Delivery not distribution: Service versus Product!

V Raghunathan has been a prolific author, banker, columnist and corporate executive.An accomplished chess player, a gifted cartoonist, perhaps the largest collector of ancient locks and padlocks in India and much more. Anyone who wishes to get better insights into his seminal thinking and his versatility ought to visit www.vraghunathan.com.

I saw him recently post the launch of his latest book “Ganesha on the Dashboard”. Raghu brilliantly portrays how educated, smart and tech – savvy, Indians can be surprisingly unscientific in their daily lives. Take the way we go about buying a new car, he says, and goes on to elaborate. We identify an auspicious date and time, then proceed to break a coconut, plonk a plastic deity of Ganesha on the dashboard, and zoom off at a great speed, refusing to wear our seatbelts. Like we refuse to wear a helmet while driving two-wheelers. I was tempted to add – just the way we refuse to protect our boards without caring to protect them by availing a Directors & Officers’ insurance. More on that when we deal with issues in corporate governance.

Here are some very candid and perceptive responses by Raghu to my explorations into Delivery not Distribution:

Q: As an eminent Behavioural Finance expert do you see a disconnect between the distribution and delivery approach in financial services?

A. Yes there is. This disconnect is the same as the one arising from treating financial services as products. For instance, while we call mutual funds or insurance as financial services, the fact is the industry willy nilly markets them as products. Even an insurance-linked savings “product” is sold for its superior returns, as is a Mutual Fund, for example. We often see claims to being No.1 Fund of the Year based on returns and rarely based on service. Terms like financial products, financial agents, financial engineering, or even financial technology continue to create a product myth around what is essentially a service. Once the industry comes to terms with the fact that it is predominantly a service sector (never mind that the sector is in fact called Financial Services) and not a product sector, the misunderstanding between service delivery versus the product distribution will be automatically resolved.

Q. To what extent should distribution, predominantly borrowed from the FMCG industry, be reigned in within the confines of financial services?

A. My short answer to your question is this: Yes, there is a crying need to reign in the tendency to distribute, nay push down the throat of the innocent investors, suspect products, when what the investors need really is deliver of high quality service.

But let me also give you the long answer. The tendency to productise services is so strong in the Financial Services industry that even Insurance Sector, with respect to which there should ideally be far less confusion as to whether it is a product or a service, is increasingly trying to posture itself as a financial product. One would think for example, that insurance is essentially a risk-mitigating service for a fee. The service is to protect folks from financial ruin in case an event of small probability carrying huge loss were to happen. And for this service, folks pay a fee, or a premium. This service becomes all the more delicate because often the culmination of the service is linked to some sort of tragedy, calamity or some other unsavoury event. But unfortunately, this is also a service, where if the disastrous event did not happen, the insured views the premium paid as a “dead loss”! One gets a feeling as if one paid the premium for nothing! After all what did you get in return for the premium? It is not easy for the mind to come to terms with the fact that you should pay good money for nothing to happen!

It can be argued that it is this human nature which leads insurance companies to “productise” their services, and spike an insurance deal with some savings component, so that this “dead loss” concern is mitigated to some extent. Of course, from here it is just one more step to another product with even a lower insurance component and a higher savings component and create ULIP-type products, and from there just another jump, even for someone from a respectable stable, like HDFC Standard Life, to offer what they call as Savings Assurance Policy (SAP), with zero insurance element and 100% “savings” element which is in fact worse than an FD in a bank in every aspect, and does not even protect your principal. With this, the productising is complete – complete with adulteration! For instance, if the above-referred Savings Assurance Policy were to be viewed as an edible product, it would be the equivalent of pure white lime solution being marketed as milk! The problem is, once the productising a service becomes a competitive thing and more people and companies doing it, and then some start contaminating some of the products, and then others start contaminating even more products and so forth, everything becomes par for the course. Now it is all about distribution of those contaminated products. There is no service to deliver. And it goes without saying that while financial service is all about integrity and commitment, productising them gives rise to the exact opposite – namely Greed.

Why do investors fall prey to such products? Nobel Laureate and famed behavioural economist Daniel Kahneman calls this the substitution heuristics. For example, he talks of two questions that were asked of from young participants from the student population. The questions were asked in the following:

How happy are you these days?

How many dates did you have last month?

Do you think those who had more dates reported being happier than those who had fewer dates? The answer was no. The correlation between the response to the above questions was nearly zero. Clearly, dating was nowhere in their minds when they were asked about their happiness.

Now another set of students from the same campus were asked the same questions in reverse order, namely:

How many dates did you have last month?

How happy are you these days?

Surprisingly, this time the correlation between the responses of the two answers were extremely high! What happened? Apparently, dating was not the centre of the students’ lives (as evidenced from the response in the first case). But when they were asked about their romantic life, those who had had many dates were reminded of the happy times of their recent lives, while those who had had no dates had no such happy association, and were in fact reminded of their loneliness. Thus this emotion of remembering happy times or being sad, reflected in the responses for the second question this time!

Now why I quote this example is that when people see a product coming from HDFC Standard Life, they are reminded of the tremendous brand that HDFC has created for itself. Since the association with HDFC is positive, no one thinks of questioning their offering – Savings Assurance Policy – seriously. Had the same product been offered by a lesser brand or an unknown brand, it is a safe bet that there would have been few takers. But that means every time a bad product is associated with a top brand, there is some brand erosion. And this erosion is slowly but steadily multiplied by the number of innocent victims whose savings were directed into such a product by sharp salesmen.

But what is interesting is, even when the industry apes the product segment, it is most reluctant to recall bad products sold by it, like good automobile companies do worldwide. For example, with respect to Savings Assurance Plan, I had personally written twice to the Chairman, Mr. Deepak Parikh, to recall this faulty product, and received no response. And if this happens with the best of the names in the industry, one wants to be wary of virtually everyone else!

Q. Some of the recent woes emanating from the Wall Street did have origins from the ways of distribution with total disregard to the well-being of governance, share-holder and the end customer interests?

A. Of course. When the service of home loans and student loans to the riskiest of borrowers was productised as sub-prime mortgages et al masquerading as investment products, we had this contaminated product being widely distributed replacing the service delivery of the good old banking. And the shareholders, and the tax-payers worldwide ended up paying the price.

Q. Are there any learnings for our industry from such way-ward behaviour?

A. As I said earlier, productising financial services underlies why Greed dominates the financial sector. Service has a noble ring to it. If the industry sold itself based on the services it offers, its mind-set would be ‘cleaner’. But the moment it starts selling ‘products’, the mind-set is that of simple trading and all that is fair in love, war and trading becomes fair for financial services sector too, and Greed takes over. Our major learning in this regard could fall under different baskets.

Regulatory:

Whether it is Mutual Funds or Insurance, their service aspect alone should be regulated by their respective regulators. Ideally they should be prevented from productising themselves, especially in areas that is not their domain. For example, insurance industry has no business offering savings products. Such products should be regulated only by those charged with the oversight of savings, namely SEBI.

But what is more important, regulators must have proper data base and have the wherewithal to ensure that faulty products do not get through their goal post. For instance, it is difficult to imagine a responsible insurance regulator letting a product like Savings Assurance Plan enter the market.

Perhaps it is time the regulators also took a relook at the Groups whose insurance companies market their products in tandem with their Mutual Fund Counterparts within the Group and hard-sell them through their Group’s network of bank branches via their branch managers – typically entirely innocent of investment knowledge – to the unsuspecting customers at the bank.

Management:

Managements should learn to pitch themselves more at the service end than the product end. For example, a Mutual Fund should resist the temptation to advertise itself based on its returns. By definition, a Mutual Fund is a service in which a small investment can reap the benefit of diversification; a service that collects all the dividends from the various investments and pools them for the investors; a service that brings some benefits of research into equities; a service that meets the risk-return profile of the investor and advises him to invest wisely and so forth. It would be so much more in keeping with good corporate governance to advertise themselves based on the ‘delivery’ of these services.

Q. How should the customer interface architecture of financial service industry be fundamentally different from the rest of businesses?

A. In a way I answered this when I said the financial services players should stick to their respective domains. For example, I am dead against a branch manager selling savings products to the bank customers. Combining the network of Insurance, Investment and Banking is fraught with major risks, as management oversight in such cases is often blinded by greed. I have personal knowledge of school teachers, 65 year old house wives and retired clerks who have been made to withdraw their PF funds and invest in this or that silly product ‘recommended by the branch managers’, who have a target to meet in this regard! I have seen innocent customers whose risk profile test in a branch clearly stated that not more than 13% of the investment should be invested in equity, had 60% of her savings invested into equities by the Manager in mutual funds, which lost nearly 30% of its value within a year when the investor had stated clearly that she wanted her funds within 18 months for building a house! In my mind, Banks should stick to banking and not peddle mutual funds. Mutual funds should stick to the service of pooling resources and sell only through identified brokers. Insurance companies should stick to the business of insurance and nothing more. Problems crop up only when these parties start crossing each other’s territories and set off land mines wittingly or unwittingly.

Q. Any other thoughts in this regard?

A. Only this. Behavioural economics repeatedly shows that greed a rather dominant sentiment in investment. Regulators worldwide would do well to keep this in mind.