There are No Developed Nations in the World

The moment you start to ask questions about things happening around you, the more interesting the results you get to see. Having lived in three different countries, I've had the good fortune to understand similar events from several perspectives to develop a viewpoint. One of the things that I find interesting is to understand why certain countries have "developed" while others are still "developing". My interest was however in understanding people and their behavior as it is attributed to those two words.

When I read news articles and commentaries that use the term developed nations, I find it fascinating to understand how different people have their own take on how they interpret their nations and their qualification for being "developed" or "undeveloped". In that mess, I fail to understand what the true meaning of a developed nation is? I personally believe that only a foolish person could have come up with such a biased view of the world in the first place. What has been developed in your nation that has not been developed in another nation?

If it is about industrialization, then yes, certain countries are surely developed. But, the larger interpretation of people in general is that developed nations have developed ideals, developed thoughts, developed behavior and a developed strength and perspective on worldly matters. This somehow has given many nations the license to decide on what are sane and truthful decisions in the world. This is where things fall apart. I haven't seen a single case of a so called "developed nation" being all of this except for being industrialized. I have however seen many of these developed nations do senseless, childish and undeveloped actions that in no way qualifies them to be developed as human beings.

Assuming industrialization happened sometime in the 18th century, it is pretty difficult to understand how building an assembly of cars, rapid mining of natural resources or doing anything with iron and steel has made people truly advanced. Materialistically yes, intellectually maybe, but as a good human being, no way! The First World War, a bunch of European nations that fought among each other, was precisely a large scale event to remember because industrialized production of stuff that can kill humans faster and better were developed. The Second World War, fought again by the same old people not happy with the human capability to produce mass destruction, was another industrialized opportunity to build something quicker to eliminate something quicker. Unfortunately, my views are blinded by the fact that I'm ignoring a very basic characteristic of a human being - to be greedy and gluttonous in life.

After those historic events came the most childish prank, a reflection of human underdevelopment and the inability to grow beyond basic animal instincts for territorial greatness - the Cold War. Two nations fought a proxy war, generated lies, masked truth and most important of all, brought money into the orbit of war games. The result was a massive wastage of the human intellect in interpreting the science behind the atom to create a nuclear arms race in the world. A developed mind would have pursued peace as the world's most powerful weapon for human development instead of a stockpile of disastrous toys. After that, there hasn't been anything worthwhile to mention when it comes to developed nations. If humans have consistently done something in the world, it has been the ability to fight against one another.

A developed country should represent people with a developed mindset. Nothing apart from wisdom through knowledge can help a person achieve this status. It is the ability to act and think beyond an animal that makes a human being a developed person. Instilling a sense of fear among others by acts of intimidation or killing may make you powerful, but degrades a human being to levels below that of an ordinary animal. After all, even an animal kills only to satisfy its hunger, not for creating a status symbol. The capability to apply wisdom and restraint in your ability to deal with people around you is what takes you closer to being a developed human being. Sharing that profound capability to control your mind and the monkey that tries to uproot it, among other people creates a developed nation.

However, there is definitely an argument that is to the contrary. "Developed" nations are not messy, unclean and troublesome to live in as compared to other "undeveloped" nations. Hence, there has to be something profoundly great about the people of these nations that the undeveloped people in other countries lack. Even I had that notion in my mind, until I lived and observed for long enough in a developed nation. The answer merely goes back to a basic characteristic of a human being. When people get what they want to lead a life (food and shelter) they become happy. When a group of people become happy due to the ability to have these basic needs satisfied at an individual level, they become peaceful socially. When socially peaceful people live in a nation, they tend to do well to others within their group. When any of these benefits are threatened or uprooted, human beings behave badly. Sometimes, this comes at the cost of denying someone else the same comforts of life.

Today's nations are merely reflections of this trend. The British lived happily when they got what they wanted even if it was at the expense of some other person's lost resources and freedom. Today, when they see that comfort being shaken by other people coming to share it, they have complained. When Americans lost jobs to outsiders, the comfort zone was shaken and they have complained. Ludicrous immigration laws, trade barriers and several other biased human strategies are reflections of that behavior. In all these there has never been the case where people pursued greatness beyond basic human greed to achieve the true status of a developed person or a nation.

Past civilizations in India, China, Egypt, Iraq and the African continent had a structure that closely resembled a true developed nation. A nation where greed or its manifestation in the form of money was not what people yearned for to achieve human greatness! History unfortunately is only a collection of half-truths. So, with only a certain possibility, we can say that there were developed nations in the past, but for certain, there are no developed nations today, and given our downward spiral, there will be no developed nations tomorrow.

Why do we build a Discounted Cash Flow (DCF) Model

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There is a lot of literature on the web explaining the importance of a DCF model and how to build one. However, as I recently realized, not many companies are focused or care enough to build an effective cash flow model to evaluate an investment. The fact that these are large corporations borrowing heavily from Wall Street makes it a matter of concern.

The fast pace of decision making in a demanding high growth technology based world has forced companies to bank on experience and/or gut feeling to make an investment. Although, this is in effect not a bad way to run a business in a highly competitive industry such as e-commerce for example, there is still what I call a "responsibility" towards adding more reasoning for strategic investments. The main reason being that the money that a company spends on its investments or excesses is actually money borrowed from investors who are expecting a return on their investment. Greedy- yes, but so is the way capitalism works.

So, when a company decides to make use of the money, they got to have a better reason as to what returns that will produce. This should go above and beyond rosy statements on what this strategy means for the company. The only way this can be done is by adding the language of finance to a strategy. This is where the discounted cash flow analysis comes into the picture. There are several other ways in which a financial analysis of an investment can be made to judge if it is sound in its fundamentals. One can look at top line or bottom line numbers and still feel comfortable about what they are getting into. The big winner among them however has been the DCF approach. Simply speaking, it goes a step further from just a limited accounting analysis and does what can be the best theoretical approach to determining a discount rate (cost of capital).

When I did my MBA, I had a hard time understanding these concepts as I was a slow convert to the field of finance. It was not until I joined my company post my MBA that I started exploring these concepts in detail. Anyways, in short, the DCF does some pretty simple and basic steps to arrive at what is called as a "Free Cash Flow" - as the term suggests, it is cash that is available for the company after it has factored for all costs related to an investment.

Starting with the sales an investment generates, we get to the EBITDA, do a small manipulation with the DA portion (Depreciation and Amortization) by including it for tax purposes and removing it for cash flow purposes, and adjust for working capital and other capital gains. In effect, once all these are meticulously done, we get to what is called as an "incremental free cash flow". This figure is what makes a DCF model better than just a simple accounting practice of arriving at the Net Income. Cash Flow is a much realistic estimate of what the company truly has in its hands after generating the required money for an investment. If the FCF is negative for a prolonged period of time, it in effect indicates that something may be wrong with the investment. Now, once the company has say $10,000,000 of cash, it now has an obligation to its investors that it needs to fulfill. Ideally speaking, it has more of a direct obligation to pay for its leveraged debt than for its equity, but in a ideal scenario, equity investors or share holders do expect some money for the shares they hold in the company.

So, there is where the discount rate comes into the picture. The discount rate is applied by using compounding on the FCF over the number of years that the investment is expected to produce sound returns. Compouding is simply used as laws of greediness dictate that money earned today is used to make more money tomorrow. So, the interest will also be invested to generate more money. The discount rate as such is also called as the "cost of capital" - the reason being that the capital (money) that a company gets has a corresponding cost (investor return) attached to it that the company needs to pay out. DCF model relies on what is called as the WACC (Weighted Average Cost of Capital) to arrive at this discount rate.

The WACC is a weighted average as it uses the D/E ratio to arrive at what portion of the discount rate (or investor return) is attributed to the debt holders and the share holders. The laws of capital markets dictate that the debt holder has the first right towards returns and then comes the share holder (provided there is anything left to give them). The debt portion is for a very funny (or greedy) reason tax deductible. Hence, it is dealt with in a different manner. The equity part of the discount rate is determined using what is called as the CAPM. A Nobel prize winning concept, it is fairly simple to understand but complicated to derive. Nevertheless, it looks into the performance of the company in the market to determine what returns the company can provide. CAPM has its own set of limitations as does the DCF model or any other financial analysis for that matter. No matter what, the discount rate or WACC eventually is applied on the FCF to determine what remains in terms of cash for the company after paying for all its obligations.

DCF model can be manipulated to suit the needs of the person building the model. This is where subjectivity in assumptions, a lack of conviction on part of the person building the model, the desire for glory on part of management to prove that their decisions are always right comes into the picture. These human interventions can in turn affect the "truth" of the model. Many people in the place I've worked claim these to be the reasons why there is no point in wasting time building such complicated mechanisms. In other words, it is a safe way to put ones inhibitions and fears on the backburner, for who wants to embarrass themselves by working on tough financial models. After all, nobody is truly judged for performance based on what they do to run a business, it is the money they generate that matters.

Then comes the NPV to make quick decision based on the DCF analysis. NPV or Net Present Value is just a way of deriving the "time value of money" of the entire investment. By bringing all the money a company makes to year 0 (starting year of investment) and subtracting it from the initial capital investment for a project, a number shows up that indicates what is the prevent value of all the money a company makes in the future on that project. The number has to be positive as if it isn't, it indicates that the investment made is not generating the required returns.

This is the DCF in short. The reason why it is important to have belief in the model and make a sincere attempt at using it is to make a relatively better objective evaluation of an investment. If greed and glory are overcome, a bad investment or negative NPV will be readily defended by a financial analyst to prevent the company from making the investment. Unfortunately, it also needs a strong commitment on the part of the largely ignored and demoralized financial analyst to face the outcome of his/her recommendation. After all, life is not fair. The DCF model may have said something but the fickle minded consumers who eventually utilize the benefits of an investment may think otherwise. The company may not make the $10,000,000 that they desired to make and the DCF analysis is to be blamed!

Book Review: Greed and Glory on Wall Street - Kids on the Loose!

I recently completed reading "Greed and Glory on Wall Street" by Ken Auletta. Set in the 80s, this book has already been reviewed by many over the years. Although decades old, this book is still an interesting read, especially the final chapter that talks about lost glory and the changing face of capitalism. It is interesting to note that, given the new fate of Lehman Brothers, it doesn't surprise one that Investment Banks have been a symbol of "desperate greed" since ages. Desperate since experts put the blame on a changing society and growing complexity in capitalism as the reasons for such greed.

The author is definitely impartial in analyzing happenings that led to the then collapse of Lehman Brothers in 1984. However, throughout the narrative, there definitely was a sense that the truth is still hidden somewhere in between. After all, the people who interviewed must have planned out a strategy for keeping their names intact. Anyways, it’s exciting to understand how the job of "raising money" can be so convoluted in reality. The fact that it’s just a bunch of gluttonous individuals managing that process for an entire nation (or world depending on how one sees it), makes it all the more shocking. The mess in Ken Auletta's version of Lehman Brothers is just one such example. A bunch of fighting kids with a singular motive to get rich quickly, empowered by a system that promotes easy handling of money, led by a management that believes only in making money, can only be nothing but a perfect recipe for disaster. It's interesting to note that when people in Main Street don't get a hold of how they are getting rich, they obviously can't raise their voices against what self-proclaimed "bracket" firms in Wall Street bulging with money are up to.

This book never gives a clear picture of who the culprit was in orchestrating the demise of Lehman Brothers. In fact, I felt there was none. Pete Peterson, the Chairman, did his best to keep up his reputation as a proud investment banker. Money and fame go hand in hand, and he embraced it dearly. Lew Glucksman also did his part to keep up with his desire to mint money out of selling bonds. While one believed in prestige from corporate finance, the other believed in sales & trading. Nevertheless, both dealt with a board and a bunch of partners, who when combined together, were nothing more than a bunch of kids boosting capitalism and their bank accounts with unimaginable chunks of money.

Just when I was adjusting myself to the end result that Lew Glucksman, was brought down by a board that just wanted to keep its money safe, I read the book "Liar's Poker" by Michael Lewis. That further changed my perspective on Wall Street banking and what could have truly happened to Lehman Brothers. In short, I would put it as nothing but changing market forces killing the super strong bond market growth in the mid 80s. It eventually led to severe losses for all firms that made boat loads of money creating and selling bonds, led to Lew's team losing their shirt and of course Lehman, its pants.

In a capitalist world where the rules are meant to be broken, super bright men (unfortunately women didn't have a recognizable place at that time) with IQs that help them understand how a home loan can be transformed into a completely unknown package of securitized bonds, keep changing the rules of the game. When governing bodies are slow to react (which I feel will always be the case in the fast paced world of Wall Street), a kid who can handle or break a bunch of telephones while buying and selling financial instruments will always call the shots. A 23 year old college graduate will guide the fate of an investment made by a large insurance firm through money sucked from a "not-meant-to-be-understood" health insurance premium it has been charging drug-dependent citizens stuffed with one-a-day pills for a new syndrome defined and marketed by a big pharmaceutical company trading in Wall Street to feed multi-billion dollar blockbuster drug research and become a profitable company.

I never realized money was so easy to get as long as you have a fool that you can take a ride for. The investors in the 80s obviously fell in that bracket. The investors of today may be different, and a bit more diverse (or global as some people describe today), but when they deal with Wall Street, they cannot get a better deal. After all, you make money by taking away someone else’s. Of course, Wall Street gives investors the money they desire. It's just that as the dollar moves from one hand to the other, a few pennies slip through a small hole in the pocket. The less you feel bad about orchestrating it, the happier you feel buying large mansions in overpriced locations and smoking large chunks of expensive cigars with the arrogant belief that you are the smartest guy on the planet.

The Logistical Challenge to e-Commerce Growth

Question: What does not excite a consumer to purchase a product at an online retailer instead of at a physical retail store?

Answer: Several reasons. Starting with the idea that consumers still prefer to view/feel the products they buy to technical challenges such as fear of fraud in using credit card for payments. Most of these and other challenges have been tacked by online retailers through better pricing, greater assortment, ease of researching and ordering products and the move towards safer financial transactions.

Given this new world that has evolved over the past 3-4 years, the bigger question is how else online retailers can grow their clout in a largely changing world. According to an emarketer analyst, US retail e-commerce sales will reach $146B in 2008, up 14.3% from the previous year. However, the growth rates of online sales will steadily decline over the years. The indication in the report is that the online retail channel is maturing.

I feel that apart from several other important challenges that e-retail needs to tackle, there is one reason why customers tend to purchase offline than go online. It is the time taken to deliver the product as a function of the cost incurred to receive the product. This I believe is the biggest logistical challenge that e-retailers should find an answer for.

Question: So, how bad is it?
Answer: I tried to answer this question by doing some research on the net and came across a very good article that talks exactly about the challenge I was talking about. In an article in cnnmoney.com titled "Consumers say no to high shipping fees", it shows that about 43% of consumers abandon a shopping cart citing high shipping fees as a reason. It also indicates that when consumers compare online and offline prices, savings is realized in the shipping fees.

Question: So, what are online retailers doing to tackle this issue?

Answer: Many online retailers such as Amazon.com are using programs such as "Super Saver" shipping and "Amazon Prime" to tackle this challenge. Wal-Mart also came up with an answer through the Site-to-Store program. Having personally studied and worked on changes to the Site-to-Store program while working at Walmart.com, I have experienced the growth potential of such cross-channel initiatives, although I feel that the program could have been well thought out and executed better in some areas. But yes, I do feel that multi-channel retailers have greater scope for innovation in tacking this challenge than pure play online retailers. The reason being that, they can offer a different shipping mechanism as compared to a standard ship-to-home option to the consumer.

Question: How can we define this challenge?

Answer: I feel that like every economic or statistical model, it can be mathematically defined by an equation.

Loosely defined, the equation could look like:
Consumer's online purchase decision = fn(time to deliver, cost to deliver, price, availability)

There is a strong correlation between the "time to deliver" and the "cost to deliver" variables due to the challenge posed by the carrier companies that retailers use for shipping products. As is obvious, carrier companies attach a cost directly to the speed of delivery of the package, which either the retailer has to absorb or pass on to the consumer. In the future, online retailers may consider this as a single large strategic challenge that they need to effectively confront.

Question: How can an online retailer work on this challenge?
Answer: This is obviously a tough question to answer, especially for a pure play online retailer. Store retailers with an online component can still gain efficiencies by introducing multi-channel options like store pickup and online divisions leveraging the partnerships built with carriers by the store network.
Pure play online retailers such as Amazon can still leverage scale of operations for better deals with carriers. However, it still turns out to be an expensive affair given the rising costs of gas and the inability for carriers to effectively mitigate them. But, I believe there is a solution.

The solution lies in what Wal-Mart has done with its suppliers over the years and continues to do today with its sustainability initiatives. Partnering with carriers to remove costs out of the system will be the way to go. Easier said than done given that Carriers like UPS and Fedex already have exceptional processes in place to squeeze costs out of the system. But there is scope for more efficiencies in the process if retailers can use historical analysis to predict ways in which consumers place their orders and the shipping methods they employ. If this is shared in advance with their carrier partners, the carriers in turn can plan their trips to the retailer's distribution centers and network the trips to the consumers location. To be continued in a later post...

Book Review: The "Invisible" Continent - Politics at Play

Recently I read a book by the famous strategy consultant Kenichi Ohmae, called "The Invisible Continent". Although written for audience in the early 2000, it did provide interesting insights into a changing world. A world defined by entities that do not physically exist, but still control the economic direction of participating nations. The book definitely provides insights into how structure needs to be established in the uncontrolled cyber environment, with globally acceptable legal laws defining the ways of the business.

I found the author admirable and highly inspirational, a nobrainer given his phenomenal success at McKinsey. However, what I found interesting in the midst of all the business-economic recommendations he generously provides (without a consultation fee!) to companies and countries in the book, is his political viewpoint on nations. This makes me wonder if a business personality is highly successful only if he can rope in political views to answer business dilemmas!

Nevertheless, what excited me when reading this book was the validation of nationalistic feelings of a Japanese citizen that another author, Chalmers Johnson, had portrayed in his book - "The Sorrows of Empire". Kenichi questions the bureaucratic stodginess of Japanese political establishments and their reluctance in questioning the unwanted high costs of "maintaining" a foreign army (the US military) to "protect" Japan against its "enemies"! The dilemma lies in who the enemy truly is and why. Kenichi also talks about his association with Malaysian premier Mahathir Mohammad, described as a visionary who repeatedly challenged financial markets badly influenced by the West and at the same time promoted investments to allow Malaysia enter the information super-highway. The Asian financial crisis and the crisis in Latin America were explained by the actions of fickle minded global investors (primarily in the US) pulling money in and out of a country triggered by the slightest economic provocation. How the Japanese funds into American markets indirectly influenced it is interesting to learn.

But the biggest surprise I had from reading his book was his veiled attack on American economic policies in an otherwise highly appreciate prose on the American economy and their willingness to make bets on the next big unproven money machine. His take on how the United States dominated the world on two platforms - the dollar and the English language is worth reading. What I loved the most about it from a personal standpoint was that, even before I read this book, I always had this notion in my mind - if you would appreciate a single American who transformed the destiny and fortunes of the country for decades to come, it would be the guy who said - "let's make the US dollar the global currency for exchange in the World". This happened shortly after the "World" Wars (I'll explain in an other post as to why I put the World in quotes) and led to global recognition of the US dollar as a powerful currency in the market. However, my thinking capabilities stopped at that thought and I didn't have any intellectual inputs to back or further that view. Kenichi has a similar opinion on the power of the dollar and how the country is protected from inflation due to the constant inflow of funds from safety seeking investors (both legal and illegal), a privilege that allows the Fed to mint money without fear of ending up with large unmanageable cash reserves. He proposes a new currency similar to the Euro, a more expanded conglomerate of currencies from participating nations to alter this platform. However, I do not personally see a huge benefit from it apart from displacing the US dollar from its platform status, in turn, reshaping the World as we see it today, for good or bad!

On a final note, there was one aspect of the book or rather Kenichi's thought process that I wasn't comfortable with. In all the political talk of borderless nations, an economic system that has no place for politics, a continent that transcends cultural and regional biases and a system of universal opportunities for all, Kenichi repeatedly exposes himself to the inability to hide his nationalistic feelings as a Japanese and a "developed" nation psychosis of partnering with the developed West (the "Euro" nation and the US) to improve the lot of the "developing" World. I felt that references to this inherent belief contradicts the recommendations and feel-good moments that he tries to portray through the Invisible Continent. If the Invisible continent is indeed for everyone to enjoy, why should the skeletal structure of that continent and life into the continent (rules, regulations, laws, players, benefactors and beneficiaries) be molded by the so-called "developed" nations? If playing in the invisible continent is one that favors intellectual tenacity, why should other nations be restricted from framing the constitution of this continent?