Transaction Costs and Competency Development

In 1937, Ronald Coase, wrote an essay “The Nature of the Firm”, through which he introduced the concept of “transaction costs”. Ronald Coase was to later on receive the Nobel Prize for Economics. In economics a transaction cost is a cost incurred in making an economic exchange. Transactions costs are the costs which directly hamper the competitiveness of companies and where all things being equal, would determine the rise or fall of these companies.

So how does one relate the concept of transaction costs to long term viability of organizations? One answer as given by Jeffrey K Liker, in “The Toyota Way” is:

“Base your management decisions on a long-term philosophy, even at the expense of short-term financial goals”

This is an important aspect to be considered by the service industry. The service industry has been growing globally and in many countries represents in excess of 50% of those countries GDP. The Indian IT industry is primarily composed of the services sector. So what is a service and how do we reduce transaction costs here?

A Service has been defined in many ways. One definition has been given in the ITIL Service Design Book; “A means of delivering value to customers by facilitating outcomes customers want to achieve without the ownership of specific costs and risks.”

This is like a caterer providing cooked food to an organization for lunch where the company does not want to set up its own kitchen and hire its own workers to produce lunch, or an Insurance company engaging the services of a BPO to process its claims, or a Telco using the services of a provider to process the paperwork of the millions of clients signed up each year. There are so many other services, like remotely managing infrastructure, or software maintenance work, or even development work.

Efficiencies in all are achieved by better “quality”. Better the quality, lower are the transaction costs. For service providers the quality comes from better equipped people. If the service provider has systems in place to ensure less wastage, or reduced effort in providing services, it is more competitive. To have better quality one needs to understand Peter Drucker’s statement “Quality in a product or service is not what the supplier puts in. It is what the customer gets out and is willing to pay for”. So reading Drucker’s statement, we can take it that quality is developed by creating internal competencies or capabilities which help in reducing the transaction costs and hence improve competitiveness over time.

Further in organizations, one of the supplier’s is the L&D or competency development department. Developing internal competencies is not a one shot affair, but a process of continual effort of time and money in building people. Developing capability happens when you enable people to get a sense of real life exposure through scenario based training. As Confucius said:
“I hear and I forget, I see and I remember, I do and I understand.”

For any company to grow, its people are its strength’s. This is a Maxim, we have heard for a very long time. However the true strength is not in the people alone, but in the “talented and productive people”. To develop people, one needs to see the long term perspective and build in the systems and their associated costs and not take the short cut by having a transactional approach to competency development.

Strategizing Business Continuity

"In Strategy it is important to see distant things as if they were close and to take a distanced view of close things", Miyamoto Musashi

9/11 changed the way we looked at the world, at ourselves and the way we do business. Organizations suddenly realized what vulnerability was and the impact of various factors on business continuity. Over-night BCM or Business Continuity Management became the new buzz-word.

As I read the very recently released edition of Service Strategy, ITIL 2011, I came across some interesting factors related to Service Strategy and business continuity. The first was the identification of strategic industry factors and the second was the management of risk. Some of the quotes were so relevant that they reminded me of a case of a major telecom service provider. It was known for the quality of its voice services.

The ability to provide voice services to its customers were managed by a series of NOC (Network Operating Centres) across the country. Consequently to ensure seamless services for its customers in a very competitive market, a series of contingency plans were drawn up to ensure business continuity.

One of the plans involved the continued operations of specific servers at these NOC’s. It was factored in by the BCM people that some redundancy had to be built into the system in the event of damage or malfunction of key servers. Accordingly a set of servers were setup at an alternate location which would take over in the eventuality that the primary servers failed.

However one particular step to restore functionality needed manual intervention. Accordingly as part of the plan a quick reaction team was designated and this team would take the required action in the event of an emergency. The team members were provided specific mobile numbers by the telecom player to be called when the event occurred. It was thought the team members would be able to respond and have the back-up running in less than 30 minutes, an acceptable risk.

“Everything in strategy is very simple, but that does not mean that everything is easy,” Carl von Clausewitz

Unfortunately tragedy did strike and there was a fire at a NOC in one major hub. Voice Services went down. As per the business continuity plan steps were initiated to get systems up. Unfortunately it took more than 3 hours to get the systems on track.

When the post mortem was done, a fundamental error was seen. The quick reaction team was to respond when the voice services went down. However the means to contact them was through the same voice services they had to restore.

At times strategizing needs a common sense approach and understanding what to do and what not to do.

The Importance of Service Transition

“With the right pricing, a business will lead its field, brand loyalty, have the cash to expand and be highly profitable” - Peter Drucker

In these highly competitive times when businesses are under constant pressure to get the right pricing and reduce Capex (Capital Expenditure) and Opex (Operational Expenses), there is a constant change in service and product lines. To ensure the smooth flow from one service to another, “Change Management” and “Service Transition” play an important role.

While many managers understand the meaning of Service Transition as the addition or modification of planned or supported service or service components and its associated documentation some fail to realize the importance of Service Transition.

One interesting example of Service Transition which provides an insight on how things can go wrong is given below:

On 23 July 1983, an Air Canada Boeing 767-200, flight 143 from Montreal to Edmonton ran out of fuel at 26,000 feet midway into the flight. The Captain with extensive experience as a Glider Pilot was able to land the plane at an unused airport, Gimli, Canada, using techniques normally applied by Glider Pilots with no fatalities. This flight made aviation history and gave the plane its name “The Gimli Glider”.

On investigation by the “Transport Safety Board of Canada” the following was noted:

• The Boeing 767-200 was a new addition in the fleet. The planes had been in service for 4 months prior to flight 143, and the “Minimum Equipment List” or set of procedures had been updated more than 50 times
• Earlier planes had 3 crew members flying the plane, including the flight engineer who was responsible for fuel loads.
• The 767-200 had two crew members, and the duties of the flight engineer had not been adequately distributed amongst the pilot and co-pilot.
• Air Canada had just converted to the metric system of calculations for determining the fuel load, which were done in a complex calculation between volume or the holding capacity of the fuel in the fuel tanks and the weight of the fuel, so that instead of 22,300 Kg of Fuel, the flight had 22,300 pounds of fuel, or about 10,000 Kg.

All these errors got compounded to such an extent that the lives of more than 150 people were put at risk. The conclusion of the review board was this was a result of poorly managed transition caused by a series of corporate failures and minor human errors.

These errors happen so often in many things we do. While for a lot of managers the consequences may not be that dangerous, from a business perspective they could be. Thus an important learning from this is the importance of Service Transition in today’s business where minor faults can be catastrophic.

‘The art of progress is to preserve order amid change and to preserve change amid order.’— Alfred North Whitehead

Lessons from the EC2 Crash

The advantages of utilities is that they are available when you need them and are cheap, as in less costly. They can be turned off by the user at his desire which helps regulate the cost. The reverse is that it can also happen that the utility can get shut off and then you are left in the lurch. It’s like using electricity from a grid, available on demand, metered to your consumption, perfect for business, till it shuts off and leaves you in the dark.

The Cloud has often been compared to a utility service only much safer and robust, available to match your budget and needs so that your business is cost effective and can expand with capital constraints. The fact is that cloud services have been available for quite some time and have been relatively reliable. This perception however, took a bit of a jolt last week, on around the 21st of April when Amazon Web Services’ Elastic Compute Cloud or EC2 had a disruption in services for clients, in some cases for more than 36 hours. There were around 75 sites which crashed because of this outage. Needless to say the clients were not happy with some being at the risk of being put out of business, an event which has happened in previous cloud outages from other vendors.

The EC2 service has been available for more than five years, and has grown over time. The outage happened not because of any internet issues or security issues, which many would have thought to be the key culprits. The fault lay somewhere else, in one of their data centres and an ongoing upgrade there.
For those clients dependent on EC2 or any other outsourced service this again highlights the danger of choosing to outsource services without having a clear assessment of needs and business impacts of failure. It highlights the importance of contingency plans for business continuity.

Outsourcing is a reality and makes business sense. However the question of outsourcing is not just about saving money on a transactional cost calculation basis but a wider overall cost benefit analysis. With passing time organizations need to be cost effective while continuing to provide excellence in their services. No organization will have a monopoly forever, allowing it to charge a premium. It would need to constantly innovate, and reduce its costs of operations.
For this, organizations need to constantly train and imbibe in its people the value of excellence. In the words of Aristotle

“Excellence is an art won by training and habituation. We do not act rightly because we have virtue or excellence, but we rather have those because we have acted rightly. We are what we repeatedly do. Excellence, then, is not an act but a habit.”

The lessons learnt from the EC2 crash are that outsourcing and its implications need to be learnt and that there is no substitute for constant training to provide excellence in service.

“Data Centres-Another Growth Story”

The great communicator, US President Ronald Reagan once famously said that “Information is the oxygen of the modern age. It seeps through the walls topped by barbed wire; it wafts across the electrified borders.” This huge quantum of information available through different means is at the heart of the expansion of data banks available to organizations, governments and the general public. So where does all this information or data get stored?

Data or information is stored in interlinked servers across the world, some in isolated locations and some in server farms or data centres. A data centre is thus used to house servers, computer systems and connected peripheral parts like telecommunications and storage systems. To support its working it is dependent on continuously available power supplies and data communication services.

With the ever increasing quantum of data and consequently data centres there has been an evolution of the data centre industry from a guideline perspective for housing data centres and the business perspective. From the guideline perspective the first major integrated standard guideline for the infrastructure of data centres was the “Telecommunications Industry Association’s” TIA / EIA 606-A “Administration Standard for Commercial Telecommunications Infrastructure” of May 2002. It was followed up by the TIA - 942 Telecommunications standards for Data Centres in April 2005. This was meant for use by Data centre designers in the building development process and covered the following:

• Site Space and Layout
• Cabling Infrastructure
• Tiered reliability
• Environmental Consideration

The tiered reliability mentioned above ranges from Tier 1, which allows upto 28.8 hours downtime annually to the most stringent Tier 4 allowing a downtime of only 15 Minutes annually.

From a business perspective the growth story in India has been quite bright. As per various studies made by the Gartner, IDC and Springboard research the growth till 2014-2015 seems set to be at a rate of upto 39% CAGR (Compounded Annual Growth Rate). Gartner has predicted that the total market capacity would see an increase from about 1.3 Million square feet of data centre space to about 5.1 million square feet in 2012. This figure did not include data centres in less than 1000 square feet area which were numerous as well.

IDC meanwhile predicted the size of the market as 10,000 crores by end of 2011 against a market valued at 6000 crores in 2009. It is further predicted that India has the potential to be the hub for markets in the Middle East, East Africa and Southeast Asia.

One driver for the growth of the third part data centre industry has been the deficiency of skilled manpower and technical skills within most organizations to manage captive data centres and the associated budget constraints. While there are drivers, there are challenges too.

The growth story is just beginning and evolving. It presents enormous opportunities in the IT / ITES space.

Can the Cloud (IAAS) Replace RIM?

“No one would dispute that information technology has become the backbone of commerce. The point is however, that the technology's potential for differentiating one company from the pack - its strategic potential - inexorably diminishes as it becomes accessible and affordable to all”

- Nicholas G Carr, in an article titled “Does IT Matter?” in the Harvard Business Review, May 2003.

Cloud Computing has turned that vision to reality by providing awesome computing power, much as a Utility service like power or water, to be consumed in the quantity and time of ones choosing, avoiding the setting up of substantial captive IT infrastructure.

Thus a question which arises is that would Cloud Services replace the booming RIM business? This is a fear in the minds of many companies pursuing or in the process of pursuing the RIM business. This fear stems from the mistaken belief that the cloud and RIM are interchangeable services.

The cloud is a public access environment albeit with many flavors, typically with multiple customers accessing the same infrastructure. It’s a great service for many small and medium sized businesses which could otherwise never have had the wherewithal to setup sophisticated IT infrastructure. However “Cloud” services can hope to replace captive IT Infrastructure only to a limited extent. This arises due to the following reasons:

a) Legal and compliance issues especially regulatory requirements such as accounting and auditing standards, banking regulation and information provision requirements such as SOX.

b) Data Export limitations. Certain rules like the Data Protection act in the UK and the Data Protection Directive (Directive 95/46/EC) of the European Union prohibit the transfer of personal information of customers outside certain jurisdictions.

Risk Mitigation. While using the cloud is a great way of achieving cost benefits, the downside is the risk associated with having only a single source of service. One of the most famous examples of cloud services, “Saleforce.com” has had its customers locked out of their data during server outages. In 2009 bookmarking site Ma.gnolia crashed and ultimately went out of business.

d) Security Issues: Cloud services face a challenge between making their services user friendly and having a robust security. Since there will be multiple customers using a cloud service, weak password setting at one client could leave the door open for hacking for other customers.

Unlike the cloud environment which provides Infrastructure as a service (“IAAS”) RIM actually allows an outside organization to take care of a company’s own infrastructure. So IAAS is outsourcing the complete IT department while RIM is typically outsourcing just the manpower while keeping physical control of the infrastructure.

Therefore depending on many factors some of them listed above, each of these services (RIM and Cloud) would have their own markets and would not be competing for business. One needs to differentiate the hype from the need.

Opportunities in UID for the Banking and IT Industry

There has been a lot of discussion regarding the UID project and the scope of opportunities which exist for the IT industry in general. I would like to present some opportunities in the IT sector resulting from certain financial and banking growth activities which would be occurring. It is important to look at a number of policies and acts of parliament and the convergence thereof to see the potential for large business applications in the very near future. However to understand this opportunities one needs to see the following:

The Unique Identification Authority of India (UIDAI), was established in February 2009 to own and operate the Unique Identification Card (UID). It is an agency of the Government of India. This authority will aim at providing a unique number to all Indians based on simple biometrics.

The Mahatma Gandhi National Rural Employment Guarantee Act or NREGA is an act passed by Parliament aimed at enhancing the livelihood security of people in rural areas by guaranteeing hundred days of wage-employment in a financial year to a rural households. The outlay for this program is about Rs. 40,000 Crore (About $ 9 Billion) for the year 2010-2011.

One of the aims of the UID project is to enable payments to beneficiaries of NREGA and to avoid embezzlement of funds. Now of course the immediate potential application is to merge telecom applications to provide a means of transferring those monies to beneficiaries. A greater attraction could be to offer complete banking solutions to an untapped population of close to a quarter of a billion living in the rural areas, without access to these facilities..

This is made possible by seeing an RBI directive in 2010. The RBI (Reserve Bank of India) has been stressing on banks to increase their reach in rural areas by a policy of “Inclusive Growth”. By its letter dated 28th September 2010, RBI/2010-11/217, DBOD No. BL.BC.43/22.01.009/2010-11, the RBI has specifically extended the scope of Extension of Banking Services through the use of Business Correspondents or agents to act as banking counters. The RBI is offering incentives in the form of reimbursements for each account opened. By using these BC’s there is huge growth opportunity for banks through the following:

a) They get a cheap source of funds for their banking operations.
b) They get partly reimbursed for the administrative cost they incur while the verification is already ensured by UID.
c) They get to fulfil their corporate social responsibility by reaching out to the rural masses.

The benefit for the IT industry lies in the following:

a) Immediate application development for payment gateways, verification systems and other systems.
b) IT Infrastructure development for these BC (Banking Correspondents). India has about 638,000 villages as per the census of 2001. So even if 10% of Indian villages were to have a BC, we are talking of installing close to 63000 such Banking Counters.
c) It costs more than 1 lakh rupees per month to maintain an ATM. Even if it costs one lakh per year to maintain a BC, we are talking of a huge market in maintenance and support.

The vision is there, what we need to do is ensure the successful implementation of all these directives, which has huge business potential and at the same time could help make a huge difference to society.