Rajendra Srivastava: Given your perspective on the importance of ecosystems and the need to invest in uncertainty, as you look at the Indian economy, what would be your advice to the captains of industry or to government ministries?
William Janeway: It is entirely appropriate for the captains of industry and incumbent leaders of companies in an established position in markets to be nervous. The digital revolutionaries are coming and in many cases, they are already here. They have different cost models and different distribution models. The technical friction with which they deliver services is radically lower than what we are used to. So, there will be disruption.
But it is now becoming apparent globally in the markets of the West and in emerging countries that the context — the social, political, cultural and regulatory context in which the digital players are causing disruption — has evolved over generations. The digital revolutionaries need to learn to take the context seriously. Most of them are only learning this lesson the hard way.
There is an opportunity for a degree of collaboration. It is not a zero-sum game. This is also where public-private collaboration, co-operation and education is needed and can be productive.
I cannot emphasise enough the benefits of learning not just coding but also context
The biggest danger is disruption by what I will call ‘ignorant entrepreneurs’. They can freeze markets and prevent new technologies from providing benefits, particularly in countries where large populations have been effectively excluded from market participation by economics and where there might be opportunities for inclusion. This leads to a backlash.
So, I cannot emphasise enough the benefits of learning not just coding but also context. Whenever the new technologies come in, whether it is the railways or electrification or indeed computers and the internet, they disrupt markets. They generate a lot of costs, but those costs could be ameliorated and offset much more rapidly if both the disruptors and the disrupted understand what is going on and what is at stake.
Perhaps one area for India to re-think is our Aadhaar card implementation. This biometric identification system can have a positive impact on the Public Distribution System (PDS). It can also have a tremendous impact on the private sector, for example, for airport or hospital clearances. Now one of the recent rulings has been that the Aadhaar card should not be used in the private sector.
One of the great challenges of providing access to economic opportunity is establishing identity with creditors. And that means not just banks. It means your local drugstore or supermarket. Having a persistent identity means you are known and do not have to pay cash. It is very interesting that the two countries that are pioneering the digitalisation of identity in very different ways are the two largest, most important emerging economies of the world, India and China.
Much attention is being paid to the social credit system in China and its explicit application across the public-private divide. And this has enormous potential for benevolent and not so benevolent applications. In this case, emerging countries are pioneers. Perhaps it is a place where thoughtful experimentation with a lot of transparency might be appropriate. By this, I mean pilot programmes in different areas, whether it is in finance or the public sector or where there is a crossover, as I expect there will be in healthcare and education.
Historically, we have not done enough of this kind of thoughtful, considered experimentation. Some economists may have gotten carried away with the notion of the randomised control trial, going from the pharmaceutical industry to social programmes. But even if the rigour of the classic pharmaceutical randomised control trial cannot be met in the social context, it is possible nonetheless to run pilot programmes with serious peer-reviewed independent observation and evaluation of those programmes as a guide to policy, before we fall into an all-or-nothing trap.
I think it is useful to have evidence-based policies looking at both costs and benefits. Since I am a marketing researcher, I look at identity also as an element of trust. As a vendor, why would I ship something to you if I do not trust you?
One of the giants of modern finance theory, Nobel Prize winner Robert C Merton, asserted in a lecture that financial innovation was a joint product of technology and trust. I don’t think he would have put it that way before 2008 when so much trust was destroyed by financial institutions. This was the trust of their clients and their regulators. So, I could not agree with you more: not only on the social but also the economic value of trust.
The global financial crisis of 2008 disrupted doctrines that had been taught as disciplines. It opened up the minds of many senior and junior younger academics and scholars to the reckoning that there was a world beyond narrow models
The global financial crisis of 2008 is the gift that keeps on giving to the disciplines of Economics and Finance. What do I mean by that? It disrupted doctrines that had been taught as disciplines. It opened up the minds of many senior and junior younger academics and scholars to the reckoning that there was a world beyond narrow models that rigorously attempt to define a world. The world was much more complicated, nuanced and could explode in destructive ways.
One way of handling risk is through trust.
Some might say that ultimately, it is the only way. We want to think of our world in terms of risk, where risk is a probabilistic function that can be reduced to a mathematical basis for reasoned, logical, definitive answers. But, of course, that sort of risk is the least challenging, the least threatening outcome along a spectrum that runs from risk to uncertainty to ignorance. And when we are making decisions whose value will only be determined by living through the future, where we cannot know in advance the full consequences of our decisions, then we have to depend upon relationships of trust to be able to respond when the unknown, unexpected outcome arises.
There is a great line from The Forsyte Saga by the British novelist John Galsworthy, by one of his central figures, a very senior, prudent, conservative lawyer: in my experience, that which has not been provided for is the most likely to occur.
Within that context, when we are looking at an evolving economy or an evolving market and not a mature one, would it be fair to say that the greatest risk that you take is not taking the risk?
I take that back to the most micro level because, in my own 35 years of experience of working in venture capital, every market that I invested in was an evolving, emerging market by definition. And making investments in start-ups at the technical frontier involves a willingness to accept uncertainty as your stable-mate. This is not quantifiable, manageable, monitorable risk like an insurance company with good actuarial tables. That is a risk which you can manage. But when it comes to radical uncertainty, I learned the hard way that there is a way to hedge against that kind of risk.
In my experience, that which has not been provided for is the most likely to occur.
I identify my way of managing radical uncertainty under the joint heading of “Cash and Control.” These means: when something goes wrong, unequivocal access to enough Cash to buy the time to find out what is happening and enough Control to shift the parameters of the problem.
That is why I was very reluctant to ever invest as a passive partner. I think of it this way — say you are riding an automobile, you are sitting next to the driver and he starts to head over the cliff. Can you get your hands on the steering wheel? If you are in the back seat with two or three rows between you and the steering wheel occupied by earlier investors in a more senior position, you will never get to the steering wheel before you are over the cliff. I think those who have been funding the unicorn digital disruptors are learning a certain amount of that lesson. They have been paying enormous valuations with no access to control of companies whose founders, in some cases, have clearly been heading for the cliff edge.
It is not a question of whether you accept risk. Either you are in the game or you are not. It is how you seek to manage radical uncertainty — and I mean socially, not just financially– that makes the most difference.
So, to me, it is not a question of whether you accept risk. Either you are in the game or you are not. It is how you seek to manage radical uncertainty — and I mean socially, not just financially– that makes the most difference.
That is also where cash on hand comes in. We can look at Asia and particularly East Asia after the Asian crisis of the late 1990s when the International Monetary Fund (IMF) came in and imposed austerity on nations that were already pretty close to the brink. In some cases, that pushed them over. And the response over the next ten years was to build reserves of foreign exchange. That proved to be enormously valuable in 2008 when the global financial crisis happened. In other words, we are talking about self-insurance, whether it is at the nation-state level or the level of the individual capitalist. One prime example was demonstrated by Jamie Dimon, chairman of JP Morgan when he insisted on building what he called a ‘fortress balance sheet’ in the years leading up to 2008. The need for self-insurance is paramount as one gets closer to that frontier where the uncertainty of outcomes is unavoidable.
Cash on hand buys us time. But time can be frittered away and therefore, in the context of uncertainty, agility becomes a problem because you bought that time but frittered it away. In your experience, what has been your experience in the ability of companies to be agile in a rather frenetic environment?
Most of my experience has been in companies that are trying to grow rapidly into rapidly growing markets. And there, agility comes in two different ways. There are two different domains for new companies.
When you are burning cash, agility usually begins by finding a new Chief Executive Officer (CEO), because it means repurposing the venture, the project. It means that you have stumbled in your original vision. Perhaps you have some intellectual property that is worth more to somebody else who already has an established channel to the market. Or maybe there is an adjacent market where you have learned enough to know that it could make sense. Maybe, you have to really shrink and focus on what the customers and the market are telling you is valuable. But it is pretty extreme and pretty radical surgery.
The second scenario is the promised land. Your customers give you more money than it costs to deliver them the goods or service that you are selling. In other words, you have a positive cash flow from operations. I learned a big lesson about positive cash flow from operations from my most important mentor during my early years as a venture capitalist. If your customers actually like what you are doing and are prepared to pay for it enough so that you can pay all your bills, it not only means that what you are doing is economically worthwhile, it has liberated you from dependence on the problematic availability of external capital, whether it is equity or debt, whether it is from the bank or from the market. That means you have options. You can take time to explore the alternatives for growing value if you are operationally stable and do not need the next round of capital to stay in business long enough to make a change.
If your customers actually like what you are doing and are prepared to pay for it enough so that you can pay all your bills, it not only means that what you are doing is economically worthwhile, it has liberated you from dependence on the problematic availability of external capital, whether it is equity or debt, whether it is from the bank or from the market.
This is an area where, I am afraid, a lot of lessons need to be learned both by entrepreneurs and by institutional investors who are investing in private, illiquid ventures but without the control that venture capitalists traditionally seek and obtain.
We need ‘options thinking’. To exercise the options, you need information. But you also need a change of guard because the organisation isn’t ready to execute a new strategy unless it has a new chief.
That is correct. Of course, there are extraordinary founding entrepreneurs who go all the way with the business. Jeff Bezos is a prime example. Bill Gates was a prime example. But we have many examples where the venture needs a different kind of leadership to succeed. And that is one of the pressing challenges of the current investment environment and not just in the United States (US) for these new digital companies with enormous promise. The manner in which the investors have been prepared to almost embed the founder in the control position, no matter how much money is raised, is problematic. This is regardless of whether the company is public and you can sell your shares or whether it is still private and locked in. I think it is very problematic, but I am a venture capitalist so you might expect me to say that.
These new digital companies with enormous promise are worth more than the GDP of most countries, except maybe the top ten or so. Now you are looking at a situation where you have a company that is big and influential– not just in terms of cash, but influential in the connection that they have with customers. How does the state manage? What are the regulatory challenges for the state?
We did evolve competition policy as a responsibility of the state beginning in the late 19th century with the rise of the industrial giants in the oil industry, the steel industry and the railroad industry, not just in the US and Europe. In the case of the English common law, through the ‘restraint of trade’ doctrine, the tradition made it illegal to participate in a conspiracy. But if there was no conspiracy, then it was one company and the common law did not apply.
Similarly, in the US, the anti-trust laws — the Sherman Act and Clayton Act — were developed. This was in response to the extraordinary and unprecedented economic power that translated into both financial wealth and political influence at a scale that had never been seen before. Two Republicans, President Teddy Roosevelt and his successor William Howard Taft, were the ‘trust-busters.’ In the name of creating more competitive markets, they made anti-trust more than just about dealing with the relationship between the giant industrial companies and their customers. They argued for more competition on the supply side and not just the prevention of abuse on the demand side. That was what we thought was the law up through the 1970s.
And then out of the University of Chicago emerged what came to be called ‘Law and Economics,’ a kind of a joint venture between the Law School and the Economics department. This was a new doctrine based on the teachings of mainstream Economics. It asserted that left to themselves and without government interference, markets will deliver the efficient i.e., competitive outcome. Consequently, the only concern of antitrust law should be demonstrable abuse of the consumer by the vendor. It was no concern to the government what the competitive conditions were in the markets in which vendors and suppliers were competing. That remains the doctrine in the US today. And that is why there has been virtually no attempt to limit or restrict the manner in which the digital giants, such as Facebook, Google and Amazon, have been absorbing potential competitors through acquisition.
This may come to be one of the most important aspects of what is now clearly a pretty public backlash against Big Tech. Academics, lawyers, people of standing and respect are all saying that we have to re-think competition policy for the digital age. The European Union (EU) has been a leader here. I think there is a lot of appropriate argument about whether their General Data Protection Regulation is the right approach. There are many people who believe that it is actually going to benefit the big, established digital giants by making it difficult for new emerging companies to meet requirements of privacy. But I think we have just started on that voyage. It took a generation from the 1880s through 1920 for a relevant competition policy to evolve. I don’t see why we should expect it to take less time now.
In the digital world, the ability to monetise the consumer’s data and sell it to advertisers is the source of market dominance. Rethinking policy in that context is hard.
Another aspect is thinking through what competition policy means. The Law and Economics approach would say that if the service is free to the consumer, there cannot be any abuse. This is because abuse means that the price has been raised by a monopolist seller. That is the thinking in a world of physical goods. It does not apply in the digital world, where the ability to monetise the consumer’s data and sell it to advertisers is the source of market dominance. Rethinking policy in that context is hard. A young Indian-American legal Scholar, Lina Kahn, has generated a great deal of attention for her 2017 article in the Yale Law Journal, “Amazon’s Anti-Trust Paradox.”
Let me switch topics and move to the venture capital business. As a venture capital investor looking at the Indian market — and we can be industry agnostic at the moment — there is plenty going on. For example, Amazon versus Flipkart/ Walmart or Uber versus Ola and so on. Looking at investment in India, what are two reasons to get in and two reasons to stay out?
Now I am not speaking for Warburg Pincus, but I can tell you why about 25 years ago, Warburg Pincus as an investment firm decided that we had to participate. The first reason was extraordinary growth that was unavailable in the mature, developed markets of the western world. The second is something that we have learned along the way. Our learning about fast-growing markets is that they are characterised by a remarkable array of diverse niches. There is high diversity even within the same ‘market,’ whether it is a market for healthcare services, the market for education or market for food. There is enormous diversity across this subcontinent along multiple dimensions — economic, cultural, linguistic. And that is a reason for staying because you have so many multiple alternative opportunities for doing something valuable that it proves to be economically worthwhile.
The number one reason for staying out? I do not think this is the case in India, but I participated in a lot of discussion at Warburg Pincus in the 1990s about Russia. The way I put it to my partners was that if we are going to invest in a new geography, we would like to know three things: first, that there are rules of the game; second that we are allowed to find out what the rules are; and third that we can live with those rules when we find out what they are. And we did not invest in Russia in the 1990s.
If we are going to invest in a new geography, we would like to know three things: first, that there are rules of the game; second that we are allowed to find out what the rules are; and third that we can live with those rules when we find out what they are.
And corruption is the other thing. Every member of Warburg Pincus, either partner or non-partner, takes a test every year on the Foreign Corrupt Practices Act. I promise you we take that very seriously. And the US Foreign Corrupt Practices Act reaches back through companies to the directors of those companies and to their personal assets as well. It is a very powerful law.
The same principles hold: growth and potential are the draws, but they also create uncertainty and risk. Thank you very much. This has been a wonderful conversation.
The legendary economist Herman Minsky first called William H Janeway ‘theorist-practitioner’ more than 25 years ago. As a ‘theorist practitioner’, Dr Janeway’s contributions have encompassed the worlds of high finance at Warburg Pincus and economic theory at the University of Cambridge where he continues to be affiliated with the Faculty of Economics. He has been with Warburg Pincus since 1988 and helped build up the portfolio of information technology (IT) sector investments. Dr Janeway’s deep understanding of the history of bubbles helped him predict the internet stock crash of 2000. His book Doing Capitalism in the Innovation Economy: Markets Speculation and the State came out in a revised second edition in May 2018. It received critical acclaim in outlets as the New Yorker and the New York Review of Books. It was named one of the Best Six Economics books of 2012 by the Financial Times Chief Economics Commentator Martin Wolf.
ISB Dean Professor Rajendra Srivastava is one of the world’s leading authorities on Marketing Strategy and Innovation. A highly cited scholar with works published in leading marketing journals and recipient of several awards and honours, Dean Srivastava has also advised and trained senior management at global multinational corporations.