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Cultural Identity: The Sports we Watch

January 31

 

On chilly rainy day, I stepped into a pub. I ordered a local Ale and a Shepherds' Pie, and watched the local football game on the large TV screen. The home team was trailing 0:4, which made people watching more interesting than the game. Yet, at the end both teams won a trip to the finals in London, so everyone was happy. All felt like I was back in god 'ol England.

 

But then the TV switched to another channel. It looked like a team wrestling sport with complex rules - men wearing big helmets and hugely inflated shoulder pad were wrestling each other to the ground, interspersed with the throwing of an egg-shaped ball. Well, they call that football too. Evidently I was not in England, but in an English-themed pub at the far South Western corner of Canada.

 

My thoughts turned back to a dinner conversation last week in Calgary with a gentlemen in his 70s who emigrated from Poland to Canada thirty years ago. Yes, he said, he made the right decision to come to Canada all those years ago. Canada more than any other country allows newcomers to fit in, at least in the second generation - his sons now both hold professorships at Canadian universities. But, most of his friends in fact were other immigrants from Europe. "In many ways we are the same with the Canadians", he said, but there are subtle differences. "This is most evident is the sports we watch."

 

Spectator sports as carrier of cultural identity, and of cultural affinity?  Many other example come to mind. Today, the news reported Danes celebrating their European championship in handball - who in this part of the world even knows what that is? A few years ago I experienced a huge spontaneous street party in Helsinki: Finland had just beaten Russia in ice-hockey - Canadians would certainly understand, but who else? And then there is cricket, a buzzword that gets English, Indian and Australians simmering with excitement, while (almost) everyone else literally switches off. Spectator sports have become such an important part of life for people in modern societies, that they have indeed become an important part of popular culture.

 

This raises interesting suggestions for culture research: Can we proxy cultural affinities by the spectator sports that people watch? It is far more parsimonious than the over-engineered proxies we often use in management research, yet might be highly effective. 

  • Postscript: The game I watched in the pub was the qualifying for the London Olympics in women's football ("soccer" to Americans), Canada lost to the USA but went through as second North/Central American team. 

 

Starbucks: Measuring and Benchmarking Performance in an MNE

January 30

 

A short article in a Canadian newspaper got me thinking about the merits of multinationals reporting their performance in regional segments (i.e. separated for different regions of the world0. The article reported that Starbucks was changing its reporting practice from distinguishing 'domestic' (i.e. USA) and 'international' to reporting three segments 'North America', 'Asia Pacific' and 'Europe Middle East and Africa. Academics will be pleased with such more detailed data as it allows us to do some more rigorous analysis - a lot of research on international performance of big firms stands on thin data as companies don't publish what we would need for rigorous analysis. However, what are the implications for managing subsidiaries?

 

The article argued that this changed reporting practice would put pressure on Canadian Starbucks to increase its profit margins: Since they are now joined accounting-wise with the US, the Canadian would be under pressure to increase its profitability to the levels achieved in the USA. The more I thought about it, the less this statement made sense to me.

 

In the article, executives from Starbucks attribute their lower margins to higher costs of milk (raw material for 'Latte') and barristas (low/medium skilled human capital). In other words, marginal costs are higher. In addition, we should add, the customers willingness to pay (demand curve), which in turn depends on their preferences (and hence the brand reputation) and competition, the availability of alternative providers of coffee shops - and there are plenty of other chains in Canada, such as "Tim Hortons" which people here seem quite proud of. In other words, the profitability one can achieve in a market depends on the costs and market structure in that market - and you cannot really compare profitability (in terms of return over sales) across different markets.

 

If Starbucks was indeed maximizing its profitability in terms of return over sales, then it would probably shrink to operating in its most profitable market only - which obviously they are not doing. Rather, they are (presumably) trying to maximize total profits - which means operations abroad - such as Canada - are making a positive contribution as long as they generate more profits than the costs of capital.

 

If, hypothetically, Starbucks tried to increase its profitability in Canada, it would face several options. Firstly, it could raise prices, or close down some of its least profitable branches. With competitors all around, the main winners of such a strategy would be Tim Hortons, Blenz and other local coffee shops who would happily increase their market share. Secondly, it could take over a competitor to increase market share. This may be an option that consumers are unlikely to appreciate, and that may face obstacles from the competition authorities. Third, they could use their bargaining power to lower the costs of milk and or staff costs. Yet, this will limit their ability to attract quality inputs and people to work for them - apart from conflicts with labour laws. Either way, singular focus on profitability can seriously harm long-term market positions.

 

The bottom line is this: You need to be very careful when to use 'profitability' (as a ratio) or 'profits' (as an absolute value) as a performance criterion. As rules of thumb, for existing operations, when benchmarking against a direct competitor, profitability may be appropriate. When considering operations in an additional market, it is the absolute contribution to profits that matters. 

  • Strauss, M. 2012, Starbucks' Northern Grind, Globe and Mail, Page B1&B4.

 

 

DOWN: Blackberry, Nokia; UP: Apple, Samsung, HTC

January 29

 

The morning newspapers I have been reading while traveling in Canada, had one big business story throughout the week: the decline and uncertain future of Research in Motion (RIM), until recently the pride of Canadian technophiles. As a start-up company of the 1980s, RIM led innovation of mobile phone and its 'Blackberry' became the favorite toy of business folks in financial centres around the world. Yet, this week, the founders and co-CEOs resigned and handed over the leadership after months of losing the buzz of a leading technology brand, and market share, and consequently losing three quarters of its share value.

 

The story reminds me of the competition between Nokia and Eriksson in the 1990s. Nokia was first to realize that phones were becoming fashion items, while Ericsson focused on technology. Eventually, Ericsson formed a JV with Sony to create a joint brand ... but I have not seen a phone of either brand for quite a while.

 

Now the next generation of technology has pushed past Nokia and RIM. Apple's iPhone and iPad have become not only the most fashionable brand in the sector, but have created an entirely new way of using phones - as a platform for a wide range of applications few inventors even thought about a few years ago. They have been joined by Android phones based on a open software created by Google, with handsets provided by Samsung, HTC and others. The buzz among technophiles has moved on - the places where the best software engineers go to work are no longer Nokia or RIM, but Google, Apple, and (in Asia) HTC and Samsung.

 

The shift is evident in the ranking of the most valuable brands published by www.interbrand.com.  From 2009 to 2011, Apple has been rising from 20th to 8th, Samsung  from 19th to 17th, while HTC as the first ever brand from Greater China joined the list at rank 98. At the same time Nokia dropped from 5th to 14th. Blackberry has been rising from 73rd in 2008 to 54th in 2010, but dropped two places in 2011. Yet, technological hick-ups and slacking sales suggest they probably had fallen further by the end of the year.

 

The competition has shifted every few years. Initially, it was about building technology making phone smaller, then about fashion brands, and now it is about standards. It is no longer individual brands competing, but different systems and their software platforms. The more and better the applications running on a standards, the better the business for everyone operating on that standard. Apple has its own standard, and controls it firmly. Android is a shared standard backed by Google. Nokia joined forces with Microsoft to develop a Window's based standard. RIM still believes in its own blackberry software, even though the release of the latest version had to be postponed.

 

When competition turns into 'standard wars', usually only one or two survive. It just not practicable for all developers of 'apps' to develop four different versions. If RIM wants to persist with its Blackberry software, it will need a miracle by RIM's new leadership to play in the same league as Apple and Google. And in the lower league, there is not much money to be made.

 

 

Happy New Year 2012!!!

January 1

 

Economists usually get their forecasts wrong, and journalists are even further off the mark. Many economists predict a serious recession in 2012, and journalists, especially the British press, expect an Armageddon. So, is that actually good news because it won't happen? I actually think so. 

 

The world economy is volatile. It always is. Emerging economies have known that for a long time having frequently experienced financial crisis (e.g. Asia 1997), health scares (SARS, bird flu etc) and natural disasters (earthquakes, monsoon, tsunamis). Consequently, business have realize that flexibility and adaptability are essential to prosper under such circumstances, and they developed their capabilities accordingly.

 

In contrast Western Europe has seen three decades of relative stability, even the unification in 1990 did little to disrupt business; it rather offered easy opportunities to extend business. However, the financial and housing market crisis of 2007 - along with the Icelandic volcano and some minor health scares made clear to business leaders that Europe is not living on an island of stability. Hence, many businesses in the real economy (i.e. outside the financial sector) rediscovered the importance of flexibility and adaptability, and developed their capabilities accordingly. As 2011 drew to a close. consumers defy scaremongering in the media and keep consumer spending high, while manufacturing enterprises across Northern Europe (not just Germany!) report full order books (references below). Businesses - and to some extent consumers - have learned to live with higher uncertainty.

 

Meanwhile, we have over the past decade learned about the power of self-reinforcing bubbles in financial markets, and in some other markets like real estate. One excessively large forecasts chases another, people make investment decisions based on the forecasts, until they have collectively created a lot of overcapacity. Hence, the positive trend is accelerated until the bubble burst. Likewise, negative bubbles reinforce themselves - notably the activities of short-sellers. But the financial markets can't go against the real economy for ever. So, the short-selling bubble will burst eventually.

 

Hence, the global economy in 2012 faces a lot of uncertainty. However, businesses in many countries are much better prepared to handle such uncertainty than the popular press would make you believe! Welcome to 2012, a year of fresh opportunities!

 

 

 

Taking risks, making predictions for 2012

December 31

 

It is a popular past time on news years eve - not only among journalists - to try and predict what will happen in the new year. Here are a few offers of my own. Will any of them come true?

  • Germany: After further defeats in regional elections, the F.D.P. party self-dissolves as most of its MPs join other parties - just enough to enable to Merkel government to muddle through. Meanwhile, the pirate party enters further regional and local parliaments, but is hit by a series of scandals as its inexperienced politicians say outrageous things, and by the end of 2012 it disappears into the insignificance it came from.

  • Denmark: The new government stumbles a bit while it learns how to govern the country, but apart from that nothing special happens, and the country stays out of (international) headlines.

  • UK/EU: After a referendum in the UK, followed by a referendum in Scotland, the UK government negotiates its exit from the EU (surprised that noone else actually cares), while newly independent Scotland becomes the new 27th member. Scotland prepares to introduce the euro by 2016. Subsequently, with the British veto gone, the EU Parliament is strengthened to provide stronger democratic control over the EU Commission.

  • Eurozone: After Greece defaults on part of its government debt, but continues to use the euro (perhaps in a similar fashion as Montenegro and Kosovo), financial markets calm down in view of quite different economic situations in other countries under pressure in the eurozone, and serious cuts in deficits across member countries. 

  • USA: I do NOT venture to predict who will be the next president of the USA. However, due to even larger polarization of the candidates than at the last election, most voters actually support neither candidate, and demonstrations against 'the banks' and 'the system' will spread from the anti-Wallstreet movement of 2011. For foreign observers, it is obvious that changing the election system to proportional representation would solve the national governance crisis, but no major politician in the USA will support that idea for fear of dislodging their own power base.

  • France: Francois Hollande will become the next president of France, beating the National Front candidate in a run-off election. The most left-wing candidate in a generation will benefit from a wave of anti-banking - and by implication anti-Anglo-Saxon - popular sentiment.

  • China: XI Jinping will become next president of China. The government will be increasingly assertive in a nationalist sense: firstly, rejecting foreign "interference" about Chinese policies alleged to create trade barriers, or to violate human rights; secondly, imposing central control over wayward provincial leaders pushing their own pursuit of capitalism too far, and/or being entangled in corruption or other scandals highlighted by local protests.

 

 

Amsterdam to Berlin! and London?

December 17

 

Sitting on Amsterdam to Berlin train, I am reflecting over the state of the European Union. Overall my travels have been smooth and having just one currency in my wallet is just one of the little benefits that European integration has brought for businesses and travelers.

 

In fact, at dinner in Rotterdam, my hosts kept pointing out the "ships bound for Germany" passing on the river, heading up (!) the river to German river ports such as Duisburg. Rotterdam is an one of the most important seaports serving German industry, and the integration with German industrial base in the Ruhr area is a major strength of the Southern Netherlands region. No-one here would want to get back to the system of small nation states, each with its own currency, and causing each other headaches with their diverse regulations for about everything.

 

The view looks so much difference from headquarters of the Conservative party in London. The English in their mind have a much greater 'psychic distance' to the rest of Europe, not only they travel much less to their neighboring countries, but because their mindset is informed by the history of their empire, and a supposedly glorious economic past that somehow prevents many opinion leaders to critically engage with the social and economic challenges England faces today (I don't want to repeat myself, so read my earlier blogs).

 

In our textbook, I had included a discussion point on the relationship between the UK and the EU (chapter 8, p.252), offering the following statements:

"to understanding the ambivalent relationship of the British, or more precisely their political leaders, towards Europe is to understand that most British politicians of the 20th century never appreciated the EU as a political project, but rather focused on the economic benefits."

"Psychologically, many people of Britain see themselves as an independent nation with a major role on the world stage rather than a part of Europe, to which they geographically belong."

I don't really have much to add to that now.

 

The challenge thus is that the British (or perhaps more precisely the majority of the English) feel that there already is too much integration, while this integration is essential to most other Europeans. Based on this public (or media) opinion, the British government uses its veto to bloc core EU members from developing solutions to their problem. This obviously is highly unsatisfactory. The logical solution seems to be a 'multi-speed' Europe where those who want more integration, and others stay in the outer circle of the European Free Trade area. This is idea isn't popular either because those in the outer circle loose some of their privileges in the single market, and have no influence on regulation that eventually they may have to adapt anyway.

 

From an economic perspective, the UK leaving the EU would cause more harm than good (especially to the UK). But given the political obstacles in the UK to constructively working with the rest of Europe, it is an option that may serve many interests best.

 

 

27 minus 1: Why the UK exit might be good for Europe

December 14

 

At the conference I was attending, the British colleagues had to endure a fair bit of jokes. Or they took it proactively: The host of the 2012 conference offered the prospect of a European on conference held outside the EU - in Brighton.  With the repeated statements from the current British government in their domestic communications that they wouldn't lift a small finger to help their neighbours (friends is obviously not the right word here), it should have come little surprise to find the rest of the EU proceeding without the UK.

 

At the same time, conservative backbenchers 'threatened' to call for a referendum on EU membership. Let me make a prediction: If the UK went ahead with the referendum, I suspect the yes-to-exit campaign will be in for a surprise: They would receive from massive support from across Europe. Despite broad appreciation of many aspects of British culture, language, etc, many people across Europe are getting fed up with British politicians enjoying their 'pain in the neck' role. Obviously, many people will see the UK exit as a failure, which it probably is. But there are positive sides for the EU too:

 

  • The EU will be able to strengthen the European Parliament, which is directly elected, vis-a-vis the European Council, which is essentially the heads of the national governments.  Such strengthening has long been opposed by the UK fearful of loosing their national veto on key EU initiatives.

  • The EU will not longer have a member that receives an extra discount  in terms of the taxes it transfers to the EU (negotiated famously by Maggie Thatcher), an issue strongly resented by other net contributors such as Netherlands, Germany and the Nordic countries.

  • The EU will be able to move forward with its revision of the regulation of the banking sector, another area currently held back by British opposition.

  • The EU will have one strong-willed partner less at the table when it comes to negotiations over any other issues, such as product standards. Even so, if the UK was still in the European Free Trade Area, it would have to implement many rules even though they were not at the table when they were negotiated - or face trade barriers. 

  • The EU will no longer be the scapegoat for everything that goes wrong in Britain, the Brits will finally have to realize that most of their problems (a fragile yet overblown banking sector, a weak education system outside the elite, a squeaking infrastructure, and large and growing inequalities and the resulting social tensions) are home-made and can only be addressed in at home.

  • The EU will not be drawn into political conflicts at the other end of the world, out on the frontiers of the former British empire (or commonwealth), where the British feel they ought to send an army.

  • The EU can appoint someone as foreign affairs representative (one of the highest offices in the EU, currently held by a Brit) who someone who actually has experience in international politics and diplomacy and does need to learn the basics on the job.

Among the disadvantages from the EU perspective three are important ones:

  • An important lobbyist for free markets, less government intervention, and simpler regulation would no longer be at the table (though in current years this influence seems to have been weak anyway as British governments focused on getting exemptions rather than making the rules better).

  • An important trade partner is likely to be separated by some barriers to the free flow of goods, investments, services and people. If we assume the UK remains in the European Free Trade Area it would become like Norway now. That means that most of these four freedoms would remain - as long as the UK adopts the relevant EU regulation. But, over time regulations are likely to diverge, standards are no longer mutual, and hence trade would decline. As the UK is less important to the EU than vice-versa these losses will fall mainly on the UK.

  • One country in the EU would probably be a second looser: Ireland exports a lot to the UK. But then, Ireland may be able to compensate for that by presenting itself as the most important English speaking location within the EU!

It seems, overall, 27 minus 1 is a formula that "Europe" (in the usage of the word common in England) could live with quite well. Charles de Gaulle would not be surprised. 

 

 

No alternative!

December 12

 

As I spend a day traveling I ended up reading a lot of newspaper columns on the EU summit - lots of people being unhappy with the solution put on the table (especially British newspapers) but no-one seems to know any viable alternative.  I have spend the weekend at a conference with academics from across Europe - and I can tell that none of my colleagues from across Europe is happy with the solution. But noone could provide a solid suggestion what to do instead.

 

Doing nothing - apparently preferred by the British government and the British media - is certain to make things worse. Sometimes I really wonder what the critics of the euro really want: braking up the euro will make a lot of things a lot worse for about everyone. For some mysterious reasons a lot of journalists and politicians in Britain seem to think it is not theirs to worry about. Actually, as the British economy is more dependent on the financial sector (as % contribution to GDP) than most other countries in Europe, and the British private sector has a high net foreign debt, the British economy is going to suffer more than most if we have a new financial crisis.

 

It is obvious that mistakes have been made in the past - see yesterday's blog. But 'what would have been if' does not help us forward. Nor does 'I told you so' - because I certainly can't recall anyone warning of a bank bail-out of the scale that happened. May be, letting Greece go bust right at the beginning of the crisis would have been better - but even that seems now unrealistic speculation.

 

So, what are the alternatives? After reading a lot of newspaper space, I can see a lot of opinions, but no solution that is better than the one on the table.

 

 

What went wrong with the Euro?

December 11

 

Twenty years after the Maastricht treaty was signed, the mood in Europe is rather somber. As everyone seems to be concerned about the future of the Euro, let's step back an analyze what went wrong.

 

The first set of reasons relates to the budget deficits run by the governments of the eurozone. The Maastricht clearly stated a limit of 3% of GDP in any year - along with a maximum level of inflation, and a maximum level of debt. However,

  • Greece was admitted to the euro despite unsustainably high levels of debt, and budget deficit data that turned out to be incorrect (some say, deliberately misleading).

  • the treaty was not clear on how to enforce that 3% limit: Would countries be punished, and how? As it happened the European Commission tried to enforce the criterion and penalize the first offenders, some smaller countries. But then both Germany and France broke the and were granted exemptions, which made the rule rather soft, to say the least. 

  • the fixed 3% limit does not allow budget deficits to be adjusted to business cycles, as most macro-economist suggest they should be. In other words, 3% in a recession is OK if the money is paid back in a boom period.

  • the decision making process in the EU implied that major decisions concerning to the eurozone, such as the negotiations last weekend, still need approval of all EU members, even those that are not member (and even those who have a contractual exemption meaning they are not committed to ever joining: the UK and Denmark).

The resolutions of last weekend aim to address the above issues by creating and enforcing new rules on budget deficits. This is clearly important. Yet, it addresses only part of the problem. In fact, it assumes that the budget deficits are the outcome of unsustainable government spending in the past. This, however, is true really only in the case of Greece. In other countries - notably Ireland and the UK - the budget deficit is primarily a consequence of the bank bail-out of the years 2007/08. Politicians rarely tell you that because that would severely inhibit their ability to enforce expenditure cuts or tax rises on their distrusting populations. Thus, there is a different way to interpret the current crisis:

  • The Maastricht treaty did not consider the possibility of a massive crisis such as that of 2007/08, and the consequences it had for government budgets. Even with a different set of rules, they would probably have done those bail-outs.

  • As a consequence of the bank bail outs, governments issued large volume of debt now held by banks. Hence the default of some countries would affect banks across Europe, reportedly especially French banks, but also German banks and various other countries - with the UK banks heavy exposed to Irish debt. It is this fear for their banks and the possibility of a domino effect that drives governments not to allow default of any country.

This analysis suggest that reform of the banking sector should be the first priority. It would include making the banks - and their leaders - pay for the benefits they received from taxpayers in 2007/08/09 would be the appropriate approach to the crisis.  But few in power seem to take any serious steps in that direction - perhaps unsurprising given the close ties between Wallstreet and Washington, and even more so between the city of London and the Conservative party of Britain (who receives reportedly half its donation from the financial sector).

 

 

European Brand Value in China

December 7

 

Chinese consumers love European brands. It must be like paradise for the brand manufacturers of French cosmetics, German engineering, Swiss watches and Italian fashion! All the the big name brands have not just one, but loads of sales outlet in the fashionable districts of Shanghai. And many more, that I have never heard about!

 

The love for European brands brings fore some very peculiar effects. For example, Chinese companies buy up German companies not because they are interested to selling to Germany, but because the German affiliation and brand names helps them sell their produce in the world largest domestic market, China. An interesting example is Pearl River Piano. My co-author had written up the case, and mentioned their acquisition of the German piano maker Ritmuller as key strategic move to build an international premium brand. Problem was, I had never heard of the brand. So, I called up an expert on German musical instruments industry (my dad) to ask him, and he had never heard about them either. So, I got surfing. Yes, the brand existed - but mainly in the sales catalogues of antique dealers. For all I could find out, the company went bankrupt in the word financial crisis. That was in was the crisis of 1928. Ever since it has only been a retailer of pianos. Yet, for Pearl River the brand name was still a desirable asset to acquire to help building a brand associated with the German piano-making tradition.

 

For another example, try to google my name when you are in China. You are likely to come to the website www.klausmeyer.cn, which belongs to a knife maker in central China. As far as I could infer, they acquired a small company (or only the rights to the name?) established in the 1920s in Solingen, the centre of German knife making craftsmanship. I could not find any contemporary linkages between the company and Germany. (and, to be sure, I have no relation to them).

 

Some go even further, and simply invent a European brand name and association. Using a foreign sounding brand name is of course not new, US-firm Haagan Dasz does it, many aspiring entrepreneurs in China follow the idea. But some go as far as claiming to be imported from Europe. They earned themselves a not very flattering article in the China Daily, the Chinese government's newspaper. One company even went as far as feature a picture of the Italian trade representative in the publications. In fact, he was visiting to investigate the firm's fraudulent claim of being 'made in Italy'.

 

Why do European brands sell so well in China - real or fake? I believe there are two reasons. Firstly, association with brand names are a very important means for Chinese to express status and self-esteem, and "imported" conveys higher status than "local". In addition, "imported from Europe" also conveys a higher product quality as Chinese consumers still distrust their home made produce in many sectors, there just is too much sloppy produce around. Chinese entrepreneurs are slowly starting to build their own brands, but even in their home market they face an uphill struggle in terms of challenging into the premium segment.

  • China Daily, 2022, Faux 'imported' brands that are made in China, December 7, page 17.

The World's Coffee Shops

December 1, 2011

 

A fascinating aspect of globalization is the spread of coffee shop chains around the world. While coffee shops have been around for decades - especially Vienna once was famous for them - an American entrepreneur popularized the concept, created a franchise concept and took it around the world. Soon, Starbucks, Costa Coffee and The Coffee Bean started popping up around in virtually every town and city around the world. Indeed, Shanghai is said to have more Starbuck's than New York of London. Does that imply the world will soon resemble Seattle, Washington?

 

In fact, this globalization of the coffee shop is more in appearance (and profits) than in substance. While coffee is consumed in all these shops (or should I say bars), they actually play a very different role in different societies. In Shanghai, where quite space is scarce, offices are cramped and homes are small and shared, the coffee shops provide peaceful atmosphere - not really quite except early in the morning - that serves many social purposes. Today, while working quietly on a paper, I have been observing in the same shop a  group of business people negotiating, a group of young women preparing for a fashion photo-shooting, a young couple on a date, two different business persons working on their Laptop, and a couple having, well, a 'difficult conversation' (she was crying, I was glad NOT to understand Chinese...).  Last week I was witness to two different job interviews - in both cases Westerners - in addition to the usual crowd of housewives chatting, students flirting, and tourists munching a convenience lunch.

 

Coffee shops must be a dream research field for cultural anthropologists, different people using very similar spaces in so widely different ways is telling a lot about the societies in which we life.

 

 

Why are the Rating Agencies so Powerful?

November 11, 2011

 

In summer of 2002, I was attending a comparative economics (EACES) conference in the medieval Italian City of Forli near Bologna. One of the key note speakers - my memory tells me John Eatwell, but apologies if I got the name wrong - delivered a key note address in which he attacked the (then) new banking regulation known as Basle II. Essentially, he argued that this regulation forced all banks to use the same formal models to model the risk of their investment portfolio - and in classifying the risk of individual assets they would henceforth all use a small set of external indices. These models using those external indices thus are critical for key performance variables of the banks, notably the equity that they have to hold. In simple laymen's terms, the more risky investments they have, the more own capital they need.

 

The central bankers and financial sector regulators - and in fact most commentators at the time - thought that is a good idea, because it provides some sort of objective criterion to assess how risky a bank is - and weather our savings with the bank are save. Eatwell dared to disagree. He argued that the new rules would increase the systemic risk in the banking sector.  Basically, if everyone was using the same risk models and the same external indicators - those provided by the rating agencies - then a small change in any of the indices would result in all the banks having to make adjustments in their investment portfolio - in other words they have to rebalance the risk-profile of their portfolio quickly to prevent their own rating to be affected. Hence, a downgrading of an asset will trigger a lot of sales of that asset in a short time, resulting in a substantive change in the price of the asset, and consequently increased volatility of the price of those assets. If all banks then have to revalue this particular asset at the same time, this would increase the systemic risk - i.e. the chance that many banks experience financial difficulties at the same time.

 

Of the audience, few appreciated Eatwell's argument, and I suspect many did not even understand his arguments as most were general economists, not banking specialists. Yet, in recent weeks, I often had to think of that talk in Italy as politicians were lambasting the rating agencies as being too powerful. Actually, they are powerful because the legislation that followed Basel II made them so powerful.

 

The reliance on indices by rating agencies exposed its first flaw when the financial crisis of 2008 broke because the agencies obviously did not rate certain complex assets correctly, keyword mortgage backed deposit certificates. Their own models (as far as I understand) considered each asset in isolation, and insuffuciently (or not at all) considered the interdependence of different assets.

 

The second flaw became apparent throughout the spring and summer of 2011 when each blink from a rating agency triggered a flurry of real trading activity in government bonds of various countries. Essentially, even the expectation of a change in a rating makes it more expensive for a borrower to get money from the banks, to roll over credits, and in worst case can case default. The rating agencies are private, US-based financial institutions that produce the indices for their clients, who pay for the privilege; they (may) know how financial markets work in the USA, but their understanding of financial instruments used elsewhere is sometimes limited.

 

To change the system, legislators would have to re-think their banking regulation and supervision - which is tricky because it is embedded in international agreements of Basle II and now Basle III. However, to take that systematic risk and the increased volatility out of the markets again, regulators need to allow for (and encourage) a greater diversity of risk models and indices. If everyone is forced to act in the same way, systemic risk will continue to create bubbles and crises on a global scale.

 

 

 

Quietly Overtaking? Chinese Motorcycles

November 8, 2011

 

Walking the streets of Pudong - the modern side of Shanghai - during rush hour, one has to pay attention not only to cars that seem to know few traffic rules but to motor cycles zooming along the slow lane. What makes those motor cycles tricky for pedestrians is that they come quietly. How can they be sooo quiet? The answer is down the road in the department store, right next to the teddy bears. Here at Carrefour, they are for sale for 2,000 to 3,500 RMB (about €300 to €400): electrical motorcycles! That's about half the price I paid for my bicycle in Denmark - a really nice one though.

 

Meanwhile, in Europe the politicians are quibbling about the appropriate standards, and about loads of health and safety rules that electrical vehicles will have to fulfill. Everyone seems to expect miracles of energy conservation from them, but only few rather expensive electrical vehicles make it on the roads, and mostly in the luxury segment.

 

I just wonder who, once the standards have been approved, will be best positioned to produce an affordable electrical bike? The Chinese are rapidly sliding down the learning curve, moving up the standards curve may take them a bit longer, but not that much longer.

 

However, there still is a little problem. Many drivers, in the true spirit of energy conservation, seem to switch of their lights, making them tricky to spot for pedestrians or cars to spot in good time. That shouldn't be a problem though in countries like Denmark or Germany where the police happily fines even cyclists for not using proper lights. 

 

 

Welcome to Growth, Chinese Style

October 30

 

A few weeks ago, I moved to China. The country is challenging and perplexing, yet exciting in many ways, and thus I have taken a 'time-out' on my blog to digest my impressions before sharing them with the world. There are a lots of first impressions, that on second sight tell a very different story.

 

The question that has been most occupying me in the last days is the "insane" growth expectations that entrepreneurs and business leaders are chasing. If I say "insane" I mean that from a European perspective where we might see high growth in some niche technology markets, but generally consumer market or GDP growth are in single digits - if they grow at all. Yet, here annual growth expectations for entire industries are rarely in the single digits. Yesterday, I spend the day listening to car executives - both Chinese and foreign investors - discussing the car industry in China. Their growth ambitions are huge, both in terms of getting a share of the domestic market, and (for domestic firms) to bring Chinese cars to world markets. In line with this, huge investments are made in both R&D and in production capacities.

 

The (apparently shared) baseline expectation on which these strategies are build are annual growth rates of car sales in China in the magnitude of 20%, with China accounting for one third of the global car market in 2016. China is already the largest car market by units sold - way ahead of the US and Japan. But 1 in 3 cars sold in China? China counts for one fifth of the world's population - so this one-fifth is going to buy one-third of all cars? How realistic is that?

 

Forecasting is always a dangerous business, and I suspect that some of these forecasts are simply extrapolating growth rates of early industry growth not taking into account saturation effects. Actually, according to numbers I picked up from a magazine distributed at the conference suggest growth in 2011 of about 5% - and mainly for foreign brands with on average zero growth for domestic brands. Yes, there are still lots of people without a car, but where are they going to put their cars - the roads are already congested and parking spaces scarce.  Moreover, with a few years lag after the initial surge in car ownership, and new competitor to the car industry will enter the market, the 'used car industry'. That will change the dynamics of the industry again.  

 

So, the real question is, is the investment in car industry manufacturing capacity soon doomed to create overcapacity and sharp price competition, or am I just a pessimistic European who just doesn't understand China?

 

 

The impact of minimum pricing on alcohol

August 31

 

The Scottish government announced that it wants to introduce minimum prices on alcohol with the aim to reduce excessive drunkenness. Health groups believe that minimum prices on, for example, beer would reduce binge-drinking, and thus reduce a major health problem in Scotland (and other countries with long winter nights). Let's leave the health implications to the pertinent experts; how about the complaints by the drinks industry and retailers that they would suffer from this policy? I find most of their arguments flawed. A fundamental problem with statements from industry associations is that they focus on the impact on their weakest members - while those set to gain remain unmentioned. So what is the likely impact of minimum prices?

 

Minimum prices are a distortion of the market that reduces the premium of premium-brands over mass-market brands, and (like on labour markets) those offering quality below what buyers expect at the minimum price cannot sell their produce; markets don't "clear". This suggests that the negative effects will affect some industry players and not others, and some drinkers but not others.

  • The Scottish Whisky Association complains about the purported impact on their sales. Yet, for all I know, Scottish Whisky is competing in the premium segment, as are locally brewed beers. If the price difference is reduced, these premium brand producers should if anything see an increase in sales because of the reduced relative attractiveness of cheaper brands.

  • Cheap beers are likely to see reduced demand - that's basically supermarket own brands, and other mass produced beers - but (normally) not wine and whisky.

  • Retailers will no longer be able to offer special offers. This reduces their marketing strategies of attracting youngsters with special offers of cheap beer - Thus the ASDAs and Aldis of Scotland may suffer. Yet, this may actually be in the interest of brand manufacturers because they usually don't like their brand being sold "too cheap" because it harms their brand image. 

  • The Scottish Whisky Association also complains about the possible negative indirect impact on their exports because other countries might introduce similar legislation, and that would harm Scottish exports (alcoholic beverages account for a large share of Scottish exports). For example, Russia recently tightened up it regulation of the sales of alcoholic beverages by raising taxes and limiting sales form small kiosks and the like, which affected mainly less expensive beverages produced locally (Carlsberg, the market leader of locally produced beer in Russia thus suffered a substantial drop in its share price). However, the impact on imported beverages - who compete in the premium segment - is minimal. As the UK drinks industry is generally positioned in premium segments - Whisky rather than beer - I don't see why they would suffer substantially. In fact, they should gain relative to local producers.

  • Finally, it is claimed that the policy affects mainly poorer people, and young people: Middle class citizens will continue to sip their wine or whisky, while working class folks end up paying more for their pint in the pub. This seems to be true. But then, binge drinking is also a working class phenomenon, and young people shouldn't really be partying with too much alcohol anyway (and certainly not when under age). 

A completely different issue is whether this policy would be judged as anti-competitive by the EU competition authorities. This could be the case if it was found to favour local producers over foreign producers. The drinks industry claims that local industry would suffer, which suggests the opposite, while they simultaneously emphasizing the supposed illegality. This is rather contradictory.

 

In conclusion, while lobbyists enjoy the limelight, most of what they say is internally inconsistent, and thus best ignored - unless your are a mass producer of cheap booze, or a supermarket using special offers on beer to attract customers. 

  • Lucas, L. & Bolger, A., 2011, Scots renew drive for minimum price on alcohol, Financial Times, August 31, page 2.

 

 

Trying to discontinue a broadband subscription

August 30

 

I am blogging this as I am put on hold by my broadband service provider. They have a fancy website with lots of options to subscribe to additional services, but nowhere does it state where to cancel the service. There is only on 0845 phone number (which is an extra-expensive number where the service provider charges callers by the minute) - which after 2 minutes takes you to on one person, who turns out not to be in charge, and then another wait ... to another person who asks all my details and then passes me on to another person, who asks all the same details again ... and 12 minutes after picking up the phone I finally being told than my service is being cancelled (not without several attempts of selling me new services along the way).

 

As I was hanging on the phone with nothing else to do, I was thinking about the service I have had from the over the years. The broadband worked alright, no complaints, but the fees went up several times - First, I wasn't given the introductory offer that had been advertised at the time - but the difference was too small to bother complaining. Some time later, they increased the fee unless I switched to paperless billing; and although I did that the fee was still £2.50 higher than before. And, I ended up not seeing the bill because it went an e-mail the broadband provider had set up, but which I never used and had long forgotten the password to. Meanwhile about twice a month, I received advertising through the letter box advertising yet more services.

 

Why do service providers like telecoms and utilities (and banks aren't much better) treat their customer like that? If it was truly a competitive industry, they'd be providing service customers want - easy to use customer service and no spam mail in electronic or paper form! But switching costs are high, alternatives are few in a de facto oligopolistic industry, and consumer associations are weak in the UK, so companies push their luck... I am tempted to say, "never again Virgin Broadband" - but then I suspect the others won't be any better either.

 

 

Limits to outsourcing!

July 30

 

Last week I had an experience that many consumers are familiar with: you call up a company you have been doing business with to get something done, and the person you end up talking to (after first answering half a dozen questions from a computer) seems to have no idea about you and what discussions you've had with the company in the past. There seems to be no continuity of staff, and people in different parts of the organization don't seem to know what the other units are doing. The underlying issue is, of course, that some of the people you talk to are contracted to do specific bits, and indeed don't know more than the specifics of what they are contracted to do - and what they see on the computer in front of them. 

 

In business, it's called outsourcing, and some seem to think it is the magic bullet to lower costs. However, as The Economist out it this week: "Service companies, for example, contract out customer complaints to foreign call centres and then wonder why their customers hate them". In the case of my phone call this week, indeed, the lady spoke with a strong accent and seemed to have a problem understanding why I was unhappy with the handling of a request I had put in a phone call three days earlier. I'll just be gradually downsizing my business with this particular bank...

 

In another case, I have long running arguments with a publisher where things seem to get lost. While my main contact person stays the same, specific tasks seem to be routinely contracted out to individuals or small firms - some in the UK, other in India or the Philippines. This results in people doing specific tasks having no idea of the project as a whole, or of issues that had been discussed and agreed ages ago. As an author, I end up spending a lot of time chasing avoidable mistakes ... it might save the publisher money, but costs me a lot of time.

 

The biggest issue is that braking up a work process, especially in service industries, into small bits that can then be outsourced can result in a lack of coherence of the entire process, lack of continuity over time, and in very unpleasant customer (or business partner) experiences - and extra costs in fixing what went wrong. Big service companies that lock customers into (de facto) long term contracts, or industries where all major players agree that lousy service is acceptable, often get away with that. In truly competitive industries, I would quickly sell my shares when I experience lousy customer service, because customers won't be hanging around for long.

  • The Economist (2011): Schumpeter: The trouble with outsourcing, July 30th.

 

 

Downward Spiral? UK Loosing Equality of Opportunity

July 29

 

As governments across Europe are fighting their budget deficits in the aftermath of the financial crash of 2008/09, a major concern is that the cuts mainly hit is relatively least well-off in the society. This is a particular concern in the UK where, more than elsewhere, the government is committed not to raise taxes, and cutting across the board government services (including local government services) that many of the poorest depend on. The government is concerned that some of the richest taxpayers might leave and for low-tax "havens" - but what are the consequences if basic social services such as family support, state schools or local libraries are reduced? 

 

I have repeatedly written about the importance of investing in education, as a foundation for future property, and for earning the incomes that would allow to sustain the current living standards in a competitive world. But there is also a social implication that is possibly even bigger. It is important for the coherence of a modern society that, even if not every one can be rich, at least there is something approaching "equality of opportunity" - that is even if you are poor, society provides with opportunities to reach leading roles in business, academia, professions, government etc.

 

In this context, I found some shocking evidence for the UK in an unlikely source: The Alumni Newsletter of London Business School. I had heard before that in many professions, such as journalism or law, the chances for people from non-privileged background are worse today then they were in the 1950s. However, now I see concrete data. For example, at Oxford University "in the late 1960s, two-thirds of the student body were from state schools, including direct-grant schools. By 1997 it was down to 46%". This is reflected in this Alumni's personal experience: "When I was there, we had a lot of kids from South Wales who were brilliant and who have done extremely well ... [today they have] not one in ten years. They are not applying and when they do they're not of the right standard." The underlying issue is that in the UK primary and secondary education has become more segregated over time as fees for the better schools went up, while state schools in many parts of the country are suffering from lack of funds. Hence, how much you parent earn and invest in your education determines your chances of getting into a good university. To some degree that is unavoidable, but nowhere in Europe this discrepancy is so big as in the UK.

 

The LBS Alumni article focuses on one Alumni, Sir Peter Lampl, who has succeeded of rising from South Wales to business leadership, and now set himself the goal to reverse the trend, mainly through a charity that gives scholarships and special training to talented youngsters. Such philanthropy increasingly fills important gaps in British society (as it has in the US for a long time), and with government policy needs for philanthropic help will be increasing sharply. But can philanthropy make up for the gaps in the state educational system? Shouldn't all youngster enjoy the opportunities of education? Shouldn't society invest in its own future by investing in all young people?

  • London Business School Alumni News (no. 126, 2011) "Fighting Disadvantage", p. 28-29.

 

Can Engineers really become Entrepreneurs?

July 20

 

A few weeks ago, Lord Alan Sugar dismissed one of the candidates of BBC show "The Apprentice" with very disparaging remarks about engineers, seemingly suggesting that an engineering education and running a business just wouldn't match. That ruffled a few feathers amongst some of my friends. To be fair, teaching business to engineering students is not popular among business school lecturers (though less in Bath than in my previous places of work): It requires a very different way of thinking: In engineering classes, students learn a strictly logical, mathematical way of analysis - and there is normally only one correct answer. In business, decision makers have to deal with a lot of information, and a lot of uncertainty, and consequently it is all about managing this information overflow, and making decision under uncertainty without being sure what exactly the outcome will be.

 

Yet, while engineering students are very different from business students, there are actually a lot of engineers that eventually turn into successful business persons. Lord Sugar came around the acknowledging the entrepreneurial spirit of an engineering-trained inventor when he announced the winner of this years' The Apprentice: Tom Pellereau. In Bath, this was reason to celebrate as he holds a MechEng degree from the University of Bath.

 

However, engineers becoming entrepreneurs is actually far from unusual, even in England. For a recent research project, we interviewed a number of entrepreneurs who had set up their own business in high tech activities such as semiconductor design, cancer drugs, or micro-energy generation. Their businesses are highly specialized (as you would expect for a start-up) but they have global ambitions - and if they succeed they will contribute to the economy beyond their personal interests. As it turned out, all of the key people were either engineers or pharmacists by training.

 

However, they did not come straight out of university: they build their competences in a distinguished career, often combining large corporate and small biz experience. They have been working in their industry, and through the global linkages in the industry, they also build a lot of international experience, and they have been moving from pure technology roles to more commercial roles such as sales. Hence, for the entrepreneurs in our study, it was the combination of engineering training with experience in the industry, in commercial roles, and in international activities that enabled them to setting out on their own, and attract funding for their business idea. Some of our entrepreneurs added an MBA, but most learned about business by doing it. The following quote from one of our interviewees captures the essence:

"It is a fascinating circle for me, because I started out here [University of Bath] as an electrical engineer. I went to my early technology industry and moved much more into a management and sales role. But with this [start-up] business, ... it takes me full circle to where I started from, in some strange respect. But I am a little different, I come at it from the experience of running global businesses at the management side, but having the technical grounding is a actually really core for ... being able to understand the industry and understand the technology. It is a pretty important piece of making the whole [start-up business] successful. But you have to learn how to apply that to markets, of course."

Compared to these entrepreneurs, Tom Pellereau is still special: He set out directly from University to become an inventor and bring products to market. His curved nail file is rather low tech compared to a cancer drug or a semiconductor, but it still holds global market potential. My advise to engineering graduates would be to strategically build a portfolio business competences to complement your technical expertise: and when you know how to do it, you are ready to take the jump.

 

 

 

Culture Matters in Unexpected Ways [C3]

June 29, 2011

 

At a recent scholarly conference in Japan, I triggered some debate with a quote from an English entrepreneur whom we recently interviewed for a research project:

"You know, I am so used to this. I actually had more problems cross-culturally when I worked … with Scottish management than … when I go to China. … When I am dealing with Chinese customers or Korean customers, I am expecting and prepared that there’s going to be some give and take. I am dealing with people who are very experienced international businessmen who also are expecting some give and take. I am sure it would be different if I were dealing with someone who has never met a foreigner before. When I was dealing with Scottish, I was a senior manager in a firm run by very parochial Scottish management team. I expected things to be easier, they expected things to be easier, [but] our expectations were far apart."

The quote raises two issues. The first is known as 'psychic distance paradox' in the literature: businesspersons frequently underestimate the challenges of working in a nearby culture because they assume differences to be negligible, which they aren't.

 

The second issue is less well understood. Communities such as the entrepreneurs that our interviewee does business with, the business scholars gathered at the conference, and even our MBA students are used to interact with people of quite different origins, and they develop tacit skills in handling such situations. But not all people have these capabilities, in fact most people don't. Semiconductor entrepreneurs, business professors and MBA students with cosmopolitan attitudes are a minority within the wider societies in which they operate. When taking on leadership roles, they face the challenge that not everyone in their organization shares their global outlook - the entrepreneur calls them "parochial". This can lead to management challenges that we ought to discuss in MBA classroom. Yet, to my knowledge this issue hasn't been addressed in the scholarly literature - anyone wants to do a PhD?

  • K. Brouthers & L. Brouthers, 2001, Explaining the national cultural distance paradox, Journal of International Business Studies, 32: 177–189.

  • Meyer, K.E. & Xia, H.T., 2011, Born Global Resource Integrators, AIB Conference, Nagoya, Japan, June.

  • O'Grady, S. & Lane, H.W. 1996, The Psychic Distance Paradox, Journal of International Business Studies 27: 309–333.

 

European Crises: UK vs Greece [C8]

June 22, 2011

 

The two countries most hit by the by governmental budgetary crises in the wake of the 2009 financial crisis are the UK and Greece, both hot budget deficits of over 14% at the peak of the crisis. For comparison, the eurozone [in theory] allows its members a deficit of 3%. However, that's where the similarities end - the source are quite different, as are the policy responses, and the appropriate responses.

 

In Greece, the origins of the budget crisis are structural. Already before the crisis the balance of revenues and expenditures was out of balance, the national debt was - relative to GDP - one of the highest in the world, and Greece only sneaked into the euro because it submitted what is now known to be incorrect data about its debt. The additional costs to governments arising from the financial crisis, then pushed Greece over the edge - in the views of the financial markets (or more precisely, the rating agencies).

 

In the UK, the budget deficit was slightly below the European average; in fact Tony Blair left office after a decade as prime minister with a slightly lower debt (in % of GDP) than what he inherited from his Conservative predecessor, John Major. The British national debt surged as a direct consequence of the financial crisis: 1) The banking bail-out was almost as large as in the US (and hence much higher as % of GDP); 2) income tax revenues dropped sharply as those high earning financiers in the city also used to pay a lot of income tax, and 3) an economic stimulus program launched by the Brown government in December 2007, including a 1-year reduction of VAT from 17.5% to 15% that was largely ineffective. The current Conservative-LibDem government likes to blame Gordon Brown for the deficit, but that is more than a bit disingenuous: Neither of the parties had lobbied at the time for better banking regulation (and the rules had been designed by the Thatcher government in the 1980s), nor did they at the time offer alternatives to the banking bail-out and the fiscal stimulous.

 

The policy response also has been quite different. The UK devalued its currency through very loose monetary policy (or, quantitative easing) which reduced debt held in other currencies, and provided advantages vis-a-vis trading partners (a big problem for Ireland) - but also resulted in rising inflation, among other through import prices.  Greece did not have this option because it uses the common currency (and since its debt would have been in dollar or euro anyway, it would not make that much difference anyway.

 

Both countries now are pushing unprecedented austerity packages, cutting government expenditures where ever they can. In the Greek case, where the deficit is the result of long-term structural imbalances, this seems unavoidable. It is less obvious in the UK, where the causes of the deficit are short-term in nature, and the structural issues that the government ought to prioritize are 1) the regulation of the financial sector, and 2) the relative weight of the financial sector in the UK economy - the result of deliberate policies over the last 25 years. This however required investments in such mundane things as education of the workforce to build human capital outside the elites ... not a priority for a Conservative government.

 

 

 

Chinese Capitalism [C2]

June 6, 2011

 

Management Organizational Review, a scholarly journal focusing on contemporary management issues in China, devoted a special issue earlier this year on "Chinese Capitalism", to examine what sort of economy China is developing into. The contributors are all esteemed China experts in different academic disciplines, and based in the USA. A common theme across the contributions is that the state continues to play a much more extensive role in the economy than in virtually all other market economies. Yet the authors disagree on the economic significance and the likely future evolution of this influence.

 

On the one end of the spectrum, Andrew Walder (of Stanford U) argues that gradually - very gradually - private entrepreneurs are accumulating wealth and are joining the economic elite. He thus expects the nature of the national elite itself to shift - in a very gradual but continuous process, which in the long term will change the nature of the relationship between state and economy. Neil Fligstein (U of California) and Jianjun Zhang (Peking U) take a "varieties of capitalisms" approach and search for similarities between China's evolving system and other market economies, and suggest that France may come closest. Yet there are important differences that they expect to persist: In France, the role of the state is focused on welfare and social issues, whereas the Chinese state takes a much larger role large in actually owning and directly influencing firms. Also the role of organized labour is different. French trade unions do not hesitate to take on their state employers to bargain for higher wages, safer pensions or shorter working hours. That's not imaginable in China.

 

Nan Lin (Duke U) digs deeper to explore how state-affiliated companies (i.e. most of the largest companies) by the state, and thus by the Communist Party. Many of the largest firms may be listed on the stock exchange, yet different sorts of state-affiliated entities hold controlling equity stakes, and possibly more importantly, the typical career paths of leaders take them through leadership roles in government administration to state-affiliated companies, and back. This intrinsic overlap of economic and political elites secures continues influence of 'the state' over key companies. In his introduction, Marshall Meyer (Princeton U; no relation) pushes this point further. At the onset of the financial crisis, the Chinese state pumped massive amounts of money into the economy, mainly via state-affiliated firms. In consequence, the contribution of state-affiliated firms in GDP has been rising over the last few years, reversing the trend of the past three decades. For Marshall Meyer, this signifies a significant shift in the direction of Chinese economic transition in the long run. 

 

Taken together these contributions indicate a process in which the balance of power constantly shifting between "the state/the party" and "the market/private entrepreneurs". Most scholars of economic transition tend to conceptualize transition as a process of changing from one system to another loosely resembling "Western" capitalism. The reality however is a process that involves a lot of experimentation with new arrangements, with the balance of power swinging like a pendulum. The Chinese variety of capitalism is not a clearly defined form, and may never be. Rather, like Yin and Yang, the centralizing forces of the stat/parties and the decentralizing forces of private enterprise find ways to co-exist - a contradiction perhaps to Western minds, but less so in an Eastern philosophy. 

 

As a final remark, when were studying comparative economics in high school - comparing East versus West Germany, or Soviet Union versus USA - a basic point our teachers were ramming home is to compare real world to real world, and ideal model to ideal model - and avoid the journalists' style of comparing what they saw in the East with their textbook model of the West (or the other way around, in that TV station we didn't bother to watch). Yet, this remains a challenge even for these esteemed scholars - their (implicit) benchmark is the USA, yet with an ideal image, at times understating the role of the state entities, and overstating the effectiveness of corporate governance in rewarding performance.

 

Estonian Capitalism [C2]

June 4, 2011

 

Visiting Tallinn, Estonia again after 15 years, I have to appreciate the transformation the country has gone through. Once part of the former Soviet Union, Estonia today is a full member of the European Union - including passport free travel and the common currency, both achievements that the UK is far from.

 

Estonia has embraced the free market economy more comprehensively than most (or all?) countries in Europe. This is evident in the numbers of small businesses serving the tourism industry: small traders, restaurants, pubs etc - yet without the chaotic street traders that are common in many emerging economies. The free market nature is evident even in the taxi: Taxi companies are competing on price - every company has their own pricing scheme, and passengers are free to choose which taxi they pick - not whoever is first in the queue as in all other cities and airports I know. At the same time, the government keeps a low economic profile, and has made sure not to run substantive budget deficits for two decades now.

 

Estonians have also embraced the electronic age more than most, possibly inspired by their neighbours to the North, the Finns. Famously, when the newly independent government met for the first time in the mid 1990s, it had no paper documents at all, as all ministers arrived with documents on their Laptop. This spirit is evident literally everywhere: Wherever in town I wanted to check my e-mail, I found a wireless network that I could log in for free - also here at the airport (so this blog will be uploaded before I board the plane!). Another neat expression of the embrace of the electronic age is the name card that conference organizer provided us: It has a memory stick build in, complete with all the conference papers.

 

Of course, the legacy of the Soviet regime is visible, but one has to look for it. The 1960s residential blocks not far from the hotel are probably most obvious, as is the odd old house in bad repair, even in the historical old town. But that is not too different from Western Europe, where those who look also find lousy architecture and incidences of neglect. On a positive side, Tallinn has an electronic bus system like many Central and East European cities: On top it looks like a tram, at the bottom like a bus. In these days of energy conservation, these Soviet-era systems have gained a new life.

 

Also in other ways Tallinn feels more like a North European city than like a post-Soviet city. Near the old town, modern skyscrapers house banks and hotels, department stores are mushrooming, people are busy partying in town on Friday night ... Also politically, Estonians have become quite like other Europeans: They are grumbling about having to contribute to bailing the Greeks, who adopted a less market oriented form of capitalism.

 

 

Lists versus constituencies in Scotland, Wales, and England

May 7, 2011

 

The mixed election system used at last week's election in Scotland and Wales provides an interesting quasi-experiment on the different implications first-past-the-post (FPTP) and proportional representation systems. Voters have cast two separate votes for a constituency candidate and a regional list, which was used to add a proportionate element to an essentially FPTP system. These two votes allows us to control for tactical voting that usually affects results to extrapolate impact of alternative systems.

 

In Scotland,

  • The constituency vote alone led to 73 constituency seats as follows: Scottish Nationalist (SNP) 53, Labour 15, Conservative 3, Lib Dem 2. If the 'English' rules had applied, then the SNP would have more than 2/3rds of the seats, enough in many countries to change the constitution. (But then, the UK has no constitution, and the rules for Scotland are set by the UK parliament anyway).

  • The regional lists vote generated SNP 44.0%, Labour 26.%, Conservatives 12.4%, Liberal Democrats 5.2%, Greens 4.4%. If this was distributed using a pure proportional system with minimum threshold of 5% (as is common in continental Europe), a parliament of 73 seats would look as follows: SNP 37, Labour 22, Conservatives 10, Lib Dems 4.  (Or of 129 seats: SNP 65, Labour 38, Conservatives 18, Lib Dems 8). Either way, the SNP has a 1 seat majority.

  • The actual system in Scotland created by the (UK) Labour party at the time of devolution in the late 1990s uses the regional lists as a corrective on a regional basis, and there is no need to jump a country-wide 5% hurdle, but there is a de facto threshold of a similar magnitude separate for each region. So, the actual Scottish parliament is close to proportional, but more splintered than either of these pure systems would generate of 129 seats: SNP 69 (53 direct + 16 from regional list), Labour 37 (15+12), Conservatives 15 (3+12), Lib Dems 5 (2+3), Green 2 (0+2), Independent 1 (0+1). (The independent got 6.5% in the Lothian region).  

  • Under the German system, which combines lists and proportional by allocating the number of seats proportionately, but then giving the first seats to those candidates elected directly, this would be the same proportions as above SNP 65 (53 + 12), Labour 38 (15+13), Conservatives 18 (3 + 15), Lib Dems 8 (2+6). Constituency winners get their seat, independent of the national results.

In Wales,

  • the constituency vote alone let to 40 constituency seats as follows Labour 28, Conservative 6, Plaid Cymry 5, Liberal Democrat 1 - which means a clear 3/4 majority for Labour.

  • the regional lists vote generated: Labour 36.9%, Conservatives 22.5, Plaid Cymru (PC) 17.9%, Liberal Democrat 8.0%, UKIP 4.6%, Green 3.4%, Socialist 2.4%, BNP 2.4%, Welch Christian Party 0.9%, others/independents 0.9%. With a threshold of 5% in a parliament of 60, this would yield: Labour 26, Conservatives 16, Plaid Cymru 12, Lib Dems 6. Note, however, how close UKIP and the Greens are to the 5%-threshold - if either of the had made 5% they would enter with 3 seats. No overall majority for anyone.

  • In the actual system, the seats were: Labour 30 (28+2), Conservatives 14 (6+8), Plaid Cymru 11 (5+7), Lib Dems 5 (1+4). Here the results is actually dominated by the FPTP element as only 20 seats are allocated from the lists. Labour got additional seats from he lists because their constituency direct seats are highly concentrated in some 'regions' of Wales and they have no direct seats in other 'regions'.

  • Note that 'regions' in Wales are actually quite small: Each region elects 11 to 13 seats, of which 4 are allocated through the lists. This means the minimum threshold is actually quite high, about 6-7%. This was to high for UKIP (5.2% in South Wales East) and the Greens (5.2% in South Wales Central). 

  • In the German system, where representativeness if paramount, but all constituency winners get a seat, the number of members of parliament would be increased from 60 to 64 to make the numbers add up: Labour 28 (28+0), Conservatives 17 (6+11), Plaid Cymru 13 (5+8), Lib Dems 6 (1+5).

In England, we had local council elections. First-past the post was the only system on offer. In my constituency, I had the choice between exactly two candidates, representing respectively the party in government (Conservative) and its coalition partner (Liberal Democrats). Neither of which had bothered to campaign much. Unsurprisingly, voter participation was much lower than in Scotland or Wales...

 

Footnote for techies: I used Hare-Niemeyer system to calculate seats under proportional system. Under De Hont system, the smaller parties may get one seat less and the large parties get one seat more. 

 

 

Business in the long run...

April 26, 2011

 

Business history books, if they are well-written, provide an interesting way to remind ourselves of the long-term implications of what we are doing. Too much of decision making in business - and scholarly research - is driven by specific short term decisions, with few thinking through the likely long-term consequences of our actions. Stepping back and recognizing ourselves and our businesses in the long-term flow of history provides a wider horizon of opportunities - and of unintended side-effects. Good historians can also dig deeper into activities and decision-making as they explore company archives that provide rich information that contemporary business researchers can only dream off. Moreover, an advantage of studying a 'dead' firm is that as researcher one can be more frank in discussing the weaknesses without concern to the reputation of the company that today carries the name.

 

Over the Easter break, I have been reading a meticulously researched yet very readable business history of Beecham, which in the 1980s and 1990s was a major UK pharmaceuticals and consumer goods giant. It was written by a former colleague of mine, Tony Corley of the University of Reading (well, strictly speaking Tony retired some 15 years before I arrived in Reading, but he was very much present in the office ... some people never really retire).

 

Tony Corley traces Beecham from the foundation as a pill manufacturer in the 1840s to its amalgamation first in 1989 in "Smithkline Beecham" and then in 2000 in "GlaxoSmithkline". The story of Beecham includes many early international business activities of the sort we research in the age of globalization. Before 1914, when Beecham was still a family-owned firm, it had a production subsidiary in the USA and export sales especially to Commonwealth countries such as Australia, Canada and India. Already in the 1960s, Beecham had an R&D subsidiary in the USA and was engaged in extensive "reverse knowledge transfer"; it appointed a non-British CEO in 1986; and after the merger with Smithkline it had legal headquarters in the UK, but operational headquarters in the USA. Such high degrees of internationalization continue to create major organizational challenges even for the best multinationals.

 

Key to the evolution of the firm have been the men (no women) at the helm of the organization. Each one of them leaves his mark on the organization, but often not in the way they intended. Several entrepreneurs shaped new paths of growth and/or profitability for the firm, while others kept the firm afloat in volatile times. Tony Corley does a great job in exploring the character of the key players in the company, and the interplay between them in the company leadership. While most of the leaders had major achievements, none of them was flawless, each having personal weaknesses. Great people sometimes also make great mistakes, that successors then have to deal with. The worst mistakes of Beecham CEOs, arguably, relate overly ambitious diversification strategies - notably in 1914, 1945 and 1971. According the Freek Vermeulen, whose book I reviewed here a few weeks ago, this continues to be a major trap in today's boardrooms. 

  • Corley, T.A.B., 2011, Beecham from Pills to Pharmaceuticals, Lancaster: Crucile Books.

 

 

Alternative Vote System (2): Qui Bono?

April 4, 2011

 

In the run-up to the UK referendum, there has been quite a lot of speculation as to which party would gain from AV. In particular, the Conservatives seem to be running scared that any system other than the current one would undermine their ability to run the country. Well, most of what is being said in the media on this topic is, in my humble opinion, nonsense. 

 

The essence is that candidates that appeal to more than their core supporters have a chance of overtaking candidates on the basis of second preferences. While this may impact on the kinds of candidates that the parties put forward, I believe this will only have a small impact on the distribution of seats in parliament:

  • While the media seem to expect the LibDems to gain about 20 seats, my own simulations do not support this view. I simulated an AV system for all London constituencies (see May 11, 2010), and found the LibDems not getting close to gaining any seats in London, while the Conservatives had a net gain from Labour of 2 seats.

  • In principle, the second preference votes are likely to help candidates who take a centrist position. In the British context, this might help independent candidates representing local interests and a distaste for 'Westminster politics' in general (a common sentiment). Results from Australia, where AV has been used for a long time, suggest such a possibility: there 4 of 150 MPs were independents (plus 1 Green who counts as sort of independent) (see August 22, 2010).

  • If voters see LibDems as being "between" Labour and Conservatives, they might be able to pick up a large share of second preferences, and hence seats. However, during the Blair years, the LibDems actually moved to the left of 'New Labour' on some issues, while now in government they support the Conservatives. So it is not clear how popular they will be as second preference. I would rather put it in a different way; under an AV system, the LibDems have strong incentives to position themselves as a party of the political centre. 

  • Will the AV system help smaller parties? Small parties that have radical views supported by a hard core of supporters but hated by most others - say Socialist, Loony or BNP - are going to find it even more difficult to get any seats (which would be a good argument for extending AV to local elections).

  • Small parties that offer positions of broad appeal, i.e. in the political centre, may benefit from second preference votes in specific constituencies where the candidates by the big parities (whoever is big in the particular constituency) are highly unpopular. They would then play a role similar to independents and tap into the 'anti-Westminster' mood. Thus, conceivably, UKIP or the Greens may get a seat or two.

Based on this analysis, I suggest that the shift to AV is really about local dynamics, not about majorities in parliament. So, it hard to see why the Conservative party is so opposed to giving voters more power. In Scotland and Wales they should actually be able to pick up a few seats. Perhaps they really fear that the "everyone-but-Conservatives" vote is very powerful. 

 

 

Alternative Vote System (1): Changing Dynamics

April 3, 2011

 

On May 5, Britain goes to vote on a referendum on (small) changes in the electoral system. The proposal is for an Australian style 'alternative vote' (AV) system, where voters rank their preferences rather than simply select only their most preferred local  candidate. Why do many think this change is necessary, and how is it going to change  elections?

 

The basic problem is that for the last three decades, including the eras of Maggie Thatcher and Tony Blair, Britain has been governed by parties that had received less than 43% of the popular vote. While they had a more or less solid majority in parliament, they did not have a majority of the people behind them. The current coalition government is an exception. In the 1950s, over 90% of voters voted for one of the two big parties; in the last couple of elections, only about 70% did.  In consequence, governments lacked legitimacy.

 

An obvious solution to this problem would be to shift to some form of proportional representation. Yet, this would radically alter the power structures in the country (see May 8, 2010), and the vested interests of those in power in the country (not just the political parties) make such a radical change politically infeasible. 

 

The proposed AV system is simulating a run-off election: The votes for the least successful candidate are redistributed to the candidate with most votes until one candidate achieved at least 50% of the votes. Hence, any MP would have support by at least 50% of the voters - even if this is only a second-best sort of support. Situations of candidates representing a constituency with less than a third of the votes could not happen. In areas of Britain with strong regional parties, notably Scotland and Wales, such situations are quite common. In London, the MP from Hampstead was elected with 32.8% of the votes - so two third of voters were against their representative...

 

What are the consequences of the AV system? I believe the main changes are in the dynamics on the local level.

  • As candidates in most constituencies need at least some 'second preference' votes, they need to be careful not to alienate supporters of other candidates. In the simple majority system in place now, it is OK if half of the voters hate you as long as you have a strong group of core supporters and the others don't all vote for the same other person. Under AV, a polarizing candidate is likely to get few second preferences. Consequently, parties are less likely to put forward candidates with radical views supported by their core supporters but few others.

  • Incumbent MPs always have an advantage because they are already known to voters, while challengers typically have yet to build their reputation. When an incumbent looses support, under the simple majority system there are two scenarios.  Either multiple challengers end up competing with each other, making it easy for the incumbent to be re-elected. Or, the locally largest party puts forward a candidate, who then received votes 'against the incumbent' rather than because voters consider him/her as the best candidate. Under AV, voters are not limited by the decision of the locally-largest party as to who shall be the challenger. They can rank multiple challengers on top. In consequence, it will be easier to vote an incumbent out of office! And that's probably why so many sitting MPs are opposed to AV.

  • Under simple majority, it suffices if the vote for others is divided, or opponent voters don't show up at the election. Under AV, having two equally strong candidates from the centre left does not help the right wing candidate, nor do two equally strong centre right candidates de fact help the left wing candidate. Hence, there will be more competition as to who will represent the 'centre left' or 'centre right' sort of position - and voters have more choice.  

  • In the so-called safe constituencies, where the winning candidate won last time with more than 50% of votes, nothing much will change (there are surprisingly many of those, including 32 of 73 constituencies in London). As before, hardly any serious campaigning will take place and voters will be taken for granted. However, seats may marginally get 'less safe', which is good for voters in the sense that they receive more attention from Westminster.

  • Under simple majority, many voters vote tactically not for the candidate who they like most, but vote for the candidate who is the 'least bad option' of those two (rarely three) who has a realistic chance given results at the last election. Under AV, they can record their true preference with their first preference, and still ensure that their 'least-bad-option' gets ahead of the candidate they really don't like. This means voters can communicate a much more differentiated opinion to their politicians than under the simplistic current system.    

In conclusion, I do not expect AV to change the majorities in parliament. Yet, it will change what sort of individuals will be representing the parties. And, it will make it easier to throw out sitting MPs. These dynamics of course threaten the interests of some of those currently in power. As with any proposed form of electoral rules, those who benefited from the old system are opposed to it. The question is whether the British people want the preserve those power structures, or give voters more options to trigger change.

 

 

Freak o'Management

March 29, 2011

 

if you liked Freakonomics, then you are likely to like this book, Business Exposed, too. I picked it up at an airport, a rather unusual place to find a book engaging with the latest scholarly literature. However, this book provides witty insights into how to managers rally function, drawing on contemporary empirical research published in esteemed journals such as the Academy of Management Journal, yet communicated in the witty, story-telling style of an executive MBA class. Freek Vermeulen, a London Business School professor (and blogger), illustrates his ideas with evidence from solid research and examples of (in)famous firms along with personal conversations with top executives. What emerges is demystifying management.

 

Vermeulen does not offer an integrative theme or an overall message beyond wanting to show that managers aren't as esteemed as they pretend to be, like the proverbial emperor with no clothes. Yet, he is thought-provoking in (almost) every section, challenging readers to develop their own interpretations. However, I believe there is a common theme, namely a profound distrust of the teachings of mainstream economic analysis of the firm. Vermeulen shows that managers do not behave in the ways traditional theories (such as agency theory) suggest, and that instruments inspired by such theories create highly counterproductive incentives for managers to misbehave - essentially because few markets are as efficient as these theories assume.

 

While traditional theory suggests that financial incentives induce top managers to act in the best interest of the firm (and shareholders in particular), Vermeulen argues that legitimacy with their peers is often more important to them - and determines their compensation packages. This leads to counterproductive behaviours such as acquisitions of which 70% fail, management fads that lack empirical support, and managerial compensation unrelated to performance (but primarily to firm size). 

 

Despite (or because of) the compelling evidence, it is hard to draw specific lessons from this book for management, or for policy makers. In his conclusions, Vermeulen suggests that "more rules and regulations, and more quantitative and financial controls, are unlikely to solve the problem... Instead, organizations need to tap into the fundamental human inclination to belong to a community" (p.208). 

 

Another message arising is that better-designed incentive schemes with less asymmetric distribution of risk, and external directors that are truly independent would go a long way. In other words, getting a few top-notch business school professors as external director ought to help monitoring CEOs. Yet, what we learned from Vermeulen on how boards are selected (namely by insiders) suggests that professors would be highly unlikely to be appointed - which manager would want to look naked in front of his or her externals?

  • Vermeulen, Freek, 2011, Business Exposed: The Naked Truth about what Really goes on in the World of Business, Prentice Hall.

 

LSE and the Business of Fundraising [C9]

March 4, 2011

 

This morning's newspaper headlines report the resignation of the director of the London School of Economics over allegations of close relations to the Libyan regime. What is going on?

 

To put things into perspective, let's have a look at how universities around the world are funded. Donations play an important role in the revenues of many universities, and while this is still relatively new to the UK, it is a well established in the USA and in Asia. There, you will frequently find buildings, classrooms, research centres, or even entire business schools named after individuals that gave the university large amounts of money. While universities normally have procedures in place that are to prevent donors from influencing the content of research and teaching, it does raise ethical issues. One university that faced a serious ethical dilemma of this sort recently is Imperial College London. They had accepted a large donation from a businessmen and renamed the business school into the Tanaka Business School. However, when Tanaka faced allegations of embezzlement and fraud and had face courts in New York, the name became a burden. Eventually, Imperial settled to rename the school of Imperial College Business School, but retained the name Tanaka Building.

 

As universities pursue rich people to part with their cash, they tend to target alumni that already have a connection with the University, and tend to have a continued interest in the development of their alma mater. What appears to have happened at LSE is that shortly after Gaddafi junior graduated with a PhD, the LSE it attracted £1.2 million from a Gaddafi family foundation, of which £300,000 were actually received so far. As far as I am aware, there is no suggestion of the money having influenced the award of the degree. However, while rebuilding relationships with Libya was official government policy at the time in both the US and the UK, ex post accepting money from the disgraced Gaddafi family is judged unethical, and that's why the LSE president resigned.

 

The Guardian also lambastes the LSE on its front page for training 400 Libyan civil servants, a critique that I fail to understand. What better way to work for inner reforms of a country than to train its civil servants, and to discuss with them the practices and values of ones own society? In particular, this program was aligned with UK government policy at the time - how much can you criticize LSE for aligning its own government? (Of course, we could argue that universities ought to keep distance to governments of the day, but with the increased pressures that governments put on universities to demonstrate the 'impact' of the government grants they receive, this is unlikely to happen).

 

Looking forward, I would predict that we will see a lot more of such ethical conflicts. Current government policy of cutting all sorts of funds to universities, combined with pressure to get more funds "from the private sector" (especially but not only in the UK), forces universities to redouble their efforts to attract private donations. Since the funding that universities receive for undergraduate education and research are not sufficient to achieve the world class standards that both students and the wider community expect, universities have to find ways to cross-subsidize these core activities. This involves convincing rich people to part with their cash. Since individuals, especially rich ones, have the habit of attracting controversy, or even fall from grace in some sort of scandal, expect more discussions on the ethical aspect of university fund raising in the future!

  • Financial Times, 2011, "Davis quits LSE over links with Libya", and "LSE was warned of dangers of Libya cash", both March 4. (the latter article is most informative on the extensive deliberations within LSE when offered the donation)

  • The Guardian, 2011, "LSE boss quits over Gaddafi cash scandal", March 4.

  • Peng, M.W. & Meyer, K.E., 2011, "Naming Your School" (Closing Case to Chapter 9), in: International Business, London Cengage.

 

Analyzing the UK Trade Deficit [C5]

February 11, 2010


What is happening to the UK trade? To gain a better understanding why the international trade data for the UK are so disappointing, we need to look at the long-term trends. Financial markets and media often look at monthly changes, but they tend to tell us rather little about the underlying structural issues. I thus downloaded the data from the Office for National Statistics [Students: this is a very useful and easy-to-access source!], and generated some graphs.


Firstly, how big is the trade deficit in a historical perspective? Actually, the annual trade deficit is the biggest ever (Figure 1, green line) and the monthly trade deficit is the second biggest ever (Figure 2). The data allow us to separate trade in three categories (services, oil, and non-oil goods), which is quite instructive. Firstly, oil (blue line) turned from a regular net surplus to a regular net deficit in the years 2003 to 2005 – it seems North Sea oil is running out and the UK needs to import more of its energy (hence the discussion about nuclear recently). In the overall picture of international trade however, oil does no longer make a big difference.


Second, the trade deficit for non-oil goods (essentially that’s manufacturing) has been rising continuously since 1998. It reached its biggest ever annual deficit in 2010, and its biggest ever monthly deficit in December 2010 (brown line). So, something rather worrying is happening here. Exports have actually been growing, but by not much more than inflation rate (Figure 3). However, imports have been rising much faster (Figure 4), and thus the gap has been widening.


Following the devaluation of 2007/08, I would have expected a J-curve effect: in the short term import prices (in sterling) rise with volumes unchanged leading to increasing (sterling) value of imports and a widening trade deficit; while in the medium term, trade pattern change as consumers adjust their behaviours and therefore import volumes fall, leading to an improvement of the trade balance. Yet, such behavioural adjustment is not happening, to the contrary the gap continues to increase. Specifically, despite being able to undercut their competitors by about 25% in euro or dollars (compared to 2007 prices), British companies are not able to export substantially more. Why? I offer my explanation in the blog of February 10.


Third, service exports have been the big success story of past decade (red line). Rising surpluses in the trade in services have compensated for the trade deficit in goods. Those service data are a bit more volatile, in August 2005 service exports sharply dropped causing the biggest ever monthly trade deficit. And at the height of the financial crisis, in October 2008 to January 2010, the service balance reached its biggest surplus of over £5 billion monthly. I am not clear why that is so.


In principle, the trade-in-services surplus points to a strength of the UK economy. However, there are two problems. One, financial services have been a major contributor to this surplus, and we all know the costs of the financial service sector to the UK tax payer in the financial crisis. Due to the crash, the sector is much weaker now, and presumably taxpayer would want tighter regulation to prevent having to pay for another big bailout. The question thus is if the export of financial services is sustainable at the pre-2009 levels.

 

Two, many services such as business-services (accountants, consultants, engineers), tourism and education depend on easily moving people around – either bringing your people out to deliver the services, or bringing your customers into your country. The recent policy changes that make visa applications more costly and more cumbersome for non-EU visitors to the UK is not exactly helping the competitiveness of the service sector, which made such an important contribution to the UK economy over the past decade.

 

Overall, my deeper digging into the data reaffirm by grave concerns regarding the long-term competitiveness of the UK economy.

 

 

UK: Exporting Needs Capabilities [C5]

February 10, 2010

 

Basic macroeconomic theory suggests currency devaluation leads to export products becoming cheaper abroad, while import prices rise, hence exports increase and imports decline, leading to an improvement of the trade balance. Moreover, when an economy grows slower than its trading partners, this also should improve the trade balance.

 

Yet, the UK experienced a radical currency devaluation in 2007/08 that is now making its way through import prices (note record inflation data), while GDP growth was negative again in the last quarter of 2010 - and the trade deficit in December was the biggest since 2005. While a small part of it may be due to one-off issues (purchases ahead of the large VAT increase on January 1st), the yearly data show a growing trade deficit. What is going on?

 

The government on the same day made a major announcement to support small and medium size enterprises by offering new or extended export guarantee and loan facilities, thus matching schemes common in many other countries. This seems to make sense. Curiously, the announcement also states that the scheme is to be self-funding and no new employees will be taken on by the administrating department. It's not clear how that is supposed to work. Whether this scheme is just hot air or actually can deliver on the promises, it is curing the symptoms and not the causes.

 

The real cause of British export underperformance are weaknesses in the underlying resource base, competences that would enable companies to produce products (and services) at qualities and prices that others would be eager to buy. Britain has a handful of companies that are world-leading in their field, from Rolls Royce in aircraft engines to branded foods like whiskey and tea. It has entrepreneurial communities developing new technologies from semiconductors, to green energy, to biotechnology. And it has top-notch universities that deliver leading edge science, engineering and business research and education. Yet, these represent only the elite in their respective field. A strong national performance you need a broad base - not just a few outstanding role models.

 

Yet when we look beyond those frequently cited examples, Britain faces a large resource gap. Other countries in Europe and Asia have invested heavily in the human capital base over the past generation - beyond the elite. If Britain want to catch up again with the world's leading exporters it needs a massive investment in its human capital - I am thinking here of pre- and primary education, state schools, vocational training (the backbone of the German and Nordic economies!), and competences in languages other than English, to name just a few examples.

 

The trade deficit cannot be fixed in the short run, structural weaknesses created since the days of Maggie Thatcher (or even longer) cannot be corrected in a few months. This is a task for a generation. Investments in human capital have to take place today to enable export performance in 10 or 20 years. And nice words and fancy schemes don't help if they are not backed up by resources. Sadly, current government policies, notable huge cuts in many of the pertinent budgets, are likely to further weaken Britain's human capital base.  

 

For a start, it would be useful if the newspapers actually cared to report the depressing numbers - this morning, only in the FT did I find a small column on the depressing data...

 

Danisco under offer from Du Pond [C14]

January 12, 2010

 

One of the companies that I have been following over the years, Danish food ingredients manufacturer Danisco, is under offer from US giant Du Pond, who offer a huge premium over the stock market price of the firm. What makes this erstwhile Danish conglomerate such an attractive target for an American food and chemicals business? The essence is that relentless focus on a core line of business makes the firm a good fit for a strategic investor.

 

Danisco was created in 1989 by merging three moderately diversified Danish business operating in businesses loosely related to the food industry. From the outset, it has been selling off peripheral businesses and strengthened their position in three lines of business, looking globally for targets: foods and food ingredients, sugar, and packaging for the food industry. Then around 1999, they make another radical change, and focused even narrower. Now their ambition was to become the global number 1 for food ingredients. Hence, they merged with Cultor of Finland, and in the next couple of years, they sold the branded food and packaging businesses they had build up over the years.

 

The sugar business had for many years the backbone of Danisco, and its main cash cow. However, deregulation of the EU sugar market put the writing on the wall for teh sugar industry, and Danisco sold the sugar division about a year ago to German competitor Nordzucker. So, the company became highly focused on natural food ingredients while becoming increasingly involved in biotechnology products of use outside the food industry. This now makes it a good fit for Du Pond who operate in industrial biotechnology as well as in food ingredients.

 

Danisco's shareholders are probably going to celebrate big wins - and for the top management a strategy persistently pursued for over a decade pays off handsomely. The offer price is DKK 665, compared to DKK 520 a week ago, and about DKK 450 at the beginning of December. It is too early to speculate if there are consequences for employees of the firm.

 

I had a look at the strategy of Danisco in two papers in recent the years, and it features as Opening Case of a chapter in our forthcoming textbook:

 

On the Du Pond-Danisco announcement see:

 

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