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The coming winter: A survival guide for firms

Deep Kalra, the founder of MakeMyTrip, has demonstrated time and again what it takes to weather a storm. The company has navigated every single crisis that came its way since 2000.  (Mint)Premium
Deep Kalra, the founder of MakeMyTrip, has demonstrated time and again what it takes to weather a storm. The company has navigated every single crisis that came its way since 2000.  (Mint)

  • Every crisis triggers opportunities and a series of innovations
  • The true test of batting skills is on a bad wicket. The SHEs—sustainable and honest enterprises—are the ones that have a higher probability of bouncing back from a crisis.

BENGALURU : In October 1973, on Yom Kippur, the holiest day for the Jews, the combined forces of Egypt and Syria launched a surprise attack on Israel to recover Sinai Peninsula and the Golan Heights, territories Israel had occupied. After initial losses, Israel struck back hard and their armies soon reached the gates of Cairo and Damascus. Israel’s victory came with heavy casualties on all the sides.

Those were the days of the Cold War. The two superpowers of the time–the US and the USSR–took sides and provided moral, monetary and military support to their protégées. The Arab world was in a quandary. For a short while, it appeared that the military might of Israel, with US backing, may prevail in the region and the neighbouring Arab states had no option but to accept it.

Soon, they realized that there was one way to punish Israel and its allies. Five major countries of OPEC (the Organization of the Petroleum Exporting Countries) decided to cut oil production by 25%. They imposed an embargo on oil exports to the US, the UK, and a host of other countries that had sided with Israel. Oil prices shot up by more than 400% in under four months.

This was the first time the oil producing nations were able to act in a concerted manner. This was also the first real oil shock that the world had seen. Between World War II and 1973, the world had shifted away from coal to oil as the primary source of energy. Hence, the oil crisis turned the world upside down. Countries, dependent on oil imports, were caught in the throes of a balance of payments crisis. Cost structures of industries, which were dependent on energy, went awry. This sent stock markets across the globe into a tailspin.

Every crisis brings opportunities—and innovations.

The 1973 oil crisis triggered a series of innovations and energy conservation initiatives. For the first time, it also created a deep awareness of the limited nature of resources and energy. The US introduced daylight savings measures to cut down consumption of energy for lighting along with a new speed limit of 55 miles per hour that optimized fuel consumption by vehicles on the highways.

Exploration of alternative and renewable sources of energy received a big boost. Denmark led the effort in wind power and, by 2015, wind energy contributed to 42% of the total energy consumption in Denmark. France was reliant entirely on imported oil. In response to the crisis, the then French Prime Minister, Pierre Messmer, announced what came to be known as the ‘Messmer Plan’—a nuclear power programme aimed at generating all of France’s electricity. Nuclear power allowed France to compensate for its lack of indigenous energy resources by applying its strengths in heavy engineering. Today, nuclear power accounts for 75% of the total energy consumption in France.

The oil crisis also led to an upheaval in the auto industry. The Japanese car industry had been devastated in World War II and the US auto industry had galloped ahead. However, the oil crisis provided an opportunity for the Japanese to close the gap. It led the way in the development of fuel-efficient engines and compact vehicles. Turbo charging, hybrids, electric vehicles, light-weight materials were all innovations that optimized fuel consumption in cars. Although American auto companies introduced compact cars, they took a while to understand the long-term implications of the oil shock and the change in customer preferences. In less than two years—by 1975—Japan had become the world’s No. 1 exporter of cars.

According to the World Bank, 18% of the world’s energy consumption in 2015 came from renewable sources, which is some progress considering that in 1973 that number was close to zero.

Now, for the second time in 50 years, there is a realization that the world is unlikely to run out of fossil fuels. The current oil crisis is likely to further accelerate exploration of alternate energy sources and probably render oil irrelevant before we run out of it.

Metcalfe’s law & bubbles

The current crisis, which has bankrupted smaller nations like Sri Lanka, is a result of several things going wrong, all at the same time. It is estimated that covid-19 created an economic shock that is anywhere between two to three times worse than that created by the 2008 financial crisis. Central banks across the world, and the US Fed in particular, overcompensated by printing and pushing into circulation unimaginable amounts of money. The bubble which it produced was punctured when inflation put a stop to this mindless money creation. The timing couldn’t have been worse. The war in Europe had just erupted.

Quite astonishingly, an obscure law in network engineering, namely ‘Metcalfe’s law’, created the frenzy that triggered two tech bubbles: today’s bubble and the one that culminated in the dotcom bust. Metcalfe’s law was initially formulated to describe the effectiveness of Ethernet connections. In very simple terms, Metcalfe’s law merely says that the effectiveness of a network is proportional to the square of the number of devices. With the spread of the internet, this law was extended to measure the effectiveness of social networks.

Even Robert Metcalfe, one of the pioneers of the internet who shaped the law, would never have imagined in his wildest dreams that the idea he gave birth to—‘the Network Effect’—would drive waves of irrational exuberance in the investing world.

When you have a hammer in hand, everything looks like a nail. With Metcalfe’s law in their intellectual arsenal, venture capital firms and hedge funds hallucinated network effects where none existed.

Most dot-com companies, and the companies that rapidly took shape in the bubble preceding this crash, operated on the premise that if you could unleash the network effect through advertising, discounts, and early adoption, you could create a ‘winner take all’ outcome.

The idea of the network effect would by itself never have induced the mad rush for growth and the neglect of profitability, if not for two powerful individuals—Alan Greenspan and Jerome Powell. Both chose to conveniently believe that supply chains are infinitely elastic, and easy money is an unqualified enabler of economic growth. They were blind both to common sense and the lessons of history. Greenspan had to subsequently confess before a congressional committee that he should have paid more attention to the housing bubble that built up under his watch. Greenspan, who had enjoyed the status of a demigod, quickly vanished into obscurity after 2008.

SHE principles

An important trait of resilient individuals, and companies, is that they don’t take success too seriously. Taking success too seriously leads you to believe that it is you, and not the circumstances, that has had a predominant role in the success. As a result, you tend to mechanically repeat behaviours that produced success even when the circumstances have changed completely.

Another important trait they demonstrate is in being grounded and having enough faith in their core ideas to swim against the tide. I call this ‘strategic clarity’. Hence, they are constantly questioning any trend that cannot be explained by common sense or first principles thinking, and don’t blindly hop on to any ‘bandwagon’. R. Gopalakrishnan, an ex-director of Tata Sons, has an interesting term for such a company—‘SHE’ – Sustainable and Honest Enterprise. These are the kind of companies that have a higher probability of bouncing back. The true test of batting skills is on a bad wicket.

In 1999, when K.Vaitheeswaran along with V.S.Sudhakar and the others started Fabmart, India’s first ecommerce company, little did they know how ill-timed their venture was. Besides being ahead of their time, the dotcom bust killed any aspirations they may have had for scaling Fabmart. But they quietly shifted focus and energy towards building out Fabmall, the physical retail chain that subsequently merged with Trinethra. The combined entity was eventually acquired by the Aditya Birla group and rebranded as ‘More’. Vaitheeswaran continued to run Fabmart, under the name Indiaplaza.com, and V.S.Sudhakar and the rest went on to pursue other things.

Almost a decade down the road, conditions were once again conducive for V.S.Sudhakar and team to pursue their dream of building an online grocery company. He co-founded BigBasket. The company has been a perfect example of Gopal’s SHE.

In 2016, India experienced its own version of the dotcom bust, and in the shakeout that followed, several online commerce companies that had scaled without paying attention to the SHE principles had to shut shop. BigBasket sailed through this downturn. The company’s reluctance to be pushed into doing anything unsustainable ensured that it was never the darling of a certain category of investors. And that was a good thing. Its valuation has grown at a steady and modest pace that reflected the intrinsic value of the underlying business.

The equivalent of the Hippocratic Oath for public companies is to assiduously protect the interests of the minority and retail shareholders. Companies whose valuations see a steep decline after an initial public offering (IPO) are mostly the ones with questionable business models and insufficient commitment to protecting the interests of the less informed retail investor. BigBasket, on the other hand, is the kind of company whose public valuation, the day it chooses to go public, is likely to be in line with its private valuation.

Success in a crisis

Another example of a company that successfully navigated every single crisis that came its way is MakeMyTrip (MMT). Deep Kalra, the company’s founder, has demonstrated time and again what it takes to weather a storm.

MMT started in 2000. Soon after, travel was hit big time because of 9/11. The terror attacks against the US followed on the heels of the dotcom bust. There was no way MMT could raise money under these conditions. Deep Kalra chose not to take a salary for more than a year and some of his senior colleagues took non-trivial pay cuts. He made some of them co-founders. They cut costs on every front including office rentals. Slowly, things changed, and they found some believers who were ready to invest. Today, MMT is light years ahead of the number two online travel company.

India’s IT services companies like Infosys and Wipro were also hit by the dotcom bust, and their share prices fell anywhere from 70% to 85%. However, all these companies had a high gross margin that allowed them a lot of leeway. The nature of their business was also such that the crisis wasn’t life threatening; and while what they went through was crushing, the degree of difficulty was not comparable to what MMT had to go through.

One example of resilience often cited is that of Amazon. Amazon listed in 1997 at $18 and rapidly rose to $100 before dropping to under $10. Mark Johnson wrote in Businessweek: “Amazon survived the dot-com bust because it had a viable and innovative business model built around a market-changing customer value proposition and a radical profit formula."

Tim Berners-Lee, who invented the World Wide Web, has an entirely different explanation. He believes that Amazon almost didn’t make it, and just got plain lucky by raising a whole lot of money a month before the market crashed, giving the company the cushion it needed to ride out the turmoil of the early 2000s. But for this, Amazon would probably have been in the company of Webvan (grocery business that filed for bankruptcy in 2001) and pets.com (liquidated in November 2000), and someone would have probably come up with a well-constructed argument on why Amazon had done all the wrong things that led to its shut down. These divergent views illustrate that attributing a cause to an outcome in complex situations is simplistic and fraught with error.

Not to be uncharitable, it is more likely that a lot of Amazon’s subsequent success had to do with its customer centric approach and an ability to mimic the operating style of a startup. It allowed the company to innovate and yet have the stability and governance mechanisms of a large company.

Every fresh cycle of entrepreneurship in India has produced entrepreneurs who are younger and smarter. They will learn their lessons quickly. Some will perish, but that’s not a reason to deride the ambition that motivated them, but an occasion to celebrate the ones that weathered the storm and emerged stronger and wiser.

(TN Hari is the author of Pony to Unicorn and an advisor at The Fundamentum Partnership.)

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