Dale Boccabella

The federal government is tipped to be eyeing the online world in a bid to shore up­ collapsing federal tax revenues. This move has more to do with squeezing “little areas” to get more tax, and ensure a surplus – and less to do with redressing unfairness that brick and mortar retailers may perceive.

Australian brick and mortar retailers would love to see a tax on “large” overseas internet sales through a lowering of the $1,000 tax-free threshold. However, given the difficulties of collection, it is not clear that it will help raise much revenue in the short term. While the government could argue that raising the threshold is an equity measure, it would be viewed by many as an exercise in shoring up the federal budget. Indeed, every revenue measure over the next 10-months will be viewed with such suspicion, even if a sound tax policy rationale underlies the measure.

Last week retailers conceded tax exemptions on internet shopping were unlikely to be scrapped, and some now argue it was wrong for them to push so hard for GST to be levied on online purchases. Their push may have alienated their customers, and their advertising campaign made them look largely out of touch. Consumers like being able to shop around for cheaper prices. However the new move as part of the GST review has raised brick and mortar retailers’ hopes again of imposing GST on what are called ‘low-value imports’.

It is going too far to say under all scenarios, it would cost more to collect the tax than it would raise. It will depend on where the new threshold is set. For example, look at the level in other countries where the low value import thresholds (in $A) is in New Zealand: $300; Canada: $20; UK: $30; Singapore $300. The Australian position of $1,000 is way above those. The question is why.

Prior to November 2005, the Australian threshold was only $250. The tax saving and therefore revenue lost to government on a $1,000 purchase is roughly $100. Simply reverting to the old standard of $250 would, at least in theory, bring in a lot of tax revenue.

However, there is little point in having a tax rule for purchases over the internet if there is no practical way of collecting it. In terms of a taxing point or tax collection point, this is very difficult.

Australia could make every online retailer in the world register for Australian GST if they export Down Under. While technically feasible in today’s world of tax cooperation, this is unlikely in the short-term.

More likely would be the imposition to collect the tax on the recipient of the overseas parcel. However the idea of having the purchaser pay tax as a separate transaction would be complicated, create a load of hassle and red tape for ordinary consumers, and is certainly not a model used under the income tax system.

The GST threshold of $1,000 is high by world standards, and lowering it to say $250-$400 is likely to raise more tax. The question is whether there is appetite on the issue among politicians. You would create a load of hassle for every voter that has begun to shop online in a big way, and the government would not be guaranteed a healthy revenue collection.

If the surplus is the goal, there are many better targets for the federal government. For example the treatment of discretionary trusts, uncapped negative gearing, and the continuation of the uncapped exemption on the family home and superannuation payouts. These are crying out for an overhaul that would raise significant revenue.

Regrettably, it appears that these ideas – that have a sound policy reason to them – are in the ‘too hard’ basket at the moment.

Instead, what we are seeing is the government trying hard to “reform” areas where the return to revenue is minor. While this may improve the tax system marginally, politicians should really be looking at the bigger items that are a major source of unfairness and inefficiency in out tax system. This is what the Henry review was all about.

Alas, with the current government majority, politicians of all persuasions seem to be sitting on the fence about tacking areas that are screaming out for reform – which is why GST on internet imports is once again under consideration.

Dale Boccabella is an Associate Professor of Taxation Law at the Australian School of Business.

From the Knowledge@Wharton today blog.

In the wake of President Barack Obama’s victory over challenger Mitt Romney in the 2012 presidential election, KnowledgeToday asked Wharton faculty for their perspective on a number of issues that will take center stage in the days and months ahead.

We posed a number of questions, including:

1. What do you think was the biggest reason for Romney’s loss? What should he have done differently?
2. What was the biggest reason for Obama’s victory?
3. An editorial in The Wall Street Journal suggested that Obama got a big boost in the election from two men: Ben Bernanke and his quantitative easing, and John Roberts, who joined four other Supreme Court justices in upholding Obamacare. Do you agree?
4. The election raised interesting demographic questions. Romney appealed to many white males, while Obama appealed to many Hispanics, Asians, women and African Americans. Does this suggest that Republicans need a better strategy to attract these groups going forward?
5. What should Obama’s strategy be for dealing with the key issues of unemployment, the fiscal cliff and the deficit?
6. Is there any reason to think that the Republicans, who control the House of Representatives, will be more willing to work with Obama to get some of these issues resolved? Can the two parties hope to work together?

Here is what we heard:

Peter Cappelli, director of Wharton’s Center for Human Resources:

“Aside from the tactical issues, the fundamental issue in the election was the role of government. The vote was basically split between those who did not think government did much for them economically and those who thought government either did, or should do, something for them. The Democrat/Republican divide always reflects this issue, but it was much starker this time because the Republican position was more extreme, particularly in the proposed cuts for social services.

“The Romney campaign suffered because its proposals seemed to frighten too many voters who feel they need government protection. The Romney ticket also could not shed the baggage from the primaries on social issues – women’s rights and immigration, in particular – that hurt them with those voters.

“The biggest reason for the Obama victory in my mind was that Governor Romney’s various gaffes shifted the contest from being a referendum on President Obama and the poor state of the U.S. economy to being more of a referendum on Governor Romney. Much of the energy on the Democratic side seemed to be [directed] to voting against the Romney ticket.

“There are a hundred things that made a difference to the election. Certainly if Obamacare had been turned down by the Supreme Court, things would have been bad for the President, but then it was bad for the Democrats when the Supreme Court upheld Citizens United. Quantitative easing appears to be helping the economy, but it has been bad news for the President that none of the other treatments before helped much. A lot of other things could have gone differently that would have affected the outcome….

“The big question seems to be how the Republican party, especially in the House of Representatives, will see their effort over the last four years to obstruct anything that would appear to give the President a legislative victory. The goal of that approach was to prevent the President’s reelection. That did not work. So what do they do now?”

Mark V. Pauly, professor of health care management:

On why Romney lost: “The economy recovered enough to take away his main argument for change.”

On The Wall Street Journal editorial: “I do not see that the court decision on health care reform meant more votes for the President. It kept an issue alive — you need to vote Republicans [into office] to get rid of Obamacare — but that was obviously not an important enough issue, nor should it have been since in the short run, relatively few people gain or lose from health care reform.”  

On dealing with the issues of unemployment, the fiscal cliff and the deficit: “Republican control of the House of Representatives will keep us at the same point in discussing these issues as we were before the election.”

On whether the two parties can work together: “Now that the House knows it will have to deal with the President, I expect they will try to get some things resolved that were held hostage to the election. I think the President has used most of the ammunition he has in terms of executive orders and the like, so I expect the House will pull things their way. We will have some tax increase on millionaires and billionaires, but of course we do not have enough [of them], so that will not help the deficit that much. It will just make Democrats feel better.

“I am hoping this will set the stage for bipartisan tax reform along the lines of the Rivlin-Domenici or Bowles-Simpson [debt reduction plans]. Both have big health care parts to them. I think the election gives cover to Republicans to go along a little.”

Kent Smetters, professor of business economics and public policy:

On why Romney lost and Obama won: “Obama had a better ground game — more regional offices, more effort to get out the vote. Romney also focused solely on jobs without painting a broader picture. He should have channeled Reagan a bit more.”

On The Wall Street Journal editorial: “I don’t agree with it. Money injected by [the third round of quantitative easing] is basically just sitting on bank balance sheets. I think that the [Supreme Court decision on health care], if anything, helped mobilize conservatives behind Romney.”

On the demographics question about Obama’s popularity with minorities: “The election raised interesting demographic questions. Romney appealed to many white males, Obama to Hispanics, Asians, women, African Americans and other ‘minorities.’ Does this suggest that Republicans need a better strategy to appeal to these groups going forward? Romney also appealed to married females. But, yes, the Democrats are effective at class war politics. Republicans need to do a better job of explaining how prosperity is better than envy.”

On a strategy for dealing with unemployment, the fiscal cliff and the deficit: “The ‘fiscal cliff’ is a horrible term. Minus five for Bernanke for coming up with it; minus 10 for still being an old school Keynesian. Otherwise, I like him.

“The real cliff is if we keep focusing on the short run without also addressing the huge budget deficit. The problem with the U.S. economy is not the lack of consumption. We have plenty of it. The problem is the lack of investment. We need to address the fiscal cliff by removing some of the uncertainty about future tax rates and returns to investment. Any proposed solution to the fiscal cliff can’t be short-term and [can’t work without] comprehensive reform of the tax code and spending side that improves the long-run situation as well.”

On whether the two parties can work together: ”No, they will continue to play chicken. Hopefully, however, it will lead to a grand compromise, like the 1986 Tax Reform Act where Reagan and the House Democrats hammered out a deal that was tenable to both sides.”

Mark Duggan, professor of business economics and public policy:

On why Romney lost and Obama won: “A key reason for Obama’s victory is that the economy has been gaining more momentum over the last few months, with unemployment falling below 8% and job creation relatively strong. This may have given voters more confidence that his policies, such as his help for the auto industry — an important issue in arguably the most important state of Ohio — were working. His handling of Hurricane Sandy also probably helped to give him just a bit more support so that he pulled out wins in pretty much all of the states that were deemed battlegrounds.

“While Florida has still not been called, the races in states like Ohio, Virginia and Colorado were sufficiently close that even a small boost might have helped lead him to victory. Plus his victory margins in Wisconsin, Iowa, New Hampshire and Nevada were somewhat bigger than expected. On the foreign policy front, I think most people felt he won the third debate; that may have helped to tip the balance for many voters, too.”

On issues like the fiscal cliff, taxes and unemployment: “As for big things that are coming down the pike, the President will be negotiating with Congress on what to do about the upcoming fiscal cliff. Effective January 1, 2013, there are a set of spending cuts and tax increases taking effect that will lower the deficit by about $600 billion, which is close to 4% of GDP. While reducing the deficit is important, many think that a change in government policy of this magnitude could put the economy back into recession. Thus, it will be very important for Obama to work with Congress to make the right tradeoff between starting to tackle the deficit and stimulating economic growth.

“Certain parts of the fiscal cliff, like the payroll tax holiday (a 2 percentage point cut in this tax for all workers on their first $115,000 in earnings), are very unlikely to be renewed, but others — like the spending cuts and increases in income taxes — are likely to be negotiated. Long-term deficit reduction is also hugely important, with changes needed to the tax code and to entitlement programs.

“The fact that Obama will now be a second-term President may make it easier for him to confront these challenges as he does not need to worry about being re-elected. Indeed, that is why many support term limits.”

Tim Harcourt | The Airport Economist

When you are punting on this year’s Melbourne Cup, have a bit of sympathy for Australian export businesses who have to make their big bets on international markets in the Asian region. Like a good punter Australian exporters have to look at the horse, the jockey, the state of the track, and of course, the odds. And it is not just a flutter for them but a major business decision that will affect their livelihood as well as the well being of those whom are dependent on their business as well.

To help the average race goer understand the nuances of exporting, the following export ‘form guide’ has been produced. 

Horse number one is Great Samurai, representing the Japanese market. It’s a long standing champion, has been written off by some, but still very capable and strong and has helped others develop in the East Asian stable yards through outward investment.

Secondly, there’s New Dynasty, representing China. This dynamic new colt has surprised seasoned punters with his ability to maintain a fast pace, year after year.

Thirdly, Passionate Tradition, representing Korea. This little known but powerful galloper with an industrious approach has revealed new appeal to punters in recent years.

Fourthly, there’s Fragrant Harbour, representing Hong Kong. Known for slipstreaming the colt from China but also an attractive performer in her own right.

Fifthly, there’s Little Dragon, representing Taiwan. She is occasionally overshadowed by her new high profile cousin, New Dynasty, but she’s a tidy performer who has rewarded loyal supporters well over many seasons.

Next is The ASEAN Emissary, representing Vietnam. This is the dark horse of the East Asian field that has put together a string of good seasons in recent years and seems set for even better days ahead.

Next is Taj Mahal, representing India. An up and comer who is twinned sometime unfairly with New Dynasty, but is coming into his own thanks to ongoing reform of stable practices.

Finally there’s Archipelago, representing Indonesia. Had question marks a while ago but had now start challenging the field and becomes am up and coming favourite amongst Aussie punters.

Racegoers should also consider a few newcomers amongst the emerging markets including Arabian Nights from Abu Dhabi in the United Arab Emirates, Samba Fever from Brazil and even a roughy like Genghis Khan from Mongolia, Burmese Days from Myanmar or Boratnomics from Kazakhstan might be good for a place.

So there you have it, your own export form guide for Asia. Fortunately, back in the real world, exporting is clearly not all about luck as much as skill and strategy. It requires good research, innovation, flexibility and good knowledge of your prospective market. And most importantly, the evidence shows that it does pay off. According to economic research, exporters are, on average, faster growing, more profitable and more productive than non-exporters. Exporters also pay better wages; provide better employment conditions and higher quality jobs than non-exporters. In short, exporting is a good bet for both large and small players in the international trade game but you’ve got to be a stayer in the Asian Century.

Tim Harcourt is the JW Nevile Fellow in Economics and an adjunct professor in International Business Strategy, at the Australian School of Business, the University of New South Wales (UNSW) & author of The Airport Economist:  www.theairporteconomist.com.

Associate Professor John Evans

Dr Amandha Ganegoda

The Rumsfeld classification

In the Finsia Journal of Applied Finance in 2008, we used the “Rumsfeld” classification of risks to identify the different types of operational risks and how to best approach each type of risk from a quantification perspective. The Rumsfeld approach characterised risks into:

• known/known (ie, we know the risk exists and we know how to model the outcomes);
• known/unknown (ie, we know the risk exists, but we don’t know how to model it with any reliability); and
• unknown/unknown (ie, we have no idea what risks might exist and, by definition, no idea how to model the risks).

This classification system, in terms of risk management, implies:

• for known/known risks, it is appropriate for the institution to accept these risks and to manage them through economic capital;
• for known/unknown risks, it would be prudent to transfer these risks to another entity; and
• for unknown/unknown risks, these should not be taken on at all, and are best managed by “positive” contract wording that specifies what risks the institution is exposed to.

The Diebold classification

In their 2010 book on risk management, Diebold et al advocated a slightly different classification system consisting of identifying risks as Known (K), Unknown (u) or Unknowable (U), but the implication of this classification system was the same as our Rumsfeld approach.

Both the Rumsfeld and Diebold classification systems are based on the extent of knowledge available as to the occurrence of an event, and how to model the outcome of the event. Under the Diebold system, K refers to situations where there is a broad agreement between experts on the relevant theories and the underlying models, u refers to situations where there is more than one competing theory or a model in which none of them have reached the status of a paradigm, and U refers to situations where there is no theoretical model.

Our extension of the Diebold classification: Ambiguity

In our soon-to-be-published paper in the Australian Journal of Management, we have extended the classification system to include an “Ambiguity” group of risks, as there are situations in which future outcomes are vaguely defined due to ambiguous behaviour of the market participants, but the risks are neither K nor u. In this particular context, we use the term Ambiguity to refer to the uncertainty created by market participants’ ability to respond differently to certain events and circumstances.

Although often ignored, Ambiguity is an important source of indeterminacy, which is difficult to measure and manage like risk, nor can it be reduced by investing in knowledge as for a u-type risk. A primary source of Ambiguity is the ability to understand something more than one way and to respond differently.

Examples of ambiguous situations are surprisingly common. A classic example of how Ambiguity can lead to disastrous outcomes is the highly publicised and controversial credit rating system of asset-backed securities (ABS), which served as a catalyst to the recent subprime mortgage crisis and the consequent global market meltdown. The originate-to-distribute lending model of the banking industry, which has been partly blamed for the subprime mortgage crisis, heavily depended on the ability of the rating agencies to accurately value ABS. Rating agencies used a scale similar to the ones they used to rate bonds to rate the probabilities of default on ABS. It was only later realised that although a BBB tranche of an ABS may have the same expected loss as a BBB corporate bond, the loss distributions of the two are significantly different. Even though the BBB ABS was priced higher than the BBB corporate bond, most market participants failed to notice this due to the Ambiguity created by similarities in the notation of the rating systems. If rating agencies used a different notation from the one they had been using for the bonds, investors might not have made the false interpretation.

Why introduce Ambiguity?

Whereas previously we included Ambiguity risks in the u category, we feel that these risks have significant differences from the u-type risks and that specific attention should be brought to these risks. Our classification would then become:

• K, where we know the risk exists and can be confident of the modelling;
• A, where we know the risk exists, but recognise that there is a range of outcomes, each of which can be modelled, but where we are uncertain as to which outcome will occur due to the difficulty of predicting human actions and counteractions;
• u, where we know the risk exists, but we are not confident of how to model the outcome; and
• U, where we have no idea what risks exist.

Issues remaining

There are still some issues in using this classification system. First, even though we might have a model for a K-type or A-type risk, care needs to be exercised in understanding the model rather than just blindly adopting it, as the assumptions may not be appropriate in all circumstances. Second, in terms of the implications of this classification (as well as the Rumsfeld and Diebold versions), there is a serious problem in that it would inhibit financial product innovation, as most innovation would involve at least u-type and U-type risks. If introduced as part of a prudential regulatory process, it could result in inefficiencies in the capital markets. To some extent, the effect of the introduction of u-type risks could be ascertained by stress testing, but care needs to be exercised in the acceptance of the results as the process is highly dependent on historical experience. Reverse stress testing, where you search for events that would cause insolvency, can also be useful. It may be possible to manage the u-type risk by spreading it across the capital markets so that the impact on any one institution is minimised, but, as the global financial crisis showed, poor information systems may not detect cumulative risks of this type – with disastrous consequences.

There is also another issue with this classification. It may infer that once classified, a risk remains constant, which is not correct, and there is the possibility of misclassifying a risk as a type K when it is in reality a type u. For example, a u-type risk may, with the passing of time, become a K-type or A-type risk, and it is hoped that it will in fact become reclassified and reduce the risk. Also, once a U-type risk occurs, it progresses to become a u-type or A-type risk.

Matching the correct tools to each classification

While the proposed classification system will highlight the differences between risks, it is then important to develop tools for assessing these risk types. History is littered with misunderstandings of what is an appropriate tool for measuring a particular risk. A classic example is that the models based on the assumption of daily market returns are Normally distributed. Using daily returns of the Dow Jones Average, Estrada pointed out that the lowest of the best 10 daily returns during the period of 1900 to 2006 was 8.6 standard deviations above the mean. If we assume that the life of planet Earth is around 4.5 billion years, under the Normal assumption one return of this magnitude or larger should occur every 223,014 lives of our planet; and yet 10 such returns have been observed during the period of 107 years. The degree of the error is enormous, yet the Normal assumption is widely used in the pricing of derivatives, as well as in economic capital calculations. Furthermore, Estrada showed that for an investment made between 1900 and 2006, by not being invested in the best 10 days of the market, the terminal wealth would decrease by 65%, whereas by avoiding the worst 10 days of the market, the terminal wealth would increase by 206% relative to a passive investment strategy. The aggregate outcome – in this particular example, the long-term performance of the investment – is largely determined by just a few extreme observations, and demonstrates the disproportionate impact of the extreme events on the aggregate outcome and the importance of properly accounting for those extreme events. In other words, in contrast to light-tailed risks, the uncertainty of risk measure for a heavy-tailed risk would be largely determined by the ability to accurately estimate the probabilities of the extreme events. The mean and standard deviation hardly provide any useful information.

In dealing with A-type risks, the analysis must be very different from that for K-type and u-type risks. Cognitive psychologists have studied behavioural traits of humans, including herding, framing, mental accounting, loss aversion, overconfidence, conservatism and anchoring. These behavioural traits can often assist to explain (and maybe even to predict) market anomalies and events, such as bubble formations, erratic trading activities, and overreactions to information. A risk manager who pays attention to the cognitive behaviour of market participants will have a better chance of understanding financial markets and their future direction. The findings of behavioural economics show that financial markets and their participants may not always behave rationally. Hence, it is always a good idea to perform a scenario analysis by relaxing the “rational” assumption of traditional finance theory to see what can happen when market participants behave irrationally.

Finally, when dealing with U-type risk, we believe that the focus should be on proactive crisis management. Even though a solid risk management framework will aid in containing risk, unforeseen events would still occur simply because we are unable to predict all possible future states.

Taleb famously defines such events as black swan events. Even though black swan events are almost impossible to pre-identify, this does not necessarily mean that we cannot prepare for an unforeseen crisis. Diebold et al point out that although crisis events may have unique and unanticipated causes, most of the time the required post-crisis responses are often quite similar. Thus, readiness for a known possible crisis can become useful in responding to a surprise crisis situation. For example, several experts have pointed out that the system redundancies developed in New York city in anticipation of the Y2K bug (which never materialised) became indispensable for the fast recovery of the city’s transportation and telecommunication systems after the 9/11 attacks.

The lesson here is that even if one cannot anticipate the nature of a possible black swan event, it is still possible to have some sort of contingent plan in place to assist in a crisis situation. The ability to steer through a crisis depends more on the decisions made before the crisis than on the decisions made in the midst of it.

We identify four important traits a company should have in order to successfully steer through a crisis. First, it is important to have an established process to monitor near-miss events. Monitoring near-miss events can provide early detection of problems, as well as avoid possible future crises. Second, a corporate culture that encourages the reporting of problems rather than the habit of hiding them is vital for early detection of a problem and appropriate response. Third, flexibility of organisational structure is important, since – similar to the evolution of species – only the organisations with flexibility to adapt and innovate will survive while the others will become extinct. Last, but not least, firms need to maintain good public relations and collaborate with relevant parties. Unless firms develop cooperative relationships with their partners, they will not get preferential assistance during either a crisis or an opportunity.

The message

The message is clear: in developing a risk management strategy, it is critical to classify risks according to their characteristics in order to better understand possible outcomes, and then to build models that are appropriate for ascertaining those outcomes. “Shoehorning” inappropriate models into a situation to save costs will lead to disasters, as we saw in the global financial crisis.

John Evans is an Associate Professor and Head of Risk & Actuarial Studies at the Australian School of Business. Dr Amandha Ganegoda is a Research Assistant at the Australian School of Business. This article first appeared in Risk Management Today.

Tim Harcourt | The Airport Economist

The Asian white paper is a great chance for Australia to explore the opportunities our closest neighbours offer us, and education is the key: as it offers great points of engagement with Asia and longer lasting and deeper relationships.

The long-awaited Asian Century white paper was released on Sunday. Ken Henry’s paper covered a broad range of issues including education, language skills, technology and security in the fastest growing region on the planet.

Australia has been earning big dollars through rocks and crops – now we’ve got to do a bit more learning through education and service exports. But I argue that now it is vital for Australia’s trade that the white paper lifts our engagement with Asia, and identifies opportunities for government and business.

Just speaking an Asian language whilst helpful is not sufficient – we need to be Asian business literate, and understand the economies of our Asian partners to succeed in our engagement.

As younger Australians engage with Asia through education and exchange, technological advances and social media, the nature of their relationship with Asia will be different from that of previous generations. Demographic change in Asia will mean more opportunities for Australian services providers in the traditional areas of education and tourism but also in areas focused on wellbeing.

We should be at the forefront of offering financial services to Asia, and Australia could become the dominant financial centre in the region. Australian capability in financial services will be critical in the fourth wave of our economic engagement with Asia, as finance is the fuel that lubricates international trade. Financial services trade volumes picked up substantially in 2011 after four years of stagnation, rising by 22 per cent.

Tim Harcourt is the JW Nevile Fellow in Economics and an adjunct professor in International Business Strategy, at the Australian School of Business, the University of New South Wales (UNSW) & author of The Airport Economist:  www.theairporteconomist.com.

From the Knowledge@Wharton today blog.

Austerity in Spain and most of Europe has failed, according to Wharton management professor Mauro Guillen.

Further proof came this week with the announcement that the Spanish economy’s downward spiral continued, with GDP shrinking by 0.4% in the third quarter — the fifth-straight quarterly decline — and unemployment hitting a record 25%.

Despite the government’s attempt to put off a eurozone-led bailout of public debt, expect Spain to accept terms within two to three months, says Guillen.

In this video, he addresses the question: Have attempts at economic reform in Spain worked on any level?

This post was previously posted in Knowledge@Wharton today blog: Spain Sputters as a Bail-out Moves Closer

From the Knowledge@Wharton today blog.

Skyrocketing sales of tablets and mobile devices have hinted at the notion that desktop and laptop PCs — once the staple for home computing — are beginning to collect dust in many households. And now, the numbers are starting to show that: Last week, Microsoft, a company whose business depends heavily on sales of PCs and related software, announced that its first-quarter net income dropped by 22%, with revenue down 8% from a year before. That followed an earlier report by research firm IDC that global PC shipments fell by 8.6% in the last quarter.

For many observers, such data suggest that the “death of the PC” is imminent. To get some perspective on that grim outlook, KnowledgeToday asked three Wharton faculty members if they envisioned a time when the humble personal computer as we know it will no longer exist.

Peter Fader, professor of Marketing:

Declining earnings at Microsoft are one thing — they are now facing viable competitors when it comes to operating systems and office tools, so that’s all part of the natural ebb and flow of competing firms. But I don’t see any signs of a declining market for PCs. Okay, maybe the forms are changing, but I view a tablet plus optional keyboard as a PC. Maybe a smartphone is different, but anything with a screen that is frequently operated with a two-handed keyboard is a PC in my book, and that seems to be a very healthy growing market.

I predict that the forms will continue to evolve — we ain’t seen nothing yet — but for the foreseeable future, I see strong demand for a device that does the kinds of things that a PC currently does. Microsoft may continue to fade away, and even the mighty Apple will fall, but that kind of device has a very healthy future.

Eric K. Clemons, professor of operations and information management:

“Death of the PC” is like death of the mainframe: Neither is likely to occur, and, indeed, the move to the cloud has made “big iron” [mainframes and servers] more important as a share of global computing, rather than less important. The PC serves a function. Sometimes I do not want to rely on the Internet, as when I am at 37,000 feet. Sometimes I do not want to rely on the cloud, as when I am working on a first draft of a legal opinion. Where we do our computing has for a decade or more been determined by telecom speed, local PC processor speed, need for storage and local PC storage capacity, software costs, and the need for privacy and security. The balance will keep changing. [The young] “digerati” will continue to mock old guys who write coherent emails on laptops instead of sending short tweets from an iPhone. Both smartphones and tablets will have a place, but so will laptops and desktop PCs.

Daniel A. Levinthal, professor of management:

Technologies, even ones that suffer an enormous degree of substitution, tend to survive in particular niche applications. Indeed, while the volumes will shrink, so will competition, and modest margins over modest volumes can be earned.

Also, the definition of the distinct category of “PC” may be (or is getting) a bit blurred. In what ways are the new Microsoft devices PCs or not PCs? Is the definition a function of the nature of the operating system? What fraction of processing is done on the machine versus (via an app) on a server? Is it a super narrow definition which implies a microprocessor made by Intel and operating system by Microsoft?

This post was previously posted in Knowledge@Wharton today blog: Has the ‘Death of the PC’ Been Greatly Exaggerated?

From the Knowledge@Wharton today blog.

Frugal engineering, or the process of trying to reduce the complexity and cost of a particular product, has been fashionable in India for some time now. Today, even as Apple’s iPad, Samsung’s Galaxy and Microsoft’s Surface battle it out at the pricey end of the spectrum, the tablet wars in India are being fought at the bottom of the pyramid.

Prices are falling to very low levels. Canadian company Datawind has launched a $40 tablet, with schools in India being its target market. However, this isn’t Datawind’s first foray in the country. The Indian government ordered close to 2 million tablets, branded Aakash (sky), from Datawind as part of the National Mission on Education. These tablets were priced even lower — with subsidies, they cost $35 for students and teachers. But delivery delays, failure to provide customer support and other problems resulted in the government ending its association with Datawind. The company is now offering its tablets — branded Ubislate — on its own.

Unfulfilled promises might have toned down the hype around Aakash, but Union HRD Minister Kapil Sibal has announced that a new version — the Aakash 2 — will be available for students soon. “Hopefully, on November 11, you will see the President of India talking to 20,000 students from across the nation, who will have their hands on [an] Aakash,” Sibal said at the Economic Editors’ Conference held in New Delhi in early October. “At the moment, we are actually formulating a Cabinet note for the manufacture of five million Aakash tablets without any financial burden on the Ministry of Finance,” he added. Sibal hopes to price the tablet at $35 by setting up manufacturing facilities in India.

The tablet market, traditionally dominated by global leaders Apple and Samsung, is already beginning to feel the heat from local players. According to a Cyber Media Research (CMR) report released in mid-October, Indian company Micromax enjoys the lead in the country with an 18.4% market share. Second is South Korea-based Samsung with 13.3% and Apple with 12.3%. (Market share has been measured in unit shipments between April and June of this year.) Rounding out the top five are local players HCL and Karbonn. All the Indian companies have “affordable” (nobody uses the word “cheap”) devices. The Micromax range starts at slightly more than $100. Apple and Samsung tablets cost at least five times as much.

Other manufacturers have also recently entered tablet territory. The CMR report states that until the second quarter of this calendar year, around 90 vendors had launched tablets in India. The report also says the ASV (Average Sale Value) of the tablets in the second quarter of 2012 dropped to around $240 from $480 in the first quarter of 2012; most vendors have launched their products in the $90 to $180 price range. For example, startup WishTel priced its tablet — IRA Thing 2 — at $120. Noida-based Zync Global has a range that starts at $75. The government-owned Bharat Sanchar Nigam is selling the basic model of the Penta T Pad (manufactured by Delhi-based Pantel) for $75.

According to the report, “Landscape of Tablet PC market in India” released in mid-October by MAIT, the representative body for the Indian information technology and hardware sector, the market for tablet PCs in India is set to grow at 40% every year for the next five years. Last year, tablet sales stood at 1 million units. India is the “new blue-eyed growth opportunity”, says MAIT president Alok Bhardwaj. “[The tablet] is fast becoming one of the drivers of rapid growth in the IT content consumption and hardware sector in India.”

But does frugal engineering work for technology products? The “affordable” car — the Nano — is selling below expectations. The Simputer, a hand-held computer developed in 2002 for India as a low-cost alternative to PCs, was a disaster. Priced at $230, it was too expensive for the rural consumer. There were technological glitches, too. But frugal engineering seems to have worked for sectors including cell phones and printer cartridges, however.

Faisal Kawoosa, lead analyst for telecom at CMR notes that low-cost tablet vendors “have tried to put in everything in terms of features and functionality — even those not present in Apple. For instance, [the tablets] have USB slots. But whether that is working well performance-wise is a question mark. It is too early for us to judge.”

This post was previously posted in Knowledge@Wharton today blog: Tablets in India Take to Frugal Engineering

Dale Boccabella

There are changes to taxation law, which are being introduced as part of the Mid-Year Economic and Fiscal Outlook. Company tax, the baby bonus and private health insurance are being targeted by the federal government.

The budget has lost $3.9 billion in tax receipts for this financial year since the May budget and $21 billion over four years. In particular declining commodity prices have led to a crash in forecast receipts from the mining tax from $13.4 billion over four years to $9.1 billion. As a result, the government has increased some taxation.

Corporations will have to pay company tax monthly, rather than quarterly. While this will ensure that instalments are closely aligned to fluctuations in these businesses’ income, it isn’t exactly going to be helpful to firms which are already struggling under a bureaucratic workload.

On the cuts to the baby bonus from $5000 to $3000 for the second and each subsequent child, this is a relatively minor item for the government – however it will impact on parents. Expensive items such as the cot, pram, change table and baby capsule can sometimes be reused for subsequent children, but they are often hit by other costs.

There are changes to private health insurance starting in April 2014. This will increase the cost of all premiums. Under the latest round of cuts, the government’s 30 per cent rebate will no longer automatically be increased to match the annual increase in premiums. Instead the rebate will be indexed to inflation, which is normally less than the premium increases. There’s a double whammy too – if the premium increase is less than inflation, the rebate will be indexed to that.

We already saw increases in the May budget. At the time, the government means-tested the private health insurance rebate, which will save it about $2.8 billion over four years. This further measure will save $700 million over three years. For those people who thought they had escaped by being under the private health insurance means testing limit, they will now be hit by having the rebate indexed to inflation. However I expect this measure may put a bit of pressure on the funds to try and cap their premium increases.

Dale Boccabella is an Associate Professor of Taxation Law at the Australian School of Business.

From the Knowledge@Wharton today blog.

The often oddly illogical behavior of insurance buyers and sellers has long fascinated Wharton health care management professor Mark V. Pauly and his colleague Howard Kunreuther, Wharton professor of operations and information management.

During their decades-long collaboration on market studies, the two compiled notes on the ways that insurance companies, consumers and regulators get it wrong — Pauly describes it as “a rogue’s gallery of insurance anomalies.” That collection ultimately became so substantial that they turned it into journal articles and then into a book titled, Insurance & Behavioral Economics: Improving Decisions in the Most Misunderstood Industry, to be published in December.

Why “misunderstood?” In an interview in the LDI Health Economist, a publication of the Leonard Davis Institute of Health Economics at the University of Pennsylvania, Pauly identified some of the reasons insurance buyers and sellers misconstrue each other’s intentions and responses so frequently. Topping the list is consumers’ widespread uncertainty about predicting risk or estimating probability, and a time-lag sense of entitlement to things that weren’t actually purchased in a transaction.

“Insurance is a contract where you pay your money up front and then whatever you’re going to get from it, you get later on,” Pauly said. “But just like a pre-paid vacation, that can be a recipe for frustration: People arrive at the hotel and believe they are entitled to free Mai Tais even though the fine print of their confirmation says they’re not. The thing I think people do understand — but want to pretend they don’t understand about insurance — is that if you didn’t pay for it and it was not specifically in the contract, you’re not entitled to it. Once consumers have paid their insurance premiums, many really do want to think they’re entitled to be paid for anything bad that happens to them.”

Insurers, Pauly said, “have just the mirror image. They see themselves as promising a certain number of things for a certain amount of money; and if you didn’t pay them for it, they shouldn’t be required to deliver it to you.”

However, he pointed out that the book doesn’t just target consumers’ foibles. “There’s plenty of blame, stupidity and irrationality to go around” for insurers and government regulators as well, he noted.

“We’re aiming this book partly at scholars and partly at people in the insurance industry who are sometimes inept in explaining what they do and why,” Pauly stated. “We say, ‘You’re often as irrational as consumers even though you have much more at stake.’ Hopefully, the book will make insurers think more carefully about what they do and also give them a little bit of defense for some of the things that need to be explained to consumers, regulators and policy types.”

Another goal of the book is to establish a benchmark for good insurance performance, then explore how various markets succeed or fail at meeting that benchmark.

“The majority of insurance dollars spent in the U.S. are spent in markets that are functioning fairly reasonably, but there are some markets where it’s totally nuts,” he said. The book makes an effort to compare the two different kinds of markets to identify characteristics that predict potential problems…. The book not only discusses anomalous insurance markets, it also discusses non-anomalous insurance markets because it wants to identify the characteristics that tend to predict anomalous behavior.”

One of the markets the authors scrutinize is health insurance, and their conclusions may surprise many.

“I don’t feel as bad about health care insurance after writing this book as I did before,” said Pauly, “because compared to a lot of other insurance markets, it’s not nearly as messed up. The kind of insurance sold even before the Affordable Care Act [ACA] provided pretty good coverage against low probability catastrophic events, which, in this case, is the potentially bankrupting circumstance of becoming a hospital in-patient.”

Health insurance performance behavior “was better than other kinds of insurance,” he said. “For instance, in terms of flood insurance, a consumer could say, ‘It will never happen to me because I haven’t seen a flood in my neighborhood in quite a while.’ But they do see catastrophic health events often enough to know that these aren’t that low a probability. So, from that point of view, health insurance looks better than average.”

One of the things the ACA is trying to address is that “if you buy your health insurance as an individual, there are really high administrative ‘loading’ and selling costs,” Pauly pointed out. “But the percentage of that for health insurance is about the same as other kinds of insurance people buy as individuals, like auto collision or homeowner coverage. That doesn’t mean it’s either bad or good. It just means that the imperfection and waste in the individual insurance market isn’t something unique to health insurance. It seems shared by virtually all insurances that people buy on a one-on-one basis.”

Pauly notes that many economists have their doubts about the ACA’s health insurance exchanges – competitive marketplaces designed to allow patients to buy insurance directly from a pool of different health plan options. He tells an economist joke to make his point: An economist and non-economist are walking down the street when the non-economist says, “That looks like a $20 bill over there. Why don’t you go pick it up?” But the economist keeps walking. The non-economist asks, “Why didn’t you go pick it up?” The economist says, “Don’t be ridiculous. If it was a $20 bill, somebody would have already picked it up.”

The moral, said Pauly, is that economists often suspect that if something isn’t happening, it shouldn’t; if exchanges were a good idea for individual insurance, wouldn’t there already be automobile insurance exchanges and homeowners’ insurance exchanges and life insurance exchanges? So how much can they add for health insurance?

But he is keeping an open mind. “I try not to be an economist one day a week,” he said. “Then I say there might be some good new ideas in the exchange concept, but they will have to be invented from scratch.”

Another focus of the book is “deductible aversion” — consumers’ tendency to automatically select insurance plans with the lowest out-of-pocket costs, despite the premium reductions from reducing coverage a little.

“The typical homeowner’s policy,” said Pauly, “will have a US$500 deductible. It turns out that if you bumped up that deductible to $1,000 or $2,000, the amount of premium you could save is generally much more than anything close to the average amount more you would lose in benefits. But people just like low deductibles.”

Ditto in health insurance, he said. “Many consumers and most policymakers are wary of increasing deductibles. But there’s a camp that believes that a more rational health insurance system would be one with high-deductible health plans of the kind that are, at the moment, winning the marketing battle in the group market. We will have to wait and see what kind of rationality or irrationality wins out.”

This post was previously posted in Knowledge@Wharton today blog: When Insurance Buyers and Sellers Speak Different Languages