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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Risks and return considerations for companies investing in foreign markets

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Since the past few months, the telecom service provider Uninor has been under scanner on eligibility criteria for allocation of 2G spectrum, by the former telecom minister of India. India’s Department of Telecom (DoT) has imposed a penalty of Rs 6.35 crore for not complying with the roll-out obligations, of which Uninor has been directed to pay Rs 3.8 crore by the telecom tribunal TDSAT, following the company’s petition challenging the penalty imposed by the DoT. The cancellation of licences or even the imposition of penalties could severely hurt cash flows of Uninor and of some other telcos which were issued similar notices.

Uninor is a joint venture between reality firm Unitech and telecom firm Telenor of Norway, of which the Norwegian government is a major shareholder. Telenor’s acquisition of 67.25% stake in Unitech Wireless of India was funded with a Rights issue in October 2008. Telenor’s share price had dropped by 25% on the announcement day and by 45% over the month. The negative market reaction could have stemmed from the fact that India was an unknown market for Norwegian investors and they had doubts regarding the future returns from investments in India.Now, with India’s Supreme court monitoring the 2G scam investigations, their future is increasingly looking uncertain. Till date Uninor is reported to have invested around Rs 9,000-10,000 crore and set up 30,000 towers.

This brings us to the question why do companies invest overseas and what are the risks and the expected returns for investing in the foreign markets.

Some of the key reasons for which companies choose to invest overseas are to gain access to new markets, to obtain superior or less costly access to the inputs of production (land, labor, capital, and natural resources) than at home or to build strategic assets, such as distribution networks or new technology. Diversification into uncorrelated markets may result in reduction of risks.

A point to be noted is that the cost of capital for investors of a company that invests in a foreign land is different from the cost of capital for investors of a company investing in its own stock market.  This is due to the fact that the investors investing in a foreign country are exposed to risks such as exchange rate risk, political, sovereign and expropriations risks. The dividends can be paid to these investors only after the generated cash is repatriated to the home country. During war or unrest there could be possibility of expropriation in a foreign land. As such, the parent company may not be able to repatriate interests, dividends, or royalties it earned abroad, send home the funds held in a foreign bank account opened by a branch office. Sovereign risk or transfer risk refers to the possibility of the cash generated in the foreign country being blocked when the reserves of hard currency in the host country are low. Such risks can typically be insured by private or government insurance companies.

In case of Telenor, the cost of capital for evaluating an investment in India is likely to be different from the cost of capital for an Indian firm, let’s say Idea cellular evaluating a similar investment in India. The returns from the investment of an Indian firm in India are likely to be strongly correlated with the Indian market index since there are common factors that affect all Indian firms in similar ways. On one hand exchange rate risk, political, sovereign and expropriations risks increase the riskiness of the Norwegian investment. On the other hand, the same project may yield benefits of diversification of risk for Telenor, if the returns from the Indian project are essentially uncorrelated with the returns on the Norwegian market portfolio.

The return on equity for an Indian firm making an investment in India can be calculated by using a beta (the non-diversifiable risk of a company) obtained by regressing returns from a portfolio of stocks in the same industry on the Indian stock market index. Beta is the product of the relative volatility of a security’s returns and the correlation of the security’s returns to the market’s returns.

For the Norwegian firm, the company would first forecast the cash flows from operations in India. It would then take into account the effect of intra-firm transactions, which will be affected by international taxation, transfer risks and remittance Policy. At the same time, the discount rate by which the cash flows will be discounted will be different for domestic company & a foreign company. For the foreign company the discount rate will take care of the exchange rate risk, country risk, political, sovereign and expropriations risks. At the same time the beta used for calculation of the discount rates will also be different, to account for correlation with the market.

Due to the inherent riskiness of overseas investment, investors may have a home bias and would expect higher returns on the cost of capital if the target acquisition is funded with investors’ money.

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