Impact of policy environment on funding start-ups in India

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Funding has always been the biggest challenge that every venture has to face. Particularly the technology and knowledge based start-up enterprises that are based on intangible assets such as human capital and an entrepreneurial idea. In absence of physical assets, such start-ups find it difficult to secure bank financing and they need to approach equity financiers such as angel investors or VCs. Mostly start-ups do not even have access to working capital loans; though some finance companies offer collateral-free working capital loans to small enterprises with at least three years of operations.

Like any other investment, the investment in start-ups is influenced by the policy environment prevailing in the country. The current policy environment in India is reasonably conducive for start ups, but still leaves a lot more to be desired. Domestic money to VC/PE funds are either restricted or prohibited in current regulatory framework. For example SEBI regulations for Domestic Venture Capital Funds do not permit registration of a fund which would have corpus of less than Rs.5 crore ($ 1 million). This makes it difficult for angel groups and seed funds to get registered and raise funds. Pension funds, which are the biggest source of money worldwide, are not allowed to invest in VC/PE funds. Insurance companies are allowed to invest in infrastructure funds only; even banks’ exposure to VC/PE funds is severally controlled.

The National Innovation Act that proposes tax incentives for angel investors is likely to be passed by the government. The Department of Industrial Policy and Promotion (DIPP) in India also plans to incentivise venture capitalists (VC) who invest in small and medium-size enterprises (SMEs). It is anticipated that with implementation and stabilization of Goods and Services Tax (GST), the environment will be more favourable for promoting entrepreneurship and business.At present, for a business, planning to set up manufacturing units in India, the existing complex and high taxation structure consumes a large portion of the available cost arbitrage. Though the manufacturing cost of most products in India is nearly half than in the west, but due to tax levied at various stages, the cost advantage is reduced by almost 50%. The existing multi tax structures often compel manufacturers to base their inventory and distribution decisions on tax avoidance rather than on operational efficiency. The implementation of Goods and Services Tax (GST) is expected to reduce the hassles associated with the existing tax structure and facilitate investment decisions to be made purely on economic concerns, independent of tax considerations.

The policy environment in India is gradually evolving and regulations are expected to evolve in a manner that encourages more investment bringing it at par with that in the mature markets. However the timelines by which these proposed policy changes will be implemented and the overall impact on the VC community is yet to be seen.

First in the Race – Apple and Samsung

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Apple and Samsung are embroiled in several legal fights; both are contending for global leadership of smartphone and tablet market, with Samsung poised to surpass Apple in the race in 2012. Smartphones are an interesting example of a product category where the second or third movers have considerably learned from the experience of the product innovators. Long before Apple launched the iPhone in 2007, IBM had released the first smart phone called Simon in 1993.

Often the pioneers spend a lot of resources to come up with new and innovative products, demonstrate it to the users and test the market. In the meanwhile, newer companies that are more agile and are quick to see the opportunity, understand the product – market fit, learn from the mistakes of their predecessors, make a big bang entry and harvest the potential in the market already created by the earlier explorers. They survive and even make it big.

Samsung, for example, has perfected the game of being the second mover. They study the market leader meticulously, copy every aspect of the market leader’s strategy in minute details, and further improvise on the execution of the strategy.  They end up not only in catching up, but even surpassing the market leaders. It was the success of the iPad that made Samsung roll out the Galaxy Tab. Even the Galaxy Note was preceded by the Dell Streak.

On the other hand, there are companies such as GE or Siemens that have been successful in retaining the first mover advantage and in creating next generation products in a continuum while phasing out the older ones. One of the parameters of strategic health for GE is the proportion of revenue earned by products which have been brought out in the previous 2 years. It means that such companies need to have a whole range of next generation products in the pipeline. This is relatively easier for companies that cater to the B2B market, where customer expectations can be understood within a reasonable time frame, due to existing contractual relationships with the customers. It is more difficult for the companies to gauge the customer expectations in the B2C scenario, though the B2C market offers the advantage of high volumes.

This brings us to an interesting question that why the pioneers with all their obvious advantages such as a brand image, a customer base and a dealer network in place to push the new product, are still not able to retain the market leadership. Going back to the Kodak story, what could they have done differently so that having been the pioneers in digital technology, they would have continued to be so.

This steers the discussion towards a very important trait of executive leadership – the ability to foresee the horizon of changing technology and customer expectations. An organization has to be futuristic, open to accept that the world can change overnight and the confidence to believe they can be the leader in the changed world too. It requires the tenacity to persevere, understand the market’s perception of their products, support R&D to improve on the products and make required changes to their products or their marketing approach in order to sustain the market leadership.

The path to achieving this trait could be through corporate entrepreneurship, if promoted in a true sense within an organization. This group would need to be supported and backed by the topmost authority in the organisation and would have to be reasonably separated from the current culture of the organisation, to encourage them to think differently and foster a culture of innovation. This may also, at times, require convincing the shareholders and the board to take a dip in immediate returns for long term gains.

This leads to an interesting question next. Which of the items of mass consumption today is most likely to into oblivion replaced by a newer generation product in the next three to five years? Who knows? Plastic money could be one! Already some companies are developing mobile payments solutions that focus on the convergence of online (e-commerce) and proximity (face-to-face) payments.

 

Kodak – Image Blurred

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On 19th Jan, 2012, investors woke up to the news of Kodak’s filing for Chapter 11 bankruptcy protection in US Bankruptcy Court in Lower Manhattan. This gives the company an automatic stay for 6 months during which it has protection from creditors and the time to reorganise itself.

Founded in 1880, by George Eastman, Kodak became one of America’s most notable companies that established the market for camera film and then dominated the field. Neil Armstrong used a Kodak camera to take pictures on the Moon in 1969. Eighty films that have won Best Picture Oscars were shot on Kodak film and the phrase “Kodak moment” captured people’s imagination.

Analysts feel that the firm’s late entry into the digital market is a key factor in its recent troubles. Although Kodak was one of the original inventors of digital photography in the mid 70s, it did not commercially begin to manufacture digital cameras for the next two decades due to the fear of the cannibalisation of film. As a result Kodak failed to keep pace with developments in the market and competitors steadily eroded its share of the market.

Since the late 1990s, the sales of photographic film declined and the revenue from the sale of film started fading. Since 2003, the company took the decision to halt investing in its film product, closed 13 manufacturing plants and reduced its workforce by 47,000.

Kodak adopted a product innovation strategy for digital technology, and came out with model offering consumers top-quality cameras at reasonable prices and other innovative products such as a printer dock. Consumers could insert their cameras into this compact device, press a button, and watch their photos roll out. By 2005, Kodak ranked No. 1 in the U.S. in digital camera sales.

Although Kodak’s digital camera business became a roaring sales success, business it could not replicate the rich profits of the film business, as mass-market cameras yield slim profit margins. As other competitors raced into the market, the digital cameras soon became commodities that further eroded the profit margins.

To boost profit margins, Antonio Perez, who became Kodak CEO in 2005, tried a number of turnaround strategies and cost-cutting efforts. He steered Kodak away from its traditional market in cameras to focus on home and commercial printers with the hope it would create a competitive advantage. Kodak turned to patent lawsuits to generate revenue, winning settlements from LG of South Korea. Kodak also attempted to sell its digital imaging patents, but failed to garner enough interest among potential buyers, driven in part by fears of Kodak’s deteriorating financial health.

Since 2004, Kodak has reported only one full year of profit, so the attempts to reinvent the company’s core business model have yet to bear fruit. Kodak has secured $950 million in financing from Citigroup to stay afloat during Chapter 11 proceedings. It remains to be seen if the company can emerge from bankruptcy, reorganize its business structure to increase productivity, reduce cost and keep pace with the evolution. Kodak could even be looked at as a takeover target.

A stubborn culture, refusal to push forward with digital technology after creating one of the first digital cameras, and inability to reinvent the core business model led to Kodak’s failure to remain competitive in a changing world. This also shows that companies, when they are successful with a certain way of working, imbibe a strong culture, which is the company’s strength, but the same culture may also impede the company from adapting to changing needs.

Fall of the Rupee – Part II

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Continuing from the last post, let’s see how the price of rupee is determined vis a vis dollar.

The market determines the price of a currency vis-à-vis another based on its demand and supply.  Some countries that permit exchange rate to be determined by the market do not impose any restriction on the amount of local currency to be exchanged for foreign currency. On the other hand, countries with a nonconvertible currency policy, fix the exchange rate by diktat. The Indian rupee is fully convertible on current account but there are restrictions on convertibility on capital account. This means that though foreign exchange for trade in goods and services is determined on the basis of market demand and supply, but the government has put in some restrictions on flow of different forms of capital in & out of the country.

Some of the probable causes of the rupee’s depreciation against dollar are –

Deficits in the trade of goods and services – India reported a trade deficit equivalent to $196 billion in October 2011 as compared with $104.4 billion in March 2011. The widening trade deficit poses downside risks to the weak Indian currency. Surpluses and deficits in trade of goods and services reflect the competitiveness of a nation’s economy and impact the value of currency. The decrease in growth of exports coupled with the increase in imports has contributed to a widening deficit in trade of goods and services.

Fiscal deficits – India has been running large fiscal deficits due to dwindling growth in tax revenues, rising subsidy bill and the government’s failure to raise funds through stake sale in state-run firms. The market usually reacts negatively to widening government budget deficits the impact is reflected in the fall in the value of rupee.

Capital flight – The government has attributed the depreciation in rupee to the withdrawal of funds from India by the Foreign Institutional Investors. A number of scandals, governance deficit, policy delays and slowdown of growth in India, have seen FII’s pull funds from India.

RBI has taken short term steps to stabilize rupee by reducing banks’ forex trading limits and curbing speculative activity resulting from exporters cancelling their earlier contracts and rebooking exports to take advantage of sliding rupee, thereby fuelling depreciation. To increase the supply of dollars, RBI may announce a scheme for overseas Indians to bring in their funds, or offer higher returns to NRI’s. RBI may also sell dollars to oil management companies to prevent spikes in demand for $ due to large imports. But there are limitations in selling dollars from capital reserves as India’s foreign exchange reserves are mainly created by purchase of dollars bought in by FIIs and may be needed if FIIs choose to exit.

While RBI might not introduce capital controls to prevent outflow of dollars from the country, as it is against India’s policy of moving towards full capital convertibility, but RBI may ease rates in future to bring in liquidity. This will boost the equity market & money will flow into the country as growth picks up.

 

Fall of the Rupee

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The Indian rupee continues with its free fall against dollar having fallen up to 18% in Dec 2011 from its year’s high in July 2011. Rupee has been Asia’s worst performing currency this year.

The depreciation of rupee against dollar means that now it takes more rupees to buy a dollar; thus indicative of an increase in the demand of dollar. In absence of sufficient dollars to cater to the increased demand, there is supply-demand mismatch which causes the price of a dollar to rise against the Indian Rupee.

The impact of a depreciating currency varies across businesses. Export oriented industries such as IT services which earn revenues in $ and incur costs majorly in rupee gain from the fall in rupee. In contrast, the import oriented industries such as Oil Management Companies which import crude are negatively impacted due to fall in rupee as they end up paying much higher for the imports. Furthermore the Indian companies that have raised debts in foreign currency will have increased burden to service interest payments.

One way of reducing such losses is to hedge against currency movements. But since it is very difficult to forecast exchange rate, the risk due to sharp changes in currency rates are not completely mitigated . How much a company hedges and at what rates, is therefore based more on the risk appetite of a company rather than on the accuracy of forecasts.  Among the top 3 Indian IT firms, Infosys, is the biggest beneficiary of the current depreciation given that its hedging for $ receivables is lower than that of TCS & Wipro.

 

None the less, the sudden movement in exchange rates is discomforting for business as well as government. It becomes difficult for the government to meet its targets of fiscal deficit.

Left on the markets and the economy, exchange rate adjusts on its own and again settles to a value such that there is no arbitrage. Till the rate settles, changes in exchange rate will have large implications on the domestic prices, company’s profitability and government finances. But sometimes, these movements can be very steep and a sharp incessant fall can destabilise the economy and put government under pressure to intervene. Which is when, the Reserve Bank of India, central bank to the Government of India takes rescue measures by selling or buying dollars or other open market operations to improve dollar supplies and ease the fall of rupee.

Material Girl and Mother Monster

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Besides the obvious similarity in their profession and the huge popularity enjoyed by the two music artists, the other common point between Madonna and Lady GaGa is that they both have been chosen the subject of case study at B Schools.

 

I remember having an interesting start to the strategy class at London Business School with a slide on Madonna. Came to know that she started her career in 1982 and by 2008 she had amassed personal fortune of $300 million with a record sale of 220 million albums. Michael Jackson wondered what it was about her that made her so popular. Not a great dancer or a singer and yet she is always at your face. The answer lies in her positioning, efficiently leveraging and exploiting resources, employees, relationships (Prince, Warren Beatty, Sean Penn & Guy Ritchie) and other organizing skills such as building and using and even breaking alliances, creating controversy, manipulating press but above all ambition, discipline and self development. With an uncanny ability to spot trends, Madonna became known for her music and sex appeal in the period 1988 – 1995, turned to brazen sexuality and controversy in 1996 – 2002 and again reinvented herself into spirituality and politics between 2004 – 2008. She has a very strong sense of what it takes to survive in the business.

Now Lady Gaga has been chosen the subject of a case study at European School of Management and Technology, in Germany. Gaga’s case is different than that of Madonna as she is recognized by music industry insiders as having real talent. She is known to never lip-sync during performances and also writes many of her own songs. Nicknamed as ‘Mother Monster’ and recognized by most for her provocative outfits and wild shows, she is “the most successful contemporary entertainer”. High demand for a special 99-cent download of her album ’Born This Way’ caused the servers of online retailer Amazon to crash.

Says Professor Krupp, Gaga seems to have found the balance between business and art. At a time when the music industry is struggling to compete with free Internet download, Lady Gaga has adapted social media and used her social media strategy to her fullest advantage. She has developed an army of fans through virtual interaction by using Facebook and micro-blogging site Twitter.

 

The two cases highlight that an individual or an organization can shake up an established industry and bring about strategic innovation by framing and answering the three fundamental strategic questions “Who, What , How” ; “Who is the customer”. “What do we offer this customer,” and “How do we create value for the customer – and ultimately for ourselves”.

Bail me out – Kingfisher Airlines

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Corporate India is abuzz with the news of KingFisher’s need for a bailout. Though the airlines company has  not yet defaulted, but with a debt exceeding Rs 7000 cr and losses mounting to thousands of crores, there is little doubt that the company is at the brink of default.

Again, this is not the first time when the company has sought rescue. The airlines underwent a debt restructuring exercise in April 2011, when a consortium of 13 banks converted their debt into equity, paying a significant premium of 62% over the ruling market price of shares.

In the event of a bankruptcy, the assets are liquidated and proceeds are paid to the creditors in the order of their seniority. The equity holders receive only the portion of the proceeds that is left over after paying off the creditors (which, for a company under distress can reduce to nothing). By agreeing to convert a part of their debt into equity, the banks helped the company to lower its interest payments and thus infused liquidity in the company. In the process, the banks increased their ownership stakes in the company while consenting to forego their interest income. After the conversion, the banks equity stakes in KF increased to 23.37% whereas the promoter shareholding including Vijay Malaya’s and other United Breweries group companies fell to 58%.

The question now is, after a restructuring attempt this year itself, what could be a means to salvage the crisis ridden airline. At this stage, when the company is reeling under debt and is at the point of default, any new investment will benefit the debt providers as the cash flows generated from the business will go towards serving the debt interest. Therefore no one will want to put in new equity, not even the promoters. Neither will the creditors be interested to lend more as the company will/may not be in a position to pay the interest.

In wake of such a situation, both creditors and equity providers would now need to agree upon a restructuring plan wherein creditors could either accept a haircut on debt (by reducing interest/increasing the debt tenure/ granting moratorium) or consent to convert a portion of debt to equity. The company could also go in for supra priority financing where the providers of new money get priority on cash flows over the other existing debt holders.

Restructuring at this stage may require both the promoters and creditors to put in new equity. There has been some news about government having requested Life Insurance Corporation (LIC) to purchase a portion of new equity. In the final shareholding promoters’ stakes is bound to get further diluted from the present 58%. If the promoters holdings are reduced to a level of around 35%, it will open up the possibility for banks, LIC & other shareholders to get together and vote out the current management. It is not uncommon in many parts of the world to vote out a failed management in favour of a competent and professional management.

Such an exercise will send a strong message to founders that restructuring may reduce their stakes to a point where they could lose the ownership and control of the company, if such need arises. This will make them prudent in managing the company and prevent them from taking rash or highly adventurous decisions, as a poor management could cost them the ownership of their company. This will augur well for the India Inc, which is still dominated by family businesses where promoters are generally closed to bringing in outside management. Finally, it will also send a clear signal that incompetent owners cannot flourish at the cost of their employees, while keeping their high salaries and indulging in lavishness.

That, in a free market economy, will be a perfect disincentive to promoters managing their companies poorly.

Stuck in the middle – Kingfisher Airlines

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Kingfisher is losing ground. Vijay Mallya is seeking investment, investors are not exactly willing to oblige.  Brand Kingfisher is a strong brand known for its excellent product & service offering. So what went wrong with the airlines?

Captain Gopinath, the founder of Air Deccan believes that Mallya’s big mistake was to change Air Deccan to Kingfisher Red. Kingfisher Airlines catered to the top of the pyramid while Air Deccan was meant for the base of the pyramid and came with its huge customer base and massive network.

After Kingfisher acquired Air Deccan, the rebranding of Air Deccan as Kingfisher Red left little difference between the two brands. They looked the same and offered similar services. This created inconsistency between the value proposition and the market segment to which the brands catered; Kingfisher Red remained neither low cost nor full services. With add on frills, it came out costlier than the other low cost airlines such as Indigo & SpiceJet.

Markets punished the inconsistency. Passengers started to migrate from Kingfisher Airlines Economy to KF Red, which was cheaper and almost on par. And the low cost fliers ditched KF Red for the really low cost airlines. This led to cannibalization of the mother brand while simultaneously hitting the acquired brand.

According to management theory, competitive advantage for a business is derived by either selling a product similar to the contemporary products at a lower cost or creating a unique product and charging a price premium for it. The source of competitive advantage for a business is either a Cost Advantage or a Differentiation Advantage.

Looking at the Kingfisher case, in light of the two generic strategies i.e. Cost Leadership & Differentiation, it is proven yet again that loss of focus on the generic strategies or any attempt to blur the boundaries between the two, leads a business to be ‘Stuck in the middle’.

How consumers can help you create new products | How consumers can help you create new products – London Business School BSR

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Role of Independent board directors in Indian companies

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The probe into Satyam scam is finally over.  SEBI has barred Satyam Computer’s founder B Ramalinga Raju and four others from markets for 14 years and asked them to return Rs 1,849 crore worth of unlawful gains with interest.

Following the takeover of scam-hit firm Satyam by Tech Mahindra in 2010, Mahindras were contemplating to sue the company’s erstwhile independent directors to recover Rs 11 million paid as commission to non-executive directors during the financial year 2008-09. Each of Satyam’s former independent directors were paid a commission of Rs 12 lakh over and above sitting fees for the financial year 2008-09.

The Independent Directors of Satyam included renowned people like management guru Krishna G Palepu, Pentium chip innovator Vinod Dham, former Indian School of Business dean Prof Mendu Rammohan Rao, former cabinet secretary TR Prasad, former IIT Delhi director V S Raju and US-based academician Mangalam Srinivasan. It is ironical to note that in the presence of such eminent independent directors, the company’s founder Ramalinga Raju could manage to fudge the company’s accounts for several years.

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