin product can be a net loss product and a super low margin product can be a profitable item.

There is the issue of overheads here. Traders who work on volume products on low margins strive to keep overheads low. This way they can ensure good profits even with gross margins of around 2 - 5% only. For some MNCs on the other hand, profits are not even 10% of the gross margins. MNCs have an expensive bureaucracy to support and pay salaries to. Point that I am trying to make is that increasing margins is not the only way to make more profits.

A vendor who is unreliable would need lot of followups. This follow up is done by a buyer, and this buyer gets her salary from the buying organisation. So, a low cost vendor might actually be a loss making proposition. A bad quality product or a wrong shipment can surely be returned to a vendor. The vendor may also give a 100% credit note against the returns. But, the time lost in creating this return journey is a cost to the buyer. Similarly, a customer who demands frequent deliveries or who keeps changing order commitments is surely more expensive than a customer who lifts material in higher quantity, has lesser frequency of replenishment and also who give stable orders.

Instead of haggling on margins, the electronic manufacturers and the retailers could sit together and analyse these very cost drivers. In a truly modern sense, the modern trade must give up the aggressive postures and come to the negotiating table. Together with the manufacturers, maybe they could work out arrangements of last mile delivery to the consumers homes or offer special after sales service deals.

Same for manufacturing companies. An electronics company has significantly greater efforts in selling to smaller stores than large format chain retailers. Pan country buying decisions are probably made from one office for large format retailers. For smaller mom and pop stores, every small store would need a sales executive from the manufacturing firm visiting every week. The savings in sales effort costs would easily more than make up for the lower throughout in the organised retail.

The key would be for one party to demonstrate maturity and initiate the process. This is not a zero sum game where one firm has to lose for the other to win. There are numerous cost drivers besides the basic price. There can be a truly win win solution here. It is not a fight of the retailer versus the manufacturer. It is actually a relay race where both players have to work together to capture and satisfy the end customer.

Not all customers are equal. Some customers are extremely expensive to serve. Profit for a company is not the direct price of the product minus the cost. There are many overhead expenses. And these overhead expenses are not shared uniformly over every customer.

For a trucking firm, a customer with uniform orders is less expensive to serve than one with sporadic requirements. Few large orders are easier to pick and dispatch rather than many small orders. For an automobile dealership, a flexible customer who buys the vehicle available in the showroom is more profitable than a customer who takes a long time to decide or one who needs a specific configuration.

In spite of this knowledge in most cases we generally charge the same price to all customers. The differential supply chain cost is rarely considered. While in cases there may be some differential in the price, it is rarely calculated from the cost of actually serving a customer. Marketing segments customers according to channels, need of service, etc. Costing segregates costs of every resource and every product. No function looks at cost of serving customers and then creating differential pricing.

Meru cabs is a provider for taxi services in Mumbai, Delhi and a few other Indian cities. Customers who book cabs by using a call centre are billed a convenience charge of Rs. 50 extra. Customers who book online are spared of this cost. The Rs. 50 is clearly an approximate cost for the additional services the customer uses.

Every business needs to think about this idea. By creating differential pricing, businesses can actually direct customers towards specific services. If a customer knows that by placing orders in a certain manner he may get a better rate, the customer might change her behaviour.

With a uniform pricing policy, good customers may feel cheated. In spite of being low cost customers they pay as much as other customers. There is a definite danger of such customers changing vendors. In the end, the business will be saddled with high proportion of high cost customers.

Differential pricing can be created on the basis of various basis. It can be the number of orders, quantity per order, consistency of business, number of delivery locations, number of product variants asked for, etc. Every business will have its own dynamics and the pricing has to be configured accordingly. The aim is to reward good customers and also to motivate other customers to migrate to better relationship pattern. Of course, the ultimate aim is to make doing business easier and more profitable.