Continuing from the previous week (Just like that)
Have you noticed that whenever you ask your child to break a routine, e.g., wake up early, sleep on time, eat healthy, spend less time on the phone; the default response is mostly “no”! You try to offer incentives or sometimes use threats to elicit compliance, which in most cases is not a durable response.
Try remembering your childhood – didn’t you also behave in the same manner with your parents, as your child is doing with you?
Now recall the response of the government officer, customer care executive, your senior in the office, your housemaid, your car mechanic, et. al. whenever you made a request that was not routine or strictly as per the laid down procedure. Wasn’t the default answer mostly “no”.
In my view, the default “no” is deeply ingrained in our social and cultural consciousness. This could be one of the root causes of several problems afflicting our society. We as a society are not adequately trained to manage exceptions. It is one of the major causes of widespread corruption, avoidable litigation, and mafia.
What a “no” costs
A flat “no” for a small deviation that could have been ignored or corrected leaves you with three choices. You can pay the officer, hire a middleman, or go to court. Say a minor defect in your papers means two more rounds of a government office. Paying Rs 2,000 to get it done today looks cheaper than two lost days, and many of us pay. The work gets done, but the citizen has paid extra in money, effort and time.
The worst damage is slower. You stop trusting the system. Middlemen find a steady business. Bribery starts to look normal, and in the worst cases, the mafia fills the gap.
Why the officer says “no”
Since last week’s post, I have been thinking about why the officer says no so quickly. Part of it is habit. But I think a large part is plain safety. If he says no, nobody can question him. If he says yes to an exception and something goes wrong later, he alone has to answer for it, maybe years later, in an audit or an inquiry.
This is the same thing I wrote about last week: adding a check is safe, and removing one is risky. The officer is not stupid or lazy. He is doing the sensible thing for himself. So, I would not blame culture alone. Culture teaches the habit, and the incentive keeps it going.
Why a simple fix will not do
My answer was simple: review the procedures, build rules for exceptions into them, and train officers to say “this can be done this way” instead of “this cannot be done”. I still believe in it, but there is a catch. If every exception depends on one officer’s judgment, we have only given him more power, and more power at the counter is exactly where bribes come from.
So, exceptions need a written route. A short list of small defects that can be corrected at the counter, such as a missing stamp or a spelling mismatch. A fixed time limit. A record of what was allowed and why. And a senior who must decide within a few days if the officer cannot. With this, the officer is covered when he says yes, and the citizen has a way forward when he hears no.
Teaching children to handle a break from routine is a good idea too. It will take a generation to show results, so it cannot be our only answer, but it costs very little to begin.
What this means for an investor
You can carry the same thought into investing, but I need to be careful here. When you read the management commentary of your companies, you will often find lines like these:
· The execution of the project was delayed because it rained heavily during the monsoon.
· Pollution control measures in Delhi NCR impacted the execution of projects.
· We could not meet margin guidance due to raw material inflation.
· Forex loss affected the reported profit by 10%.
· Shortage of raw material due to the war in the Gulf region impacted production materially.
· Competition from cheap Chinese imports is hurting margins.
When I first read these, I called them excuses. That is too harsh, because some are fair reasons. What matters is which kind of reason it is.
Some of them are predictable. The monsoon comes every year. Pollution curbs in Delhi NCR have been a regular feature of recent winters. Raw material prices go up and down, and currencies move. A company that is caught out by these again and again has not planned well. A forex loss that cuts profit by 10% suggests a large exposure was left open. It may have been a choice, because hedging costs money, but as an investor you should know it was a choice.
Others are not predictable. A war that cuts raw material supply is not something anyone can plan for in detail. Here the test is not whether the shock came, but how the company responded. Did it find another supplier, pass on the cost, or just wait? Competition from cheap Chinese imports is a different matter again. It is not an exception at all. It is a question about the company’s cost position and pricing power, and it depends on your view on the quality of the business.
So, I would not cut a company’s valuation just because its commentary has a reason in it. I would ask a few questions first:
· Does the same reason come up quarter after quarter?
· Did peers face the same problem and do better? If they did, the reason is not the whole story.
· Has management met its own guidance in the past, or does it keep missing?
· Does the company hold buffers, such as cash, hedges or alternative suppliers, for risks it knows will come back?
If the answers are poor, I would want a bigger margin of safety before I buy. I do not have a formula for it, and I would be wary of anyone who says they do.
A good system says “no” when it must, and “yes, if” when it can. I would look for the same habit in a good management. I would also like to hear your own experience of the default “no”, from either side of the counter.