Tag Archives: markets

Capital’s bargaining power

Recently a friend and I was working on some business ideas. We were thinking through scenarios where smart people come up with great business ideas or business models that can generate impressive returns but require capital to do. If the capital markets work perfectly for the specific risk profile of the business (assume that it can be assessed correctly), then all capital should only be able to demand the market rate of return on capital.

We ran some simulations on this. To simplify the whole business and risk, we assume it is a very low-risk infrastructure project that returns constant cashflow across 10 years, one year after the initial cash injection. A project that can bring in >27%, when raising all of its funds from a capital owner, should be split 60-40 if the market hurdle rate is at ~12% for that risk and tenure. This means that though the capital holder is financing 100% of the project, he needs to give up 40% share of the returns to the ones who structured and pulled the project together.

Now, when the project returns rises to 33% over 10 years; and the market hurdle rate remains at 12%, then the capital holder needs to give up 49% share. This means that if the project that the smart guys are able to put together can return more than 33%, then the capital owner needs to give up more than 50% of the returns even though he is contributing 100% of the upfront capital. This is a hard bargain for the ‘entrepreneurs’ organising the resources to strike with capital holders.

This is perhaps how the Thomas Piketty argument about the relative bargaining power of capital gets played out. At the same time, capital can afford to be more patient because the cost of upkeeping capital isn’t as high as trying to upkeep a living person with the wits and capabilities to develop all the ideas and organise the resources. And because capital is more ‘tangible’ and ‘calculative’, it can keep forcing all kinds of cost upon labour side of the equation. In this blog post, labour basically includes the ‘entrepreneurial’ elements as well that is typically somewhat associated with capital.

This is where debt comes in. Instead of getting a co-investor, the project entrepreneur should be able to borrow to finance the project. And the debt tenure can be shorter. A simple solution could be to take out a 4-year debt at 7% interest; this would require the entrepreneur to sacrifice 85% of the project cashflow for the first 4 years, in exchange for the rest of the project’s cashflow. Technically, when structured as a debt, the market interest rate should be lower than the market hurdle rate. Yet because the ‘project’ is new and may not have a sufficient track record, financiers may demand collateral and other risk-management tools to enhance the credit standing. Technically, when structured as a debt, the market interest rate should be lower than the market hurdle rate. Yet because the ‘project’ is new and may not have a sufficient track record, financiers may demand collateral and other risk-management tools to enhance the credit standing. This means that the entrepreneur would have to give out more than he needs to reduce the risks of the capital holder further despite the risk profile of the project.

So, the entrepreneur who does not have any capital to contribute will be seen as having a mouth-watering return since there isn’t any ‘capital at risk’ for the entrepreneur, but the reality is that there is some opportunity cost. Yet if the entrepreneur’s salary is built into the project returns, then he doesn’t have the ‘opportunity cost’. The extra upside would be his ‘supernormal return’.

Fast followers

Being a fast follower is a good strategy; it allows you to take in the lessons from those who have tried and failed first. It is even a strategy that enables you to become a leader from public’s eyes.

But the challenge for the fast follower who gained leadership status is falling into the trap of thinking they are the leader. Their skills in curating what they learnt from the mavericks, scaling what was small and bringing things to market fast, are not going to be suited for what is required to take real leadership: influencing the market, uncovering innovation from their own values and principles.

They may have to pivot at some point when they’ve outcompeted all those whom they were fast-following.

Waiting for standards

There are lots of excuses to choose from for a business to avoid the sustainability pressures upon them. Especially those who doesn’t want to have anything to do with activities that are not geared towards generating profits. One of them is the lack of standards in terms of what constitutes being sustainable.

And so the wheel turns and regulators churn out a whole bunch of different kinds of standards: CSRD, TCFD, GRI, CDP, SASB, UN SDGs – and all of them are basically reporting standards.

Technically they don’t tell you exactly what being a sustainable business is about; but they do emphasize some aspects and bring to fore different aspects of the business that may not be captured in more traditional business disclosures.

Nevertheless, no one is going to be able to tell you what is the ‘sustainability standard’ threshold that marks your business as being sustainable. There are ways to look good in each of those disclosure standards of course – and businesses sure knows how to cherry-pick the ones. The whole industry could even gear up to pander to that kind of work.

Yet at the heart of building a sustainable business is really considering the relationship of the business with everything else other than profits. And only you as the leader, the business owner, the manager, the employee can make decisions that determine how sustainable the business it. The metrics that you care about will naturally be tailored to your business.

You don’t have to wait for some regulators or the ‘market’ to make up their mind.

Waste management complexities

Since starting my career in the environmental sector more than 10 years ago, I’ve been dealing with waste management issues. Frankly, the circular economy wasn’t spoken of yet. And in any case, a lot of the waste generated cannot be recycled. The fact is that we never even quite gone into the first ‘R’ of the three ‘R’s yet.

Singapore waste disposal figures
Total waste generated and disposed in Singapore (tonnes per annum), Source: NEA Statistics

The thing is, as the country’s population grew and economic activities multiplied, waste growth continued. There was probably a dip in terms of per capita waste generation, but the overall amount of waste we were disposing of grew even if the gross waste generation didn’t quite reach the ‘peak’ we had in 2017.

Our ability to manage this waste is important and it is largely because we’ve been able to get rid of them and maintain the cleanliness of our city, and not burden our businesses with the excessive waste that we have been able to keep up with our economic growth and remained an attractive destination for business, and economic activities. These are, of course, the positive externalities of having a robust waste management programme.

Yet waste is a complicated matter; the fact that waste management produces a positive externality doesn’t necessarily mean that we need to have more of it because that is usually based on the amount of waste that needs to be managed. On the other hand, when you subsidise the management activity, there is a risk that you’re undercharging the people generating the waste, which is the source of the problem in the first place. That brings us beyond the territories of your traditional economic externality analysis.

So, it becomes a political issue. And there’s even a question of willingness to pay, not in the traditional sense that people will not do it anymore. It is about how much you can keep charging the people without losing political support and risking losing votes. This is why public policy surrounding waste is complex, and you can’t leave it to a technocratic government to solve such a problem. You can employ some of the technocratic arguments to help you get some buy-in, but you’d likely need to deploy more tactics than that.

Analysing externalities

In public finance, there are multiple approaches to determining how to use the public budget. There will always be the standard expenditures that will have to be costed in, the overheads to cover the public service.

Then there are past liabilities that will need to be paid for. But then, each time, the government can make a decision whether those liabilities are still worth their while to continue financing.

After which, we determine the infrastructure and other investments essential for development of the society. When it comes to investing into infrastructure, the government will definitely need to meet needs, but they might have to ask themselves what kind of social benefits are generated in order to work out whether the price tag for fulfilling those needs make sense.

This is the realm of externalities. And the reason we care about that is because the free market would not. If private benefits exceed private costs, then the free market will find its own means of fulfilling those needs. When there are externalities, the government has to step in. From a business point of view, where there are negative externalities, it is a revenue-opportunity for the government. And where there are positive externalities, the ruling political party can get some political mileage out of it.

Such is the interaction across politics and economics that is worth a bit more attention.

Feature or bug

The only time you have to say something is a feature, not a bug, is when it appears to be a flaw. The notion behind this idea is that there was an intention. That aspect of a software, or product design, or service experience was not supposed to be a flaw but an intentional part of the design. It assumes there was an intention, some objective being served.

The reason people might think it was a bug could be because:

  • They had different objectives from that of the way the product designer had imagined the objectives of their users to be
  • They were not the target audience of the product/service
  • They were forcefully making a product fit their needs
  • They did not know how to use the product – which could reflect badly on the UI design or the UI of whatever instructions needed
  • The product had a poor product-market fit
  • The product designers were giving excuses for themselves

There isn’t supposed to be a debate whether something is a feature or a bug. It should always be resolved by the one who had designed the product/service. If it was a result of something being overlooked, it is a bug, and pointing out that it could be a feature is just an excuse.

Significance of work

What does a job mean for you? What is work to you?

It used to be just tasks or collection of tasks that had to be done. The tasks were easily connected to the end goals.

Then things got complex and the tasks were clear but it felt more distant from the ultimate outcomes that the whole lot of people were trying to achieve.

Finally we did away with task-based identification of the work and changed parts of the work to be based on creating some kind of outcomes. In trying to connect the outcomes to the person, we lost the clarity on the specific tasks required. That can lead to undisciplined exhaustion of energies and burn out.

On the other hand, for all the jobs where tasks can be clearly specified, technology has been used to displace human workers. Leaving humans to only supervise or check through the results. In fact, at some point even the quality checks can be automated.

Where does that leave us? What does that mean about the future of work?

The future of work can be meaningful if we resume our human role of caring for who the outcome of work is for, and the manner in which the work is done. We carve out that higher role for ourselves by being capable of continuous improvement that focuses on the final objective of the work itself – the satisfaction of the user.

Promoting into oblivion

One of the big struggles of corporate is that when you have clearly defined roles where there are job titles, managers, and the ‘managed’, there is this false sense that you get promoted because you’ve proven yourself. Now, you start being required to work with entirely new skills, and you no longer have to use that much of what you were good at.

The tricky bit often in management is that the corporates are not sufficiently focused on training and bringing you up to the level required because mass training is easier to justify than just training a handful of people. Moreover, in many organisations, being in management has a lot more to do with handling internal politics and jostling for resources than to do with getting the real work done. Politics is of course important because that enables the delivery team to be able to deliver but if you just got promoted from being the best performer in the delivery team, you’re almost completely oblivious to what this new management role really is about! Not to mention growing the skills overnight to be able to do the new job well.

Some organisations, like the military that operate based on the old British aristocratic style tries to overcome this problem by having two classes within the service. The commissioned officer and the non-comissioned officer tracks are ways in which you focus one group on the ‘leadership’ (really, it is more management) skills. In contrast, the other group are more focused on ‘operations’ (or what is deemed more as ‘follower’ type) tasks. Of course, reality is a lot more complex than that but this form of organisation, while crude, aligns expectations and allows the specialists to focus on the frontline nitty gritty and have the ‘leaders’ focus on the big picture elements. Over time, though the commissioned officers have ever been trained in the basics, they lose their ability to really keep up with the changes on the ground to be able to command at high level.

Yet that form of organisation is probably not ideal as it can be a bit elitist and does not incentivise people to perform in ways that allows them to utilise their potential well. It boxes people into neat categories that serves the organisation more than the individual, and at some point, a lot of people would give up on the system as they find themselves uninterested in being thumbed down as second-class citizens, or being forced only to do the big ‘leading’ kind of stuff.

The market presents a new way of organising people, and as our markets develop, I’d expect a lot more small tiny firms to exists and serve large swathe of people when technology enables them to.

Solving the right problems

One of the greatest challenges confronting our modern world is the sense that when there is a solution for something, the idea that we didn’t apply it indicates a lack of responsibility or some kind of mistake on the part of a human. The fact a surgeon could have healed someone but failed to puts the blame on the surgeon even when the chance of success is probabilistic. Of course, some things require a lot of resources to achieve even when they are feasible, so that doesn’t mean that the feasibility of a solution isn’t the only parameter to determine whether it should be applied or not.

Yet somehow at the back of our minds, if we didn’t apply it, that seem to imply we did not try hard enough or do our best. The issue is that with limited resources, you probably can’t ‘do your best’ in everything. There’s only this much you can give. This applies even to the government, whether it is taken from the budget perspective or the use of manpower.

And for a small country with a lean government like Singapore, solving for the ‘which problem’ to tackle is perhaps increasingly important as there will always be some fringe issues that you can deal with to make yourself look as though you’re doing your job when you’re not making any progress. The recent cigar dish case seems like one of those situation where it is probably not significant enough to escalate to higher (or more mature) decision-makers while seeming to have that easy solution of ‘order them to remove it’. We have a limited attention span available for our public servants, especially those handling frontline issues.