But like trigonometry (for non-science students that is) and other lessons, we tend to forget this as soon as we leave school. The top management in some of the largest corporations the world over or have their names severely maligned for forgetting this idiom. The fortunate few with contacts in high places are still out there, making more money… so when we hear of a large company getting even larger, should we rejoice or step back and see what the company has been doing to grow – the right thing or the thing that makes more money.
Classic example - Citigroup – Market Capitalization of 300 billion US dollars in 2006, that's more than the GDP of Pakistan and Sri Lanka combined! (for 2012 Source: http://en.wikipedia.org/wiki/List_of_countries_by_GDP_(nominal))
Circa 2008 the market cap of Citigroup fell to just 6 billion US dollars. Thousands of people were left jobless as the US economy struggled to come to terms with the 2008 crises. The US government had to step in to bail Citigroup out. Corporations like Lehman Brothers went bust…. With them bursting the bubble we realize that there is no such thing as being "too big to fail".
Lessons to learn
Like all living organisms, all firms seem to follow a pattern – Birth, growth, maturity or stagnation and decline or death. Obviously everyone wants that growth phase to continue for as long as possible.
Some firms tend to grow by doing what they are, the right way – not compromising on principles; their aims don't change from being service oriented companies to becoming bigger, for the sake of becoming bigger. Vanguard, the largest Mutual Fund in the US springs to mind here. They've held fast to the principles that John Bogle laid down for them, and least until now, seem to be focusing on their customers rather than their size. For others the aim shifts, from servicing the customer in the best way to merely becoming larger. Their balance sheets, instead of becoming report cards for performance, become the raison d'être. For increasing the size of the balance sheet, corners start getting cut, then chipped off entirely. In most cases they get away paying a penalty, which would be miniscule compared with their ill-gotten gain.
Ethics and transparency tend to be the first sacrifices on the altar of getting a healthier balance sheet no matter what the cost. Many good companies do this, what separates them from the great companies, is that great companies will do it right, the healthier balance sheet is a by-product of doing the right thing, rather than the end in itself.
We need to use the Lehman crisis as an example…. of what to avoid doing. Instead we have scenarios unfolding today that seem to mirror what was happening in the US, almost perfectly. Large organizations becoming larger, the customer left with fewer choices, massive entry barriers being erected to restrict the playing field and creating a monopolistic scenario
Economics 3.0 – the pitfalls of creating Monopolies
According to Wikipedia, here are some of the characteristics (and our interpretation of them) of a Monopolistic scenario:
• Profits Maximized: Maximizes profits, at the cost of the customer.
• Price Maker: Decides the price of the good or product to be sold, but does so by determining the quantity in order to demand the price desired by the firm
• High Barriers: Other sellers are unable to enter the market of the monopoly because of huge entry barriers created by the market player, preventing other entrepreneurs and firms for entering.
Slow Learners?
A similar situation is stirring here in India's financial industry, where big players are growing bigger, causing a monopolistic scenario. The biggest example of this is not a financial conglomerate, or a bank or an NBFC… it's a stock exchange called the NSE or the National Stock Exchange. In 1992, just before the National Stock Exchange (NSE) was recognized as a stock exchange, there were 24 others in business. Two decades down the road, all transactions are carried out exclusively via NSE and the Bombay Stock Exchange (BSE) and to some extent through the MCX Stock Exchange. Activity at most of the other stock exchanges has come to a grinding halt. Recent rules have mandated that for a stock exchange to be recognized as such it has to have a net worth of Rs 100 crore and annual transactions of Rs 1,000 crore. If all business is being routed through the NSE, then how will the smaller exchanges reach these high numbers? The regulator needs to step in here to ensure that a monopoly is not created; we do not want an exchange to start chasing numbers and duping millions of investors to merely grow. The regulators need to ensure that the exchange does not adopt practices that are unfair to customers, merely to see their fees and net worth increase.
The regulators need to step in…. And they are
The financial industry in India has regulators like SEBI, to govern the market; there is also Competition Commission of India (CCI) that plays a very important role and believes that free and fair competition is one of the pillars of an efficient market economy. On 25 May 2014, the CCI had issued a show-cause notice to the NSE, the country's premier bourse, for abusing its dominant position in the equity and equity derivatives market to lock out competition in the currency derivatives market, where it charges no fees. However the penalty order by CCI was stayed by Supreme Court in September 2014.
Unfortunately the mutual fund industry too seems to be heading in this direction. Going back to the characteristics of a monopoly, if any industry has high entry (and exit barriers) then it tends to lead to a monopolistic situation. So any brilliant fund manager or IFA cannot set up their own mutual fund unless they have a net worth of 50 crore maintained at all times, thus an industry which has already seen the exit of a couple of foreign players will continue to consolidate and see more players exiting and the choices that an investor has will shrink. Power and AuM starts getting consolidated towards the top, and who knows, mal practices could start creeping in – a la Citibank and AIG in a bid to grow larger.
The CCI has thus set the tone by sending a notice to the NSE, maybe the powers of the CCI need to be expanded to ensure that no monopolies or monopolistic scenarios get created in any industry, which could, through high prices exploit the common consumer.
It's a simple rule of economics that for an economy to flourish, we need competition. This will help customers with more options to choose from. As companies become more and more competitive, prices could come down, thereby benefitting the customer. The regulators too have to ensure that organizations should grow by doing the right thing and not merely grow for the sake of it, else we could have letters from many more CEO's claiming to have ridden the tiger for too long. Strong regulations, relative ease of entry and exit should be the characteristic of any industry, which will thereby benefit the end customer.
However, not all giant conglomerates see a downfall. Ethics and core values have taken some to great heights of success. The Tata group is one such company that epitomizes that values can go hand in hand with success. The group since year 1868 has only expanded its business in different verticals. This has won it the respected and admiration of its patrons and peers.
Disclaimer, Statutory Details & Risk Factors:
The views expressed here in this article are for general information and reading purpose only and do not constitute any guidelines and recommendations on any course of action to be followed by the reader. The views are not meant to serve as a professional guide / investment advice / intended to be an offer or solicitation for the purchase or sale of any financial product or instrument or mutual fund units for the reader. The article has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Whilst no action has been solicited based upon the information provided herein, due care has been taken to ensure that the facts are accurate and views given are fair and reasonable as on date. Readers of this article should rely on information/data arising out of their own investigations and advised to seek independent professional advice and arrive at an informed decision before making any investments.
Mutual fund investments are subject to market risks read all scheme related documents carefully.
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