I believe that no one, no matter how well informed, has a monopoly on narratives and that is reasonable for sensible, well informed people to disagree about the value of a company.

– Narrative & Numbers by Prof. Aswath Damodaran

Our ability to think about something is based on thoughts, which can be either visual or verbal. In his book, Prof. Damodaran tries to capture the process of looking at narratives & numbers like a Right Brain / Left Brain approach to understand valuation.

The Indian IT industry is trapped in one such narrative problem. Their lack of a strong narrative comeback for their problems is causing a lot of disillusionment. The people working in the industry get anecdotal data about how good or bad things can get. The people gazing from the outside, the shareholders, the analysts, the investors, all seem to be captivated by the disconnect between the historical numbers & the future expectations.

A strong narrative can either convince us to strongly back our investment idea or it may help us to stay away from a situation. So what happens when the narrative is confusing? The future has always been uncertain, a narrative doesn’t change that. All a narrative can do is help us tolerate the volatility till the expectations become real.

The best way to solve a narrative problem, is to actually start delivering on the promises. If people keep talking about the same things & the numbers don’t eventually back up the words, then the stakeholders start losing faith.

One of the key jobs of the management of a company is to find a reasonable way to organise incentives for the employees. This makes sure that the employees are motivated to stay on the mission. There has to be a different kind of narrative, a more nuanced narrative for the employees to make sure they understand what’s going on & how is the management thinking through it.

The current problem in the narrative is that the media has blown the lid off the idea that job losses is an essential theme. The real challenge is to focus on how are the IT companies transforming themselves. The company’s communication about how they’re changing slowly, is vague at best. This causes unnecessary distress. Should the investors sell off their investments in the IT sector & sit on the sidelines to wait for the inflection point in the industry? Or should the investors grit their teeth & power through this slow patch? These questions can’t be answered by what the management is communicating today.

How to solve this narrative problem?

A few good examples of a narrative delivering the numbers already exist. The solution is slow & difficult, which will probably result in questioning the basic premise of India as an outsourcing hub for IT work.

There are many international IT companies who have also established their presence in India to tap into our country’s talented base of engineers. These companies have systematically moved a lot of their work near the client, increasing their cost base & reducing their margins. They’ve also been making judicious use of their cash flows, not just to grow the business but also to periodically return money to shareholders. They are slightly levered & take full advantage of their debt repaying capacity. They’ve also been acquiring smaller companies to fast track their skill upgrades to help their clients with newer & cheaper solutions.

The most important part is, they’ve been actively communicating this to their stakeholders which has led to less confusion within the organisations & in the minds of the shareholders. The growth in their reported numbers & their market value is a case in point.

It is high time the Indian IT industry overcomes this narrative problem & brings clarity & vision back in the minds of all stakeholders. Like Prof. Damodaran says, the story has to be simple, credible, inspiring & must lead to action.

We are all biased by our own investment narratives to some extent but it helps to have a bias tilted more towards reality than to an improbable future. Professional managers running the business face the same biases as investors despite having more data about the business & the industry. Prof. Damodaran, in my view, correctly prescribes for company management –

Your greatest personal peril is at the transition points in the corporate life cycle, where unless you adapt, you will be challenged and perhaps displaced.