The INR 2.5 Sugarcane Juice and Consumer Spending

This afternoon when I was walking by JP Road, Andheri (west) I saw a crowded shop. My curiosity led me to that place which I saw was a sugarcane juice shop where it was written in bold all across the shop - “Full Glass Rs. 2.5” I happily drank a glass of sugarcane juice. While I was walking back to my college, I had an interesting thought. I remember drinking a glass of sugarcane juice for 5 bucks 16 years ago. My memories went back to those balmy days in Delhi when I used to go to a nearby park, play cricket and gulp a glass of sugarcane juice in a shop near the park.

Suddenly I asked myself when inflation averaged more than 5% for the past decade or so, the price of sugarcane juice should have increased from Rs 5 in the year 1992 to somewhere close to Rs 10 ( in the shops of same kind of course!). But I remember drinking sugarcane juice for 5 bucks for a long time and now it’s 2.5 bucks! What is causing this anomalous reduction in price?

We see a lot of products whose prices come down because the products are associated with some technology and it is common wisdom that enhancements in technology can reduce the costs and hence the prices. But the sugarcane juice vendor doesn’t seem to be blessed with any technology and he uses the same old machine driven by an electric motor. In fact the real estate prices have escalated greatly and that too running a shop in a place like Andheri West should in fact increase the overheads and hence the price. But we are seeing the reverse.

There are two reasons I can think off. The first is that the transportation and logistics has improved big time as compared to a decade ago. This means cost of sugarcane supplied to a shop does not increase much from that a decade ago. The second and most important reason is that there is an increase in consumer spending across all strata of Indian society. This leads to a lot of people drinking sugarcane juice as compared to a decade ago and hence the number of glasses of sugarcane juice sold per day increases which considerably reduce the overhead costs (land, electricity etc) per glass of sugarcane juice. Hence increase in consumption is one of the most important factors that have reduced the price of many items.

Increase in consumption spurs the GDP growth which leads to better economies of scale. This leads to reduction in price. But this price reduction can’t happen on a continuous basis. Let us analyse why. We saw in the sugarcane juice case that the costs could be minimised by increasing the efficiency of the game. The shops have increased the number of glasses it could sell per day. It can sell more as people buy more. But it can’t produce more than its capacity. To technically put across, all these years the sugarcane shop has been moving towards achieving a higher ‘utilisation rate’ or ‘utilisation capacity’ or in other words increasing its efficiency to cut costs. Prices will fall till utilisation of resources is maximised.

World’s top notch Management Guru CK Prahalad believes that for achieving sustainable growth, corporations should look at ‘Inclusive Business Models’ (co-creation!). The fact of the matter is that, as explained above increase in consumption should lead to increase in GDP which should again lead to increase in prosperity and consumption in a merry go around way, but the bottomline is that for this cycle to be sustainable the consumption should be ‘Inclusive Consumption’. By ‘Inclusive Consumption’ I mean the whole India including those at the bottom of the pyramid earning and spending more. A recent McKinsey report suggests that India will be the 5th largest consumer market by 2025. All these signal very interesting times to come!

In pursuit of 'Rationality' ( A 'Probabilistic' Explanation)

"All the World's a stage and we all are actors" said William Shakespeare. When I read this poem way back in my 9th grade, my understanding of this was totally different as against my current interpretation. Most of us are not true to ourselves. We are not truely rational though we proclaim so. Why is it so?

A child is born with certain numerical abilities. Even before mathematics is formally taught to a child, it can count the number of toys it has with it. It can add the number of toffees it has even before the mother teaches 'addition'. The logical explanation for this characteristic is that the child has genetically inherited such a trait. Man has been playing around with mathematics for tens of thousands of years and hence he is genetically strong.

I have always loved mathematics till now and so have many of my friends. But I have observed one peculiar behavior. Most of my friends including me are pretty strong in Algebra, Geometry, Numbers but most of us are dreaded by the chapter 'Probability'. Most people I have observed are not very comfortable with 'Probability' and 'Combinatorics(Permutation and Combination)'. What can be the reason for this? The most common answer I get from people is that 'Probability' is tough. But why is it tough?

It is an intrigiung fact that though Geometry, Algebra, Numbers had been in use for thousands of years, 'Probability' is one branch of science which was popularised only post 15th century when some gamblers wanted to estimate their return from the game of chance. Probability is relatively the new kid on the block of science. So the element of 'Probability' is not strong in our genes. And it would still take hundreds of years before genetically, the mankind is comfortable with probability. But what is the implication ?

'Rationality' is strongly related to 'Probability theory'. One way of looking at rationality might be choosing the right path from a given set of alternatives. Such a choice can be termed as rational decision making. Decision theory was popularised by the 18th century mathematician Thomas Bayes (of Bayes' Theorem fame). 'Decision Theory' applications are indispensable tools for the rational decision making by managers(My MBA friends would agree with me on this fact). But we don't use decision theory beyond our professional life. Do we draw a decision tree for our day to day decisions? A lot of our decisions are taken not from our minds but from our hearts. We are not perfectly rational simply because we are not genetically coded so. Nevertheless we are in pursuit of rationality.

It will be a really interesting proposition when more and more of rationality creeps into the society. It'll be a whole new world. Marketers can't allure customers by 'Buy 1 get 1 free'! Investment Bankers and other traders would no longer successfully underwrite European Options! Insurance industry would rewrite its business equations (FYI Insurance Rationale is very much based on Bayesian Probability theory)! And students would say 'Probability' is a piece of cake!!

US Slowdown and its impact on the Indian IT industry

Recently there has been talks of a slowdown in the US economy. Business Gurus opine that it will affect the Indian IT industry because the majority of the Indian IT revenues come from the US. I would beg to differ. I feel that all this is noise created by the media. And the stock markets react to it adversely.

In an event of US Slowdown, some economists argue that companies would get into the cost cutting mode and reduce their IT budgets and hence outsourcing revenues will reduce. But there is another way of looking at this. A lot of companies would feel that developing in-house IT capabilities would be a high cost proposition and hence outsource more. These companies will temporarily stop its in-house IT plans and outsource more to low cost destinations like India. Hence I would argue that US Slowdown would relatively benefit India.

The bottomline is that it is for the time to tell what would happen in the future!

What is common between CAT and capital markets?

I’m writing this article exactly a year after my CAT 06 results had come and when a lot of my friends are eagerly awaiting their CAT 07 results. When you are attempting the “all elusive” CAT for the first time, then the day of result is one which you can never forget. My memories are fresh even after a long gap of 365 days. I was eagerly awaiting my ‘Verbal Ability’ scores because my scores varied with each and every ‘Answer Key’ published by various coaching institutes. I still remember my various scores. My scores as per PT, CL, TIME and IMS keys were 31, 26, 16 and 16 respectively. Finally I got a shocker of my life when I got 6.25 in the ’IIM’s (Decider) Key’ (0.25 was ‘grace!!’ score since they had eliminated a question since 2 options were not printed for a question)

Let me delve a bit upon the capital markets at this juncture. I was thinking about investing in the markets and was analysing certain options. I was thinking about the returns of the mutual funds and that of the equity markets themselves. For those who don’t know much about mutual funds let me explain a lil on that. Mutual funds, in short are those funds (funds of ‘aam’ junta) which the “smart” fund managers invest in the equities (most common instrument) in the capital markets. There are funds like the ‘blue chip’ funds where the fund managers invest only in the blue chip stocks of the BSE sensex (India’s popular stock market index). When I was looking at the return on these mutual funds, I was in for a surprise. What I observed was the mutual funds on most occasions gave lesser returns than that of the markets themselves. Then I convinced myself thinking about fundas like diversifying the portfolio and risk mitigation in mutual funds and stuff like that. Generally mutual funds invest in debt and equity instruments and hence the returns are lower. But the funds that I observed invested only in the ‘sensex’ blue chip stocks and still gave lesser returns than the market’s return indicated by the sensex. Why is this happening? This is scenario not only in India but across the globe. Then I realised that markets as a whole comprising millions of traders are better of than the fund managers. It was a hard fact even for me to digest, but again this is the reality and power of markets. Collective wisdom is far superior to an individual’s intelligence. For those who want to research more into this you can google on topics like ‘behavioural explanation for stock market fluctuations’ and stuffs like that. In fact behavioural finance itself is a wonderful research area.

Coming back to the CAT stuff, what IIMs should have done when there was so much of an ambiguity in the answer keys? I bet even if all the IIM profs are separately asked to come up with the keys, there would have been at least 10 versions of the key. What IIMs should have ideally done is to evaluate all the answer paper on the basis of all these 10 versions of the keys and then look at the distribution of scores across the 10 keys and should have finally selected that key which gave a better 90 percentile cut off score. It was very sad to know that the 90%le cut off was around 20 last year. And doing this in definitely not a laborious process since all the answer sheets are initially fed into the system and the responses of the candidates are digitised. It takes time to feed these answer sheets into the system’s scanner and evaluating doesn’t take any time. It takes hardly a few hours to evaluate once the responses of the candidates are scanned and digitised. The logic behind this is very simple. Collective wisdom is always better than that of an individual’s intelligence the same funda of the mutual funds and markets. This is applicable to cases as that of CAT 06 English paper where different experts came up with different answers and all the CAT 06 takers would agree to me with the fact that the answers were very subjective and not objective. In fact there are a lot of statistical distributions which can be used to analyse these 10 keys. For simplicity I’m not getting into those nitty-gritties, but a simple way would be to choose that version of the key where the score corresponding to the 90%le mark is the highest. I had been thinking about this for a year, but I thought about the correlation between this aspect and the mutual funds – markets paradox and this CAT stuff helped me getting more clarity on that paradox.

For those God level profs in the IIMs who teach statistics and those mighty fin profs who are an adept at behavioural finance, please put in your thoughts in solving a real time problem like this where careers of thousands of serious aspirants are at stake! All the very best to CAT 07 takers who are eagerly awaiting their results!