He is a management thinker. Tarun Khanna is Jorge Paulo Lemana Professor at Harvard Business School, where he has studied, and has worked with multinational companies and investors in emerging markets worldwide. He has served as the head of several courses on strategy, corporate governance, and international business targeted to MBA students and senior executives at Harvard. He serves on the board of India's largest microfinance company, SKS Microfinance.
Khanna recently wrote a book, 'Billions of Entrepreneurs: How China and India Are Reshaping Their Futures and Yours'. But we are here to talk about his latest book which he has written in collaboration with Krishna Palepu, 'Winning in Emerging Markets'.
Senthil Chengalvarayan, Khanna redefines emerging markets and speaks about the challenges posed by institutional voids and how to manage them.
Below is a verbatim transcript of the interview. Also watch the accompanying video.
Q: When you talk about emerging markets (EMs), who is this book written for? Is it people, for anybody wanting to enter in any EM or are there some EMs more equal than others that you are looking at in this book?
A: All of the above and some more. It is meant to speak to anybody who has an interest in understanding what is going on in the EMs around the world and to provide a conceptual map, so they can begin to understand their way around the opportunities and pitfalls in these EMs.
Q: It?s a very large universe - when I read through the book, I find tables that seem to lump and this is no disrespect to some of the countries, a Korea, a Brazil, a China and India in the same basket as say a Nigeria or a Pakistan. So it's a very broad basket?
A: And I would make it even broader. I would put in United States in that also. The reason is that ultimately we are defining an EM simply and I hope powerfully as a situation where buyers and sellers have trouble coming together. And those situations as you saw with the recent subprime meltdown and the mortgage fiasco in the US could happen in developed economies also.
By and large they tend to happen more in the developing economies, the poorer countries which happen to be the faster growing countries today. But there is nothing conceptually axiomatic about that, it doesn?t have to happen in poor countries.
We hope that the part of the framework is in pointing out commonalities across different situations that people may not think are common as well as in identifying idiosyncrasies that are unique to different markets, so that people who start with the framework will have a very concrete Monday morning action plan to say, these are some of the things that I must address if I want to be active and successful in this place.
Q: So when you lumped in the US with this, so you are looking at an EM is somewhere where as you have mentioned later where an institution fails. But what is more important, is it the size of the market, is it growth opportunity?
A: None of the first set. In fact the starting point for this book was when my colleague Krishna and I realized that a lot of the existing definition of EMs were almost tautological. In other words people said that EM is simply one that is poor or fast growing or corrupt or you pick your adjective you wish to use.
Those are fine as descriptions of EMs but they don?t really tell you what the defining characteristic is. They don?t tell you what to do, what the action implication is of a particular situation being emerging or of emerging market A being emerging in a different way from emerging market B.
So the defining characteristic for us is simply the failure of buyers and sellers to either find each other, to have the information of where the others are, or the failure of buyers and sellers to consummate a transaction with each other because they are worried about the sanctity of the contracts, they worry that the other party isn't trustworthy, things of that nature. That is the defining characteristic
Q: You have mentioned that all EMs feature institutional voids and you go on to define three institutional voids that you think are important, that is the absent or unreliable sources of market information, an uncertain regulatory environment and an inefficient judicial system. Is any of this more important than the other?
A: Again it depends according to different countries. For instance the information about financial transactions, information about the credit worthiness, about borrowers and about potential issuers of equity breaks down.
In Korea, even though we think of Korea as being a relatively developed country and a member of the OECD now, whereas the same information is very prevalent in a place like Chile or in urban India. So that particular institutional void is more severe in Korea than in other parts. If you take something different it would be more severe in other places.
So that?s I hope the part of the framework is to say that start with identifying what are the strengths and weaknesses that are idiosyncratic to a particular country and build your plan according to those situations.
Q: Which of these three are the easiest to handle or to deal with?
A: I think it's very hard to say that A is harder than B. The severity of these voids varies from place to place. What's more, it varies according to the nature of the opportunity that?s in place relative to the mechanisms that have emerged to deal with the opportunity. That gap is an issue.
That?s why any time you see a quantum leap in the availability or the opportunity to do something, think about the internet that came around in force in the late 90s or in the early part of the last decade. It was a situation where there were suddenly lots of opportunity for people to get together in a way they hadn?t before and make a business.
But we hadn't figured out how to exactly bring them together, how to make sure that there weren?t scams and frauds going on. So for a period of time while those rules and systems and informal norms were emerging, they were institutional voids. They were voids in how buyers and sellers came together.
Then it took people like all these established names now Amazon, eBay and so on to establishe those norms, as well as regulatory authorities to emerge and say these are the regulations that are needed in place. Now those voids are much less present. That cycle repeats itself anytime there is a big quantum leap itself.
Q: Coming to India, which is the biggest void in India?
A: I have been thinking a lot about this. If I had to pick I will pick two though I would have trouble ranking them. One is the absence of risk capital which is endemically deficient in many developing countries.
Q: Despite a very well regulated capital market?
A: We are not even close. So the capital market is well regulated in spaces. In risk capital, angel finance is starting to become prevalent but still has a long way to go.
Q: And what causing that absence? Is it regulatory, is it legal?
A: It?s missing in most places around the word. So Silicon Valley, Tel Aviv, perhaps Bangalore, perhaps part of Shenzhen area. These are the exceptions and there are a couple of other exceptions.
Q: Are you distinguishing between Indian investor and private equity or both?
A: I think private equity is much more prevalent than angel investing or risk capital. Risk capital is genuinely - some guy comes up to me and says I have a great idea, give me some money and let me bank on it. So nobody is willing to put that cap to that risk because there is no mechanism in place to adjudicate whether this is a good person to allocate money to, whether he or she has been through the ring, to have his idea validated etc.
Q: Could it also be because the angel investor perhaps finds equal returns in a slightly less risky business like private equity? You can get in India at a slightly more mature level and still make your money?
A: That?s potentially part of it. I don?t think we have any good data to answer that question precisely. My guess is though it?s basically people would be willing to put ? there is a lot of capital available in India as you know, it is sitting in large stashes with a set of individuals or set of types of individuals.
Fortunately we have moved away from a situation where it was all under the mattress. So at least it is getting deployed in productive capital formation. But we still haven?t gotten to the point where it is backing untapped human capital which is the one resource that we have in spades, which brings me to this second big institutional void which is how do we get the 400 million people that are locked outside our economic mainstream and have them bridge the gap to come into the mainstream economy. That?s a big set of institutional voids.
Q: Being averse to risk capital is also because the lack of information?
A: Huge part of it.
Q: So are you glad or at least heartened by the fact that the company that you are associated with - SKS Microfinance - has finally gone in and launched an IPO in the sense maybe bringing that thing back into the mainstream?
A: That?s one form of economic inclusion that Vikram Akula and his team of people - no credit to me - has brought into the economic mainstream by enabling productive livelihoods and I think they have done spectacular social service on that front.
There are some newer efforts. There is a company that we are just creating right now called Aspiring Minds which is explicitly in the business of telling companies why should you hire only from ten places, why not 20,000, and it is basically lowering information barriers to getting people into this.
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