ECO 550 Dealing with Risk Asymmetric Information and Incentives

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ECO 550

India is a developing country with second largest consumer market in the world. There are lot of possibility to expand the business for any organization in India. As USA, India have multiple player in the wireless market. In the three-headed slugfest between Bharti Airtel Ltd, Reliance Jio Infocomm Ltd and the Vodafone-Idea combine, each entity has already spent somewhere between ₹2 trillion and ₹3 trillion in gross capital investments. But the sharp rise in investments, especially since the entry of Reliance Jio, has also led to a shrinking of the market size. As the chart above shows, industry revenues have fallen by about a third since Reliance Jio’s entry. And this is before the new entrant’s latest salvo that involved a sharp cut in post-paid tariffs and international calling rates.

  • Use Evaluate a company’s recent (with in the last year) actions dealing with risk and uncertainty.

After Jio launch its services in the market in 2017, all the other players observing high risk in the market. Even Jio itself took a big risk by lowering the price plan for wireless services. They started a new race in the telecomm market where existing players are collaborating with each other like Vodafone-Idea merger. Prior to 2017 telecomm companies were in the profit and customer were paying high service fees for wireless services, but Jio changed everything since it’s launched. On the launch they lowered the price for the internet packages which forced other companies to lower their plan’s price to be sustain in the market.

“India’s digital services market is continuing its exponential growth trajectory with Jio expanding its coverage and further deepening in existing areas to achieve 99 per cent population coverage during FY 2018-19,” Reliance Industries NSE 1.34 % Limited (RIL) . To achieve this Jio have to compromise with his profit and take more risk in the market, which will be uncertain as other companies are teaming up to fight in the market.

Risk Management is the forecasting and evaluation of financial risks together with the identification of procedures to avoid or minimize their impact. We tend to think of “risk” in predominantly negative terms. However, in the business world, risk is necessary and inseparable from performance. A common definition of risk is a deviation from an expected outcome. That deviation can be positive or negative, and it relates to the idea of “no pain, no gain”. Following are the suggestion that can overcome the effect of risk and proactively handle its outcome positively.

  • Offer advice for improving risk management.

A solid understanding of risk in its different forms can help project manager to better understand the opportunities, trade-offs, and costs involved with different approaches.

  • Reduce undesirable performance inconsistency
  • Align and add varying views of risk management
    • Build confidence with stakeholders and the investors
    • Enhance corporate governance
    • Successfully respond to a changing business environment
    • Align strategy and corporate culture
    • Creates greater focus, discipline and control
    • Clarifies the distinction between risk-taking and risk-avoidance behaviors
    • Improves tools for quantifying risk exposures
    • Increases accountability for managing risks across the enterprise
    • Facilitates timely identification of changes in an entity’s risk profile

In economics and contract theory, an information asymmetry is present when one party to a transaction has more or better information than the other party. Adverse selection refers generally to a situation where sellers have information that buyers do not have, or vice versa, about some aspect of product quality. It’s rare to find a software organization that follows a single methodology to the letter. The bickering between software engineers about methodologies can be as heated as two politicians on the debate stage, each insisting their way is the one and only “right” way. Verizon recently started following agile methodology. It’s new for everyone in the organization and still teams are learning to working in agile environment. Earlier Verizon used to follow waterfall methodology where project time span start from two months to six months depend on the project criticality and size. An agile Scrum process benefits the organization by helping it to

  • Examine an adverse selection problem your company is facing and recommend how it should minimize its negative impact on transactions.

Some of the team move completely agile but still some teams are not yet reached to the point. Due to this problem project face issues when more than one teams are involved. Mostly teams work differently and use the work structure suits to them. Recently we found that business team already moved to agile where as we in the POS still working in the old fashion. Business team create requirement for the projects as project owner and POS team provide IT solution for the project. Issue here was that business team providing info for the project but in their manner which is not aligned with POS requirement sheets. So in the starting phase of the project teams used to loss important data, even as team work on different methodology work process get missed.

  • Increase the quality of the deliverables
  • Cope better with change (and expect the changes)
    • Provide better estimates while spending less time creating them
    • Be more in control of the project schedule and state

One of the first things that needs to happen when managing agile and waterfall hybrids is to stop finding fault with the differing processes and find some common ground. The methodology process wars must end and, instead, the teams must focus on providing value for the customer. There must be an attitude across the organization that the teams are working together, not against each other. Dependencies and integration points between the teams must be well understood. This is where planning, communication, and coordination is necessary. Waterfall teams do more planning up front and may want answers and commitments that the agile teams don’t feel prepared to give. Project managers, product owners, and stakeholders from all teams need to meet, communicate, and collaborate regularly, always keeping their common mission of providing customer value in mind.

Moral hazard is a situation in which one party gets involved in a risky event knowing that it is protected against the risk and the other party will incur the cost. It arises when both the parties have incomplete information about each other. Moral hazard occurs in different types of situations and in different arenas. For example Verizon is working to enhance 5g network which is not in use yet and there is a race going on between all the wireless companies. Enhancing the network is completely Verizon’s call but suppose if 5g network become failure and don’t provide the feature as its promise then who will pay the cost of it?

  • Determine the ways your company is dealing with the moral hazard problem and suggest best practices used in the industry to deal with it.

Suppose it’s go as expected but still are we sure Verizon is not going to charge extra for this feature where customer says I am not interested with 5g and living happy with 4g networks. In the current scenario customers are not sure about 5g and its advantages. On the other hand Verizon is not sure how market is going to accept the 5g. This uncertainty of the info makes customer uncomfortable and can use the higher churn rate for the Verizon in the future. Following are the best practice by following which Verizon can resolve this issue in the future for any moral hazard problem.

At the root of moral hazard is unbalanced or asymmetric information. The party taking risks in a transaction has more information about the situation or intentions than does the party that suffers any resulting consequences. Generally, the party with extra information has more motivation, or is more likely, to behave inappropriately in order to benefit from a transaction. The benefit of the asymmetric information often occurs after the transaction has taken place. Once information is clear and understandable to the customer they would be happy to retain with the Verizon and by doing this Verizon churn rate will go down too. And though if customer is not satisfied then Verizon can use the other tool of providing more incentives to the customer to retain. Incentives play a key role to retain customers. No doubt 5g have so much potential to gain advantage in the market but Verizon have to use it in the proper way.

  • Make information less asymmetric
  • Change or modify the incentives

The principal–agent problem, occurs when one person or entity (the “agent”) is able to make decisions and/or take actions on behalf of, or that impact, another person or entity: the “principal”. In other words the principal-agent problem occurs when a principal creates an environment in which an agent’s incentives don’t align with those of the principle. Generally, the onus is on the principal to create incentives for the agent to ensure they act as the principal wants. This includes everything from financial incentives to avoidance of information asymmetry. The principal – agent relation has the following characteristics:

  • Identify a principal-agent problem in your company and evaluate the tools it uses to align incentives and improve profitability.

When we go to doctor and they write a prescription, mostly customer is not aware of any medical term. So when customer submit the prescription to the pharmacy, mostly they try to provide medicines that doctor mentioned, but suppose pharmacy don’t have same in the stock. If pharmacy don’t have proper guidelines to handle such situations, then it can cause a principal-agent problem. Here pharmacy act like a principal and customer will be an agent. If pharmacy don’t have same brand of the medicine and without consulting to the customer or doctor they handover a different brand of the medicine. Suppose customer is allergic and that medicines reacted adversely on him then who will be the responsible here. To avoid such principal agent problem pharmacy should have clear guidelines written and well explained to their employees.

  • The principal designs the contracts, he decides upon the effort level he expects from the agent and he pays him accordingly;
  • The agents accepts or not the contractual terms and he makes the efforts he is expected to
    • The agent works or takes some actions for the principal

An organizational structure defines how activities such as task allocation, coordination and supervision are directed toward the achievement of organizational aims. The typically hierarchical arrangement of lines of authority, communications, rights and duties of an organization. Organizational structure determines how the roles, power and responsibilities are assigned, controlled, and coordinated, and how information flows between the different levels of management. For example my organization have following structure.

  • Examine the organizational structure of your company and suggests ways it can be changed to improve the overall profitability.

A structure depends on the organization’s objectives and strategy. In a centralized structure, the top layer of management has most of the decision making power and has tight control over departments and divisions. In a decentralized structure, the decision making power is distributed and the departments and divisions may have different degrees of independence. Issue that we face multiple time is that higher management set the goal based on discussion at their level, which later on they determine that it’s not achievable.

  • CEO
    • CTO
      • Senior Vice President
          • Vice President
              • Director
                  • Additional Director
                      • Manager
                          • Employee
                              • Consultant

                              One solution for this could be that while the higher level management going to take any decision they should involve technical team too in that if it’s related to IT team. The team who handles the issue every day can come up with great solutions and suggestions. Technical team not require in all meetings but manager of an IT team should be enough technical to keep correct point in front of the higher management.

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