US Recession

The stock market in India has been making new this week, for a change for all the wrong reasons. The world markets are down and there was a quick solution required. The Fed responded by cutting the interest rate by 75 basis points and the markets responded by coming back to the green zone again. So, was it all this easy? Why wasn't it done earlier? Let's evaluate.

In the US, although the economy has grown, jobs have increased and productivity is higher, things are not as good as they seem. Currently there are three negative effects happening.

1. The oil prices are sky rocketing

2. the sub prime mess has left people feeling poor as the value of their assets (homes) has gone down. The sub-prime mess has also extracted the liquidity from the market.

3. The dollar devaluation

How did sub-prime extract liquidity? Who really lost the money?

When the times were good, the banks and other financial institutions offered loans to people to build their homes. China was also investing in real assets in US which made the realty market heat up. China maintains its currency at a certain level viz a viz the dollar because to keep its exports attractive to US. If Chinese currency appreciates then US consumers will need more dollars to buy the same good and hence make it unattractive. Therefore, China buys a lots of dollars hence creating an artificial demand for it and appreciating the price. Then China buys real assets in US with these dollars.

Now, when real estate was sky rocketing, banks offered loans to people even with lower credit scores. Why did the bank do that? They did it because they could charge a higher interest rate to cover for the extra risk they were taking. People found it attractive because now they could own homes and with the property prices going high, the value of their asset would go up. They could then refinance the loan at lower rates and pay off the higher interest rate mortgage that they originally took. On top of that, the banks offered lower interest rate for first two years and higher interest rate for period after that. The later interest rate would readjust based on certain factors. This gives enough time for the mortgage buyer to improve its credit score, and in the mean time the house prices will also go up. This was a nice business and many people took loans. This increased the demand for the houses and hence heated up the realty sector even further.

Now, banks couldn't keep so much debt on their balance sheets. They therefore, securities these loans and sold them to other financial institutions and hedge funds. These securities are like bonds with future payments coming from the mortgage payments. These securities were also categorized into higher, medium and low risk. These securities were then traded and there was an attractive market for these securities. There was another agency for the rating of these securities which for some reason, rated these securities as high and totally ignored the risk. The banks who didn't have these loans on their books were now safe. Since their incentive was linked to selling more of these loans, they blinded themselves and bypassed any due diligence.

The business kept on going, unless one day the bubble burst. The home market started declining. This meant when the higher interest rate period came, the home owners were not able to refinance it, as the value of their asset had gone down. They started defaulting on their payments. The banks were forced to carry out the foreclosure of loans and put up the house for sale. This now had a negative effect. The supply of homes became higher and prices went further south. This causes many more to default on their payments and more fore closures happening. All the money was used up in building houses. The ultimate loss was for the hedge funds and financial institutions like Citibank and Merill Lynch who bought the Mortgage Backed Securities.

Why recession?

Now, there was a liquidity crunch as explained above. There was no money available for companies to invest and grow their business. If business will not grow then there would be no jobs created. Therefore, the Fed decreased the interest rates. Ideally when the interest rates go down, people have less incentive to save and they increase their consumption. Companies can borrow cheap money to invest in their business. This makes economy do better and the consumption goes up. However, the down side is that the inflation goes up too because of increased supply of the money. Fed obviously does not want the inflation to go up. Therefore, it can not keep on decreasing the interest rates. 

Even the Oil prices are high. The crude has gone up to almost $100 per barrel. The gasoline is selling for $3 per gallon right now and any increase to $4 will impact consumer spending a lot. People are already battling with low house prices, and high prices with added inflation will cause the consumer spending to go down a lot, taking the economy into a recession. Most experts are divided right now as to US will hit a recession or not. Some predict a recession and some predict a slow growth rate for 1st half of 2008 with economy rebounding in the second half. Most depends on where the housing prices stabilize. If housing prices go down further, the sub-prime mess will get deeper, further reducing liquidity in the market. However, by reducing the interest rates, the Fed is helping because the interest rate for mortgage are determined from the base rate and if the base rate goes down, the subsequent rate will also go down and some foreclosures may be saved. However, most will depend on the overall housing prices.

China Factor

As mentioned above, China has kept its currency stable artificially by buying dollars. However, this also causes inflation in China. To buy dollars, China has to print more money and more money means higher inflation. This inflation has caused the prices go up very high. At the same time, China unquenchable thirst for Oil and Commodities like metals had caused a worldwide boom in prices. Now, China is in a precarious position and taking steps to cool down its economy. Any decrease in demand by China in oil and commodities will cause these prices to cool off a little bit and should help US avoid recession.

Dollar Devaluation

Fed has been cutting interest rates to add some steam to the economy. However, these rate cuts also make the investments in US Treasuries unattractive. Most people/investors/countries have option to invest their money somewhere else. With US Treasuries less in demand, the dollars to buy these treasuries is also less in demand. This decreases the valuation of the dollar. Lesser dollar value means US has to spend more to buy oil and hence adds to its recession. However, the good news is that weaker dollar will help US exports, discourage Chinese imports, encourage domestic consumption. Higher domestic oil prices may reduce demand for oil and hence bring down the world price for crude.

Summary

In summary, US recession seems eminent. There might be some probability that the turn of events and Fed's actions save it and reverse the trend, but until US savings rates go up, the economy seems to be going into a state of stagflation.

Ants Colony and Air Conditioning Systems

The beginning of 2008 with Apple

I spent yesterday night downloading the Macworld 2008 keynote by Steve Jobs and today morning watching it. Apple is out with the latest from its laboratory. Earlier in the year it announced new Mac series, fully loaded. But more buzz was created by the Macworld 2008 announcements. There were 4 mains announcements made at this keynote address by Steve Jobs.

1. Time Capsule

2. iPhone/iPod Touch software updates

3. iTunes Movie Rentals

4. Macbook Air

Let me start by discussing the Macbook Air first. On first impression the notebook looks quite stunning. The features like multi touch gesture, 0.16 to 0.76 inch thickness, 5 hour batter life, 1.8 GHz Intel Core 2 Duo processor, 2 GB RAM, 80 GB HDD (64 GB Solid State Hard Disk - optional), back lit key board, 3 lb weight were all good. What was inconspicuous though were the features missing. This notebooks does not have 1) An optical drive 2) Ethernet Port 3) Firewire Port 4) Has only one USB port. Now, given these gaps, would the laptop succeed. My take is that if someone is planning to buy just a notebook, he is not going to compromise on the missing features. However, the category where this notebook really competes is the ultra portable device, and these devices are mostly used in conjunction with your regular laptop/desktop which are more powerful and can add more devices. That way, this machine has got the basics right. While on the move, I want longer battery life, wireless connectivity, light weight and backlit keyboard. So, this will be a good second machine but would not replace as my primary machine at home or office. At a price of $1799 it looks quite attractive secondary machine. Here is an interesting link.

http://link.brightcove.com/services/link/bcpid742148386/bctid1378313911 

Here's a picture taken from www.apple.com/macbookair

Do checkout the Macbook air commercial. I like the song "New Soul" by "Yael Naim".

On the iTunes Movie Rentals side, I am a little apprehensive about its success. Though it is a great technology and Apple has done some great work getting the 9 major movie studios on board, the simplicity of DVDs can still not be replaced. The downloads of over 1 GB still remain the pain, even with so called Broadband. At least, in India, it will take me over 16 hours to download a 1 GB video on a relatively fast connection. The best thing about this service though is the portability from PC to MAC to iPod to iPhone to TV. Though you will  probably need Apple TV ( Take 2 ) for this. Another feature that I didn't like was that after renting the movie was available to be watched for 24 hours only once you have started watching it. Why should there be any restriction like that. Even when I get a DVD from Netflix kind of service, I can watch the movie as many times as I want for the whole rental duration. I would like it to be available for complete 30 days. I would also like an option to renew the rental period for about $0.99 for another 30 days, without downloading a fresh copy. If I ever have a set up with a wide screen TV, T3 Internet connection, Apple TV only then I will be able to enjoy this service. This is one technology I don't foresee to use in India in near future.

IT Infrastructure for a Manufacturing Company

To design an IT infrastructure for a manufacturing company, map the architecture to the business process.

ERP System: Obviously there will be a transaction system which will be used for order entry, financial transactions etc. Mostly, an ERP system is used to maintain these transactions. This is also the reason why most CFO's readily agree for ERP systems or sometimes they ask for implementation of ERP systems. This also provides them a single view of all transactions across all divisions and all geographies. All the transaction systems in the company connect to the ERP system to make it a system of records. Some examples of ERP systems are SAP, Oracle etc. It provides data on Engineering, Bills of Material, Scheduling, Capacity, Workflow Management, Quality Control, Cost Management, Manufacturing Process, Manufacturing Projects, Manufacturing Flow, General Ledger, Cash Management, Accounts Payable, Accounts Receivable, Fixed Assets etc

Buy Side Software: On top of an ERP sits a buy side software. This software assists the manufacturing company to buy its material from a network of suppliers. Some examples of this software are Ariba, Commerce 1.

Supply Chain Software: Supply chain software helps to maintain inventory, procurement and manufacturing. It also helps in demand planning and forecasting. Some examples of this software are i2, Manhattan Associates, Managestics.

Sell Side Software: Then there is a sell side software to connect to resellers, distributors, retailers and customers. This software is also known as CRM software.

Data Warehouse: Data warehouse takes data from all databases and consolidates it in such a form that can be easily queried. It also aggregates data from different systems, for different periods etc so that a combined query could be written on this data.

Business Intelligence: These softwares run queries on data warehouse to come out with reports that help senior management take decisions. It also come out with patterns and trends to develop strategy for a company.

Enterprise Application Integration: This set of software help one set of software to speak to the other set. e.g. it will help ERP system (SAP) to speak to DataWarehouse (Oracle). This software is becoming of less relevance because most applications provide protocols to talk to other applications and with the advent of SOA (Service Oriented Architecture).

It has been seen that there are different players who are good in one or more of each of these types of softwares. However, there is a consolidation and these players are trying to capture various segments. e.g. SAP has moved from ERP to provide buy side software also, i2 has acquires Aspect to provide buy side software, Oracle has acquired Peoplesoft etc. In the days to come, it seems the players who can either integrate all these niche softwares or who can provide a suite that provides everything and is best of breed, will win.

85 days to go

I have been running a countdown in my status on gtalk messenger. I have received various comments from my friends, some saying that get scared to see the number go down so soon, some want me to take it off while some requested me to fast forward it somehow. It reflects how everyone's experience here at ISB is different from others, and that not everyone is happy here and doesn't want this to end, while some are happy and want this college life to continue as long as possible.

Last few days have been very busy. I haven't really got a chance to update this blog, despite an entry everyday in my ToDo list. I spent my new year eve in Bangalore with my family. Just reached in time after finishing the exam in the evening. I was there for the next 6 days and returned on 6th here. From 7th the 7th term started. I have taken the subjects Outsourcing and IT business, Negotiation Analysis and IT Services and Project Management. I have taken just three this term so that I get more time for placement prep. I will need to take 5 courses in term 8.

The campus is abuzz with placement fever right now. Lot of PPTs are happening everyday, as much as 4 everyday. The job are being posted, people applying, getting shortlists and rejects. Some are enjoying while some are in to a state of panic and close to that. Today I attended PPTs for NIIT and Microsoft. Yesterday I attended PPT for Inductis.

Need to work on the Solectron case for tomorrow's class at 10:15 AM. It's already 12:45 AM. I better get back to preparing the case, though I am least motivated right now. After tomorrow's class, the weekend will start but there is a long To Do list for this weekend besides the placement prep.

IT Outsourcing - Options

IT matters! Most conglomerates are tech savvy and use IT (Information Technology) to gain a competitive advantage. Most companies are spending a substantial amount of their revenue on building IT capabilities. Big Indian IT companies termed as SWITCH (Satyam, Wipro, Infosys, TCS, Cognizant, HCL) are the “cost efficient experts” in low cost countries. These companies excelled in delivering state of the art IT solutions at low cost. However, there have been numerous changes in this industry over last few years and the business environment has become challenging. Some of the changes are:

1. Indian IT biggies looking to move up the value chain.
2. Global IT consulting companies like Accenture now  offer end-to-end solutions by operating in India.
3. There is a high demand of IT professionals while the supply of labour is low. This has increased the wages dramatically and the labour arbitrage is slowly diminishing.
4. Low availability of skilled labour has caused companies to compromise on quality.
5. High competition has led to pressures on billing rates and the margins are decreasing even further.
6. Companies unable to manage high growth leading to quality and security related issues.

Within buyers of IT services, there is an ongoing debate on whether to outsource or instead go the captive centre route. While outsourcing is cheaper and usually a necessary step to retain a competitive edge, there is no discretion in team selection and no visibility into the Software Development Life Cycle processes. Captive units on the other hand negate most of these disadvantages but most companies fear making the high investment commitment required to set up a captive unit in a new country. A case in point is Apple’s development centre in India, which was closed a month after it opened.

The captive unit business model will become a big threat to SWITCH companies. Most of the critical work will get assigned to the captive units and vendors will be used to compensate for spikes in business or for delivering the less critical and lower margin tasks. To compete in this changing environment, SWITCH companies should take the lead in establishing a new business model.

To accomplish its IT business, there are various options that any company can use. There are obvious advantages and disadvantages of each option. While accomplishing IT work in own premises might be most beneficial, it might not be the most optimum option. With the emergence of knowledge centers like India, which provide the similar or better services at a much lower cost, outsourcing and offshoring are becoming extremely important in any CIO’s agenda. Following are the options that a company can use to accomplish its IT business.

1. In-house IT department
   1. Onshore Captive Unit
   2. Offshore Captive Unit
2. Third Party Out-sourcing
   1. Near-Sourcing – location is near to incumbent’s location.
   2. Far-sourcing – location is far (e.g. American company outsourcing to India).

Within the offshoring strategy there are various options in which the IT business can be structured and accomplished. There are essentially six different offshore models. The two models at the extreme are:

1. Captive Center – Completely owned by the company for its own use.
2. Supplier Direct – Completely owned by a third party offshore supplier.

There are also a few more models which are lesser known but slowly and surely gaining importance. These are:

1. Dedicated Center
2. Joint Venture
3. Third Party Transparent
4. Build-Operate-Transfer

Captive Center: Under this model the company sets up its own offshore captive center. It starts from ground up, sometimes, in a totally new country where it has no earlier presence or outsourcing relationship.

Supplier Direct: In this model, the work is outsourced to a third party who provides both low cost advantage and special skills, while allowing the company itself to focus on its core business.

Dedicated Center: A dedicated center is a further extension to Supplier Direct model. This is also operated by an offshore supplier, but the staff, equipment and facilities are all exclusively dedicated to the company. This model has some shared processes, shared risk and shared ownership.

Joint Venture: In this model generally a company partners with an offshore supplier in a joint venture relationship and they share the revenue. A joint venture can also be between two or more global companies, with or without local partners, to build an offshore center with multiple owners. This way they share the cost and risk.

Third Party Transparent: In this model a third party builds and maintains the offshore presence.

Build-Operate-Transfer: In this model, a third party builds the captive center ground up, and transfers it to the company once it is operational. The time for which the third party maintains it can vary.

SWITCH companies currently operate in the Supplier Direct Model. This model became popular because of labor arbitrage available in India. With it huge pool of English speaking skilled population available at low wage rates, this model was highly successful. Most companies used Supplier Direct model to outsource their IT services work while some use hybrid models like having both a captive center and outsourcing some work to third party IT vendors.

In the long term, any company needs to invest in what it considers the core. If some work is clearly not the core and hence not of long term value it should be outsourced if it makes economic sense. On the other hand, if the work is strategic for the longer term then the continuity of the work and the people (after all, it is a knowledge economy) is required and investments have to be made. With this reasoning, some companies operate their own captive centers and outsource the low value work to third party vendors in low cost countries.

With no distinction between any two third-party IT services vendors, cost became the only distinguishing criteria. As competition heated up, there was a huge pressure on prices and the billing rates reduced dramatically. At the same time, some of the IT consulting companies like IBM and Accenture also expanded to low cost countries to make use of labor arbitrage and provide end to end services to their clients. This forced the IT biggies to rethink their strategy as the current strategy was clearly not sustainable. The Indian companies aligned their businesses along verticals and put a strong emphasis on building domain knowledge so that they could move up the value chain.

The IT businesses have expanded at a dramatic pace and some companies have not got enough time to adapt themselves to their explosive growth. The demand for labor has gone up multifold, while the supply has been more or less constant. This has affected the quality of labor and therefore the quality of work delivered. There have been a few instances of security breaches in handling sensitive data. Most companies now believe that their India strategy is very important and a lot of time is spent of formulating this strategy. IT biggies are facing a new competition from increased number of captive units being started. As more captive units come up, these companies would start losing their clients and moving up the value chain strategy would remain incomplete. There is also an additional risk of big captive centers like GE building capacity and competency to service other clients from their captive centers.

In this highly dynamic market, a new wave of IT evolution has to gain momentum. IT vendors need to rethink their strategy to survive and excel in the future. This scenario presents SWITCH companies with both an opportunity and a threat. I believe that to compete in this changing environment, the business need for these companies is to adapt quickly to this new wave and position themselves to take maximum advantage of this opportunity. In Thomas Friedman words the situation can be summarized by the lines, “Do it before it gets done to you. The change itself is inevitable”.

 

Funny Video

This is not to suggest anything...it's plain funny...