Perils of Overtaking Investments

By V Kumaraswamy

There are severe risks attached to investments that are overtaking in nature, even while temptations to make them are high. This is an area that justifies market intervention by the government in the larger societal interest.

An easy-to-understand example is Jio’s launch, which does not introduce a new service or previously unknown product, but essentially an enhancement or more cost-effective solution to an existing demand. It is mostly a differentiated packaging of what was available through Airtel, Idea, Vodafone, etc.
The current wave of investments in retailing, some banking services, building airports in nearby areas, building parallel roadways or expressways are other examples. Jio’s financial engineering and data plans makes it more attractive for customers to switch. It is most likely commercially feasible: Perhaps by incorporating the lessons and piggybacking on other investments, it will generate better margins than previously seen by others—but these are for Reliance.

The problems with such investments are the wide divergence between private returns and net incremental returns at the societal level. Sure, it will attract new customers who couldn’t afford cellphones earlier and, to that extent, the incremental value-addition from investments will be equal at both private and societal levels.

But for customers who switch from other service providers, the two will vary vastly. Some customers may switch for better quality or range of service and, hopefully, their bills will also increase. In such a case, the net difference between their earlier bills and the current may count for net increase in value-addition at societal level (GDP increase). But for customers switching purely for better prices, even measurement becomes an issue.

In all the above cases, the private player will enjoy the full benefits of sales. However, the net value-addition for the sector as a whole after deducting the decrease in sales of other existing players is what the society gets as incremental value-addition. This will be significantly lower than new private player’s income depending upon the degree of substitution and customer switches. While the net value-addition is so constrained, in investments no such adjustments are possible. The returns on investments at the individual corporate level and at the societal level will differ, with the societal return on investments most likely to be far lower. While the former will be higher than the prevailing interest rates (otherwise the concerned corporate won’t be investing in the venture), it will be difficult to be ensure the same at the country level.

This subpar (at country level) investments will sure create problems for lending banks and equity investors. The key question is: Should the society’s savings be invested in such ventures?

If a different division of Airtel had come up with an exact replica of Reliance (even without Reliance coming out with its own), would its board approve it in the larger interest of customers and risk writing off huge standing assets on the ground? Doubtful.

And even where innovation was distinctly better; GE’s Edison fought tooth and nail for continuation of DC current over AC current supply systems being attempted by its competitors, largely to protect its standing investments rather than due to any conviction that DC was less risky for consumers. Many consumer products and durables also have such examples, but they do not create the same societal inefficiencies like in infrastructure or capital-intensive industries.

While consumers should have choice on at least cost, emerging economies can ill-afford such investments. There will be many investments into newer sectors that can deliver far superior returns at national level. We should ideally be pursuing those, rather than ‘overtaking investments’. It is easy for emerging economies to fall into the trap of investing in ventures that individually look attractive, but do not deliver much GDP, growth or employment on a net incremental basis since tested alternatives are readily available elsewhere.

Sure, in a free-market economy, there can’t be any legislations to bar private players from investing in such sectors. But those investments could be mandated to bring in equity to support such investments since the risk is higher due to uncertainties in market share capture, new investments being able to reach planned customer switches, etc. The lending banks could be mandated to insist on a far greater proportion of equity in such ventures. This could be based on net social returns calculations. Banks may also be empowered to require the existing players to bring in more equity on the advent of such investments into the related sector. This may, in some cases, force the existing ones to seek exit by selling out to the potential newcomer. The Insolvency and Bankruptcy Code at least makes exits faster and reduces idling investments.

A certain level of such investments is inevitable or perhaps even necessary for continuous upgrade of services. The sector regulator or banking regulator could perhaps prescribe minimum social return criteria for lending public money in such ventures. Alternatively, the proportion or quantum of funds that can stay invested in such ventures may also be specified.

Turning useless wastes to useful wastes

In Beverly Hills… they don’t throw their garbage away. They make it into television shows.” —Woody Allen.

Indian wastes are ‘useless wastes’. Our consumption habits may have leapfrogged, but our disposal habits are primitive. We mix up useful wastes with useless wastes, destroying the value in the former—you can’t compost paper and vegetable remains mixed with broken glass and plastic pet bottles, nor can you recycle paper mixed with food wastes and electronic remains.
If India has to successfully deal with its wastes, two paradigmatic changes are required in our thinking.
Unfortunately, it is the rag-pickers and the municipal authorities who are made to grapple with the messy problem, without either adequate incentives or resources. The problem has to be back-loaded on consumer product companies who created the non-destructive, non-biodegradable or unconsumed packaging or products and also benefited from it; and instead of trying to segregate mixed wastes, we should prevent it from getting mixed in the first place by appropriate incentives or punishments for compliant or errant behaviour, respectively, at the stage of the mix-up.
If this principle is accepted, (1) all packaging material should also go back to the packager—just like the truck goes back to the truck owner after the delivery of cargo—and they should be made to pay for the costs of such ‘back trace’, (2) what comes into the city and urban centres should go back from where it came, and (3) electronic hardware (which are potential future debris) and packaged food (which comes with non-biodegradable packaging) should be handled at the time of the original sale itself. Outlined below is a system of incentivising segregation at source and the benefits therefrom.

The suggested scheme
1. Every consumer and industrial manufacturer/marketer should be mandated to file their recycling plan or reclamation plan annually, or on a one-time basis. This can be enforced through fines or suspension of licence, till complied with.

2. They should be made to declare on the packaging (where it is multi-layered, on each of them) what value the marketers are prepared to give back to the consumer if he/she hands over the empty containers, cartons, plastics, corrugators, etc, to the point of sale. For example, water bottles may say: “Collect 40 paise against this bottle”. This would help create a ‘waste currency’.

3. Marketing companies should be mandated to collect at least 50% initially, and by the third year if at least 90% are not collected, their manufacturing licence should stand suspended (a similar procedure of disposal to source supplier exists in the Atomic Energy Regulatory Board regulations). The actual collection must be audited by independent entities.

4. To ensure compliance that marketers make efforts to collect back, few things can be done:
–   An upfront deposit with the government can be collected, say, at 3-4% (to be varied based on the biodegradability of leftovers) at the time of manufacture or entry into state or import into India, which can be refunded back based on the percentage collection.
–   Fines on the shortfall at twice the rate will enforce recollection of wastes.
–   Over a period of time, proper price discovery will happen if the enforcement is tight. If competing consumer marketing companies start offering different rates for recollection, it will be a signal to tighten enforcement on manufacturers who offer poorer rates.

5. Marketers may not deal with the wastes themselves. They will locate third-parties to reclaim, recycle, sell to re-users, or incinerators, energy companies, etc. Positive values will be reclaimed by recycling. Reusable material will be sold at commercial values. The rest may be sold to energy or incinerating companies.

6. The end-consumer may not find it worthwhile to go to a shop and exchange the waste currency. Rag-pickers may pick up wastes at the doorstep, and claim the waste currency at a discount and hand it over at sales counters. This will incentivise source-segregation. Rag-pickers should be trained to pick up all wastes and exchange the value of wastes, and dispose of the rest in designated ways.

7. Special shops will emerge that only concentrate on the collection of all wastes for a margin in every shopping mall, street corners, etc.

8. Heavy fines should be levied on selling companies for litters found in the open, which will induce some policing by them directly.
In addition, litter disposal should be made part of the Swachh Bharat Abhiyan.
Forward distribution is highly working capital intensive, requires expensive shelf space, advertising and product promotion, besides hefty retail margins. Wastes being reclaimed do not suffer from any of these. In fact, the total cost (net of recoveries, if any) involved may not be more than 1-2% of the selling price of base material, excluding the manpower involved.

Estimates of employment and benefits
The Indian retail market for FMCG and pharmaceuticals was estimated at $630 billion in 2015. In FMCG, packaging costs typically account for 3-4% of sales value—the costs incurred on packaging on sales of $630 billion (`42 lakh crore) is likely to be about `1.4 lakh crore.
If the fines for non-collection are kept at, say, 4% of the sales value, hopefully companies could be expected to spend at least 2% on recollection (including on wages, transportation, storage and dealing with wastes), i.e. Rs 84,000 crore.
If roughly one-third of this accrues to labour as wages, it is about Rs 28,000 crore. At minimum wage rates of around `300 on 240 working days, it comes out to be 35 lakh man-years, i.e. 0.3% of our population. This is not wayward compared to the reported 0.7% currently employed in South Africa in similar activities, compared to 0.1% in India currently.

Going forward, probably the government’s role would be minimal. It should create the enabling legislation and set-up a ‘waste police’ whose job will be to catch and fine sellers who are not marking waste currency value, people littering, recyclers not completing their jobs, supervisory audit of audits, ensuring manufacturers file their plans, certifying refunds, etc. This ‘waste police’ should be additional trained staff, and not as an adjunct to the existing police duties.
The government can use a portion of ‘funds in custody’ (through upfront deposits) or fines for training and certifying the people involved. It can train people as part of skill development programmes or get originating companies to train them (for automobiles, e-wastes, hazardous chemicals, etc).
Even if compliance starts with multinational corporations and organised sector companies, it could quickly reach 40-50%. It will have a demo effect and lead to others falling in line.