:: The Park Paradigm ::

Markets for the Digital Generation

The Economist reports on the sorry state of New York state’s quasi-public Off-Track Betting Corporation:

The OTB has in effect been operating in the red for years, but has used its reserves to keep going. By this summer it will need a cash infusion just to make ends meet. Mr Bloomberg has said he has no intention of subsidising the largest legal gambling operation in the country—not least because the city’s share of the revenues has dwindled while those of the state and the racing industry have grown.

The OTB was originally designed to raise money for the city and the state and to take gambling out of organised crime’s control by providing a legal outlet for betting. During the 1980s, it earned the city $65m a year. Just seven years ago the entity was almost sold for $250m. Today, its bleak-looking parlours are frequented by an ageing, dwindling base of punters.

Gee, what should they do? Hmmm…. how about getting the government out of the business, legalizing private operators, regulating and taxing them. Innovation: good for punters, good for racing, good for government coffers, good for transparency. Crazy, I know. Mike Bloomberg obviously knows all about the power of technology and innovation; maybe the folks over at Betfair should try to get a meeting…

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What’s not to like? My mind was set racing after reading about Max Donelan’s “energy harvester” in the Economist recently:

The “energy harvester” that Max Donelan of Simon Fraser University and his colleagues describe in this week’s Science looks like an orthopaedic knee-brace. It tucks behind its wearer’s knee and has extensions that strap around the front of his calf and his thigh. When the wearer walks, the knee’s motion drives a set of gears which turn a small generator.

On the face of it, that sounds like a recipe for making walking difficult. Surprisingly, it is not. Although the leg muscles perform “positive” work when they accelerate the leg forward to begin a step, when the leg straightens at the end of the step they perform “negative” work as they slow the leg down. If the generator in the harvester were connected during the accelerating phase the process would, indeed, be expected to increase the load on the muscles. But if it were connected only during the decelerating phase it would impose no load. It might even make things easier.

(The BBC website has a video here.)

The potential for this kind of power generation seems vast, especially in the developing world. Not only could it prove to be a robust and portable personal power source , because it doesn’t rely on a centralized infrastructure it is at once an empowering technology (excuse the pun) and without negative environmental consequences. Not only could individuals in places like rural Africa and India have free (beyond the inital investment in the equipment) access to power for things like lighting, mobile phones, and even networked computers or even femtocells, they would not be emitting any greenhouse gases, and insofar as they could replace dirty fuel burning lamps with LED lighting, pollution would even be reduced.

One of the biggest changes has been the use of light-emitting diodes (LEDs). This has transformed wind-up lighting products, says Rory Stear, chairman of Freeplay Energy, which specialises in such “self-powered” devices. The company’s Indigo lantern, for instance, can provide up to two hours of light from just one minute of winding. LEDs also last for a long time: those in the Indigo are rated for 100,000 hours, whereas a filament bulb might burn out after 16 hours.

Such products can make a huge difference to power-starved people. Freeplay’s charitable foundation reckons that the use of kerosene, candles and firewood for lighting absorbs 10-15% of monthly household incomes in sub-Saharan Africa. It is planning to test a range of wind-up LED lanterns in Kenya and South Africa this year. These, it hopes, will allow people to do things like studying at night, increasing their security and coping better with medical emergencies. Freeplay Energy is also developing self-powered medical equipment, including a fetal-heart monitor.

Imagine this married to the emerging global carbon markets, and you can imagine a day not so far in the future when a farmer in Tanzania can pay for efficient LED lighting, a mobile phone and usage fees (which he uses to stay in touch with market conditions for his produce, including hedging commodity and weather risk and as a payments platform) all by selling his carbon emissions allowance to the market. Of course, we are a bit away from having a workable “retail” CER market, but if you ask me this is exactly the sort of thing the World Bank should be working on in cooperation with entrepreneurs in developing markets.

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I don’t know what to say. It seems this morning a big brouhaha has erupted over a “private offshore trust” (…oooohhh maximum scariness and implied skullduggery…) that holds £50bn of Northern Rock’s “best” mortgages…

Nationalizing Northern Rock - however much they mucked up so far in the timing and execution of that - is the only sensible thing the Brown/Darling duo have done on the economic front since taking office. So not being very sympathetically inclined to them at this time, one would hope that the opposition would take a page out of Barrack Obama’s book and be pragmatic and honest when holding the goverment to account over the (important) details of execution. Instead we get a shrill, even hysterical response from the Tories and a good dose of the same from the press.

Granite - the main securitization vehicle (and main wholesale funding mechanism) for Northern Rock - is not exactly a secret. And there is nothing mysterious or - as far as I know - untoward about it. Anyone vaguely knowledgeble about the bank would be completely aware of it. This is not some dodgy Enron-esque SPV… And the fact that it is ring-fenced from the rest of the bank is (a) totally normal and (b) no big deal. Let me qualify (b) - yes, the rest of Northern Rock’s balance sheet is probably weaker for it - but duh, that’s one of the reasons they needed to be rescued in the first place…and given that the credit markets have seized up, on balance it is not obvious that it would help anyone (taxpayers) to bring it back on balance sheet forcibly (anyone want to buy £50bn extra gilts?). (Not to mention the bullet through the heart that would be for the credibility of the UK financial system and rule of law…) The price paid for the bank should reflect the contractual relationship between Granite and Northern Rock.

A final word, this last bit is where I’m a bit mystified as to the arguments of SRM and RAB as to the remaining equity value of the bank. They seem to think that it is worth quite a bit. Rather than go to court and fight it out, why doesn’t the Government offer them a right of first refusal on what ever deal ends up getting proposed. So for example, if the government decides to offer 10p / share, let any other (qualified, with proof of committed finance) buyer have the option of buying it at that price instead. …including the debt without any government guarantee. Not a level playing field? Sure it is. You just need a big strong balance sheet and access to credit markets in that sort of size. It is not the Government’s fault that SRM/RAB probably don’t fit that bill. If we’ve got to where we are, I suspect it is because nobody that does (have the capacity to marshall tens of billions of pounds of finance) thinks it is a particularly good way to spend it and so the government has to step in to mop up the pieces. As a UK taxpayer, I will be looking very carefully at the price the Government pays for the equity, especially if it is much above nil. And then I would hope that they work hard to re-finance it and flip it as quickly as optimizes their IRR, like any good private equity firm worth it’s salt. In this vein, rather than Ron Sandler or perhaps alongside him, I wouldn’t mind seeing Wilbur Ross or someone like him minding the shop.

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Few (non-tech) companies have even one director with a strong understanding of technology; in terms of executive directors, while the CEO and CFO are almost always represented, the board level CIO is a rare bird indeed. In this week’s Digital Business supplement, Ade McCormack asserts - correctly imo - that “Technology management is a board issue”:

There are many reasons why IT management fails to stem from the boardroom. These include: *Many business leaders have had a largely tech-free career. Their lack of experience in using technology as a tool beyond word processing makes them feel vulnerable. Making technology management non-strategic helps to keep their weakness off the agenda. * Many technologists do not want “users” interfering in technology decisions, often because their ill-informed input would be detrimental to value maximisation. Keeping users at arm’s length was standard practice because clunky technology tools and approaches did not lend themselves to mid-project change requests. Despite big improvements in the tools, user-inclusiveness is still some way off. *Some technology vendors have too much influence at board level. Their account director has more clout in technology decision-making than the CIO. This is a parlous state of affairs. Under these conditions technology management will be driven by the cash flow requirements of the vendor rather than the imperatives of the business.

Good governance, cost management, innovation management and ultimately shareholder value all require strong board level technology management.

Good IT management does not mean becoming a technologist, although future board members are likely to have spent part of their career in the IT function. It does mean ensuring there is a management process to reduce technology risks - many of which stem from abdicating decision-making to the IT function.

It also requires good technology leadership to ensure that creators and supporters of new technology feel sufficiently valued to stick around.

I first wrote about this (again spurred on by one of Mr. McCormack’s articles) almost two years ago. Unfortunately some of my optimism then was probably misplaced (or at least mis-timed) - I’m not sure we’ve made much progress on this front since then; David Yu’s rise to become the CEO of Betfair (in January 2006) still seems sadly to be very much the exception…

When I am investing, this is one of the first things I look for - does the management understand the strategic importance of technology to their business and if so how does this translate into how they run the business. Not surprisingly, my personal portfolio has a strong bias towards private companies who in my experience are often much further along in terms of embracing technology as a core pillar of their strategic discussion. All to often, many executive and non-executive directors of large public companies see technology as the bit that makes sure their Blackberry is working (or for the true traditionalist - that makes sure their secretary’s computer and printer works so that important emails get printed in a timely manner…)

I hope there are more signs of progress on this front over the next two years. Ultimately, I think it is inevitable but it might well take a generational switch in the boardroom before we see significant changes in approach or attitude. In the mean time, this offers a great window of opportunity for companies and leaders who are willing to embrace this line of thinking now.

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The march of consolidation in the financial exchange sector continues unabated, with the CME’s bid for NYMEX just the latest (and almost certainly not the last) in a long line of deals that started in earnest a couple of years ago. (Hmmm…not long after AmazonBay hit the scene…) With a valuation of $11bn being bandied about, the smart folks over at General Atlantic (a firm I admire very much and whose many investments in the financial services space indicate a vision that will be familiar to readers of this blog) must be yet again chilling the bubbly. Recall they bought a 10% stake in NYMEX just 2 short years ago at a valuation of $1.6bn. Great trade.

But while the exchanges become fewer and bigger (like the banks and insurance companies before them), do they necessarily get better? Some elements of their business clearly lend themselves to economies of scale, but at what point to these come at the expense of dis-economies of complexity and bureaucracy? (Not to mention anti-competitive concerns…) But very few CEO’s or Board’s are predisposed to cellular division, a path of inexorable growth and consolidation is the default strategy in most industries. Which of course leaves lots and lots of room for innovative and unencumbered entreprises to bubble up in the shadows of these giants. Not such a bad state of affairs.

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In the wake of the current wave of turmoil in banking and financial markets, much has been said by the great and the good, politicians and businessmen alike, on the need for ‘greater transparency’:

(from bbc.co.uk) …The leaders of Europe’s biggest economies have called on financial institutions to improve transparency in all their activities…Mr Brown said credit rating agencies, that assess the risks of financial instruments, needed to increase investors’ understanding of complex products…[President Nicolas Sarkozy said,] “We can’t let this lack of transparency jeopardise growth.” …”We need to have more transparency on the valuation of these new, very complex financial instruments,” said Ms Merkel.

(from the Guardian online) …Mr Ackermann said the industry needed to improve its risk management, review the role of off-balance sheet conduits and special investment vehicles, find better ways to value complex products, look at the role of credit rating agencies and improve its transparency.

Ahem…

I don’t want to say I told you so, but let’s just say that when I wrote this article in June 2003 (!!!) it didn’t get a resounding reception from the industry:

…In a world where competitive advantage was predicated on the ownership and exploitation of scarce and guarded information, it is only natural that investment banks built cultures of secrecy and fiefdoms as these rules were also applied within the organization.

This is perhaps the most challenging of changes that must be faced as it goes to the core of how many bankers define their self-image: I ‘know’ this fact, I ‘know’ this person (and you don’t!)

It also touches a sensitive nerve with respect to the ideal of a bank as the ultimate secure repository, the guardian of trust and confidentiality. While it is clear that any bank that wishes to remain in business must protect the trust and the contract they have built with their clients and customers, it is equally clear that they must marry this legacy with a future where the value of information is transitory, and even then only insofar as it can be processed and leveraged at speed, more often than not in real time.

The only way that this can be possible is to throw open the gates and embrace transparency. Rather than worry about who knows what, worry about who doesn’t know and what it is they don’t know.

Funny that “new model” I described in 2003 looks suspiciously similar to Web2.0 meets Wall Street…

So what is the moral of the story? Read the Park Paradigm! You just might glimpse the future…

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It’s become a bit of a truism in some circles that water will be one of the largest markets of the 21st century. So it is heartening to read stories like this one about a town in India:

…Kundapur, a coastal town in Karnataka has decided to privatize it’s water supply. To summarize, so far, this town was dependent on ground water. Now, they are getting water from the river Varahi. Residents have to pay Rs. 4000 for the connection (half of that refundable), and the monthly bill will come within Rs. 100, they’ve said.

…Of course, there is still a long way to go. The private partner who will handle the operation and maintenance is yet to be selected. There are also bound to be a large number of protests against the privatization itself. The TMC needs to get past that. Also, it seems to be the first time when such an exercise is being conducted in the country. So, other hurdles also can’t be ruled out.

Nevertheless, this outsourcing of operation and maintenance of water supply is a welcome concept, and if implemented and priced in the right way, might become a model to emulate in the rest of the country.

And to read that finally, we might see metering of water in the UK. The irony is that while many services that provide an abundant resource - ie voice minutes - continue to be ‘metered’ while scarce resources -ie water - are sold on a ‘all-you-can-eat’ basis (or worse, given away for free…) The rectification of this unnatural state will be one of the key trends of the next several years. It’s not hard to figure out really:

ABUNDANT => flat rates (reflecting fixed costs only, tending to free)
SCARCE => metered (reflecting supply and demand, and any externalities/substitution effects)

…a good rule of thumb for governments and business people in any market for goods and services.

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I’ve written in the past about my belief that a number of innovations in business are likely to originate in the developing world only to be exported and adopted in the developed world in the coming decade, turning conventional wisdom on its head. My thinking on this tends to revolve around businesses in the developing world harnessing the power of cheap and ubiquitous communications and computing (ie mobile phones) to develop innovative, robust, low-cost business models driven by (1) the need to deliver products and services profitably at extremely low (by developed world standards) price points, and (2) the lack of inhibitions with respect to thinking outside “established” ways of approaching markets and customers.

Although manufacturing - and especially auto-making - lies outside the field of my interest and expertise, this post from the Indian Economy blog highlights the new Tata Nano as an example of exactly the phenomenon I subscribe to above.

In summary, the Tatas look set to become the dominant player in the Indian car market via the new market segment established by the Nano. If allowed to compete on fair terms they should take this new segment to other developing countries too.

Will the price USP help it in developed countries though? In the United States there is a huge market for cars costing less than $10,000. Small cars were always popular in Japan and are catching on big-time in Europe too. There are lots of people even in the first world who cannot afford new cars. So there is a huge market in the biggest car markets in the world for a strong price warrior. The Nano was not made for these markets but the huge price difference it has with the cheapest cars in those countries offers plenty of room for redesign. Do you hear someone say that is impossible? Really – “impossible”?

Update:
It seems I’m in good company…

(from Fortune) …To stay ahead, Immelt is pushing GE hard into an advanced phase of globalization he calls “in country, for the world.” That may sound like some celebrity ditty composed for Live Earth, but Immelt is quite serious. He believes that by figuring out how to meet demand in these still relatively poor growth markets, he’s going to achieve hard-to-imagine price breakthroughs. And here’s what’s truly radical: As GE and others do this, these products won’t just be sold in emerging markets. Instead they’ll filter back into the rich economies - a new deflationary force that should delight buyers but devastate competitors who lack a global footprint.

Examples? “Water,” says Immelt. “There’s a shortage everywhere, even in places like California and Florida. Some systems we’re working on in the Middle East, India, and China are trying to do water desalination at $0.001 per milliliter, which is an off-the-charts low cost. We’ll never hit that in the U.S. But we’ll hit it someplace outside. And the second we do, a huge market is going to open up inside as well.” Immelt sees the same thing happening with coal-sequestration technology or MRI scanners, where GE is working on a product in China that could cut prices in half. “At the right cost point, you not only sell it in China, you open up a market among the 35% of U.S. hospitals that today cannot afford to have an MR scanner,” he says. “We’ve got 15 or 20 projects like this that are going to open up big markets around the world over the next five years.”

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After seeing this video tonight for the first time, I’m willing to go out on a limb and predict that Barack Obama will be the 44th President of the United States:

Armed with this new certainty, of course the first thing I wanted to do was to back him in the ‘Next President’ market on Betfair where he was trading at 2.80 (which by the way makes him currently the favorite in this market.) However as I am currently traveling in the US, Betfair doesn’t allow me to access my account. This of course is due to the ridiculous and hypocritical US anti-gambling statues. Very annoying. So now I have to wait until I’m back in Europe and hope the price doesn’t move against me. I’m pissed off with Betfair, even though I know it’s not their fault… Can we change this? Mr. Obama I hope your answer will be:

Yes, we can.

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As a result of some of my recent thoughts on how markets for (live event) tickets should work, I was pointed in the direction of a new start-up called yoonew:

yoonew is the world’s first futures exchange for event tickets. We have created a dynamic marketplace that helps online consumers save money and time when buying and selling tickets. Our real-time trading platform gives fans, traders, and resellers a safe and transparent place to trade tickets.
We are passionate about leveling the playing field and creating a fair marketplace where everyone has equal access to tickets. Our team focuses on building new product features that will bring transparency to markets where pricing information is not universally available. We help customers make more informed purchasing decisions so they are confident that their purchase or sale concluded at a fair price.

TechCrunch did a write-up in early January and they got a lot of coverage in the run up to the recent Super Bowl game:

I’m not 100% convinced that they’ve nailed it but it is certainly a very interesting step in the right direction in terms of introducing modern (and useful) markets technology into the historically moribund market for live event tickets. Essentially, they are selling call options on tickets to major sporting events. Moreover they have taken an original and clever approach by - at least initially - focusing on major sporting events (like the Super Bowl) where the terminal value of the underlying is different depending on the buyer. ie If “your” team gets through to the game, the tickets are of more value to you. Of course, with a properly functioning secondary market (irrespective of whether on yoonew’s upcoming secondary exchange or another market - StubHub, etc.) financially this should be irrelevant - the ‘market’ value of the tickets depends only on the clearing price of the event once the participants are known. (ie Super Bowl tickets on balance will be worth more if two teams with big, passionate fan bases are playing as opposed to two teams from smaller markets; NY v New England more valuable than Kansas City vs Detroit for example.) So a ‘rational’ trader would try to buy the cheapest options - not necessarily the option on his team, especially if you could re-sell the option before delivery. (I’m not sure this is allowed, if not it should be.) Nonetheless, the (marketing) focus on ‘real’ end buyers (people that hope to take delivery, rather than just make a financial profit) is a good angle as it plays to the psychology of ‘hedging’ rather than speculating and should add heterogeneity to their risk book.

Notwithstanding the ridiculous US laws proscribing trading on sporting outcomes, there would also potentially be very interesting arbitrage and hedging opportunities (for both yoonew as the market-maker and their customers) with trading sports risk. For example (using the same teams as above) going long New England and NY to make the Super Bowl to hedge the extra cost of delivering tickets to this pairing (vs a less valuable team pairing.) Or going long the team in the host city (which would also probably be more valuable on delivery if they ended up playing.) I’m not sure if they have any plans to offer markets on European (or global) events - it would have been great for the recent Rugby World Cup, imagine if England fans could have bought (what would have been) cheap options on the final in Paris - but if they did they could use Betfair to manage their price risk today.

Longer term, ideally you would hope that sports teams and leagues would embrace this kind of market to help manage their own pricing risk. Instead of just selling tickets (in the primary market), they could sell options on tickets and use secondary markets to dynamically hedge their risk. For a team that didn’t sell out systematically, it would be a good way to monetize potentially empty seats and even for teams that sold out perennially it would allow them to be more aggressive in finding the ‘true’ equilibrium clearing price for a given seat. For investors it would be another potential (uncorrelated) asset class to trade and invest in. I wonder what the implied volatility curve on the NY Giants season would look like? Gamma trading based on the weekly game results anyone? The question is do the owners and managers of these teams understand how this could work to everyone’s benefit or will they stick to the old model of static seat prices and unoptimized revenue management?

I hope yoonew succeeds and helps to develop a more enlightened and efficient market for tickets in live events. One to watch.

Update:
All About Alpha has a look at yoonew.

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