In the world of business, it’s crucial to differentiate between luck and skill. Currently, many entrepreneurs, investors, and policymakers seem to be confusing these two critical factors.
There are two types of market returns in corporate finance: those arising from skill (alpha) and those resulting from overall market trends (beta). A key lesson in business school revolves around cultivating the ability to distinguish between Beta and Alpha.
India’s Remarkable Growth
India’s growth over the past few years (discounting the impact of the pandemic) has been extraordinary. However, people are starting to confuse correlation with causation. The country is booming, business is growing and our portfolios are witnessing a bull run indicating that we are doing a good job of managing market trends. It, however, does not imply that we did it.
The caution here isn’t against leveraging luck but against wasting it. What’s happening in India is not just a once-in-a-decade or millennium event but a once-in-a-lifetime opportunity for the country. India is in the right place at the right time. However, if true leadership is the art of generating alpha (returns from building competencies, hard work, or innovation), we should be concerned as this massive tide (beta) lifts even the weakest boats. Often, the best times lead to the worst decisions.
Challenges for Entrepreneurs
Entrepreneurs have been hiring indiscriminately, seeking sheer capacity without regard for quality. This explosive capacity building, financed by cheap debt (real interest rates at zero) and equity (soaring valuations), has created a mix of zero pricing power in a hyperinflationary environment for employee and real estate costs. The India story is far from over, but even a slight receding of the tide will separate the merely lucky entrepreneurs from those who are both lucky and skilled.
Investor Insights
Investors, whether in public markets or private equity, have forgotten the sensitivity of real estate to interest rates and have convinced themselves that India is a haven of fiscal and monetary policy-making, with high growth and little inflation. Recently, Akash Prakash, from Amansa Capital, highlighted that the recent Bull Run has led to valuation multiples within sectors converging, with leaders and laggards being similarly rewarded. As competition increases, valuations will again diverge to reflect the quality, scalability, and competitive positioning of each company. As Warren Buffet said, “You only know who is swimming naked when the tide goes out.”
Policymaker Considerations
Policymakers have been coasting rather than reforming. Celebrating the increase in the savings rate may be premature because this rise has come from companies, not households (household savings have declined from 22.7% of GDP in FY21 to 18.4% in FY23), while corporate savings have been on the rise. The sustainability of corporate savings is not assured, and it’s too early to declare a change in India’s savings rate trends. However, several factors such as infrastructure, skill deficits, and stretched bank balance sheets mandate attention on long-term policy-making despite the high tide. The focus towards capitalizing on Beta should not make us lose sight of the alpha which will require the implementation of difficult reforms.
Balancing Luck and Skill
While it is a privilege to be in business in India as the country finds its voice, many Indian businesspeople, fall along a spectrum: some believe it’s all alpha (all skill, no luck or timing), some believe it’s all beta (a random walk where skill is an illusion), while others believe the truth lies somewhere in between—a mix of luck and skill.
Regardless of your perspective, one must concur that luck is fickle and the true law of nature lies in building a robust foundation. Even though things are changing for the better, trees still don’t grow to the sky, and hence luck is a gift to be built on, not lived on.
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