Sunday, February 23, 2014

Products (or services) and Firms: The Five Immutable Laws of Emotive Brand Loyalty

Normally, I do not post immediate sequels to my blog posts. However, the comments of my good friend and respected colleague, Dr Ganesh Nayak on my last week’s blog post, “Products, Brands and the Firm: The Five Immutable Laws of Branding”, Strategy Musings, February 16, 2014 ( have set me thinking on the emotional facets of branding. I believe I should not only clarify certain aspects of the previous blog post but also benefit from Dr Nayak’s thoughts to cover certain additional aspects through this blog post. As readers may recall, the previous blog post postulated that six attributes of a product or service, functionality, reliability, durability, maintainability, affordability and differentiability, result in sustainable branding. Dr Nayak rightly commented that important as these points are, a brand is beyond these points.

Dr Nayak mentions that the many of the six points are tangible which a customer can experience in many “me too” products as well. He points out that a premium sedan such as Nissan Teana may have all the six features to a rational mind but the said car as a brand may not be as powerful as BMW or Mercedes is. He follows up that a brand is more of emotions, as a result of which the customer does not think of critically evaluating the above six points in respect of a product under the brand; the customer takes the presence of the factors granted. He refers to Mont Blanc pen not necessarily scoring high on all the six factors but customers willing to spend a fortune to acquire one. Acknowledging the meaningful insights that Dr Ganesh Nayak brings but also reviewing Dr Nayak’s points objectively, it is clear to me that Dr Nayak’s insights point to the need to supplement my previous blog post by developing  appropriate constructs for the emotive aspects of branding.
Emotions and loyalty
Emotions are strong feelings, and are characterized by positive ones such as respect, love and attachment, and negative ones such as anger, fear and hatred. Emotions are considered to be independent of rational thought. An emotive act or product causes people to feel strong emotions. A strong brand, without doubt, is based on, and is capable of, evoking strong emotions. When Nokia decided to sell its Lumia smart phone business several people responded more emotionally than analytically; the emotions were feelings of sadness that it marked the end of a historic Finnish brand, rather than feelings of optimism that a new owner with deep pockets and an emerging mobile operating system would infuse new life. The latter was probably based on negative emotions that Microsoft could not yet make a success of computing devices and, in addition, a concern that Microsoft Windows would never be an OS platform that can revive and ramp up Lumia. Clearly, future is somewhat imperfectly but popularly prejudged on the basis of emotions rather than rational thought.
At the same time, in spite of Nokia trailing other firms and brands in product features and customer acceptance, millions of Nokia handsets continue to be sold globally, the reason being brand loyalty. Loyalty, as we know, is the quality of being faithful in support of someone or something. Like emotions, loyalty is also not necessarily based on rational thought but at the same time has necessarily a history of the customer benefitting from the product or service in terms of the six factors in the past. Emotions and loyalty reinforce or erode each other contextually. The objective of all marketing generally, and advertising specifically, is to cause positive emotions and build brand loyalty. That said, it is to be realized that both emotions and loyalty cannot materialize in thin air, and on the other hand require a record of past performance based on the postulated six factors. This blog post postulates five immutable laws of emotive brand loyalty to deepen the understanding of these processes.
The first law: An emotive brand is “product plus trust”
Certain products and firms evoke trust; a belief and an assurance that they reflect quality, dependability, goodness, service and ethics. The trust typically develops from a firm and its products consistently scoring well on the six attributes. Over time, successful firms and products get branded positively, or negatively, predominantly on a singular dimension. For example, certain firms and groups get known for ethical conduct. Certain others get known for consistently high quality of its products. Certain service providers get known for their timeliness while some others get negatively branded for their erratic schedules. Consistent delivery on product attributes leads to brand equity and sustained brand equity leads to brand loyalty. The leading and lagging brands of the world have their instructive lessons on compliance to this law. 
The second law: Branding is "banking of emotions"
A firm has to provide products of quality to be a player of any standing in an industry. Yet, some firms and their products gain a higher level of customer trust within an industry. This may be considered firm level aggregate branding. Once a firm achieves collective superiority in all of its products, occasional or isolated setbacks are taken in stride. For example, Toyota, the world’s leading manufacturer of automobiles had, two years ago, a series of product recalls in one of the most stringent markets of the world. Yet, the company could tide over the crisis rather comfortably, and even achieve higher sales in the year after. Apart from an unassailable reputation of quality, a humbled and focused response to addressing the quality concerns protected the Toyota brand. Branding is like a savings bank of emotions for the firm. The larger the account, the more secure is its future.
The third law: Firm branding is portable, product brand extendable
Firms which are fortunate to develop brands tend to be anxious to leverage the success of brands to drive success of new products. While doing so, firms tend to fritter away the opportunity by an inadequate appreciation of scope and limits for brand reformatting. As a principle, product branding can be extended in a product family but not portable across products. Any attempted portability across product lines could be suboptimal compared to develop distinctive line-specific brands. For example, Samsung could extend its Galaxy brand to all its smart phones but its porting to a camera lineup was not as successful. On the other hand, a firm which has high firm level brand equity can port its equity into new product lines. Conglomerates and firms with high brand equity are well positioned to achieve this. New firms of Tata and Reliance groups as well as new product lines of electronic giants are indicative of this.      
The fourth law: Low cost is never a high price for branding
Theories of marketing teach us that features with underlay of technology and overlay of luxury come with a price. Premium products demand higher price. That said, price competitiveness of a product, the other five attributes remaining the same, buys brand loyalty. A customer who prefers a Mercedes SUV to a Toyota Innova (also an SUV) typically has such preferences based more on the reputation of Mercedes as a luxury brand even if it is pricey. That said, the same customer who prefers the Mercedes SUV may not prefer a Land Rover SUV, despite Land Rover being better SUV brand because of the much higher price tag that a Land Rover has (Rs 2.5 crore versus Rs 1 crore of Mercedes). The practical application of the six attributes of functionality, reliability, durability, maintainability, affordability and differentiability varies from customer to customer based on the nature of the customer, the social and economic demographics and the product itself. Apart from the customer’s own preferences the overall social infrastructure influences brand acceptability.
The fifth law: Brand loyalty takes the vision of the viewer
Brand loyalty takes many forms. The reasons why a product, firm or brand commands loyalty varies from customer to customer. For someone who understands the entire spectrum of automobile industry, Toyota could be the most favored brand for its innovative accomplishments in manufacturing management, and not necessarily because of the quality of any particular model. For someone who understands aseptic practices, a hospital that has state-of-the-art aseptic practices could command respect while for many others the association of topnotch medical consultants could be the decider. It is for this reason that some brands, “super-brand” themselves to ensure higher brand loyalty. While Aquafina and Kenley mineral (pure) water brands command brand loyalty for purity, Evion and Himalayan evoke further connect with the emphasis on bottling at source of Alpines or Himalayas as the case may be.
Emotional connect
The relationship between a seller (the firm) and a buyer (the customer) is neither a selling relationship nor a purchasing relationship; it is one of human relationship. In an organization, for example, people may deliver  on performance and may get rewarded in terms of compensation, and teams may share bonuses amongst the members; however, unless there is an emotional connect or an empathetic rapport amongst the team members, the team may not be reaching the fullest potential. Even though a sales transaction between a seller and a buyer may be a onetime occurrence (or even a periodic occurrence in respect of retail transactions), the multi-factorial emotional feel of getting to know a brand, exercising a reasoned choice, being sold with care, actually experiencing the functionality and after-sales service care, and having options to upgrade to next generation products all add up to building the emotional connect around a product, firm and brand.
Wise companies, therefore, do not consider their responsibility fulfilled with delivery to the retail chain; they pursue a diligent and caring connect till the point of contact with the customer, at the time of potential sale and thereafter. While a firm cannot be present at all points of contact, the firm would choose associates and partners who are aligned with its own emotional code of connectivity. The emotive brand loyalty of a firm and its products is probably the most important determinant of sustainability in a hyper-competitive market. The emotive brand loyalty does, however, gets built on the foundations of the six fundamentals that characterize a product or service to the customer: functionality, reliability, durability, maintainability, affordability and differentiability.
Posted by Dr CB Rao on February 23, 2014  

Sunday, February 16, 2014

Products, Brands and the Firm: Five Immutable Laws of Branding

The relationship between products and brands has been an exciting and fascinating area of research in marketing strategy. Products represent performance and functionality while brands represent experience and assurance. Typically, products build brands but once built, brands outlast products. Marketing strategy, oftentimes, has to face the intriguing dilemma of new products riding on the existing brands or steering off to develop new brands. The more interesting question is also whether the firm itself represents a brand, and in some cases the product as well. In the recent years of technological innovation and marketing acceleration, the relationship between products, brands and the firm has demonstrated multiple facets. The relationships could vary across firms and industries but certain generic principles represent the essence of such relationships.

There could be a view that products, brands and firms are not standalone phenomena but are dependent on certain other critical foundational factors. For example, products may be seen to be embodiments of technology while advertising may be seen to build brands. Firms may be expected to be built not merely by products but also by a variety of tangible resources like assets and finance and intangible resources like culture and values. While this reality need not be denied, products and brands represent the final outcomes of all efforts of a firm, and represent respectively the tangible and intangible assets that together drive the competitive advantage of a firm. This blog post proposes certain simple laws of product and brand performance as influencers of firm performance. Like Newton’s laws of motion, these laws are simple but universal, and immutable.
The first law: Distinctive products make sustainable brands
Products help consumers fulfill their needs. Products offered by several firms may have similar characteristics but only certain products end up building themselves into real brands. Products get transformed into powerful brands when they offer functionality, reliability, durability, maintainability, affordability and differentiability on a consistent basis to the customers. From an organizational process point of view, these product features are an outcome of quality and competitiveness in design, manufacture and service. Firms should direct their efforts to develop products that offer the six-feature bundle through requisite organizational processes.
Firms with global leadership or national leadership, in any product category, reflect the above theorem. They master the organizational processes to provide the six superior product features, consistently product after product. Brand building is a phenomenon that clearly goes beyond advertising. It is a total organizational paradigm. Toyota, Nissan, Honda, Sony, Panasonic, Apple, GE, and any of the  top firms with strong brands have organizational processes that enable exceptional products. There exist no shortcuts for building brands but there exist well proven multiple methodologies to achieve functional excellence and integration. Each of the firms listed above has relied on functional excellence within organizational integration to reach its respective pole position.   
The second law: Differentiated products make discrete brands
Brands are expressions of product differentiation. However, overuse of singular brands on multiple products leads to monotony while underuse of a successful brand for product extensions wastes valuable resources. Samsung, it appears, has overused its successful Galaxy smart-phone brand on multiple products. LG, on the other hand, has underused any of its brands to better represent its smart phones. Companies struggle with the right balance in brand-product nexus. Product differentiation is the key to discrete brand recognition. It would appear that weaving a unique brand around each unique design theme is a helpful approach.
 In an automobile lineup, hatchbacks, sedans, crossovers, utility vehicles and off-roaders qualify for discrete brands. Each of these product segments may be known by integrated brands but each product segment can house further differentiated products, each with a discrete brand. Titan’s Raga brand represents an ethnic uniqueness for ladies watches and the Edge watch brand represents slim design form factor. Both have been highly successful, as they continue to preserve their unique propositions. However, Titan’s sub-brand Fastrack which started as a youthful brand known for its funky designs has got lost in multiple themes. At times, sequential simplicity makes the brand-product bonding perpetual and continuously expanding.
The third law: A pioneering product brands the firm
Most companies have multiple products but just a few brands. However, it is left to a few pioneering firms to develop singular products with which respective brands, and even the firms, are completely identified. This is true in highly developed markets as well as naïve emerging markets. Typically, this happens when the product provides a unique need fulfillment and/or user functionality and experience like never before. Once this phenomenon happens the world starts referring to products and use of products by the pioneering product itself. For a firm to be in such an unassailable position, it needs market-savvy innovative technologies.
Several examples, from the distant past as well as contemporary present, come to mind. Coca Cola representing sweetened beverage as a product, brand and the firm, first in America and later globally, is a classic example. So does Xerox, the pioneering developer of photocopying machines, representing the process of photocopying as Xeroxing. Philips is still remembered as a company of bulbs. Even in contemporary times, people call searching the Internet as ‘googling ‘rather than by any other name; with Google getting identified with its pioneering search engine product, in the triple formats of the product, brand and firm. Clearly, product pioneering needs to be the goal of firms that enter sunrise industries with leading edge technologies.
The fourth law: Great brands are forever
The deep, and inseparable, bond between the consumer and the product as well as the brand has one downside. When the product becomes irrelevant the brand too becomes irrelevant. That said, great brands that are made by great products have a truly mystique effect. Within reasonable generations of mankind, they never wither away; they just remain frozen in a grateful and appreciative consumer memory to be thawed into life just at the right time. Firms that are engaged in divestments or acquisitions and firms that are phasing out technologically obsolete products must keep in mind that brands have lives far beyond the products that made them.
Sony’s Walkman was synonymous with a music device running on taped music. With the obsolescence of that technology and the related product, Sony had to jettison the Walkman brand. That did not mean the demise of the Walkman brand, however; the brand came back to brand Sony music cellular phones as Walkman phones. Nissan phased out Datsun line of cars, and the Datsun brand itself, as Nissan’s other automobile products became the mainstay cars for the company. However, when Nissan set out to launch a global low cost car series, Datsun reemerged as the ideal brand that brought back its mystique. It is no wonder that Nokia has only licensed, and not sold, its Lumia smart phone brand to Microsoft; who knows what Nokia could do with Lumia brand a decade hence!
The fifth law: With branding, strategy follows structure
One of the cardinal principles of the theory of the firm, as postulated by Alfred Chandler(1962), is that structure follows strategy. However, in respect of branding, strategy must follow structure, more specifically business-product structure. Firms, depending on the industry setting and their own strategy, require diverse business and organizational structures to deliver. This leads to a brand hierarchy that cascades down from the firm as an apex brand into multiple business brands, each of which will cascade down into further product-line brands. On the face of it, such a brand hierarchy makes branding complex but with logical definition of business and product lineage, simplicity can be achieved. It would also provide for future business optimization.
The ‘strategy follows structure’ branding theory is particularly relevant when different products cater to different markets. There exist certain businesses that run on discrete brands, for example, branded generics pharmaceutical businesses in emerging markets such as India which cater to different healthcare specialties; such businesses validate the theory of branding strategy following business-product structure. Conglomerates and diversified firms benefit from the structure-driven strategy route.  One of the well established ways to retain thematic simplicity in such structural complexity is to prefix the Group’s name or the Firm’s name to all the new businesses and product lines. The examples that come to mind readily are the Tata business structures (Tata Steel, Tata Motors, Tata Chemicals, Tata Power, Tata Consulting Services, and so on) and the Google product lines (Google Plus, Google Play, Google Drive, Gmail, Google Glass, and so on).
Lessons from laws
Not many Indian companies appreciate the theory and practice of strategic branding. Either the firms  see the brand as a target rather than as an outcome or they dissipate the potential power of branding in a crisscross maze of brands. The perfect brands are those which score a 10-10 on the dimensions of revenue and profits. Most firms, however, fail to appreciate that such a perfect branding is built on the product or service scoring a 10-10 on user experience and user trust. Apple, in several ways, comes closest to the concept of perfect brand in the above perspective. The organizational competencies and processes must blend into an optimal mix to achieve perfect brands.
Even more fundamentally, Indian companies should start cleaning up the brand clutter (for example, companies getting known by multiple and complex names, and product-brand overlaps confusing customers). Firms also need to identify areas in their business-product canvas where and how the five laws of branding postulated herein can be applied. Business leaders must see branding beyond advertising or even customer recall, essentially in terms of products and services that ride on technology, quality and competitiveness to deliver on need fulfillment with the six imperatives that were mentioned in the preamble. It is worth recalling these six product or service attributes as being functionality, reliability, durability, maintainability, affordability and differentiability.
Posted by Dr CB Rao on February 16, 2014     

Sunday, February 9, 2014

Sony VAIO: Elegance in Vain, and Smart in Strategy – The Theory of Sinusoidal Business and Product Strategy

When Sony launched its VAIO (originally, an acronym of Video Audio Integrated Operation) series of personal computers, first as desktops in 1996 and later as laptop and notebook computers in 1997, not many took Sony seriously. Users were under the impression that computers were industrial and business products, for which service would be the most important. The market mainstay at that point of time was seen in terms of office and industrial use. As Sony sold its laptops and notebooks through its normal consumer retail outlets which mainly sold televisions and other audio-visual products to individual consumers and families, Sony was not considered to be channel-friendly to the computer buyers. To Sony’s credit, it proved its detractors wrong. VAIO became the preferred laptop brand competing with Apple, HP and IBM/Lenovo, for its top of the mind consumer recall. It even became a leader in large format CPU integrated desktop computers. Sony emerged next only to Apple in terms of design elegance and product sophistication.

If one would recall, laptops at that point of time were staid and boxy with black as the only color (even today, several models continue to be that way). Sony pioneered laptop and notebook design to levels that made the products works of art. Use of exotic materials and colors and incorporation of slim form factor enabled Sony to develop and offer lightweight and high performance computers that captured the imagination of young and old as well as individual users and business firms alike. The latest in Sony design innovation is VAIO Flip which represented a unique design that straddled a laptop and tablet. In terms of hardware too, Sony VAIO packed a punch with bundles of proprietary software to add considerable value to the products. Against the scenario of elegant design, sophisticated manufacture and robust branding, the recent decision by Sony to sell off its VAIO computer business to Japan Industrial Partners (JIP), booking a business loss in the bargain, has been a surprise.
Theme in strategy
The divestment of the VAIO business must have been emotional for Sony but seems a practical decision from one perspective, and visionary from another perspective. The practicality arises from the fact that the Sony VAIO may have fired the imagination of users but has not exactly raked in the requisite revenues and profits. Part of it could be related to the high manufacturing and supply chain costs related to multiple SKUs and excessive accessories. The strategy of multiple product platforms, frequent model changes, optional availability of several accessories, and celebrity led advertisement campaigns required that Sony operated VAIO as a mass market product range to financially breakeven. Yet, the products were often a trifle underspecified spec-wise and quite over-specified price-wise. The top-of-the-line design elegance inspires consumers to look for the best in hardware capabilities, but Sony traditionally stopped short of giving the best in its products; for example, 1 TB hard disk capacity is offered with a 6 GB RAM, rather than an 8 GB RAM. Even in respect of flash memory models, initial offerings have been in terms of 128 GB rather than 256 GB.  
Possibly, Sony’s reluctance to pack the ultimate punch in the internals in line with the futuristic external elegance has limited the market for its elegant products; many consumers seek RAM upgrades at their cost, for example. The strategic template set for VAIO laptops (the best in design, the next best in hardware, the maximal variety in SKUs, the best in promotion, and the highest in pricing) was thus possibly too embedded to allow a major shift for higher volumes, lower volumes and a revival in profitability.  The proposed divestment of its PC business by Sony thus makes sense in the face of Sony’s unwillingness to make any major shift in VAIO strategic theme. Interestingly, this is not the first time that Sony exited from its computers business. Sony initially entered the PC business in the 1980s with computers made exclusively for the Japanese domestic market but exited the business in the early 1990s. The proposed VAIO divestment, after a successful reentry in 1996 and growth over nearly two decades, is reflective of an approach to delete the strategy itself rather than reengineer the strategy. From a strategy perspective, therefore, firms do face the clinical option of strategic abandonment vis-à-vis thematic reengineering. That said, Sony’s decision is possibly not as simple and self-effacing as it appears.
Arena redefinition
Sony’s decision to quit the VAIO business needs to be viewed in the context of how the communication, computing, entertainment and social media arenas are getting redefined and integrated into one huge seamless arena of networking through the cloud. Smart phones and tablets have emerged as the devices which cater to this new arena. Sony’s decision to quit the VAIO computer business needs to be seen in the context of the company’s earlier decision to consolidate in the mobile phones business by buying out the stake of Ericsson in the Sony-Ericsson joint venture. Over the last few years since this has happened, Sony has demonstrated a new penchant to bring its industrial design and manufacturing elegance to the smart phones business. One may hypothesize that Sony would now concentrate all its resources to develop a smart phone and tablet lineup that caters to the four needs of communication, computing, entertainment and social media. From a perspective of developing a strategy for future, Sony’s smart phone and computer decisions together indicate how a changing technology landscape could dictate the product strategy, and an overall business strategy.
While redefining the strategic arena is important, developing a new generation of devices that meet the requirements of the new arena is equally essential. Sony’s design studios must surely be working on the new product themes. The challenge is to imagine the future shape of arena. In this case, for example, the question would be how seamlessly the nations of the future would be networked. Like radio and television waves, would carriers and the governments be offering free seamless wireless connectivity through satellites across the nations? Answers to such questions would determine how the phones and tablets of the future would evolve. It is important that product development in environments of such technological fluidity must emerge from the environments of the future rather than the capabilities of the firm. One view, for example, is that the large boutique of proprietary software that Sony bundles in its VAIO and other devices (nicknamed ‘bloatware’) has been a system drag rather than a user friend. As products become mass-market products, the balance between three types of product architectures, open, value added semi-open and proprietary, has to be carefully evolved.
Strategy, product sine cycles
Most firms that exist for the long term go through strategy cycles. These are sinusoidal curves of entry, growth, decline and exit into a business based on specific products. While this may seem similar to a product lifecycle, what is not seen is the hidden sine wave of product redevelopment that occurs, unseen to the external world. This involves deep de-learning, futuristic re-development, revalidation through piloting and finally reentry into the market.  If Sony’s strategy journey, from 1980 to 2014, is reviewed, clearly strategy can be seen to be moving in cycles (for example, into computers, out of it, again into computers and again out of it) with silent product redevelopment occurring unseen. Microsoft has also been into some kind of strategy cycles in a similar manner (into tablets, out of it, into it, and again further into it, through acquisition). Firms with strong brand equity and deep resources would use every exit challenge as an opportunity to reinvent its products and its own business. ITC, which is a market leader in cigarettes may face product exit if tobacco consumption is banned but the sinusoidal theory of strategy would require that ITC should develop tobacco and nicotine free cigarettes for a reentry.
Product strengths and environmental fit of a firm positively correlate with each other. Product stagnation and environmental transformation inversely correlate with each other. This constitutes the essence of the theory of sinusoidal theory of business and product strategy.  Strategists must define objectively, and on a continuing basis, the fit between current products and future environment. When products are considered inappropriate for the future evolution and the firm does not have the resources to reinvent the products or any such reinvention is not considered sustainable or viable, strategic exit is advisable. If the reverse is true, that is products are appropriate and can be rendered even more effective for the new environment, the product strategy must be leveraged to amplify the business strategy. The stronger the product competencies and greater the product-environment, the greater will be the amplitude of the sine wave. If the entry-peak-exit sine wave has high amplitude and long time horizon, the hidden product redevelopment reverse sine-wave need not necessarily have the same amplitude and time span; it is all a question of how technological savvy and proactive a firm is.
Ideally, the positive sine wave of product-market entry, growth and decline and product (not necessarily market) exit must be mirrored by the inverse sine wave of product redevelopment, piloting and reentry into the market. Even as the positive sine wave takes shape and rules the market, there should be several inverse sine waves of product redevelopment. Sony VAIO case study teaches us the curious but very interesting theory of sinusoidal product and business strategy. A technologically virtuous and environmentally sensitive firm should take cue to let technology and business act in concert to generate high and wide positive sine waves and simultaneously generate short and speedy inverse sine waves of product strategy.  The author believes that the theory of sinusoidal product and business strategy, as developed in this blog post, is a novel contribution to the theory of strategy that seems strapped for innovative contributions.  
Posted by Dr CB Rao on February 9, 2014    


Sunday, February 2, 2014

Expectation – Speculation and Real – Unreal Inflation: The Gross – Subtlety Conundrums of Indian Economic and Industrial Policies

The Reserve Bank of India (RBI) has refused to adopt a soft money policy once again, though the Indian GDP growth rate has decelerated to 4.5 percent, and despite cries for affordable money to fuel growth. Raghuram Rajan, the dapper Governor of RBI has stated that inflation is a greater concern than anything else. As students of economy know, inflation erodes the purchasing power and leads to a spiral of wages chasing prices. Inflation affects the export competitiveness of Indian products, and erodes India’s claim to global cost competitiveness. A major component of the Indian inflation scenario has been the high food inflation. This has hit the vulnerable sections of the Indian society, especially the daily wage earners, who are affected by only a partial inflation-indexing of annual salaries and lack of inflation-indexing of the daily wages.

The squeeze on real living conditions is contrasted sharply by the huge increase that has happened in the prices of real estate. Recent papers, for example, have been flooded with advertisements for apartments and villas that claim price tags of Rs 10 crore plus for downtown apartments and Rs 3 crore plus for apartments and villas in outlying suburbs, even in a conservative city like Chennai. The saga of galloping real estate prices against a backdrop of unsold housing stock is frustrating and enigmatic. There is no doubt that there is a huge element of speculation in the rapid increases of certain asset classes such as real estate and gold in India. Speculation, however, appears to be a larger cultural phenomenon, given the rapid fluctuations that occur in the Indian stock market and the fanciful nature of fancied stocks, euphemistically referred to as momentum stocks.
Banking on banks
Indian governments have conventionally treated inflation through fiscal policies, more specifically banking policies. Increase of interest and deposit rates on one hand, and mopping up of or release of liquidity into and from the banking system have been the specific tools.  Deployment of these tools has led to alternate cycles of high growth and low growth, accompanied by low inflation and high inflation in the better times. The current situation, however, seems to be a more disparate combination of high growth and low inflation, set in a cultural background of speculative trends. Classic banking solutions are unlikely to provide the required solution.  The other way of looking at this is in terms of demand-supply equation; the more goods and services are generated, the greater will be the price competitiveness leading to greater demand fulfillment with lower prices. As discussed earlier, the conundrum in India is one of more products and services at higher prices.    
In India, the banking sector has played an enormous role, incomparable in any other country, of supporting the industry across a broad spectrum, playing a variety of roles. The banks have been the angel investors of sorts to set up, and support, micro and small enterprises. They have been lenders of first resort for medium scale enterprises unable to or unwilling to obtain private equity investments. They have been bank-rolling large enterprises in their expansion, diversification and globalization plans. And most importantly, they have been hugely risk-friendly in supporting gigantic infrastructure projects. Without the banking system, especially the national and nationalized banking system, industrial growth in India would not have been what it has been. Yet, the banking system has got in return been a specter of bad debts, non-performing assets and delinquent or defaulting accounts. It is a moot point if this high level of bad returns is due to the gross insufficiency of risk capital for the industry on one hand and the expedient dependence of the industry on the interest bearing loans on the other or due to a combination of poor industrial management, loose loan monitoring or high interest rate regime.
Expectation and speculation
It is perfectly natural and logical for the industry and bankers to have mutual expectations. However, if expectations are not based on solid forecasts, and if results are not reviewed against expectations, any transactional relationship moves into a zone of speculation. Speculation, as can be appreciated, is the act of forming opinions about what has happened or what might happen without knowing all the facts. Speculation is nothing but guesswork without a basis of facts; speculation is also engaging in a physical or financial transaction in the hope of a profit; the more usurious the hope of profit is the more speculative the transaction becomes. Expectation, on the other hand, is a belief that an outcome will happen because it is likely. Expectation is based on refined human capabilities of logic and rationality while speculation is based on primal human characteristics of greed or fear. It is important that economic and industrial management of India is based on sound expectations and not on shaky speculations.
It is perfectly logical for the experts and laymen to expect that the RBI will raise or lower interest rates, or tighten or liberalize liquidity each time the monetary policy is announced. It is, however, pure speculation (pardon the oxymoron!) if the stock market investors and operators indulge in massive selloffs or buyouts in anticipation of, or within minutes of, any particular movement in policy. It is important that all stakeholders base their judgments and actions on expectations, and eschew any preemptive or presumptive judgments and actions that are built on speculations. It is, therefore, commendable that Raghuram Rajan has been forthright in setting expectations on inflation and growth, and not fueling speculative trends.  He discourages the widely held notion that low interest rates magically lead to high growth rates and advocates that the best way to promote growth is keeping inflation low. He is very clear, rightly so, that there is no tradeoff between inflation and growth.  That said, India faces a threat from two hues of inflation, which hopefully will be addressed by authorities with similar objectivity and candor.
Real and unreal inflation  
In any society, there cannot be a perfect match of demand and supply or of factors of consumption and factors of production. It is this mismatch that primes the drive for growth (potential demand outstripping physical supply) or leads the quest for competitiveness (physical demand lagging potential supply). The virtuous economic management seeks to develop and utilize factors of consumption and production to balance demand and supply at continuously increasing levels. The not so virtuous economic management seeks to tolerate inflation and curb consumption in times of short-supply of products and services. While this is a natural economic characteristic, proactive economic management and industrial management require that growth and competitiveness are always pursued as twin sides of the same coin. Clarity in fiscal and monetary policies set the stage for this. An integral part of this approach is the accessibility for continuously improving factors of production such as technology, talent and investments.
The economic mismatch generates real inflation as discussed above, but can be managed with emphasis on factors of production and other instruments of economic policy. However, it is the unreal inflation that tends to be a more dangerous scourge for the economy. Unreal inflation occurs when prices rule high, in some cases usuriously high, even when products and services remain unsold. The state of real estate mentioned in the beginning of this blog post (threefold increases in real estate prices when more than two-thirds of housing stock is remaining unsold, as an example) is an example of unreal inflation. There could be several other examples such as luxury hotel rooms being pricey despite low occupancy, luxury brands commanding unearthly prices  or leading smart phones costing more than computers despite increased competition and lower per manufacturer sales. The unreal inflation is a fight between firms with erstwhile monopolies and deep pockets and the new generation resource constrained firms with follow-on products. In the unequal tussle, more often than not, the economy and society tend to be squeezed in and lose out.
Philosophical issues
The discussion on inflation and speculation as well as on real and unreal inflation brings forth several philosophical issues and guideposts. Firstly, it is clear that there should be a healthy balance between risk capital and borrowed capital in an industry so that each firm optimizes its cost of capital (disregarding for a moment the invisible and long term cost of equity capital). Secondly, the industrial comity, investor community and the banking sector must anchor their transactions around expectations rather than on speculations. Thirdly, the balance between demand and supply on one hand and the factors of consumption and those of supply must be dynamically optimized, with focus on continuous growth and competitiveness. Fourthly, economists and industrialists must learn to differentiate between real inflation (which is inescapable but can be managed cyclically) and unreal inflation (which is irretrievably erosive and needs to be rooted out). Fifthly, and most importantly, economic and industrial policies require a culture of trust, transparency, forthrightness, logic and rationality amongst all the stakeholders that consider growth and competitiveness as two sides of an integrated economic and industrial strategy.
Posted by Dr CB Rao on February 2, 2014