The Hindu Business Line : ‘Satyam saga may have wider impact’

Celebrated author, management guru and thinker whose views on corporate strategy are much sought after, 67-year-old Coimbatore Krishnarao Prahalad is a globally known figure who has consulted with the top management of many of the world’s foremost companies. The Paul and Ruth McCracken Distinguished University Professor of Corporate Strategy at the University of Michigan’s Ross School of Business, Prahalad was in Chennai recently to address the gathering at the Pravasi Bharatiya Divas on the current economic scenario. For Prahalad coming to Chennai is a homecoming of sorts as this was where he spent his formative years, having schooled at the Corporation School in Nungambakkam and later at Loyola College before he went on to a distinguished career in the corporate sector and academia. Post his address to the overseas Indian community and a talk to the CII Young Indians Forum on the relevance of Mahatma Gandhi today, Prahalad spoke to Business Line on a variety of issues, including the Satyam saga, brand India’s image overseas, on how much you can regulate the corporate sector. Excerpts from the interaction:

What is your opinion of the Satyam saga? It’s being likened to the Enron financial scam in the US.

Certainly it is a big surprise and a rude shock that something as pervasive was going on for so long without being detected by multiple groups: investors, SEBI, the Company Law Board, internal and external auditors, CFO, COO, business unit heads…is somewhat unrealistic. That this could happen in a company which was well respected comes as a shock. I like to think of it as a tale of two cities — New York and Hyderabad. If I look at Lehman Brothers, Bear Sterns, Washington Mutual, Wachovia, Countrywide, Merrill, they are all venerable institutions. We need to ask some questions. Is the market system failing or is it the personal failure of individuals or is it the failure of managerial incentives. Incentives totally based on quarter-after-quarter profit growth irrespective of market conditions, can create a culture of growth at any cost.

So, I think part of it is systemic pressures, part of it is the quality of personal ethics and compliance, part of it is poor regulatory oversight or bad auditing. It is a combination of all those. Only when the investigations are complete will we know how the pieces fit in; at this stage one can say this is a rude shock to all who want India to succeed. It is going to have a significant impact on how India is looked at and how Indian companies are looked at. So it is more than Satyam from that point of view. The only hope that I have is that all investigations are done expeditiously and in a transparent way so that we restore the confidence in the system; that is the best way to deal with the issue — rumour mongering and speculation may be inappropriate, it is too serious a governance lapse to speculate. Too premature to make judgements. It is a wake-up call for all of us that things that look right may not be right. A dose of scepticism and a dose of caution is called for.

Would you draw parallels between the Satyam case which emerges as a case of fraud with Lehman Brothers who were caught making wrong calls?

In a funny way the situation is more complex; it started unravelling as a bid to acquire the assets of Maytas. Merge bad assets with good assets. But, having said that, knowing that you’re overexposed and to hide it you get even more exposed is not very different from what Lehman did. I think there are parallels. These governance lapses have a predictable logic. It’s not unique. You get onto a treadmill of deceit and it’s very hard to get off. But the key is not to get onto that treadmill in the first place.

You said Indian companies are going to have it tough overseas. So as someone looking in from the outside, what’s in store for Indian companies; do you see risk premiums going up?

We have to separate short-term reactions from long-term. India has to contend with three sets of bad news; first the current political climate in the US is concerned about outsourcing. The second is the Mumbai attacks. The perception is that India is not safe. Business Week had a cover picture with the Indian flag burning and asking the question: is India safe? Now, that doesn’t help India. Travel has dropped and FDI is going to be a little bit cautious. Third, foreign companies are having problems so they are going to pull back on their long-term investments and if they have to reduce their workforce, where are they likely to do so? They are more likely to reduce in China and India rather than in the US, so the circumstances are conspiring to make life difficult for Indian companies and this adds an additional layer of difficulty. So we have to work a little bit harder, be more diligent and demonstrate that yes Satyam happened, but that India is a country of laws and we can correct these problems expeditiously and fairly. This is an important message to give. And the tough message the government has to give to other corporates is that this is totally unacceptable. So I think reporting on this has to be fact-based and balanced...Sensationalising the issue is not going to help India. What I think is we are going to find is that there was not a single cause, not a single person (behind the whole drama). It’s just not credible. There seem to be too many moving parts in the whole issue.

Will the Satyam episode make it much more difficult for Indian companies to raise funds abroad?

In the short-term....yes. In other words, all these things are not for all-time. If you ask me in the next week will it be a problem, my answer is yes. Six months from now people would have forgotten and moved on. And I think the key is India has to get its act together. Do it fast, do it fairly. Both are important. Not just speed, but also fairness. FIIs have to put their money in places where there is growth. Most of the money is in very low return situations. India is still a great place from that point of view. And big banks in India are totally unlikely to fail. It is almost like a sovereign guarantee. SBI is a sovereign guarantee. So technically that is what it is.

I think in the next few months, I expect to see money coming back. FIIs took money away fast in three months, not because they totally lost faith in India but because they have a bigger problem back home to solve. So this is the only place from where they can take the money out to shore up their finances. The money will come back once they stabilise and different groups of people may come. NRIs may just bring the money here. And that is what I suggested to them — if you want your money to be in a safe place, go to India. Not only because of higher interest rates, it is also safer.

Good arbitrage as well?

Exactly! And the only thing to worry about is whether the currency is pound or USD against the rupee. The arbitrage opportunity is so big.

In short, what is your prescription for Indian companies to handle the recession?

Three things: Conserve cash, go for internal inefficiencies — simple things like working capital and so on. Third, do things more creatively, which is for example, sustainable development. Everybody thinks it is postponeable, may be it is not. I’ll give you a simple example. UPS loads all the trucks last in first out. Every route everyday, just by doing that and no left turns (in the US), they save three million gallons of gas per day. Even at $2 it is $6 million per day and you can do the math. Imagine what the opportunity is here in focusing on internal efficiency, new ways of doing business and sustainable development.

You said it is essential to conserve cash but you also insist that companies go ahead with investment plans.

Conserving cash does not mean don’t do anything. If you have to invest $10 to get $100 in return, that’s a good deal. So it is necessary to look for creative investment opportunities and not necessarily huge capital investment for a 10-year horizon. I believe that the opportunity for releasing cash in Indian companies is quite high. We think we are very capital efficient but only when you go into the details of each company you can see there is lot of opportunity for improving internal efficiency.

In a supposedly well-regulated economy such as the US, lots of iconic figures have fallen by the wayside, despite so many regulations in place. What do you think is the crux of the financial sector in the US coming to this pass?

There are three or four... First, the world has become extremely complex. And it’s become very interdependent. Mathematical models have become very sophisticated. Most of them are based primarily on trends. If there are discontinuities, you suddenly have problems. So, we have become very trends-oriented rather than understanding discontinuity.

The second reason is executive compensation and incentives to senior managers can lead to unethical decisions. In a growth market managers can assume that they can ride over problems. But, when the growth suddenly stops, you are left high and dry.

The third is a very important reason that people don’t fully recognise ...is that the US was known in the financial services industry as the most innovative. But while it was very innovative, the regulatory regime became very permissive instead of being more focused on regulatory compliance and oversight. When you take away the pressure of compliance and oversight, suddenly the innovation engine can go out of control. You cannot have uncontrolled-innovation in the financial services market. Therefore the balance between the extent of oversight and room for innovation is very critical. If you do too much of regulation, you kill all innovation. If there is too much innovation without oversight and only permissiveness you get a big problem. So it is a combination of factors. And I think one of the issues that India has to struggle with is how to get a regulatory regime and oversight that is appropriate given the level of risk. Of course, we do not play much in fancy financial instruments like the US did. We are a lot more conservative. Given that, how do you promote innovation, entrepreneurship and risk-taking with adequate oversight? That I think is a balance that India has to evolve over a period of time. It’s not a fixed point. As the market matures, as the people mature, the regulatory oversight has to become more sophisticated. That I think is going to be a big issue in the next couple of years.

Despite Enron’s collapse with all that regulation corporate America does not seem to have learnt, has it?

There is lots of introspection and questioning as far as compensation for managers is concerned. People are challenging executive compensation, incentives...they are challenging the moral values, the limits to market-based self regulation. So there are lots of new questions. I think the way the US works is as follows: if there is a big scandal such as an Enron the system overcorrects and makes it very hard. Then it self corrects a little bit...then it gets to a new level of regulatory sophistication. That’s how progress is made. So if you look long-term, at a 20-year horizon, the system is becoming more and more sophisticated. But in the short-term you have massive problems. But, this time the problem is out of control in the US, Europe and Japan and therefore it causes tremendous amount of global pain and global attention. It is also telling us something very important. As the Indian economy becomes larger and larger, the cost of these errors can be quite high. So, we have to be a little bit more cautious. When Indian firms were small, it did not do as much damage. Also, I remember the Asian crisis. If we recall, it had little impact on India. We all said it was so good. I said, no, you are totally unconnected with the rest of the world. Which is not a good sign. But, now we are a little bit more connected. However, we are not a China or South Korea in terms of our interdependencies with global markets. We are not totally export-driven. We are hurt, but we are still very safe. We do not have toxic assets or toxic papers, we don’t have zero growth like Europe and Japan...we don’t have an export exposure like China and South Korea. Our problem is we are not growing domestically as much. People are now coming to the conclusion that we are not as much impacted. We cannot even say that we do not have a liquidity problem. The Government has pumped in enough money. What we really have is a credit problem... because the banks are not lending and non-banking financial institutions are not getting access to credit either.

While we are a consumption-led economy, do you feel the Government has done enough on investments?

Actually, they acted very wisely and fast. But, what I find fascinating is that infrastructure projects are not approved. This is the right time to approve all those projects and get them going...because it creates employment, it puts money in people’s pockets, it increases the demand for steel, cement and so on. And it’s a good time for doing that.

You say India was quick to react to the global meltdown. But those such as Lord Swraj Paul in one of his interviews said that the Government thinking that India is not well integrated with the global economy and so better insulated than many other nations, acted a little slow…

The question is how slow is slow. Would you like waffling that you find in Europe or in the US or people taking a little bit more time and creating liquidity, making sure money is available in the banks, reducing the interest rates dramatically....very good actions. We have to create consumption. That is how we are going to get out of this mess.

So you think that the Government has done enough to bail out the economy?

I think the problem is having liquidity in banks is not the same thing as people getting access to credit. People should have confidence that the economy is stabilising and they can afford to go and borrow money again. If everybody says that I am not going borrow money, then we are not going to grow. So, demand side is as important as supply side; you have taken care of the supply side... you also have to promote the demand side.

Everybody’s talking about how assets are going cheap all over the world. What would be your advice to Indian companies — go out and acquire like the Tatas or grow at home?

It may be difficult for people to raise money from outside India. So if you raise money in India, and take it outside to buy assets, you are reducing the liquidity here. So, while it may be advantageous to a company as a country it’s a tricky question how to keep liquidity here. I think all Indian companies can grow dramatically in India. While assets may be cheap, exposure at this stage for additional liquidity in companies may be a cause for worry. So I would say what is cheap may not be cheap. Or what you see may not be what you get. It, however, depends on companies, how diversified their cash flow streams are....if it’s all coming from one location, then I would be more worried. But, if it’s well-diversified, it’s a different story. But I would be very concerned if you made big acquisitions at a low price of cash-hungry businesses. Cash-hungry businesses just don’t change character.

If Tata had acquired Jaguar Land Rover in today’s depressed market they would have got it much cheaper than what they paid for…?

We can always say that in hindsight. I think we should look at and say did we get a good deal at that time...not three years later and say it was not...at that time was it a good deal? When people talk about Corus...I ask myself a simple question...If you want to add 12 million tonnes of new capacity...how long will it take in India? So if you just look at net present value, not only the asset value that you got, but the technology and market access and so on...then say whether it’s a good deal or not. It will take 10 years to add that kind of capacity here. So what would you do if you have a desire to grow...

What else do you think brand India should do to win the trust of the international community?

I think we have to demonstrate that things will get right and this (Satyam issue) is an aberration. I think blowing it out of proportion is not in anybody’s interest.

But we don’t know what skeletons are rattling in other corporates’ cupboard?

We don’t know. We will have to be cautious. Treat this, for now, as an aberration and get on with that.

The fact that such things have happened in the US well…does it help?

But you have to be careful; that’s a dangerous argument. The world has always used what I call, a bent measuring stick. People have different standards. When a developing country has a problem it is magnified beyond belief. Contamination of hamburgers takes place all the time. We just withdraw and get rid of it. And that’s the end of that. But contamination of milk powder becomes a huge scandal. So we have to understand that we are not yet there in a situation where the measuring stick is more or less the same. It is still bent (now) and we have to respect and deal with that as if it is bent. Ten years from now it may a different story. We will visit that problem when it comes.

In the US it looks like the Government now owns lot of companies. . . America has been a great growth engine for the whole world but now people are questioning the very basis of a capitalist view of society . .

There are two distinct problems. There is a lot of discussion about the role of capitalism and dealing with the problems of five billion poor. Bill Gates calls it creative capitalism and capitalism with a conscience. The second piece is how much should we depend on markets and how much on regulatory oversight and self-organising governance. The third is — are there issues where you need global governance rather than just country and company governance like pollution, human rights violations, etc. All three debates are going on simultaneously. I think these are important debates. How it will all work out will be the interesting piece. I think we will come out of the crisis with a refined and a different view on the role of markets, regulation, the role of NGOs in providing checks and balances and how do you get Governments, NGOs and large companies to work together without losing their identity but collaboratively. I believe that we will see the emergence of a new social compact. Business has to build a social compact.

Do you think the growth rate of Indian economy will be restored?

Some parts of the country are going to grow at 10 plus per cent and some at 5 per cent. The biggest advantage is that agriculture is going to be good this year. And therefore there is going to be a lot of money in the rural sector. India is going to be a growth economy.

Related Stories:
Satyam to buy Maytas Infra, Maytas Properties for $1.6 b
Truth failed
Whither corporate governance?
Rs 7,000-crore fraud
Prof C.K. Prahlad quits HMRI

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‘Satyam saga may have wider impact’