Greek Complexity

Market-based sports strategy

Came across an interesting article today about the way in which India's public TV operator is using SMS during telecasts of cricket matches. Nothing new, you might think, except that, according to the article, people's responses are being used in a predictive fashion.

Doordarshan [the TV operator] is using SMS interactivity in a very novel way for ODIs against Pakistan. "It is happening in real time, where questions are asked and output is shown in a minute. The viewers are constantly involved in the match and feel a part of decision making with questions like: should no. 5 batsman be moved up? Will the batting side score more than 300? Which next bowler should be brought in, etc," says Singh.

Since I'm not in India, I haven't even seen these new features. So I have no idea whether these predictions and choices are conveyed to the coach/manager in real time and whether they are taken into account for on-the-field decisions. Is anyone monitoring the performance of India's back-seat coaches, I wonder. (Satish: would you comment?)

This is all extremely interesting (and perhaps in a grey area as far as the official ICC rules are concerned?). It could also be a source of competitive advantage for the team with the most knowledgable, enthusiastic fans.

This seems similar to Technology Review's Innovation Futures initiative which aims to predict technology developments by harnessing the intelligence of many "market" participants.

All very interesting.. commonalities exist across:

• The two examples above
• Idol contests in America/India/Singapore/etc
• The Wisdom of Crowds
• My new job!

I'm getting more and more excited about this whole theme. Will aim to post some concrete examples (as far as possible) about my work as well when projects get underway.

Link: From Indian Idol to cricket, SMS rules

"Scale-free" networks

TheFeature writes about research showing that so-called "scale-free" networks are better, more robust designs than the alternative.

Using e-mail rather than SMS as the messaging medium for mobile phones has made mobile Internet services in Japan more successful than in the West, says an industry expert -- a claim supported by recently discovered mathematical properties of networks.

A scale-free network is one that consists of a few large "hubs" and many distributed "nodes". This isn't as abstract as it sounds. One example is simply the way people are organised socially. For instance, cultural information spreads easily across the world, without being dependent on a central arbiter or dispenser of information.

The researcher profiled in the article says that the same concept needs to be put to use when building communication networks. He says that email networks are scale-free whereas SMS networks are inherently hobbled by their network design. One quick-and-dirty measure of this difference in efficiency is that sending a message to 1000 people by email costs the same as sending the same message to 1 person, whereas SMS costs are proportional to the number of recipients. This, he says, is a lesson that designers of future networks must keep in mind for truly scalable architectures.

Interestingly, the same lesson is applicable to business as well, or even societies. A "value web" is likely to be far more robust and valuable than a value chain. I remember reading a study of the European mobile industry landscape about a year ago which made this very point -- that the industry is organised as a web rather than a vertical chain. I imagine the same is true of other fast-changing industries such as software, semiconductors and even media.

Link: TheFeature :: Email, Scale-Free Networks, and the Mobile Internet

Private equity for public equities

AltAssets reported last month on a new fund that will apply PE techniques to public companies:

"Our approach within the SVG Advisers' public equity team has been to apply similar due diligence and valuation approaches to investment that has served private equity firms so well in recent years. The performance of [the previous fund] to date has demonstrated the validity of this approach."

I understand how due diligence might be more focused than is traditional but I wonder how PE valuation techniques are different from any other valuation techniques. Also wonder whether these guys exert control/work with the management of companies they buy into. That could be an interesting hybrid model. Wonder which other shops are applying this model.

Link: SVG to launch new fund to apply PE investment techniques to public companies

McKinsey on success in PE

Read a recent article in The McKinsey Quarterly examining the drivers of success in private equity. Although the article starts out examining why certain PE firms do better than others, the study actually identified the drivers of success in specific deals.

The sample is relatively small (11 "leading" PE firms and 60 deals) but the results aren't that far away from what one would normally expect, so I expect increasing the sample size wouldn't make that big a difference.

One thing that would be interesting to know is whether these deals all took place during roughly the same period. Has performance been different for deals that took place before 2000 and deals that took place after 2000? (I presume exits have happened only recently.)

One interesting tidbit:

The main source of value in nearly two-thirds of the deals in our sample was company outperformance. Market or sector increases accounted for the rest. Outperformance, which generated a risk-adjusted return twice that of market or sector growth, was the least variable source of value.

The article ends with:

These research findings pinpoint the practices that distinguish great deals from good ones. The five steps are, in the main, uncontroversial. They are applied inconsistently, however, and their implementation seems to depend on the individual partner's beliefs and skills. A standard active-ownership process that applies and develops best practices is the next step for the private equity industry.

An interesting point. So the (relatively) young PE industry will begin moving towards benchmarked practices and a level of maturity comparable to other more established industries. I wonder how this will play out in Asia.

• Will best practices quickly make their way into Asian PE given that the industry is very young here and has few bad habits to shed?
• Or are there too few experienced PE investors here who can transfer best practices into their Asian operations? McKinsey's article makes the point that it is not firm-wide best practices that lead to above average deals, it is good practices followed by individual partners within a firm.
• Or another reason people might not bother with instituting good active-ownership strategies within their firms could be if their target markets start heating up, and partners spend more time chasing new deals than managing their existing portfolio. But I don't see this happening.

Link: The McKinsey Quarterly: Why some private equity firms do better than others

Hedge funds target private companies in India

The Economic Times (India):

Hedge funds have realised that with just a handful of private equity investors in India, there are a lot of investment opportunities to be tapped among private companies. Moreover, they feel that the potential or returns could be much larger in the private markets, compared to public ones.

Hedge funds generally do not have partners with operational expertise of running companies — something which most private equity investors have. Instead, hedge funds have people who are capable of identifying new investment options and valuations differences.

Some of the new offerings to investors by hedge funds are positioned as “venture hedge funds”.

These new funds invest in both short and long-term assets, the objective being to leverage the short-term earning in true blue hedge fund style, while gaining from long-term profits from ventures. A balance of short-term and long-term investment means that these funds are able to deliver returns consistently and regularly over their life cycle.

Vinod Sethi, investment advisor to private equity and hedge firms, says, “If hedge fund investors start investing in unlisted companies, then valuations are going to get stretched. I don’t think it will reach a stage where competitive bidding will take place between private equity and hedge funds, as most private equity funds would like to avoid such a situation. I don’t think hedge funds have the skills to invest in unlisted companies.”

Mr Bhasin believes that private equity funds will generally have an advantage over hedge funds. “It is unlikely that hedge funds will lead an investment. At the most, they may ride on the coat tails of private equity investors. Entrepreneurs may also not be so keen on hedge funds leading an investment,” he says.

Competition between PE investors and hedge funds is fairly recent even in Western markets so I am quite impressed at the speed with which these developments have occured in India.

Separately, I wonder what sort of timeframe hedge funds typically seek from investments in private companies.

I also wonder how they realise returns, given that hedge funds' traditional strengths are not in finding exit opportunities such as IPOs or trade sales. Perhaps they are bringing in partners with private equity or investment banking or even operational experience? I do remember reading some months ago that some of the larger PE guys --Carlyle? KKR? I don't remember exactly who-- have set up hedge fund-style units to compete with traditional hedge funds. Won't be surprised to learn that hedge funds have set up their own PE units as well.

Link (courtesy of Sameer Wagle): Hedge funds smell a killing in Indian unlisted firms

Auctions and "sniping"

"Sniping" is the term used in auctions to describe the phenomenon of last-minute bids. This article describes the prevalence of sniping on eBay and the comparative lack of it on Amazon. Excerpts:

[In our data on eBay], 55 percent of the auctions have bids in the last 10 minutes, 37 percent in the last minute, and 12 percent in the last 10 seconds. There was much less late bidding on Amazon. Only 11 percent of the auctions in our data [had bids during the last ten minutes].

Big differences. Reason: eBay has a strict deadline for auctions while Amazon's rules specify that at least 10 minutes must pass without a bid for the auction to end. If there is last-minute bidding, the auction gets extended beyond its scheduled time.

On eBay, people snipe to avoid price wars. By bidding at the last minute, they don't give others who might want to change their bids in response the time to do so. On Amazon, sniping is much less effective, since the automatic extension rule means that other bidders always have 10 minutes to respond.

And sniping is not without cost: Planning to make a late bid may mean that you fail to make a bid, either because the auction closes before your bid gets through (when you're trying to make a very late bid), or because something comes up that prevents you from getting around to making a bid. (There is sniping software to address this latter problem, but when we surveyed eBay users we didn't find that it was being widely used.)

So, the question is, when is sniping worth the risk of not getting your bid in? There are lots of reasons it might be. The easiest case to think about is of a bidder who has some expert information about the item being sold, information that might affect how much other buyers are willing to pay. For example, suppose that a dealer in Persian carpets sees a desirable one on eBay. Many bidders may not be able to tell the difference between valuable carpets and cheap imitations, and so if they can identify that a dealer is bidding on a particular carpet, that will tell them that it is a good one. So, the dealer can try to conceal who he is, to avoid starting a price war, but for a dealer who bids a lot, it is hard to have lots of different usernames. A simpler strategy is for him to snipe, so that others can't piggyback on his expertise. But even without special expertise, a bidder may feel that an early bid will inspire others to raise their bids, and in such a case, sniping may be a winning strategy.

Interesting article although I'd have liked to know more about the effect of sniping on prices. Looks like it would be interesting to compare auctions of the same item on eBay and Amazon to see if sniping truly resulted in lower prices (on eBay).

Also, as far as I can remember, eBay collects a commission on completed auctions based partially on the final sale price of the auctioned good. In which case, would it be in their interest to implement Amazon's 10-minute rule? (Because that might prevent snipers from keeping sale prices lower than they might otherwise be.)

On the other hand, this other article says:

Our study suggests that increasing the hype around the auctions, having strict rather than flexible deadlines at the end of auctions, and creating an audience for the auction to make winners and losers visible, might all increase the likelihood of overbidding due to auction fever.

But "auction fever" is an "an emotion story". When there is "emotional arousal",

bidders may want not only to purchase the item, but also to beat the competition. In other words, competitive arousal can lead to a "win at any cost" mentality.

So bidders with auction fever aren't likely to be snipers as well. The very nomenclature suggests this. Auction fever = emotion; sniping = calculating and methodical.

Again, which auction type (fixed deadline or flexible deadline) leads to a higher price? I will try to do some research. My gut feel is that it will vary depending on the type of product being auctioned (esoteric vs mass-market).

Link: Amazon, eBay and the Bidding Wars, How to Harness Auction Fever

VCs and early-stage start-ups

Two somewhat different points of view. My views follow.

Someone called Mike writes on Techdirt:

The one thing that seems the most interesting to me, however, is the fact that a good number of the companies presenting at the conference are all bootstrapped to this stage. While it's likely that some of them will score large buckets of [VC money], it's good to see at least some startups realize that starting up a company doesn't mean "get VC first." Of course, this may have been out of necessity. Many of these companies were born during the past few years when trying to raise money from VCs was a complete waste of time. The question, though, is whether or not things remain this way, or if the VCs are starting to turn their attention back to earlier stage companies again?

And Jeff Nolan responds:

First of all, the amount of venture capital that has been invested in the last couple of years has been substantial and growing by any measure, so the idea that a startup raising financing is "a complete waste of time" is factually inaccurate. What has happened is that we have reverted to a demand-driven financing environment which simply requires a company to demonstrate that they are fundable, which in many cases requires them to bootstrap early development.

Let me add my two bits worth about early-stage VC in Asia.

In Singapore, where I am based, early-stage venture capital is non-existent. Variety of reasons:

• Investors are risk-averse.
• There really aren't that many potential Googles out there in Singapore and the rest of South East Asia.
• Investors see a bunch of lower-risk but still fairly high-return opportunities outside traditional technology-based, Silicon Valley-type investing.

So truly innovative technology start-ups have had to bootstrap or tap angels, grow for a few years and only then consider approaching professional investors. I myself am working with a couple of companies that fall into this category.

In India, early stage VCs are slowly making their presence felt. I get the feeling that early stage VCs in India are primarily corporate VC arms. People like Intel Capital and Analog Devices have been there for quite some time. Others like Nokia and Cisco are now entering the market.

Established non-corporate/standalone "VCs" in India have so far been late-stage private equity players and not early stage VCs of the Kleiner Perkins or Sequoia variety.

A lot of money has gone into growth stories and I believe buyouts will slowly become a part of the scene as well. This isn't really about risk-averseness. It's about making "easy" money (in quotes because, well, is it ever that easy?!) by investing in less risky, later-stage ventures that still manage high IRRs because of India's booming growth in areas such as BPO and IT.

Another factor might be that, due to India's cost structure, a technology start-up in India would not be able to absorb the type of capital investment that Western VCs are typically used to making. A million dollars in India goes a long way. And the same VC can't sit around evaluating and making hundreds of $50K investments. It just doesn't work.

Now that early-stage VCs are (re)entering India, I'm curious to learn what kinds of companies are actually funded by them, at what stage and at what valuation.

In China, where my knowledge really isn't that deep, both early-stage VCs and late-stage PEs are making investments, and have been doing so for some time. In some areas, the market has been heating up, particularly in the Internet and wireless sectors. Steven White at INSEAD has done a formidable amount of research on VC in China. This paper from INSEAD Knowledge is one example.

Looking back up at this post, I've really rambled away from the original topic! Well, as long as it's useful to at least a few readers...

Pricing securities

My friend Yi-wei and I were discussing today how useful it is to determine the "correct" price of financial securities using theoretical models. The conversation was sparked off when he commented:

It's quite fantastic when the same underlying model can be used to price so many different instruments.

To which I responded:

But I still keep hearing in my head one of the questions you once asked in class about whether market participants price a security according to a certain model because the model is correct, or because they believe the model to be correct. I remember the question was never really answered satisfactorily. You had referred to how options markets existed long before the Black Scholes model (for pricing options) was devised. So how were options priced before the model was developed?

Yi-wei:

I think people priced securities according to arbitrage... B-S is also based on arbitrage... after understanding B-S, it's not too bad a model... but it's a model after all.

Me:

Hmm.. but then how did participants know at what point to say, "I won't pay more than $x"

Yi-wei:

Because if you did, there would be arbitrage opportunities. If you pay less, there would be arb too.

Me:

No I think there is circular logic there.

Let's say the market consists of three participants. Or even just two. A certain security (does not have to be an option) is trading in the market.

I decide it is worth $5.

You agree.

Therefore the market price is $5.

But according to a theoretical model, it is worth $50.

I want to know how the individual participants arrive at $5 or 50 or whatever. Not how they take their cue from the market.

Yi-wei:

Any theoretical framework makes a lot of assumptions. The results (prices) differ to the extent that individuals' assumptions differ. We are all speculators, we speculate on the expectations we have of the future.

Me:

Exactly.. so then it means that the value one arrives at depends on the factors we use in our own mental models.. which may not agree with others' mental models or theoretical models.

So is there a "correct" model?

Or is it simply, "The market says so, so that's what the price is."

I tend to think it's the latter.

After all, take for example, HP's recent stock price movement. Before carly resigned, the price was X. After she resigned, the price was Y. Theoretically, i don't see why there should have been a large change. But the market disagreed.

So I conclude that there is no "correct" price.. only the price the market is willing to bear.

Yi-wei:

Haha.. I have some thoughts on that, but got to go now. Let's chat again after class.

So let's see where this discussion goes. I invite comments from readers and, since I'm sure this topic has already been debated by academics and practitioners, references to any resources on this topic are also welcomed.

The Apprentice as a marketing vehicle

Mark Carlson says:

Midway through [The Apprentice] I realize, this is an hour long commercial for Levis. And I like it.

Now my mind shifts from the narrative, to the real story – this is a moment of business genius. How often can a marketer engage even a single customer so deeply?

Does The Apprentice point to a business model for more modest media, like blogging or Podcasting?

I was talking about Mark's thoughts with an INSEAD professor. Now, I was really impressed by this idea so I was talking quite excitedly about this. I got a fairly simple and direct question in response: "How much does it cost to do this (get your brand on The Apprentice)?"

I'd never thought of that. I should have been talking about this to a marketing professor instead of a professor of accounting!

But seriously, how do the Levis, Procter and Gambles and Burger Kings of the world measure RoI for this sort of publicity exercise?

Link: Indexed Forever ? When a Business Model Fits Like Your Favorite Pair of … Headphones?