We need to do Better
Beta is doing the basic job. It is “Meets Expectations”. It is acceptable performance and adequate returns for the amount of risk taken. When you hear about pure execution, about putting your nose to the grindstone and getting S*** done, about Message for Garcia and not goofing up, you are hearing about Beta. It is “Practice Makes Perfect”, “करत करत अभ्यास ते, जड़मति होत सुजान| रसरी आवत जावत ते, सिल पर परत निसान||”. Most of the activity in the world requires Beta. The Tortoise is Beta. But also, the Hare shows why Beta is rare — there are 10,000 ways to screw up and only one way to not.
Alpha is outperformance. It is “Exceeds Expectations”. It is the reverse swing. It is innovation, it is the new, it is celebrated. It is Archimedes destroying the enemy fleet by focusing concave mirrors at it. It is the Big Short. It is the use of the PHL licence by Uber in London when you are a black cab driver. It is the final perfection of the steam engine by James Watt. It is the final discovery of the best filament to put inside a luminescent bulb. It is the glamorisation of a totally commoditized category of product like MP3 players by a washed-out has-been bailed out of his ignominy by his most hated frenemy. It is very often, NOT the first inventor who achieves financial alpha. To the losers in the contest, it feels like the winner cheated, but they cannot exactly explain what rule he broke. In the end, they settle for the conclusion that he is no gentleman.
Ambitious people playing with Other People’s Money often aim for Alpha but the goddess of Alpha is fastidious about whom she favours. Those whose professions require sustained generation of Alpha find after some success that she is also fickle. One way that those who have found themselves unable to generate sustained alpha have continued to thrive is by simply taking additional risk, by taking on leverage, by doing carry trades, by being heroic, by harnessing and goading themselves beyond safe limits, or simply finding a Hit Formula like LTCM’s liquidity arbitrage or Bhai’s Eid blockbuster and churning out progressively larger and larger versions of it in new and non-similar territory. This is Leveraging Beta. However, when too many risks are taken, carry trades explode, currency and financial crises result, mines get waterlogged, battalions ride into storms of bullets and get slaughtered, derivatives trades result in billions of losses, embedded puts in FDI get exercised, and the sting in the tail of Leveraged Beta bites.
Generating beta is assumed to be a given. This assumption is made by the same set of people who believe that markets are efficient to some degree, if not to the ultimate degree. Most of these people have been students or teachers all their lives. They are very, very smart. They don’t trade, they don’t labour, they don’t take financial risk. They have tenure. They consult, rather they are consulted. They take fees. Personally, they generate alpha. The other smart people in economics, finance, entrepreneurship and anything moderately innovative in the developed world also operate at the margin, generating alpha, even if they don’t believe in automatic beta or market efficiency. Most people who surround and support this innovative cream are smart enough to know 90% of the story. The intellect of the cream contributes the 10% that changes outcomes. They play their 2 cards in Texas Hold’em to produce a 5% hand-win rate, but a 99% dollar-win rate. They scan the periphery, the boundaries of knowledge, accumulate the visions from similar occupants of the crows-nest and correlate, evaluate, ratiocinate and illuminate. The more marginal the things someone knows in the developed markets, the more unique the value they can generate and add. They generate alpha, outperform benchmarks, generate supernormal profits, widen markets, create new products for latent demand and take products to places no one knew they were needed, often tweaking price and formulation/wrappers. Looking at what marginal folks are spending their marginal time on is actually a design pattern for one of the top VCs on the planet.
For the smartest to focus on alpha makes absolute sense assuming good, hard-working people are working on the beta. In the developed world, infrastructure, medicine, healthcare, education and standards of life were at least adequate and always progressing rapidly if not awesome in an absolute sense in the last few decades. There always was a fundamental base of economic activity on top of which the alpha-generators could operate. So, despite all the hand-wringing about the smartest students working on finding ways to get people to installs more apps and click on more ads, at least the world was not stopping in its tracks. Progress has stopped and infrastructure has decayed for decades even in the western world, which does allow the opportunity for full stack startups in the developed world, but that is not the point of interest for us here.
The point of interest is developing markets, where this has always been the case. There is no base of beta on which to build alpha. There is only the full stack startup to be done because practically no layer of the stack exists. For the smart people here to focus on generating alpha is to miss the biggest elephant of opportunity in the room.
Even if you buy a Porsche in Gurgaon, it will travel at the same 30 kmph. The way to travel fast is to build roads or rail tracks or helipads. The way to get people to buy a lot from you is not to get stuff into their houses (whose cost kills you without locational AND temporal density — three people living close together must be ordering from stores that are close to each other at almost similar times, with not too much time taken to get past … literally… gatekeepers, when moving from one to the other, for you to achieve any economy of scale comparable to the delivery boy of the local store), but to get it near enough to them that they can leave it all to you. The way to go from 50 million to 500 million is not just TVC but probably vernacular apps+site, own warehouses, own logistics, own IndiaPost, own shops and own correspondent ecommerce assistants+bankers+postmen+village_level_entrepreneurs, not just a faster website. The way to build a transport infrastructure in Bangalore is not to build a point to point car/ride-share service, but a higher-coverage alternative to the metro. The way to provide lending to the good, but poorly evaluated borrower is not to build a lending marketplace but an NBFC.
The common response to this is, “We are tech people. We are engineers. This is physical stuff. The software is quick to build. It is an easy option — if it picks up, we will push, otherwise we will pivot.” All well and fine, if you like that sort of thing, but who do we think built the bridges, tracks and roads in the Western world? Bureaucrats? And if the response is that computer programmers are a different variety of engineer and can’t get hands dirty, well, they are also businessmen, and businessmen must do what needs to be done. Because there is no one to outsource to at a reasonable cost.
In the world of returns, we cannot have alpha before you have beta. And if God landed us in a geography where beta is not done, we must rejoice at the opportunity. Otherwise, we will be yet another generation of a country with an employable pool of 300 million unskilled and semi-skilled, which will take pride in creating something marginal like the IT revolution with its 3 million highly skilled jobs.
The pride will be entirely justified.
But we need to do beta.