India badly needs a second generation of economic reforms in the days and months to come. But that doesn’t seem to be happening. “What makes reforms more difficult now is what I call the original sin of 1991. What happened from 1991 and thereon was reform by stealth. There was never an attempt made to sort of articulate to the Indian voter why are we doing this? What is the sort of the intellectual or the real rationale for this? Why is it that we must open up?” says Vivek Dehejia an economics professor at Carleton University in Ottawa,Canada. He is also a regular economic commentator on India for the New York Times India Ink. In this interview he speaks to Vivek Kaul.
How do you see overall Indian economy right now?
The way I would put it Vivek is, if I take a long term view, a generational view, I am pretty optimistic. The fundamentals of savings and investments are strong.
What about a more short term view?
If you take a shorter view of between six months to a year or even two years ahead, then everything that we have been reading about in the news is worrisome. The foreign direct investment is drying up. The savings rate seems to have been dropping. The economic growth we know has dropped. The next fiscal year we would lucky if we get 6.5% economic growth.
How do we account for the failure of this particular government to deliver sort of crucially needed second generation economic reforms?
The India story is a glass half empty or a glass half full. If you look at the media’s treatment of the India story, particularly international media they tend to overshoot. So two years ago we were being overhyped. I remember that the Economist had a famous cover where they said that India will overtake China’s growth rate in the next couple of years. They made that bold prediction. And then about a year later they were saying that India is a disaster. What has happened to the India story? The international media tends to overshoot. And then they overdo it in the negative direction as well. A balanced view would say that original hype was excessive. We cannot do nor would we want to do what China is doing. With our democratic system, our pluralistic democracy, the India that we have, we cannot marshal resources like the way the Chinese do, or like the way Singapore did.
Could you discuss that in detail?
If you take a step back, historically, many of the East Asian growth miracles, the Latin American growth miracles, were done under brutal dictatorial regimes. I mean whether it was Pinochet’s Chile, whether it was Taiwan or Singapore or Hong Kong, they all did it under authoritarian regimes. So the India story is unique. We are the only large emerging economy to have emerged as a fully fledged democracy the moment we were born as a post colonial state and that is an incredibly daring thing to do. At the time when the Constituent Assembly was figuring out what are we going to do now post independence a lot of conservative voices were saying don’t go in for full fledged democracy where every person man or a woman gets a vote because you will descend down into pluralism and identity based politics and so on. Of course to some extent it’s true. A country with a large number of poor people which is a fully fledged democracy, the centre of gravity politically is going to be towards redistribution and not towards growth. So any government has to reckon with the fact that where are your votes. In other words the market for votes and the market for economic reform do not always correlate.
You talk about authoritarian regimes and growth going together…
This is one of the oldest debates in social sciences. It is a very unsettled and a very controversial one. For any theory you can give on one side of it there is an equally compelling argument on the other side. So the orthodox view in political science particularly more than economics was put forward by Samuel Huntington. The view was that you need to have some sort of political control, you cannot have a free for all, and get marshalling of resources and savings rate and investment rate, that high growth demands.
So Huntington was supportive of the Chinese model of growth?
Yes. Huntington famously was supportive of the Chinese model and suggested that was what you had to do at an early stage of economic development. But there are equally compelling arguments on the other side as well. The idea is that democracy gives a safety valve for a discontent or unhappiness or for popular expression to disapproval of whatever the government or the regime in power is doing. We read about the growing number of mysterious incidents in China where you can infer that people are rioting. But we are not exactly sure because the Chinese system also does not allow for a free media. Also let’s not forget that China has had growing inequalities of income and growth, and massive corruption scandals. The point being that China too for its much wanted economic efficiency also has kinds of problems which are not much different from the once we face.
That’s an interesting point you make…
Here again another theory or another idea which can help us interpret what is going on. When you have a period of rapid economic growth and structural transformation of an economy, you are almost invariably going to have massive corruption. It is almost impossible to imagine that you have this huge amount of growth taking place in a relatively weak regulatory environment where there isn’t going to be an opportunity for corruption. It doesn’t mean that it is okay or it doesn’t mean that one condones it, but if you look throughout history it’s always been the case that in the first phase of rapid growth and rapid transformation there has been corruption, rising inequalities and so on.
Can you give us an example?
The famous example is the so called American gilded age. In the United States after the end of the Civil War (in the 1860s) came the era of the Robber Barons. These people who are now household names the Vanderbilts, the Rockefellers, the Carnegies, the Mellons, were basically Robber Barons. They were called that of course because how they operated was pretty shady even according to the rules of that time.
Why are the second generation of reforms not happening?
What makes reforms more difficult now is what I call the original sin of 1991. We had a first phase of the economic reforms in 1991 where we swept away the worst excesses of the license permit raj. We opened up the product markets. But what happened from 1991 and thereon was reform by stealth. Reform by the stroke of the pen reform and reform in a mode of crisis, where there was never an attempt made to sort of articulate to the Indian voter why are we doing this? What is the sort of the intellectual or the real rationale for this? Why is it that we must open up? It wasn’t good enough to say that look we are in a crisis. Our gold reserves have been mortgaged. Our foreign exchange reserves are dwindling. Again India’s is hardly unique on this. Wherever you look whether it is Latin America or Eastern Europe, it generally takes an economic crisis to usher in a period of major economic reform.
So the original sin is still haunting us?
The original sin has come back to haunt us because the intellectual basis of further reform is not even on anyone’s agenda. Discussions and debates on reform are more focused on issues like the FDI is falling, the rupee is falling, the current account deficit is going up etc. Those are all symptoms of a problem. The two bursts of reform that we had first were first under Rao/Manmohan Singh and then under NDA. If a case had been made to build a constituency for economic reform, then I think we would have been in a different political economy than we are now. But the fact that didn’t happen and things were going well, the economy was growing, that led to a situation where everybody said let’s carry on. But now we don’t have that luxury. Now whichever government whoever comes to power in 2014 is going to have to make some tough decisions that their electoral base, isn’t going to like necessarily. So how are they going to make their case?
So are you suggesting that the next generation of reforms in India will happen only if there is an economic crisis?
I don’t want to say that. Again that could be one interpretation from the arguments I am making of the history. It will require a change in the political equilibrium and certainly a crisis is one thing that can do that. But a more benign way the same thing can happen that without a crisis is the realization of the political actors that look I can make economic reform and economic growth electorally a winning policy for me. But India is a land of so many paradoxes. A norm of the democratic political theory in the rich countries i.e. the US, Canada, Great Britain etc, is that other things being equal, the richer you are, the more educated you are, the more likely you are to vote. In India it is the opposite. The urban middle class is the more disengaged politically. They feel cynical. They feel powerless. Until they become more politically engaged that change in the equilibrium cannot happen.
What about the rural voter?
The rural voter at least in the short run might benefit from a NREGA and will say that you are giving me money and I will keep voting for you. We have all heard people say they are uneducated and they are ignorant, no it’s not like that. He is in a very liquidity constrained situation. He is looking to the next crop, the next harvest, the next I got to pay my bills. If someone gave him 100 days of employment and gives him a subsidy, he will take it.
How do explain the dichotomy between Manmohan Singh’s so called reformist credentials and his failure to carry out economic reforms?
One of the misconceptions that crops up when we look at poor economic performance or failure to carry out economic reform is what cognitive psychologists call fundamental attribution bias. Fundamentally attribution bias says that we are more likely to attribute to the other person a subjective basis for their behaviour and tend to neglect the situational factors. Looking at our own actions we look more at the situational factors and less at the idiosyncratic individual subjective factors. So what am I trying to say? What I am saying is that it has become almost a refrain to say that Dr Manmohan Singh should be an economic reformer. He was at least the instrument if not the architect of the 1991 reforms. There are speculations being in made in what you can call the Delhi and Mumbai cocktail party circuit, about whether he is really a reformer? Was it Narsimha Rao who was really the real architect of the reform? Is he a frustrated reformer? What does he really want to do? What’s going on his head? That in my view is a fundamental attribution bias because we are attributing to him or whoever is around him a subjective basis for the inaction and the policy paralysis of the government.
So the government more than the individual at the helm of it is to be blamed?
Traditionally the electoral base of the Congress party has been the rural voter, the minority voters and so on, people who are at the lower end of the economic spectrum. So they are the beneficiaries just roughly speaking of the redistributive policies. Political scientists have a fancy name for it. They call it the median voter theorem. What does it mean? It means that all political parties will tend to gravitate towards the preferred policy of the guy in the middle, the median voter.
Was Narsimha Rao who was really the real architect of the reform?
Narsimha Rao must be given a lot of credit for taking what was then a very bold decision. He was at the top of a very weak government as you know. And he gave the political backing to Manmohan Singh to push this first wave of reforms more than that would have been necessary just to avert a foreign exchange crisis. And then he paid a price for it electorally in the next election. This again the intangible element in the political economy that short of a crisis it often takes someone of stature to really take that long term generation view. IT means that you are not just looking at narrow electoral calculus but you are looking beyond the next election. That’s what seems to be missing right now. Among all the political parties right now, one doesn’t seem to see that vision of look at this is where we want to be in a generation and here is our roadmap of how we are going to get there.
Going back to Manmohan Singh you called him an overachiever recently, after the Time magazine called him an “underachiever”. What was the logic there?
The traditional view and certainly that was widely in the West at least till very recently has been that it was Manmohan Singh who was the architect of the India’s economic reforms. But then how do you explain the inaction in the last five, six, seven years? The revisionist perspective would say no in fact the real reformer was Narsimha Rao to begin with. The real political weight behind the reform was his. And Manmohan Singh that any good technocratic economist should have been able to do which is to implement a series of reforms that we all knew about. My teacher Jagdish Bhagwati had been writing about it for years. In that sense maybe Manmohan Singh was given too much credit in the first instance for implementing a set of reforms. If you look at his career since then he has never really been a politically savvy actor. We have this peculiar situation in India since 2004 where the Prime Minister sits in the Rajya Sabha, the upper house. That kind of thing is not barred by our constitution but I don’t think that the framers of the constitution envisaged this would be a long term situation. It is a little like the British prime minister sitting in the House of Lords. I mean that practice disappeared in the nineteenth century. He has not shown from the evidence that we can see any ability to get a political base of his own to be a counterweight to the more redistributive tendencies of the Nehru Gandhi dynasty. And that’s the sense that in somewhat cheeky way I was using the term overachiever.
Do you think he is just keeping the seat warm for Rahul Gandhi?
It increasingly appears to be that way. If that is true then it suggests that we shouldn’t really expect much to happen in the next two years.
Does the fiscal deficit of India worry you?
If you look at some shorter to medium term challenges, then things like fiscal deficit and the current account deficit are things to worry about. Again other things like the weak rupee, the weak FDI data, things that people tend to fixate at, but those at best are symptoms of a deeper structural problem. The deeper concern is the kind of reform that will require a major legislative agenda such as labour law reform for example to unlock our manufacturing sector. And managing the huge demographic dividend that we are going to get in the form of 300-400 million young people. They will have to be educated.
But is there a demographic dividend?
That’s the question. Will it become a demographic nightmare? Can you imagine the social chaos if you have all these kids just wandering around, not educated enough to get a job, what are they going to do? It’s a recipe for social disaster. That according to me is going to be real litmus test. If we are able to navigate that then I don’t see why we won’t be on track to again go back to 8- 9% economic growth. I want to remain optimistic at the end of the day.
(The interview originally appeared in the Daily News and Analysis on August 6,2012. http://www.dnaindia.com/money/interview_reform-by-stealth-the-originalsin-of-1991-has-come-back-to-haunt-us_1724348)
(Interviewer Kaul is a writer and can be reached at [email protected])
Interview
An SSC pass understands that inflation today has nothing to do with RBI
Vivek Kaul
The attempts of the Reserve Bank of India (RBI) to control inflation have been a non-starter. “Growth, particularly in the last two or three years, has been worth its weight in gold. In a global economic boom, an economic growth of 8%, 7% or 9% doesn’t really matter. But when the world is slowing down, in fact growth in large parts of the world has turned negative, to kill that growth by raising the interest rate is inhuman. It is almost like a sin. And the RBI killed it under the very lofty ideal that we will tame inflation by killing growth,” said Shankar Sharma, vice-chairman & joint managing director, First Global, in an interview to DNA Money.
“If you have got a matriculation degree, you will understand that India’s inflation has got nothing to do with RBI’s policies. Your inflation is largely international commodity price driven. Your local interest rate policies have got nothing to do with that. We have seen that inflation has remained stubbornly high no matter what Mint Street has done. You should have understood this one commonsensical thing,” he added.
Given this, Sharma feels that there is no way out for the RBI but to cut the repo rate in the days to come. Repo rate is the rate at which RBI lends money to the banks. “I do not rule out a 150 basis points cut in the repo rate this year. Manmohan Singh might have just put in the ears of Subbarao that it’s about time that you woke up and smelt the coffee. You have no control over inflation. But you have control over growth, at least peripherally,” said Sharma.
Growth is the only antidote to inflation, feels Sharma. “If your nominal growth is 15%, you will get 10-20% salary and wage hikes. Then you have more purchasing power left in the hands of the consumer to deal with increased price of dal or milk or chicken. If the wage hikes don’t happen, you are leaving less purchasing power in the hands of people. And wage hikes won’t happen if you have killed economic growth,” explained Sharma.
And getting economic growth started again will be very difficult. As Sharma put it “The laws of physics say that you have to put in a lot of effort to get a stalled car going, yaar. But if it was going at a moderate pace, to accelerate is not a big issue. We have killed that whole momentum. And remember that 5-6%, economic growth, in my view, is a disastrous situation for a country like India. You can’t say we are still growing.”
By keeping interest rates high the RBI has managed to slowdown credit growth of banks and thus made borrowing easy for the government of India, which has been borrowing big time to finance its fiscal deficit. Fiscal deficit is the difference between what the government earns and it spends. “There are not many competing borrowers from the same pool of money that the government borrows from. So far, indications are that the government will be able to get what it wants without disturbing the overall borrowing environment substantially. In a strange sort of way the government’s ability to borrow has been enhanced by the RBI’s policy of killing growth. I always say that India has 33 crore Gods and Goddesses. They find a way to solve our problems,” said Sharma.
Sharma also sees the rupee appreciating against the dollar, a prediction he made at the beginning of the year and which hasn’t worked out till now. But his optimism still remains. “I still maintain that by the end of the year you are going to see a vastly stronger rupee. I believe it will be Rs 44-45 against the dollar. Or if you are going to say that is too optimistic may be Rs 47-48. But I don’t think it’s going to be Rs 60-65 or anything like that.”
A major reason for Sharma’s optimism is a fall in oil prices and Indians buying lesser gold.
“At the beginning of the year our view that oil prices will be sharply lower. That time we were trading at around $105-110 per barrel. Our view was that this year we would see oil prices of around $65-75. So we almost got to $77 per barrel (Nymex). We have bounced back a bit. But that’s okay. Our view still remains that you will see oil prices being vastly lower this year and next year as well, which is again great news for India,” said Sharma. Also with gold prices touching all time highs in rupee terms gold imports have taken a beating.
“You should be seeing a much stronger rupee by the end of the year. Imagine what that does to the equity market. That has a big, big effect because then foreign investors sitting in the sidelines start to play catch-up,” concluded Sharma.
(The article originally appeared in the Daily News and Analysis on July 31,2012. http://www.dnaindia.com/money/report_an-ssc-pass-understands-that-inflation-today-has-nothing-to-do-with-rbi_1721962)
(Vivek Kaul is a writer and can be reached at [email protected])
'You can shut the equity market, India would still be doing fine'
Have you ever heard someone call equity a short term investment class? Chances are no. “I have always had this notion for many years that people buy equities because they like to be excited. It’s not just about the returns they make out of it… You can build a case for equities on a three year basis. But long term investing is all rubbish, I have never believed in it,” says Shankar Sharma, vice-chairman & joint managing director, First Global. In this freewheeling
interview he speaks to Vivek Kaul.
Six months into the year, what’s your take on equities now?
Globally markets are looking terrible, particularly emerging markets. Just about every major country you can think of is stalling in terms of growth. And I don’t see how that can ever come back to the go-go years of 2003-2007. The excesses are going to take an incredible amount of time to work their way out. They are not even prepared to work off the excesses, so that’s the other problem.
Why do you say that?
If you look at the pattern in the European elections the incumbents lost because they were trying to push for austerity. And the more leftist parties have come to power. Now leftists are usually the more austere end of the political spectrum. But they have been voted to power, paradoxically, because they are promising less austerity. All the major nations in the world are democracies barring China. And that’s the whole problem. You can’t push through austerity that easily in a democracy, but that is what is really needed. Even China cannot push through austerity because of a powder-keg social situation. And I find it very strange when people criticise India for subsidies and all that. India is far less profligate than many nations including China.
Can you elaborate on that?
Every country has to subsidise, be it farm subsidies in the West or manufacturing subsidies in China, because ultimately whether you are a capitalist or a communist, people are people. They don’t necessarily change their views depending on which political ideology is at the centre. They ultimately want freebies and handouts. In a country like India, they don’t even want handouts they just want subsistence, given the level of poverty. The only thing that you can do with subsidies is to figure out how to control them. But a lot of it is really out of your control. If you have a global inflation in food prices or oil prices you are not increasing the quantum in volume terms of the subsidy. But because of price inflation, the number inflates. So why blame India? I find it absurd that the Financial Times or the Economist are perennially anti-India. They just isolate India and say that it has got wasteful expenditure programmes. A lot of countries hide things. India, unfortunately, is far more transparent in its reporting. It is easy to pick holes when you are transparent. China gives no transparency so people assume that whatever is inside the black box must be okay. That said, I firmly believe the UID program, when fully implemented, will make subsidies go lower by cutting out bogus recipients.
If increased austerity is not a solution, where does that leave us?
Increased austerity, while that is a solution, it is not achievable. If that is not possible what is the solution? You then have a continual stream of increasing debt in one form or the other, keep calling it a variety of names. But you just keep kicking the can down the road for somebody else to deal with it as long as the voter is happy. Given this, I don’t see how you can have any resurgence. Risk appetite is what drives equity markets. Otherwise you and I would be buying bonds all the time. In today’s environment and in the foreseeable future, we are overfed with risk. Where is the appetite to take more risk and go, buy equities?
So are you suggesting that people won’t be buying stocks?
Well you can get pretty good returns in fixed income. Instead of buying emerging-market stocks if you buy bonds of good companies, you can get 6-7% dollar yield, and if you leverage yourself two times or something, you are talking about annual returns of 14-15% dollar returns. You can’t beat that by buying equities, boss! Even if you did beat that by buying equities, let’s say you made 20%, it is not a predictable 20%, which has been my case for a long time against equities. Equities are a western fashion. I have always had this notion for many years that people buy equities because they like to be excited. It’s not just about the returns they make out of it: it is about the whole entertainment quotient attached to stock investing that drives investors. There is 24-hour television. Tickers. Cocktail discussions. Compared with that, bonds are so boring and uncool. Purely financially, shorn of all hype, equities have never been able to build a case for themselves on a ten-year return basis. You can build a case for equities on a three-year basis. But long-term investing is all rubbish, I have never believed in it.
So investing regularly in equities, doing SIPs, buying Ulips, doesn’t make sense?
I don’t buy the whole logic of long-term equity investing because equity investing comes with a huge volatility attached to it. People just say “equities have beaten bonds”. But even in India they have not. Also people never adjust for the volatility of equity returns. So if you make 15% in equity and let’s say, in a country like India, you make 10% in bonds – that’s about what you might have averaged over a 15-20 year period because in the 1990s we had far higher interest rates. Interest rates have now climbed back to that kind of level of 9-10%. Divide that by the standard deviation of the returns and you will never find a good case for equities over a long-term period. So equity is actually a short-term instrument. Anybody who tells you otherwise is really bluffing you. All the fancy graphs and charts are rubbish.
Are they?
Yes. They are all massaged with sort of selective use of data to present a certain picture because it’s a huge industry which feeds off it globally. So you have brokers like us. You have investment bankers. You have distributors. We all feed off this. Ultimately we are a burden on the investor, and a greater burden on society — which is also why I believe that the best days of financial services is behind us: the market simply won’t pay such high costs for such little value added. Whatever little return that the little guy gets is taken away by guys like us. How is the investor ever going to make money, adjusted for volatility, adjusted for the huge cost imposed on him to access the equity markets? It just doesn’t add up. The customer never owns a yacht. And separately, I firmly believe making money in the markets is largely a game of luck. Even the best investors, including Buffet, have a strike rate of no more than 50-60% right calls. Would you entrust your life to a surgeon with that sort of success rate?! You’d be nuts to do that. So why should we revere gurus who do just about as well as a coin-flipper. Which is why I am always mystified why so many fund managers are so arrogant. We mistake luck for competence all the time. Making money requires plain luck. But hanging onto that money is where you require skill. So the way I look at it is that I was lucky that I got 25 good years in this equity investing game thanks to Alan Greenspan who came in the eighties and pumped up the whole global appetite for risk. Those days are gone. I doubt if you are going to see a broad bull market emerging in equities for a while to come.
And this is true for both the developing and the developed world?
If anything it is truer for the developing world because as it is, emerging market investors are more risk-averse than the developed-world investors. We see too much of risk in our day to day lives and so we want security when it comes to our financial investing. Investing in equity is a mindset. That when I am secure, I have got good visibility of my future, be it employment or business or taxes, when all those things are set, then I say okay, now I can take some risk in life. But look across emerging markets, look at Brazil’s history, look at Russia’s history, look at India’s history, look at China’s history, do you think citizens of any of these countries can say I have had a great time for years now? That life has been nice and peaceful? I have a good house with a good job with two kids playing in the lawn with a picket fence? Sorry, boss, that has never happened.
And the developed world is different?
It’s exactly the opposite in the west. Rightly or wrongly, they have been given a lifestyle which was not sustainable, as we now know. But for the period it sustained, it kind of bred a certain amount of risk-taking because life was very secure. The economy was doing well. You had two cars in the garage. You had two cute little kids playing in the lawn. Good community life. Lots of eating places. You were bred to believe that life is going to be good so hence hey, take some risk with your capital.
The government also encouraged risk taking?
The government and Wall Street are in bed in the US. People were forced to invest in equities under the pretext that equities will beat bonds. They did for a while. Nevertheless, if you go back thirty years to 1982, when the last bull market in stocks started in the United States and look at returns since then, bonds have beaten equities. But who does all this math? And Americans are naturally more gullible to hype. But now western investors and individuals are now going to think like us. Last ten years have been bad for them and the next ten years look even worse. Their appetite for risk has further diminished because their picket fences, their houses all got mortgaged. Now they know that it was not an American dream, it was an American nightmare.
At the beginning of the year you said that the stock market in India will do really well…
At the beginning of the year our view was that this would be a breakaway year for India versus the emerging market pack. In terms of nominal returns India is up 13%. Brazil is down 3%. China is down, Russia is also down. The 13% return would not be that notable if everything was up 15% and we were up 25%. But right now, we are in a bear market and in that context, a 13-15% outperformance cannot be scoffed off at.
What about the rupee? Your thesis was that it will appreciate…
Let me explain why I made that argument. We were very bearish on China at the beginning of the year. Obviously when you are bearish on China, you have to be bearish on commodities. When you are bearish on commodities then Russia and Brazil also suffer. In fact, it is my view that Russia, China, Brazil are secular shorts, and so are industrial commodities: we can put multi-year shorts on them. So that’s the easy part of the analysis. The other part is that those weaknesses help India because we are consumers of commodities at the margin. The only fly in the ointment was the rupee. I still maintain that by the end of the year you are going to see a vastly stronger rupee. I believe it will be Rs 44-45 against the dollar. Or if you are going to say that is too optimistic may be Rs 47-48. But I don’t think it’s going to be Rs 60-65 or anything like that. At the beginning of the year our view that oil prices will be sharply lower. That time we were trading at around $105-110 per barrel. Our view was that this year we would see oil prices of around $65-75. So we almost got to $77 per barrel (Nymex). We have bounced back a bit. But that’s okay. Our view still remains that you will see oil prices being vastly lower this year and next year as well, which is again great news for India. Gold imports, which form a large part of the current account deficit, shorn of it, we have a current account deficit of around 1.5% of the GDP or maybe 1%. We imported around $60 billion or so of gold last year. Our call was that people would not be buying as much gold this year as they did last year. And so far the data suggests that gold imports are down sharply.
So there is less appetite for gold?
Yes. In rupee terms the price of gold has actually gone up. So there is far less appetite for gold. I was in Dubai recently which is a big gold trading centre. It has been an absolute massacre there with Indians not buying as much gold as they did last year. Oil and gold being major constituents of the current account deficit our argument was that both of those numbers are going to be better this year than last year. Based on these facts, a 55/$ exchange rate against the dollar is not sustainable in my view. The underlyings have changed. I don’t think the current situation can sustain and the rupee has to strengthen. And strengthen to Rs 44, 45 or 46, somewhere in that continuum, during the course of the year. Imagine what that does to the equity market. That has a big, big effect because then foreign investors sitting in the sidelines start to play catch-up.
Does the fiscal deficit worry you?
It is not the deficit that matters, but the resultant debt that is taken on to finance the deficit. India’s debt to GDP ratio has been superb over the last 8-9 years. Yes, we have got persistent deficits throughout but our debt to GDP ratio was 90-95% in 2003, that’s down to maybe 65% now. So explain that to me? The point is that as long as the deficit fuels growth, that growth fuels tax collections, those tax collections go and give you better revenues, the virtuous cycle of a deficit should result in a better debt to GDP situation. India’s deficit has actually contributed to the lowering of the debt burden on the national exchequer. The interest payments were 50% of the budgetary receipts 7-8 years back. Now they are about 32-33%. So you have basically freed up 17% of the inflows and this the government has diverted to social schemes. And these social schemes end up producing good revenues for a lot of Indian companies. The growth for fast-moving consumer goods, mobile telephony, two wheelers and even Maruti cars, largely comes from semi-urban, semi-rural or even rural India.
What are you trying to suggest?
This growth is coming from social schemes being run by the government. These schemes have pushed more money in the hands of people. They go out and consume more. Because remember that they are marginal people and there is a lot of pent-up desire to consume. So when they get money they don’t actually save it, they consume it. That has driven the bottomlines of all FMCG and rural serving companies. And, interestingly, rural serving companies are high-tax paying companies. Bajaj Auto, Hindustan Lever or ITC pay near-full taxes, if not full taxes. This is a great thing because you are pushing money into the hands of the rural consumer. The rural consumer consumes from companies which are full taxpayers. That boosts government revenues. So if you boost consumption it boosts your overall fiscal situation. It’s a wonderful virtuous cycle — I cannot criticise it at all. What has happened in past two years is not representative. It is only because of the higher oil prices and food prices that the fiscal deficit has gone up.
What is your take on interest rates?
I have been very critical of the Reserve Bank of India’s (RBI) policies in the last two years or so. We were running at 8-8.5% economic growth last year. Growth, particularly in the last two or three years, has been worth its weight in gold. In a global economic boom, an economic growth of 8%, 7% or 9% doesn’t really matter. But when the world is slowing down, in fact growth in large parts of the world has turned negative, to kill that growth by raising the interest rate is inhuman. It is almost like a sin. And they killed it under the very lofty ideal that we will tame inflation by killing growth. But if you have got a matriculation degree, you will understand that India’s inflation has got nothing to do with RBI’s policies. Your inflation is largely international commodity price driven. Your local interest rate policies have got nothing to do with that. We have seen that inflation has remained stubbornly high no matter what Mint Street has done. You should have understood this one commonsensical thing. In fact, growth is the only antidote to inflation in a country like India. When you have economic growth, average salaries and wages, kind of lead that. So if your nominal growth is 15%, you will 10-20% salary and wage hikes – we have seen that in the growth years in India. Then you have more purchasing power left in the hands of the consumer to deal with increased price of dal or milk or chicken or whatever it is. If the wage hikes don’t happen, you are leaving less purchasing power in the hands of people. And wage hikes won’t happen if you have killed economic growth. I would look at it in a completely different way. The RBI has to be pro-growth because they no control of inflation.
So they basically need to cut the repo rate?
They have to.
But will that have an impact? Because ultimately the government is the major borrower in the market right now…
Look, again, this is something that I said last year — that it is very easy to kill growth but to bring it back again is a superhuman task because life is only about momentum. The laws of physics say that you have to put in a lot of effort to get a stalled car going, yaar. But if it was going at a moderate pace, to accelerate is not a big issue. We have killed that whole momentum. And remember that 5-6%, economic growth, in my view, is a disastrous situation for a country like India. You can’t say we are still growing. 8% was good. 9% was great. But 4-5% is almost stalling speed for an economy of our kind. So in my view the car is at a standstill. Now you need to be very aggressive on a variety of fronts be it government policy or monetary policy.
What about the government borrowings?
The government’s job has been made easy by the RBI by slowing down credit growth. There are not many competing borrowers from the same pool of money that the government borrows from. So far, indications are that the government will be able to get what it wants without disturbing the overall borrowing environment substantially. Overall bond yields in India will go sharply lower given the slowdown in credit growth. So in a strange sort of way the government’s ability to borrow has been enhanced by the RBI’s policy of killing growth. I always say that India is a land of Gods. We have 33 crore Gods and Goddesses. They find a way to solve our problems.
So how long is it likely to take for the interest rates to come down?
The interest rate cycle has peaked out. I don’t think we are going to see any hikes for a long time to come. And we should see aggressive cuts in the repo rate this year. Another 150 basis points, I would not rule out. Manmohan Singh might have just put in the ears of Subbarao that it’s about time that you woke up and smelt the coffee. You have no control over inflation. But you have control over growth, at least peripherally. At least do what you can do, instead of chasing after what you can’t do.
Manmohan Singh in his role as a finance minister is being advised by C Rangarajan, Montek Singh Ahulwalia and Kaushik Basu. How do you see that going?
I find that economists don’t do basic maths or basic financial analysis of macro data. Again, to give you the example of the fiscal deficit and I am no economist. All I kept hearing was fiscal deficit, fiscal deficit, fiscal deficit. I asked my economist: screw this number and show me how the debt situation in India has panned out. And when I saw that number, I said: what are people talking about? If your debt to GDP is down by a third, why are people focused on the intermediate number? But none of these economists I ever heard them say that India’s debt to GDP ratio is down. I wrote to all of them, please, for God’s sake, start talking about it. Then I heard Kaushik Basu talk about it. If a fool like me can figure this out, you are doing this macro stuff 24×7. You should have had this as a headline all the time. But did you ever hear of this? Hence I am not really impressed who come from abroad and try to advise us. But be that as it may it is better to have them than an IAS officer doing it. I will take this.
You talked about equity being a short-term investment class. So which stocks should an Indian investor be betting his money right now?
I am optimistic about India within the context of a very troubled global situation. And I do believe that it’s not just about equity markets but as a nation we are destined for greatness. You can shut down the equity markets and India would still be doing what it is supposed to do. But coming from you I find it a little strange…
I have always believed that equity markets are good for intermediaries like us. And I am not cribbing. It’s been good to me. But I have to be honest. I have made a lot of money in this business doesn’t mean all investors have made a lot of money. At least we can be honest about it. But that said, I am optimistic about Indian equities this year. We will do well in a very, very tough year. At the beginning of the year, I thought we will go to an all-time high. I still see the market going up 10-15% from the current levels.
So basically you see the Sensex at around 19,000?
At the beginning of the year, you would have taken it when the Sensex was at 15,000 levels. Again, we have to adjust our sights downwards. A drought angle has come up which I think is a very troublesome situation. And that’s very recent. In light of that I do think we will still do okay, it will definitely not be at the new high situation.
What stocks are you bullish on?
We had been bearish on infrastructure for a very long time, from the top of the market in 2007 till the bottom in December last year. We changed our view in December and January on stocks like L&T, Jaiprakash Industries and IVRCL. Even though the businesses are not, by and large, of good quality — I am not a big believer in buying quality businesses. I don’t believe that any business can remain a quality business for a very long period of time. Everything has a shelf life. Every business looks quality at a given point of time and then people come and arbitrage away the returns. So there are no permanent themes. And we continue to like these stocks. We have liked PSU banks a lot this year, because we see bond yields falling sharply this year.
Aren’t bad loans a huge concern with these banks?
There is a company in Delhi — I won’t name it. This company has been through 3-4 four corporate debt restructurings. It is going to return the loans in the next year or two. If this company can pay back, there is no problem of NPAs, boss. The loans are not bogus loans without any asset backing. There are a lot of assets. At the end of every large project there is something called real estate. All those projects were set up with Rs 5 lakh per acre kind of pricing for land. Prices are now Rs 50 lakh per acre or Rs 1 crore or Rs 1.5 crore per acre. If nothing else, dismantle the damn plant, you will get enough money from the real estate to repay the loans of the public sector banks. So I am not at all concerned on the debt part. If the promoter finds that is going to happen, he will find some money to pay the bank and keep the real estate.
On the same note, do you see Vijay Mallya surviving?
100% he will survive. And Kingfisher must survive, because you can’t only have crap airlines like Jet and British Airways. If God ever wanted to fly on earth, he would have flown Kingfisher.
So he will find the money?
Of course! At worst, if United Spirits gets sold, that’s a stock that can double or triple from here. I am very optimistic about United Spirits. Be it the business or just on the technical factor that if Mallya is unable to repay and his stake is put up for sale, you will find bidders from all over the world converging.
So you are talking about the stock and not Mallya?
Haan to Mallya will find a way to survive. Indian promoters are great survivors. We as a nation are great survivors.
How do you see gold?
I don’t have a strong view on gold. I don’t understand it well enough to make big call on gold, even though I am an Indian. One thing I do know is that our fascination with gold has very strong economic moorings. We should credit Indians for having figured out what is a multi century asset class. Indians have figured out that equities are a fashionable thing meant for the Nariman Points of the world, but for us what has worked for the last 2000 years is what is going to work for the next 2000 years.
What about the paper money system, how do you see that?
I don’t think anything very drastic where the paper money system goes out of the window and we find some other ways to do business with each. Or at least I don’t think it will happen in my life time. But it’s a nice cute notion to keep dreaming about.
At least all the gold bugs keep talking about the collapse of the paper money system…
I know. I don’t think it’s going to happen. But I don’t think that needs to happen for gold to remain fashionable. I don’t think the two things are necessarily correlated. I think just the notion of that happening is good enough to keep gold prices high.
(A slightly smaller version of the interview appeared in the Daily News and Analysis on July 31,2012. http://www.dnaindia.com/money/interview_you-can-shut-the-equity-market-india-would-still-be-doing-fine_1721939)
(Interviewer Kaul is a writer and can be reached at [email protected])
People prefer 50% free to 33% lower price…
Here is a question. You invested your hard earned money in stocks. Your investments rose in value by 100%. Then things turned around and stock prices fell by 50%. How much money did you gain in the end? Before you jump up and say 50%, just hold on. You have ended up where you started. Let’s say you invested Rs 1 lakh to start with. A 100% gain on that meant that now your investment is worth Rs 2 lakh. A 50% loss on this meant that you were back at Rs 1 lakh. A 50% loss had wiped out a 100% gain. “People are not very good at performing arithmetic with complex forms such as logarithms, fractions, probability and percentages, because, for evolutionary reasons, the human brain has not evolved to perform these functions,” says Akshay R. Rao who holds the General Mills Chair in Marketing at the Carlson School of Management, University of Minnesota. In recent research which has received widespread international attention, Rao and his colleagues found that shoppers prefer getting something extra free to getting something cheaper. This happens because of their inability at handling percentages. Rao talks about this and more in an interview with Vivek Kaul.
In recent research you found that “Shoppers prefer getting something extra free to getting something cheaper.” How did you come to that conclusion?
Our research examined the phenomenon of bonus packs in which the consumer gets a larger quantity for the same price. We contrast this offer with a standard price discount, where the consumer gets the same quantity for a lower price. Imagine that I am selling coffee beans, and I offer you 100 beans for Rs. 100 on a normal day. Then, one day, I offer you a 33% discount, so you receive 100 beans for Rs. 67. On another day, I offer you 50% extra (or free). You now get 150 beans for Rs. 100. But, I impose no limit on how many or how few coffee beans you can buy, on either day. So, on the day in which I offer 50% extra, you could quite easily have bought 100 beans for Rs. 67! Yet, most people prefer 50% more to a 33% lower price, even though the two options are economically equivalent! In fact, we find that when we offer 33% more and a 33% price discount (which is economically superior), people are indifferent.
Can you give us an example?
In India, particularly for products that are sold in bulk (such as dal, rice, cooking oil etc.) in the unorganized retail market, this tendency on the part of consumers to prefer free products is likely to be successfully employed by the retailer. In our research, we were able to increase sales of an inexpensive consumer packaged good by over 70% in a retail store, when we employed the extra/free bonus pack format relative to the price reduction format.
What sort of experiment did you carry out?
As I mentioned above, we conducted one experiment in a retail store, in which we varied the promotion format for one product (hand lotion) each week. All the other products in the store were not promoted, providing us a control for comparison. We measured sales volume during each of the weeks to compare consumer response to format variation, and found, as predicted, that offering a quantity increment yielded substantially higher sales than offering a price discount that was economically equivalent. We followed up this naturalistic study with a survey of adult consumers in a shopping mall, asking them to express their preference for options that were either reduced in price or featured an increase in quantity. We also asked our respondents to respond to some simple maths questions, to assess their computational skills. Again, as we expected, we found that those with better maths skills did not display this error, while those with poor maths skills displayed the erroneous preference for quantity increments.
Finally, we also showed that the error occurs for harmful as well as beneficial changes — people prefer a quantity decrease of 33% relative to a price increase of 50%, though both are economically equivalent.
What do people behave in this way?
Essentially, we demonstrate that this occurs because of “base value neglect” when dealing with percentages, a phenomenon akin to “denominator neglect”, a term coined by the illustrious psychologist Paul Slovic. According to this human tendency, people are not very good at performing arithmetic with complex forms such as logarithms, fractions, probability and percentages, because, for evolutionary reasons, the human brain has not evolved to perform these functions. For existence and survival, to find food and avoid becoming prey, we are quite successful as a species if we operate as “frequentists”, that is number counters. Hence, people treat percentages as whole numbers and make predictable errors in computation.
Do companies already realize that shoppers prefer something extra free rather than getting something cheaper?
Companies intuitively use some of this logic, but I am not sure they have thought this through the way we have. (If they had, our paper would not have been novel and would probably not have been published!). However, now that our paper has been published and has received widespread attention in the business press, I expect that companies will start experimenting with our results to assess whether and when they can profitably employ our theory and findings.
You have in the past said “errors in peoples’ judgments of the net effect of multiple price discounts on the same product or on different products in a bundle have implications for a variety of marketing settings including advertising, promotion, pricing and public policy”. Can you explain this in detail to our readers?
A classic problem in numerical competence with regard to the processing of percentage information is how people process multiple percentages. Think of the following example which first appeared in The New York Times and was quoted in the bestselling book How To Lie With Statistics (Huff 1954, 111):
“The depression took a stiff wallop on the chin here today. Plumbers, plasterers, carpenters, painters and others affiliated with the Indianapolis Building Trades Unions were given a 5 percent increase in wages. That gave back to the men one-fourth of the 20 percent cut they took last winter.”
A little thought will show that the maths is wrong here. If the workers were making $100 at the beginning, and experienced a 20% cut, their wages had dropped to $80. A subsequent 5% increase constitutes $4, which is one-fifth, not one-fourth of the original wage cut! Even the venerable New York Times makes maths errors!
That was an interesting example!
Now, take this example to the marketplace. Imagine that a store offers a 20% off Diwali sale, and offers an additional 25% off on Diwali sweets. What is the total discount? It is not the sum of the two percentages (45%), it is actually, only 40%! But, people systematically ignore the base value and add up percentages as if they are whole numbers. The problem becomes even more interesting when there are gains and losses. Imagine if your stock portfolio goes up by 40% and then declines by 30%. You might think you are still better off from where you started, by 10%. But, you would be wrong — you are actually worse off by 2%!
So what are the practical applications of this?
The application of these errors in advertising, promotion and pricing should be obvious. Consumers can be tricked by stores into thinking an offer is better than it actually is. From a consumer welfare standpoint, this is obviously not a good thing. So, we suggest that, the scientific insight we offer can be used to improve consumer welfare, by the introduction of regulations to require purveyors of numerical information to present absolute as well as percentage information. Particularly with regard to consumer finance (credit card interest rates) or the petrol consumption improvement of a car, it is possible for consumers to be fooled by multiple percentage changes that appear beneficial, when they are in fact harmful.
In one of your articles you discuss a study which points out: a) price may exert a non-conscious influence on expectancies about product quality b) such expectancies may have an impact on actual product performance c) such expectancies can also be induced through non-price information such as advertising claims about product quality. Can you explain this in detail?
This was a fascinating study authored by Baba Shiv of the University of Iowa (now at Stanford) and his colleagues Dan Ariely and Ziv Carmon, about which I was invited to write a commentary. The essence of their research was as follows. Some people were given a drink that was claimed to enhance mental acuity. Half the people were told that the product was purchased at $1.89 while the other half were told that the product, priced at $1.89 was purchased at a discounted price of $.89. Then, after they had drunk the liquid, they were given puzzles to solve. The group that drank the full-priced product solved significantly more puzzles (9.1) than the group that drank the discounted product (7.7)! Seemingly, people who drank the discounted drink expected that it would be less efficacious at increasing their mental acuity, and performed relatively poorly on the puzzle solving task! Their expectations sub-consciously influenced actual product performance. This is a powerful demonstration of the price-quality effect, a phenomenon that I have studied extensively over the last 25 years.
What is the learning for marketers here?
The remarkable thing about this research is the power of the placebo (as the authors term it). This placebo effect suggests that the human brain can be fooled into performing because it expects to perform. The implicit argument is that in many instances, psychology may be more important than engineering, in product design. The obvious learning for marketers is that consumers are subject to many subtle influences that have an impact on their subjective experiences. They may not be entirely rational and the creative and astute marketer is able to identify and exploit opportunities to influence consumer behavior through clever marketing.
Car dealers frequently draw customers into their establishment with the promise of an attractive advertised deal. However, upon arrival, the car buyer discovers that the deal does not apply to the model he wishes to buy. Nonetheless, after a few minutes of consultation with a ‘‘sales manager,’’ the salesperson returns with the news that an exception has been made and the deal has been approved. The buyer is relieved. Why does the dealership not simply offer the deal on the buyer’s preferred model in the first place?
The answer to this question lies in the psychological impact of the consumer experiencing relief. It is rooted in the “Good news, bad news” sequence phenomenon. People generally prefer to end on a high note (there is a good reason that dessert comes at the end of a meal!), and prefer to get bad news first and good news later, rather than the other way around. So, imagine you are boarding an international flight and reach for your passport in your pocket. It’s not there. Panic ensues. You search frantically, and find it in your briefcase. You experience an immense sense of relief because of good news following bad; this sense of relief would not have been experienced had you found your passport when you first reached into your pocket. It turns out that, when you experience this relief, you are psychologically vulnerable. Your cognitive resources to process bad news has been depleted, so your tendency to be loss averse increases. So, when a car dealer tells you that your preferred deal is not available, and then subsequently tells you that it may still be available, you experience relief and your desire to accept the deal increases, because you don’t want to lose the car. You negotiate with less vigor and wind up accepting a deal that is less advantageous to you than if you had not been taken through the bad news, good news roller coaster in the first place.
Companies often indulge in price wars when more often than not they turn out to be a race to the bottom. So why do they do it in the first place?
The impulse to fight on price is driven by many factors, not least of which is that the price variable is easy to change. Remember how Usha used to advertise in the 1980s – their slogan was “Massive Price Cut!” Dropping price in response to a competitor’s price cut is easier, particularly in the short-run, than engaging in creative actions such as promoting benefits, emphasizing your brand’s trustworthiness, alerting consumers to the risk of purchasing low-priced options that may perform poorly, and so forth. In my research and consulting work with companies in the U. S., Europe and Asia, I have found that most managers have been taught and instinctively feel that price is the most potent weapon in the marketplace. Therefore, it becomes the weapon of first resort — it is easy, available and often measurable (through changes in market share).
One sector that has been completely destroyed over the years because of price wars is the airline sector. But they still seem to have not got the point. How do you explain that?
In the year 1992, following a recession, there was a mad scramble in the airline industry in the U. S. to acquire market share. The easiest way to do so was to cut prices. And, it worked. Leisure travel increased that summer, revenues went up, but profits declined. Many experts have analyzed this continuous emphasis on price in the airline industry. At the present time, thanks to the internet and travel sites that routinely search for low-priced options, consumers have been taught by the industry to engage in price-comparison shopping. This is a phenomenon that is here to stay. Airlines have employed other means to enhance loyalty and revenue without suffering on price, through frequent flyer programs, through additional fees (such as baggage fees), but the fact remains that coach/economy travel is much less profitable than business and first class travel, particularly on international routes. Now, the managerial mindset is that price is the principal means of attracting and retaining customers.
You also write that “Managers can localize a price war to a limited theater of operation – and cut down the opportunities for the war to spill into other markets”. How do they go about doing that?
Price wars need not be global. They can be limited geographically, or to certain segments, or to certain product categories, at certain times, and so forth. Smart companies realize this. Returning to the airline industry, when a low price competitor enters a market, it offers inexpensive flights to a limited set of locations, and at certain times. The incumbent would be smart to cut prices on flights that cater to those destinations and at those times, at which the low-price competitor operates. It is not necessary to cut prices across the board. This is what Northwest Airlines did when a small rival — Sun Country — entered the market. To counter Sun Country, Northwest dropped its fares on the Minneapolis-Boston route, on flights that operated between 7:10 am and 11:10 am. That was the time at which Sun Country operated its Minneapolis – Boston flight.
Any other example?
Or, consider another creative strategy that is based on an intimate understanding of consumer price sensitivity. 3M used to make diskettes. It faced a new low-priced competitor — a Korean brand called Kao — and was faced with the prospect of a price war. Instead of dropping the price on 3M diskettes, it launched a “flanking brand” called Highland, at a low price to match Kao. Now, price sensitive customers had the choice of Highland and Kao, while quality sensitive customers stayed with 3M. This was a more profitable strategy than simply dropping the price for 3M diskettes, even though the Highland diskettes came off the same shop floor! Simultaneously, 3M signaled to Kao its intent to protect its market, and Kao eventually withdrew.
The interview appeared in the Daily News and Analysis on July 16,2012.
(Interviewer Kaul is a writer and can be reached at [email protected])
"In future, VCs will help launch new brands. Tata, Reliance had better watch out"
Companies are in a perpetual race to expand sales. And the easiest way to do that is to expand their well known successful brands into other categories. As marketing consultant and author of many bestsellers Al Ries puts it “If a brand is well known and respected, why can’t it be line extended into another category. That’s common sense. That’s why Xerox, a brand that dominated the copier market, introduced Xerox mainframe computers. A decision that cost the company billions of dollars. That’s why IBM, a brand that dominated the mainframe computer market, introduced IBM personal computers. In 23 years of marketing IBM personal computers, the company lost $15 billion and finally threw in the towel and sold the operation to Lenovo, a Chinese company.” Ries is the author of such marketing classics (with Jack Trout) as The 22 Immutable Laws of Marketing and Positioning: The Battle for Your Mind. In this interview to Vivek Kaul he speaks on various aspects of branding and marketing.
You have often said in the past that there is a a big difference between common sense and marketing sense. Could you discuss that in some detail with examples?
Common sense is another way of saying “logical.” Almost every rule of marketing is not logical, it’s illogical, which I defined as “marketing sense.” It takes years of study and personal experience to develop good marketing sense. Yet too many management people dismiss the ideas of their marketing managers because “marketing is nothing but common sense and who has better common sense than the chief executive?” Line extension is a typical example. If a brand is well known and respected, why can’t it be line extended into another category. That’s common sense. That’s why Xerox, a brand that dominated the copier market, introduced Xerox mainframe computers. A decision that cost the company billions of dollars. That’s why IBM, a brand that dominated the mainframe computer market, introduced IBM personal computers. In 23 years of marketing IBM personal computers, the company lost $15 billion and finally threw in the towel and sold the operation to Lenovo, a Chinese company. That’s why Kodak, a brand that dominated the film-photography market, introduced Kodak digital cameras. In spite of the fact that Kodak had invented the digital camera, the company was never successful in marketing the cameras under the Kodak name. And recently Kodak went bankrupt.
With all the experience you have had consulting companies all these years which area of marketing do you feel that marketers have the most trouble with?
We have had the most trouble working with large companies marketing big brands. And the issue is always line extension. Companies want to expand their sales so they figure the easiest way to do that is by expanding their brands into new categories. In other words, line extension. We have worked with Burger King, Intel, Xerox, IBM, Motorola, Procter & Gamble and dozens of other companies that invariably wanted to expand their brands whereas we almost always recommend the opposite strategy. Narrow the focus so your brand can stand for something. The second issue is timing. We have always recommended that companies try to be the first brand in a new category. But that is a difficult sell to top management. Their first question is usually, What is the size of the market? Of course, a new category is a market with zero revenues. And many, many management people never want to launch a product into any category that doesn’t already have a sizable market. We worked for Digital Equipment Corporation, a leader in the minicomputer market. We tried to get them to be the first to launch a personal computer for the business market. (IBM eventually was the first to do so, but without a new brand name which led to their failure.) In spite of days of meetings and presentations, the CEO of Digital Equipment refused to launch such a product. “I don’t want to be first,” he said, “I want IBM to be first and then I’ll beat their specs.” After IBM launched its personal computer, Digital Equipment followed, but never achieved more than a few percent market share. Eventually the company more or less fell apart and was bought by Compaq at a discount price.
How can a No. 2 brand compete successfully with a leader?.
What a No.2 brand should do is easy to explain, but difficult to execute. A No. 2 brand should be the opposite of the market leader. Why is this difficult to do? Because it’s illogical. Everyone assumes the No.1 brand must be doing the right thing because it’s the market leader. Therefore, we should do exactly the same thing, but better. That seldom works. Take Red Bull, the first energy drink and the global market leader. One reason for Red Bull’s success was the fact that it came in a small, 8.3-oz. can that symbolizes “energy,” like a stick of dynamite. So almost every competitive brand was introduced in 8.3-oz. cans and marketed as “better” than Red Bull. Except Monster, a brand introduced in 16-oz. cans in the American market. Today, Monster is a strong No.2 brand with a 35 percent market share compared to Red Bull’s 43 percent share. Also in the American market, BlackBerry was the leading smartphone until Apple introduced the iPhone. BlackBerry had a keyboard. Apple eliminated the keyboard and used a “touchscreen” instead. Mercedes-Benz was the leading luxury-vehicle brand until BMW came into the market. Mercedes vehicles were big and comfortable, so BMW became smaller and more nimble, as dramatized in the brand’s long-running advertising theme, “The ultimate driving machine.” As a matter of fact, BMW introduced the campaign with a two-page advertisement headlined: “The ultimate sitting machine vs. the ultimate driving machine.”
Do long running marketing campaigns help? How many companies have the patience to run a marketing program for two or three or four decades?
Next to line extension, that’s the biggest problem in marketing today. Companies don’t run marketing programs nearly long enough. The best example of a long-term successful campaign is the one for BMW. “The ultimate driving machine” strategy was launched in 1975 and the company still uses the same slogan today. That’s 37 straight years. Most marketing programs don’t last longer than three or four years. That’s way too short a time to make a lasting impression in consumers’ minds. I can’t recall any major marketing program, except for BMW, that has lasted more than a decade or so.
In a recent column you wrote that logic is the enemy of a successful brand name. What did you mean by that?
By “logic” I mean what you would use as a brand name if you did not study marketing and had no experience as a marketing person. In other words, common knowledge versus specialized knowledge. It’s like the Sun and the Earth. Common knowledge would suggest that the Sun revolves around the Earth and not the reverse. Look out your window and it’s obvious that the Sun is moving and the Earth is standing still. But specialized knowledge knows that isn’t true.
What is the connection with brand names?
As far as brand names are concerned, logic or common knowledge suggests that a generic name like Books.com would be a better choice than Amazon.com. If the prospect wants to buy a book, then logically the prospect would go to a website like Book.com or Books.com.
But a marketing-trained person knows that isn’t true. It’s not how a mind words. When a person hears the word “Book,” he or she doesn’t think it’s a website at all. It’s the generic name for a category of things. On the other hand, thanks to its marketing program, “Amazon” has become a specific name for a website devoted to selling books. So when a person thinks, “I want to buy a book on the Internet, he or she doesn’t think “Books.com,” he or she thinks “Amazon.com.” In almost every category, a specific “brand” name performs better than a generic “category” name. Google.com is a better name than Search.com. YouTube.com is a better name than Video.com. There is a caveat, however. In the absence of a marketing program that establishes a brand name in consumers’ minds, a generic name could do well.
Why do you say that as a general rule, any name that specifically defines a category is bound to be a loser?
Consider how a mind works. If I say “coffee,” you literally hear that word in your mind spelled with a lower-case “c.” It’s a common noun, or a generic word that stands for an entire category of things. The same reasoning hold true for a more specific name like “High-end coffee shop.” If I say “Starbucks,” on the other hand, you literally hear that word in your mind spelled with a capital “S.” It’s a proper noun, or a brand name that stands for a specific chain of high-end coffee shops. Oddly enough, you can use common English nouns in another country as brand names? Why is this so? Because consumers don’t know the meaning of these common words. So these words become proper nouns instead and usable as brand names. For example, a stroll down a street in Copenhagen turned up these store names: Biggie Best, Exit, Expert, Face, Flash, Joy, Limbo, Nice Girl, Redgreen, Sand and Steps. Nice brand names in Copenhagen perhaps. But they wouldn’t work in America.
What do you mean when you say that “the internet is exceptionally good at promoting web, not physical, brands.” Could you explain through examples?
First of all, consider the fact that the Internet has created a host of new, very-valuable Internet brands including Amazon, Google, Facebook, YouTube, Groupon, Pinterest, LinkedIn and dozens of others. How many new physical brand names were created on the Internet? I can’t think of any. The Internet is the newest, latest medium. It attracts people who are interested in what’s new and different on the Internet. So there is intense interest in any new website that promises a revolutionary way to handle some of your affairs. But there’s not the same level of interest in new physical brands. Like a new toothpaste, or a new camera, or a new breakfast cereal. That doesn’t mean that new physical brands can’t take advantage of the PR potential represented by the Internet. They certainly can, but it’s going to be more difficult for a physical brand to get a lot of attention on the Internet than an Internet brand.
You recently wrote that “If you don’t have the right strategy, good tactics won’t help you very much. And social, like all media, is a tactic. What concerns me is that too many marketers have elevated tactics — especially those of social media — to the level of strategy.” Could you elaborate on this statement?
Our leading marketing publication is called “Advertising Age.” I have suggested facetiously that the publication should be called “Social Media Age,” because a high percentage of the stories the publication writes about involve social media and marketing on the Internet. Strategy is seldom mentioned. One reason for the intense interest in the Internet is because many aspects are easily measured. A video on YouTube, for example, will be measured by: (1) The number of “Views.” (2) The number of “Likes.” (3) The number of “Dislikes.” And (4) The number and content of “Comments.” That’s a range of responses no other medium can deliver. No wonder marketing people devote endless hours to evaluating the success of Internet programs. But suppose a marketing program is not successful. Do you blame the strategy or the tactics? Today, it’s too easy to blame the tactics. My feeling, however, is that most of the time strategy is at fault.
Are there any ideas on branding which you have espoused in the past which you have now junked?
Yes, we used to think that brand names ought to communicate something tangible about the brand. Duracell is a good example. It suggests that the appliance battery is a “long-lasting” brand. But today, there are too many competitors in any given market. A tangible name like Duracell is likely to be surrounded by many other brands with similar names, confusing the consumer. A meaningless name is often a better choice. It allows you to develop your own unique meaning for the brand. Google is a good example. Initially it meant nothing, but today it means “search.”
What is your opinion on big brand names. India has a lot of them like Tata and Reliance. And they attach these names to every business or product they launch? How do you view that?
That’s line extension and it might work today in India, but would never work in America. In America, there are too many competitors in every category with distinctive brand names. A line-extended name like Tata and Reliance would be at a serious disadvantage here. Why does it work in India? I’m not an expert, but I believe that India suffers from a shortage of venture capital as compared to the United States. It’s hard for an entrepreneur to launch competitive brands to Tata and Reliance because it’s difficult to raise enough money for their introduction. But I believe that will change in future so both Tata and Reliance should be concerned about the future of their brands.
(Interviewer Kaul is a writer and can be reached at [email protected])