fundaes – Page 33 – Pertinent Observations

Studs and Fighters and Form

It’s been a long time since I wrote about the Studs and Fighters framework. I had overdosed on it a few months back, when I’d put some 3 posts in 4 days or something, but that was when I was hajaar enthu about corporate affairs.

It’s been almost two months since I quit my last job, and in this period, among other things I’ve lost all enthu for anything corporate. I don’t find Dilbert funny anymore. I usually just put well left to the office-politics posts that some of my friends on Google Reader share. And since the S&F theory was mainly meant to deal with corporate situations, that too has gone to the backburner.

I was thinking about Mitchell Johnson’s inclusion in the Aussie team in the Third Test. Given how badly he has been bowling all tour, and given that Stuart Clark hasn’t been bowling badly at all, it seems like a surprising selection. But dig deeper, and employ my favourite framework, and you’ll know why he’s still in the team.

It seems like Johnson is a stud bowler (as I’d remarked earlier, Test match bowling in general is stud). And the theory goes that form matters so much less for the stud. This is mainly because studs are significantly more inconsistent than fighters, which makes forecasting one data point based on historical data a nightmare. This also means that the last few data points say much less about a stud’s next data point than they do for a fighter’s case.

All that a stud needs to do to make amends for his hitherto bad form is to come up with one, or maybe a handful of moments of inspiration/insight. And that can happen any time. In fact, theory says that it is more likely to happen when the stud is defocussed on what needs to be done.

So even in the first couple of Tests, you could see Johnson occasionally coming up with the totally awesome delivery, which would produce wickets. Most of the time he was crap, but the occasional moments of brilliance were enough for him to make an impact. So the thinking in persisting with him is that sooner or later, he will produce enough moments of brilliance in a game that no one will look at all the crap he has bowled, and even that the moments of brilliance can push up his confidence which can lead to less crap.

This kind of thinking doesn’t apply to a traditional fighter, who isn’t capable of that “moment of brilliance”. He usually relies on consistency, and accuracy, and process to do what he needs to do. For the fighter, it has to be a steady rise from one “form situation” to another. And so persisting with the fighter doesn’t make sense. So for example, if Mike Hussey continues batting in the same way as he has been this series, there is a case of sending him to domestic cricket.

The problem with a lot of fighters is that they refuse to acknowledge the existence of studs and treat them too as fighters (on the other hand, most studs understand the existence of fighters). And this treatment of studs (assuming they are fighters) can have disastrous effects.

MBA specializations

During some casual conversation earlier this evening, I realized that I get irritated when people talk about ‘MBA finance’ or ‘MBA marketing’. I realized that I feel like not continuing the conversation when someone asks me my MBA specialization. Later I spoke to Baada about this, and he too agreed about the lack of respect for the counterparty when this topic gets mentioned.

I think it has to do with a lot of people assuming that “MBA” is just a set of courses that one does in order to become a manager. Maybe they assume that one can become a manager in a particular domain by reading a set of books. Maybe they think that an MBA is just like any other course where you get “knowledge” rather than change your way of thinking (ok a lot of people say MBA is useless and suchlike but my MBA certainly changed the way I think).

Or maybe it’s just that people find it easier to classify. Sometimes people overdo it, to the point of stereotyping. I’m reminded of my last company which worked on two kinds of products (let’s call them Product A and Product B – details are, er, classified). I started off doing a bit of A and soon I became “Associate for A”. Soon, I started doing some other stuff, which would easily fall under B. Yet, the CEO kept referring to me as “Associate for A”. It was ridiculous, but somehow he couldn’t get this classification out of his head – even when most of my time was spent doing B.

Anyways, point I’m trying to make is that people are used to classifications in education. For example, in engineering you have electrical, mechanical, etc. – all very easy. Similarly in postgrad for medicine – you can easily classify as ‘eye’, ‘bone’, etc. So isn’t it the duty of “management” also to get duly classified? And it did help the classifiers that there were three or four major areas in which most MBAs sought employment, and this made classification convenient.

Most local MBA colleges use this “specialization” funda to optimize on the number of electives that they need to offer. From a couple of interactions with people from local MBA colleges, I found that they had very few electives – the major choice that they had was in specialization. And once you picked your specialization, your set of courses would get more or less frozen which made it easy for the college to organize.

Some local MBA colleges seem to have taken this specialization thing to ridiculous levels. The other day, one of my cousins had come to me for career gyaan and he said “I’m wondering whether to do an MBA in Aviation or an MBA in media”. I completely lost it at that point and blasted him and asked him to work before thinking of an MBA. Hopefully the current bust will take care of such ridiculousness that exists in the colleges.

Even a large number of good colleges had this “specialization” funda. I’m told that IIMC had this funda of “major” where if you took five electives in a particular area, that would go on your degree certi as a “major”. However, I’ve never heard anyone from IIMC (even from those days when this classification existed) describing themselves as a “MBA in XXX”.

Anyway, the next time you ask me what my specialization was during my MBA, you’ll make sure that I lose all respect for you.

The impact of Rs. 2/kg rice

In the supplement of yesterday’s The New Indian Express (one of the six articles is here: http://epaper.expressbuzz.com/NE/NE/2009/07/12/ArticleHtmls/12_07_2009_412_002.shtml?Mode=1), it was argued about how the combination of NREGS and cheap rice (most states provide or promise to provide 25 kg of rice per month per poor family at Rs. 2 per kg) is destroying the rural economy.

One day of work under the NREGS gives a person Rs. 100. Half of that will go into buying rice for his family for the ENTIRE MONTH. Extending this argument, twelve days of work under the NREGS will feed his family for the whole year. Given that the staple is taken care of,, there is little incentive for the villager to work to earn more. And so there is a severe shortage of farm labourers, other rural workers, etc.

When the NREGS came about, some people applauded it saying that it would ensure that minimum wage laws would now be met. Given that people were now assured of a certain sum (say Rs. 100 per day) for doing meaningless stuff like digging and filling holes, they would go to do other harder and more meaningful work only if they were paid more (and you need to take into account that “real work” takes more discipline, hard work, etc. than it takes to wrok for a welfare program – so the NREGS actually pushed up the minimum wage for farm labour to much higher than Rs. 100).

Now, with various states coming up with cheap rice schemes, the whole thing has gone topsy turvy. Given the subsidized rice, it is now possible for the worker to earn enough for his staple food by just doing a few days of work under the NREGS! The only need for him to work elsewhere, and possibly harder, is to pay for his “luxuries” (considering the price of subsidized rice, requirements and NREGS pay, it can be shown that 100 days of NREGS work can pay for all the essentials).

Given that the essentials are taken care of by the combination of NREGS and cheap rice, the only reason that the worker will need to do actual (i.e. non-NREGS) is to help him save, or for “luxuries”. Yes, some workers will have special needs for money at different points of time because of which they will take on the extra work, but if you aggregate the supply of work, you will realize that the ‘hurdle daily rate’ for the worker to accept “real work” becomes really high.

Since the worker doesn’t absolutely need the money, he can now become the price-setter in the job market rather than being a price-taker. So what this effectively does is to push the “minimum non-NREGS wage” really high indeed (I can’t intuitively put a number on it, but it could be as much as Rs. 200). My bet is that a lot of rural-economy-produced goods will turn out to be really expensive next year since a lot of producers might choose not to produce them given the high cost of labour.

Quite a few commentators have said that the NREGS is a noble scheme for empowering the poor, and given that most of the ‘work’ done is meaningless, it can be replaced by simple cash transfers. The problem is that if that is combined with yet another welfare measure such as cheap rice, it can create severe distortions in the market.

The moral of the story is that if you want to help the poor, please go ahead and do so. What you shouldn’t do is to help them twice over – that can result in severe market distortions like the one that the express article talks about. What is needed is greater coordination between the centre and the states in the welfare measures.

Arranged Scissors (11) in Japan

Read this article about the formalized Konkatsu process that has become a big hit in japan:

This year Japan has gone konkatsu-crazy, with the trend spawning countless magazine articles, a weekly TV drama and a best-selling book.

A Tokyo shrine now offers konkatsu prayer services, a Hokkaido baseball team has set up special seats for those looking for mates, and a Tokyo ward office arranges dating excursions to restaurants and aquariums.

A lingerie maker has even come up with a konkatsu bra with a ticking clock that can be stopped by inserting an engagement ring.

Japan – known for its strong work ethic that can squeeze social time, and for its declining birth rates – seems to be getting its mojo back.

Japan, like India, has had a “tradition” of arranged marriage. But in the last couple of generations, people have discovered louvvu, and because of the large number of louvvu marriaged, the arranged tradition seems to be getting lost. So the “elders”, matchmaking sites, the Japanese government, etc. have come up with this wonderful matchmaking concept.

Recently a friend of mine who is in the market told me that she planned to attend one such event in India. It was being arranged by some caste association, and one had to apply with triplicate copies of CV and passport size photos. A week before the event, one would get to inspect CVs from the opposite sex (no – this was before the court struck down 377) and make a tentative shortlist, and during the event there would be some sort of a speed-dating kind of mechanism.

Again a wonderful concept, and it is good to know these things have come to India also. But my friend wasn’t too impressed. The problem with the event, she said, was that it had been monopolized by parents of bride-seekers and groom-seekers who had come there representing their children. And because of this, potential brides and grooms had effectively been crowded out of this event, rendering it mostly useless.

That is the major problem with the marriage process in India. Parents assume they know too well about their kids, and appoint themselves as the bankers. I remember that after my latest case arenotted, my mom’s primary crib was that I had not appointed her as my lead banker for the deal. She was almost of the opinion that if she had been the banker, the case wouldn’t have arenotted.

It is a similar plague that has plagued the online matrimonial sites (links in the ad bar on the left) – too many of the users on these sites are people hunting for sons-in-law and daughters-in-law rather than those hunting for husbands or wives. Soon we may have the case of parents escorting their single twentysomething kids to bars in order to help them “pick up” people.

(konkatsu article via marginal revolution)

Discrete and continuous jobs

Earlier today, while contributing to a spectacular discussion about ambition on a mailing list that I’m part of, I realized that my CV basically translates to spectacular performance in entrance exams and certain other competitive exams, and not much otherwise. This made me think of the concept of a “discrete job” – where you are evaluated based on work that you do at certain discrete points in time, as opposed to a continuous job where you are evaluated based on all the work that you do all the time.

A good example of a discrete job is that of a sportsman. Yes, a sportsman needs to work hard all the time and train well and all that, but the point is that his performance is essentially evaluated based on his performance on the day of the game. His performance on these “big days” matter significantly more than his performance on non-match days. So you can have people like Ledley King who are unable to train (because of weak knees) but are still highly valued because they can play a damn good game when it matters.

In fact any performing artist does a “discrete” job. If you are an actor, you need to do well on the day of your play, and off-days during non-performing days can be easily forgiven. Similarly for a musician and so forth.

Now the advantage of a “discrete” job is that you can conserve your energies for the big occasion. You can afford the occasional slip-up during non-performing days but as long as you do a good job on the performing days you are fine. On the other hand, if you are in a continuous job, off-days cost so much more, and you will need to divide your energies across each day.

If you are of the types that builds up a frenzy and thulps for short period of time and then goes back to “sleep” (I think I fall under this category), doing a continuous job is extremely difficult. The only way that it can be managed is through aggregation – never giving close deadlines so that you can compensate for the off-day by having a high-work day somewhere close to it. But not every job allows you the luxury of aggregation, so problem are there.

Now, my challenge is to find a discrete job in the kind of stuff that I want to do (broadly quant analysis). And maybe give that a shot. So far I’ve been mostly involved in continuous jobs, and am clearly not doing very well in that. And given my track record in important examinaitons, it is likely I’ll do better in a discrete job. Now to find one of those..

The Eighty-Twenty Rule

I first got this idea during some assignment submission at IIT. One guy in our class, known to be a perfectionist is supposed to have put in 250 hours of effort into a certain course project. He is known to have got 20 out of 20 in this project. I put in about 25 hours of effort into the same project and got 17. Reasonable value for effort, I thought. And that was when I realized the law of diminishing returns to effort. And that was the philosophy I carried along for the rest of my academic life (the following four years).

The problem with working life as opposed to academic life is that the eighty-twenty formula doesn’t work. The biggest problem here is that you are working for someone else, while you were essentially working for yourself while you wree a student. Eighty was acceptable back then, it is not acceptable now. Even if you are working for yourself, the problem is that the completion-rewards curve is completely diffferent now.

Imagine a curve with the percentage of work done the X axis and the “reward” on the Y axis. In an academic setting, it is usually linear. Doing 80% of the work means that you are likely to get 80%. Fantastic. The problem wiht work is that the straight line gets replaced by a convex curve. So even to get an 80% reward, you will need to maybe do 99% of the work. The curve moves up sharply towards the end so as to give 100% reward for 100% work (note that I’m talking about work done here, not effort. Effort is irrelevant)

Now, why did I cap reward at 100% in the previous paragraph? Why did I assume that there is a “maximum” amount of wokr that can be done? Note that if there is a ceiling to the amount of work to be done, and to the reward, then you are looking at a payoff like a bond – the upside is limited – 100% but the downside is unlimited (yeah I know it’s limited at 0, but it is so far away from 100% that it can be assumed to be infinitely far away). Trying hard, doing your best each time, the best you do is 100%. But slip up a bit, and you will get big deficits. It is like the issuer of the bond defaulting.

Almost thirty years back, Michael Milken noticed this skewed payoff structure for bonds, and this led him to invent “junk bonds”, which are now more politely known as “high yield debt”. Now, these bonds were structured (basically high leverage) such that a reasonably high rate of default was built in. In an ordinary bond the “default expectation” is that the bond won’t default at all. For a high-yield bond, the “default expectation of default” is much higher than 0 – so there is a definite upside if the bond doesn’t default. So that balances the payoffs.

So how does that translate to work situations? You need to basically get yourself a job where there is significant scope for doing “something extra”. So that if you take into account the “something extra”, the “expectation” will be say something like 90% of the work. So by doing only a bit more than your old 80-20 rule from college, you can fulfil expectations. And occasionally even beat them, resulting in a major positive payoff (either in terms of money or reputation or power etc.).

The deal is that when the expectation is lower than 100%, the reward-work curve changes. It remains heavily convex for the duration within the expectation (so if expectation is 90% of work for 80% of profit, the curve will be highly convex in the {(0,90),(0,80)} area). And beyond this, it gets less convex and closer to linearity, and so gives you a bit more freedom.

I’m too lazy to draw the curves so you’ll have to imagine them in your heads. And you can find some info on convex curves here: http://en.wikipedia.org/wiki/Convex_function

Compensation Etc.

For a change I’m keeping up a promise that I’ve made on my blog – I’m actually writing a follow-up post that I’d promised. In the past, I’ve guilty several times of promising to continue something in a follow-up post and then conveniently forgetting about it.

So I had mentioned in my last post that the word “compensation” as used to describe salary is not really misplaced. There has been a lot of debate on this topic. The opponents of the word have said that you aren’t losing an arm or a leg in order to be “compensated”. They say that you are only getting paid for the value you add, and so the use of the word “compensation” is plain wrong. I must admit I haven’t really bothered to read the arguments of the people who support the use of the word.

The basic fact: you work because you need the cash flow to fund the rest of your life.

I know a lot of career-minded folks among you will jump on me for this, but I stand by this. Just get down a little deeper, and ask yourself why you are doing what you are doing. Maybe you don’t get the kind of questions in your head that I normally do, and described in my previous post. Maybe your jobs have put you in the kind of comfort zone where you don’t really need to ask yourself such questions (I was in a similar state not too long back, I must admit). But I encourage you to make that effort and ask yourself this uncomfortable question. And it will be down to the money.

You might say that you are doing some stuff “for the sake of career development”. Rephrase that and you will find that you are doing that in expectation of higher future earnnigs. You might say that you are doing something because you want to “achieve something”. Dig deeper and you may find that you define the fruit of your achievement in monetary terms.

So where does “quality of work”, “impact on society”, “value add”, etc. all fit in? I know that in the not-so-distant past, I’ve also talked a lot about these things. I have rejected a number of potential job offers because I don’t like the “quality of work”. This definitely needs to be incorporated into the model, right?

The next basic fact: work is inherently unpleasant.

I don’t think I’ll spend too much time elaborating this here. Maybe I’ll explain this in the comments if you want. So this is where things like “quality of work”, “value add” etc. all fit in – they make work so much less unpleasant. For example, I enjoy spreadsheet modeling. So if my work involves a lot of spreadsheet modeling, I’ll feel so much less unpleasant doing it. Of course, what I am doing remains “work” and it has to be done, in a certain way by a certain day, and so it remains unpleasant. But the fact that I enjoy the core activity makes it less unpleasant.

Similarly, if you think that the work that you are doing gives you a sense of achievement, then it is as if you are doing a part of the work for yourself, and not for someone else, and thus need to be compensated less. “Compensated less”. So this is where it fits in. You get “compensated” because work is inherently unpleasant. You need some incentive to do the stuff that is inherently unpleasant. So you get compensated.

You may have to live in a city that is not your preferred choice – you need to get compensated for that. You may face an extremely long commute where you waste your time – you need to get compensated for that. You might have to work long hours which can intrude on your personal time – you need to get compensated for that. You may have to deal with lousy colleagues or customers, you need to get compensated for that. The list goes on. And if you think about it, a large part of the money that you get out of your work is just that – compensation. Compensation for your time, your effort, your mindspace, your willpower, etc.

So why work at all, you might ask. Go to basic fact one. You work because you need the money. You are in a certain job because you believe that after compensating for all your “sacrifices” for the job, it will leave you with some more money to fund your life. If you think that the money your job leaves you if you take out the “compensation” part of it is lower than what you need to sustain life, you need to question why you are doing that job.

Investment bankers (the inside the wall type) usually end up spending a lot of their time at work, and despite the reasonable bonuses they get, they might feel they are not being compensated enough. They are doing it because they expect that when they ultimately get promoted they will make enough and more to cover for all this unpleasantness. It is basically an “investment”. If, however, you think you are in a job where you are inadequately compensated but don’t see any hopes of significantly higher compensation in the future, you are cheating yourself by not looking for another job.

This also explains why it is a bad thing to compare your salary with your peers and your old classmates and then feel good or bad about it. No two people have the same needs. No two people find the same things unpleasant to the same degree. No two people make the same trade-offs. Comparing your salary with you peer gives little information.

On a closing note (I know it’s already monstrously long) I find the phrase “work-life balance” amusing. I think it is a construct brought about by the pigs so as to con the sheep into workign harder for them. There is no “balance” between life and work. Life is the master and work is the slave.

The Gladwell article on underdogs

Malcolm Gladwell (author of The Tipping Point, Blink, Outliers, etc) is back to doing what I think he is best at – writing long essays (as opposed to writing books which I think are over-stretched long essays). So he is back with his Annals of Innovation column in the New Yorker trying to explain what underdogs need to do in order to succeed.

I hope I have read this right, but my takeaway from this is that your style of play should be dependent on the situtation, your own abilities and the environment, and you should think twice before taking the standard template path. Too many conventions get established. Some of them get written down as processes. Some conventions are even converted into rules – obviously by those who follow the convention. And you have too many people who don’t really think and simply try to follow the convention without thinking whether it is the right thing to do for the occasion.

Conventions are good in the sense that they give you a good starting point. They give you a good initial solution upon which you need to build your own incremental algorithm to come up with the most optimal solution. It is also likely that in a large proportion of situations, doing things conventionally is going to work – that is the reason why they became conventions in the first place. However, deifying conventions and not even thinking of breaking them is too much of a stretch and can lead to disaster.

After I had read the article and tweeted it, one of the first questions I got was with regards to where it fits in with respect to the studs and fighters theory. The ambiguity is caused tue to the primary narrative that Gladwell uses in order to illustrate his point – about a girls’ basketball teams which uses an uncommon technique called the full-press in order to beat their more conventional opponents. While talking about this Gladwell stresses that effort and general ability can compensate for lack of skills (he was talking about running speed, drills, etc.) . Which makes it appear as if he is clamouring for fighterization.

On the other hand, the fighter is the one who follows the convention. One who doesn’t question orders, who just executes what he is told. One who starts running at the sound of the gunshot without thinking about which way to run. One whose skills are geared towards doing the stuff in the conventional manner. And doing things in a different way, doing unusual things, thinking about what to do, questioning, coming up with alternate solutions are all stud characteristics. Which means Gladwell is asking the underdog to be Stud.

So whether Gladwell is asking the underdogs to be Stud or Fighter depends on how you interpret his message. If you interpret it in the way that I did – that you need to think about your abilities, situation and environment before deciding how to do the stuff, then it is stud. If, however, you interpret it in the sense that effort and strength can compensate for skill, then it is fighter.

Maybe you should read the article and decide for yourself, and inform me. It is a pretty good article, and has a good narrative that makes it a racy read. The problem is that Gladwell (as is his usual style) overstretches the narrative and seems to read too much into it. Just keep that filter in mind and you should enjoy the article.

Preliminary reading on studs and fighters theory:

Studs and Fighters

Extending the studs and fighters theory

Arranged Scissors 10 – Modern Channels Protocol

So nowadays the process for arranged scissors has slightly changed, mainly due to the introduction of “modern” communication channels such as the internet and the phone. In earlier days, it was simple – the only way you could check out the counterparty was by way of meeting, and there was a protocol for that. There was a protocol about the kind of questions that one could ask, the standard templated answers to give, the answers you weren’t supposed to give, questions you weren’t supposed to ask, etc. And based on canned questions and canned answers, people would make the most important decisions in life.

Now you have the phone. And the internet. So you have people saying “my son wants to talk to your daughter on chat (sic) before meeting up. Hopefully you are liberal enough to allow that”. The typical answer to this is “what to do? youngsters nowadays are like this, so we have to allow this”. And the boy and girl talk “on chat”. And hope to be better informed than their counterparts 10 years back regarding the most important decision of their lives.

Now, from my very limited personal experience, it seems like some sort of protocol is being established in this “modern channel” also. Neha Vish had a nice article about this a while back on her blog, but I’m not able to find it – about a Sastri who sits behind a girl while she chats up a prospective NRI boy on Yahoo! Messenger, and gives her expert instructions. It seems like the generalized Sastri’s advise has now become part of common knowledge, and has become part of the “protocol” for “modern channels”.

The chat protocol is heavily derived from the single-meeting protocol that I had mentioned earlier. There are canned questions, and canned answers. It is in fact easier to give canned answers here since you don’t need to look into the counterparty’s eyes (though I don’t know how many “couples” actually put eye contact before making the most important decision of their lives). Heck – you can copy paste – or even have a friend chatting for you.

The essence of this protocol, as I see it, is what I call as the “direct approach”. You know that you are checking out the counterparty only for purposes of possible long-term relationship, and not to be friends, so you get straight to the point. One popular quesion seems to be “what kind of girl are you looking for?”. And then they ask about habbits and hobbits and rabbits and rapids, and about hobbies and jobs and career plans and settlement plans and so on.

By becoming part of the standard arranged marriage protocol, what has happened is that “modern channels” have also gotten demodernized, with standard templates coming into the picture. It seems like more innovation is needed if standard good old courting is to be brought back into the arranged scissors scene.

For the record, I’ve partially withdrawn from the market. I have delisted myself from the one exchange where I’d been listed. OTC search is still on but not in full josh. I like things this way, with the only downside being that I’m not getting enough material to fund this series

Update

Here is the link to Neha’s article on Boothalingam Sastrigal – the one that I had mentioned in the blog but was too lazy to dig up the link for.

http://www.withinandwithout.com/2007/09/fiction-fragment-sastrigal-and-engineers/

Tranche of wallet

One of the buzzwords in marketing in the last few years has been “share of wallet”. “We don’t aim for market share in any particular segment”, they say. “What we are aiming for is a larger portion of the customer’s share of wallet”. Basically what marketers try to do is to design their products such that a larger portion of customers’ spending comes to them rather than go to competitors (again – they claim they have no direct competitors and everyone else who competes for the customer’s spending is a competitor).

So far so good. But the problem with looking at things from a “share of wallet” pespective is that it assumes that the wallet is homogeneous. That each part of the wallet is similar to the other, and spending for different items comes uniformly from all parts of the wallet. This isn’t usually very well recognized, but what matters more than “share of wallet” (of course that matters) is the “tranche of wallet” that this particular product sits in.

I don’t think I need to give a rigorous proof for this – but some spending is more equal than others. For example, if you are dirt poor and have only ten rupees left in your pocket, you would rather buy a loaf of bread than buy a tube of lipstick. Some goods are more important than the others. “Necessities” they call them. The rest become “luxuries”. Even the “luxuries” are not homogeneous – there are various tranches in that.

So the aim for the product manager should be to get into the deeper tranches of the customer’s wallet (assuming that the top tranche is the “equity tranche” – the one that takes the first hit when spending has to be cut). Targeting the top tranche may be a good business in good times, but when things go even slightly bad, spending on this product is likely to take a hit and thus the “share of wallet” falls dramatically. Getting into a deeper tranche means more insurance, so to say.

In the world of CDOs (from where I borrow this tranche, equity, etc. terminology), people who take on the equity tranche and other more risky tranches do so only in exchange for a premium – basically that you need to be paid a premium amount (compared to lower tranches) during good times so that it compensates for lack of income in the bad times. So this means that if you are trying to target the most disposable part of the wallet (i.e. the part of wallet that takes the first hit when spending has to be cut), you better be a premium player and make enough money during good times.

So the basic insight is that. The more disposable spending on your product is for your customer, the more the premium that you have to charge. Some products such as high end fashion accessories seem to have got it right. Extremely disposable spending, which leads to volatility of income; balanced by extremely high margins which make good money in good times.

Certain other products, however, don’t seem to have got it right. One example that comes to mind is Indian IT. Some of the offerings of Indian IT companies come near the disposable end of their customers’ wallets. However, to compensate for this, they don’t seem to charge enough of a premium. So they make “normal” profits during good times, and sub-normal profits during bad times – leading to an average of sub-par performance.

So before you enter a business, see which part of your customer’s wallet you are targeting. See if the returns that you will get out of this business in good times will be enough to tide you over during bad times. And only then invest. Of course, before the 2007-present downturn happened, people had no idea what bad times were, and thus entered into risky businesses without enough of a risk premium.