Market-Based Management®

Role of Prices, Profits, and Losses

Here's a nice article by Sheldon Richman that discusses why private enterprises are so much more effective than government bureaucracies -- even at things that we traditionally book to government agencies, like disaster relief and FEMA. (current issue of the Foundation for Economic Education's Freeman journal).

A columnist in the times (John Tierney) who was so impressed with WalMart's ability to respond to Katrina so much more effectively than FEMA, suggested that Lee Scott (WalMart's CEO) should be appointed to run FEMA. Richman's response:

"But Tierney misses the point. Wal-Mart did so well precisely because it is not a government agency or contractor. There is no reason to believe that Scott could run FEMA any better than a political appointee or career bureaucrat. This is not meant as an insult. Rather, it's a comment about bureaucracy. There's an old conservative idea the government can be run like a business, but years ago, Ludwig von Mises, in his 1944 classic, Bureaucracy showed this to be a misconception."

Indeed he did. In his characteristic style, Mises would perhaps question why FEMA would even exist in the first place should we hope to have a free, prosperous society that cared anything about its citizens... Quoting from Human Action:

"Every step a government takes beyond the fulfillment of its essential functions of protecting the smooth operations of the market economy against agression [...] is a step forward on a road that directly leads into the totalitarian system where there is no freedom at all." (p. 282)

Businesses and Governments in our society both have available the tremendous information system of freely adjusting market prices. But businesses have the incentive to pay attention to them, and they have a feedback loop the government does not -- feedback that tells a business the how well it is using that information system, in the form of profits or losses, in creating real value for society. This is because it must rely on the voluntary action of consumers to gain its revenues, whereas governments use coercion (taxes) for their revenue. Government doesn't have the externally imposed discipline of the market process that businesses do - and so it will not tend to be nearly as efficient or effective.

Vision

Here I am on vacation, reading Joseph Conrad's "The Mirror of the Sea", and I come across this:

"To see! To see! This is the craving of every sailor, as of the rest of blind humanity. To have his path made clear for him is the aspiration of every human being in our beclouded and tempestuous existence. I have heard a reserved, silent man, with no nerves to speak of, after three days of hard running in thick south-westerly weather, burst out passionately, 'I wish to God we could get sight of something!' "

This is a great metaphor that gets to the heart (pun intended for Conrad fans) of the craving we all have for vision in our lives. It's more than the feeling of being lost without one -- at the personal, team, organization, or the company level...

A good vision matches our uniquely, comparatively advantaged capabilities with existing opportunities where they can be best leveraged to create the most value for society - and thereby ourselves. A good vision, in short, gives us our raison d'etre -- our reason for being. It gives meaning to our lives (personally, organizationally - at whatever level you want to apply the metaphor). Because a good vision applies to us uniquely and shows how we can create real value, it gives meaning to our lives, it makes us feel part of something important, worthwhile. We need that.

Maslow in his great treatise on management, "Eupsychian Management," talked at length how important this is:

"If you take into yourself something important from the world, then you yourself become important thereby. [...] At once, it matters if you die, or if you are sick, or if you can't work..."

He later goes on:

"This is much like stressing the high human need for a system of values, a system of understanding the world and of making sense out of it. This comes very close to the religious quest in the humanistic sense. If work is meaningless, then life comes close to being meaningless. Perhaps here also is the place to point out that no matter how menial the chores -- the dishwashing and the test-tube cleaning, all become meaningful or meaningless by virtue of their participation or lack of participation in a meaningful or important or loved goal. For instance, cleaning up baby diapers is repulsive work in itself, but it can be very lovingly done, it can be a beautiful thing for a mother who loves her baby. Washing the dishes can be the most meaningless chore or it can be a symbolic act of love for one's family and can therefore take on great dignity and even become a sacred activity, etc. This can all be applied to the industrial situation. I can use here my case of the woman who developed anhedonia (loss of zest and pleasure in life) because she had a job as a personnel manager in a chewing gum factory and simply couldn't get excited about chewing gum. She might have enjoyed very much exactly the same kind of work in a more meaningful (to her) factory."

In this sense, a vision can also function much like an organizational tuning fork. Some people can get excited about working for a bubble gum factory, others can't.

Compliance - don't assume your interpretation is correct!

Compliance is so important you can not assume your interpretation is correct. DuPont has just found out when you disagree with a government agency you normally lose, Dupont general counsel stated "our interpretation of the reporting requirements differed from the agency's". CBS news reports DuPont has agreed to settle the EPA lawsuit dealing with PFOA emissions by paying $10.25 million in fines.

The settlement involves action taken against Dupont by the EPA for allegedly withholding information about the potential health and environmental risks posed by perfluorooctanoic acid, or PFOA, under provisions of both the Toxic Substances Control Act and the Resource Conservation and Recovery Act.

The EPA alleged that DuPont withheld information for more than 20 years about the health effects of PFOA, also known as C-8, and about the pollution of water supplies near the company's Washington Works plant near Parkersburg, W.Va.

In February, the company agreed to pay more than $107 million to settle a class-action lawsuit filed in 2001 by Ohio and West Virginia residents who claimed that DuPont intentionally withheld and misrepresented information concerning human health threat posed by PFOA.

Corporations should be focused on profits - principled profits. Ignorance is no defence when compliance is concerned, that is why we say you must stop, think and ask . If DuPont consciously chose not to report the emissions then it is no longer simply a compliance problem, but one of integrity (or lack thereof). If the federal criminal investigation finds DuPont intentionally withheld reportable information the costs, for those indicted, might be significantly higher than those listed above.

How to save the American Car Industry

This from Andy Rooney (Dec 11, 2005)

Two weeks ago General Motors announced that it's shutting down 12 plants and firing 30,000 workers. Just Wednesday, Ford announced it is closing ten production lines, too. They’re firing 30,000 workers.

The funny thing is -- it isn't really funny it's sad -- I feel bad about the decline of our auto industry but the last three cars I've bought were not made by them. They weren’t made by any American car company.  I hate to say it but we no longer make the best cars and Americans are turning away from them. The Japanese Toyota has been the best-selling car in the United States for several years now.

Consumer Reports tested a lot of cars and gave their highest reliability rating to 31 of them. Of those 31 most reliable cars, just two were American. The other 29 were Japanese. Of the cars that were least reliable, 22 were American made.

I have an idea for getting American auto makers out of trouble so they don't have to close plants and fire workers: spend less time thinking up clever names and more time making better cars.

Market Analysis could save your business (or life)

Couldn't resist sharing this little tidbit from Fortune's interview of Bill Zollars (CEO of Yellow Roadway since 1999).

When I was at Kodak in the 1980s, we were buying up photofinishers in Europe to create a network to sell film to. It was a great strategy that someone in Rochester thought up. But in Italy it wasn't working. So one day the Italian general manager and I go out to dinner in Milan, and he says, "Bill, this strategy will not work in Italy." I said, "I know it's difficult, but we have to." He says, "You don't understand. In Italy, photofinishing is a family business." I said, "I understand, it's the same as everywhere else." He said, "Bill, I don't mean a family business. I mean the family business." He was talking about the Mafia. Here I was about to get my kneecaps shot off, and I had no clue. I learned that before you launch off on something, you should take the time to understand what you're getting yourself into.

Seeing Compliance as more than 'cost'

Australia has had it's own corporate (Enron scaled) scandals. This has lead, predictably, to an increase in the regulation of corporate governance. But in this age of increasing regulation it is important to leverage our investment in compliance with strategic plays. If an organization believes it is a cost-advantaged compliant producer then it is important the business does not fall prey to the idea that compliance is simply a cost. A recent study by KPMG in Australia points out the following. 

Many of the companies (studied) have a kind of "compliance myopia" which prevents them from seeing beyond their immediate need of simply complying with regulations. Thus they fail to exploit the opportunity to use the investment in compliance to deliver strategic benefits.

Risk and compliance projects are often run as individual initiatives within organizational "silos", thus potentially missing opportunities for strategic and corporate-wide benefits.

In addition, the success of the risk and compliance projects is measured by assessing whether the project is completed on time and on budget and whether it meets minimum compliance requirements, rather than whether real benefits have been delivered to the business.

A business must do more than simply comply (even when complying at 10,000%). It must recognize and leverage its compliance capability to achieve superior long-term results.

Humility

Successfully adapting to the changes and challenges our markets throw at us requires that we keep an open mind.   

Surprisingly, this isn't so easy to do.  Okay, I'm being facetious - it's not surprising at all, because there are a lot of common cognitive biases that can keep us from facing and dealing with reality... 

For instance, in Russo and Schoemaker's Decision Traps: Ten Barriers to Brilliant Decision-making and how to Overcome Them (1989), they point out how, in our quite natural attempt to avoid the pain of admitting we've made a mistake we might, "distort our meaning of what we actually did or said [...] or [...] unrealistically blame others."   This is called the rationalization bias.

Amar Bhide, in The Origin and Evolution of New Businesses, points out that lottery winners will sometimes "provide elaborate explanations for how they picked their winning tickets."  This is hindsight bias.  This and the rationalization bias above make it difficult for us to realistically assess our mistakes; this prevents us from learning important lessons that might inform our future decisons and improve our performance.

Confirmation bias is another common error -- We all have the tendency to look for and pay attention only to those facts, suggestions, data, and evidence that confirm our hypotheses and views,  while we tend to ignore the stuff that doesn't.

There are many others - a whole bunch under the title memory biases.  Overcoming them requires a good dose of personal humility -- starting, for instance, with the admission that we might be under the influence of any of these biases when evaluating a situation or analyzing a problem.   

The main weapon to wield against these biases is intellectual honesty.  The desire to be on the side of Truth rather than merely wishing Truth to be on your side.   Suspending what we "know" long enough to consider other perspectives and competing theories.   Being as honest as we possibly can with ourselves and our audience about what we claim to know, what we know we don't know.  It's the willingness to be wrong.

There are a lot of important reasons to understand and practice our Humility principle, and this post merely presents a few of the many reasons why that can be a challenge -- namely, we have a lot of natural, but potentially destructive, psychological defenses trying to shield us from the pain of reality.   And often we aren't even conscious we're using them.

MBM's Guiding Principle 8 (Humility):

Practice humility and intellectual honesty.  Constantly seek to understand and constructively deal with reality to create real value and achieve personal improvement.

An Essay Worth Reading

Here's an essay that's worth taking the time to read and think about... 

As Henderson and Hooper state in their new book, Making Great Decisions:

... many of us think unclearly ... by going through life with a list of made-up obligations.  We wake up in the morning with a long list of "must-do" items.  After a while our feet start dragging and we feel a heavy burden on our shoulders.   But we "must" press on.  Such phony obligations get in the way of clear thinking.

There's an implicit "if" in the phrase "I must" -- as in "I must do this IF I want to have such and such an outcome." 

Speaking in the lanuage of values (I want, I will) instead of the language of imperatives (I must, I have to) has the advantage of helping us think more clearly -- reminding us that we always have a choice and that we don't have to do anything unless the outcome from doing it is valuable to us. 

The downside is that it creates personal accountability for the choices we make.  After all, if you must do something (hiding the implicit if) then you don't have much of a choice, so who can blame you?

Question:  how does this tie to the MBM Vision dimension?

The Undercover Economist (by Tim Harford) - a brief review

I have to start by saying that I enjoyed Freakonomics - the author of that book (Steve Leavitt) systematically applied economic thinking to real world problems, drug gangs, teachers changing their students’ standardized test answers, and the impact of an individual’s name on their career prospects.  That said, I don't agree with everything Leavitt says, but I appreciate his approach.

I did enjoy the first chapter’s discussion of coffee prices – although I don’t drink the stuff myself. Though on the whole, I didn't find the Underground Economist to be as satisfying as Leavitt's book for some of the following reasons.

1. The "Head Start theorem". This is the idea that in a race, it is possible to change the starting position of each entrant, in order to have every racer cross the finish-line at the same time. Applying this 'insight' to the real world, the author posits it is possible to increase social equity by taxing those who will earn more money, more upfront. The upfront lump-sum tax does not have the market distorting impact of a marginal tax collected at various intervals, i.e. tax Tiger Woods excessively at the beginning of his career and you will not diminish his willingness to work hard and earn as much as he possibly can throughout his career because we’ve already collected all of the tax up front.

This theorem works well in the abstract mathematical world economists use to ply their trade. But simply translating the model, and its implications into the real world presents many problems, let me just mention a few. How do we know, before Tiger actually succeeds at golf that he will earn above average earnings in golf? Second, even if we did know Tiger was incredibly gifted we need to know, at the beginning of his career, with a fair degree of precision his lifetime earnings. (Impossible for the world we live in but quite doable on the blackboard pretend world most economists’ inhabit) Unfortunately the ‘head start’ theorem is just a clever way to 'scientifically' justify progressive redistribution and welfare programs. 

2. Only half the Arrow story was told. The head-start theorem comes from Arrow's work building a mathematical economy. However, Arrow's dissertation dealt with something called the 'impossibility theorem'. This is the idea that in a market each of us votes for what we want with our own dollars. So how will democracy work when we vote for what we want and those preferences are aggregated? In a world of subjective value (voters have different preference ordering over at least three alternatives) Arrow found that is was impossible for a social efficient outcome to result, hence the name ‘impossibility theorem’.

Harford recognizes the advantages of markets, and warns us of widespread government failure, but advocates 'keyhole' solutions; the government intervenes in a targeted way to promote a better solution than the market provides.

One of the problems is whose solution? Harford talks as if we would all agree with the ordering of the government’s priorities.  Now this would actually work if we all valued the same things, in the same way, at the same time – but how likely is that?

3. One of the great things about Austrian Economics - the economics of Mises and Hayek, is that is very distinct from other free-market thinking.  Austrian economics is not interested in describing the 'efficiency' of the market, but rather emphasizes the market is a discovery process. No-one can know with certainty what will be successful tomorrow.  Therefore it is important to allow individuals the freedom to experiment. Through this process new and innovative ways to satisfy consumers emerge, sometimes accidentally, (just look at my previous post on Drucker and unexpected success). 

Harford makes such a big deal about scarcity power and the need for government to protect us from businesses with such power. But the reality is that scarcity is an initial conditions which spurs entrepreneurship.

An excellent example is copper. As phone lines expanded there were concerns in the sixties and seventies that we would run out of copper in our attempts to connect the globe. Some prognosticators argued copper would become so scarce, and so expensive, the divide between the rich and the poor would become so incredible society might well unravel (one example is Ehrlich's Population Bomb). But history demonstrated that as the demand for copper increased, new and innovative alternatives emerged. Fiber optic cable is not a poor replacement for copper, it is actually much better. It carries signals without needing strengthening, it has greater carrying capacity of signal, it is cheaper to maintain and is less sensitive to the proximity of electro-magnetic fields (e.g. radio). Scarcity spurs entrepreneurship, and innovation in a socially productive way; something the government is unable to do. If, before the invention of fiber optic cable the government stepped in to protect us from using up the entire world's copper supply, it could well have dampened the incentives of entrepreneurs to find alternatives to copper cable.  Government intervention to protect people from scarcity power (seen today) normally does more to preserve and manage the status quo (tomorrow) and diminishes chances for new alternatives and substitutes to emerge, which 'creatively destroy' the scarcity power of a product or business.

If you really believed that something approximating the head-start theorem could be implemented in the real world, and that governments could know what was in all of our interests, and that the scarcity power of a product or business would not be eroded through the market process, then you could potentially argue government intervention has the potential to make our lives so much better. Well, I'm not buying.

Note: I find it interesting that Hartford criticizes the U.S health care system and claims it demonstrated the failure of a free market in health care. Here are a couple of gripes with that view. 

a. More than 50cents in every dollar spent on health care in the U.S comes from the government purse - how market-based can it be if government is the majority of purchases?

b. Sure Canada is cheaper than the U.S. But cost is only one measure - how about waiting time. If you need a heart operation (a quadruple by-pass can cost upwards of 85K in the U.S and less than half that in Canada). However in the U.S you get the operation, if you need it, within a couple of days. While in Canada you're scheduled, and you could be waiting more than 3 months. Call me crazy, but if I need it, I'd rather have it sooner, even if it costs more.

c.  Administration costs are more in the U.S because doctors and surgeons do less admin work. In the U.S their incentive is to do what creates value and earns them money. In Canada, if you’re a surgeon, and you are going to be paid the same whether you fill out paperwork or do one more surgery (which carries the risk of litigation), then on the margin you are going to do more admin work - thus hiding the size of the administration costs in Canada versus the U.S. Hartford is quick to discuss moral hazard in relation to patient behavior in a private health care system, but fails to even mention the same critique of doctor behavior in a nationalized (government provided) health care service.

Thanksgiving and Political Profit

A little late - but still worth looking at!

Shaw's Supermarkets, which has 200 stores in New England, complained to the state Attorney General after some of its employees reported seeing a banner proclaiming Whole Foods supermarkets, a competitor, would open Thanksgiving day. Shaw's lodged a compliant with the State Attorney General, that Whole Foods would be violating 'blue laws' passed in the 1600s - Puritian-era laws designed to keep colonists at home or in church on Sundays and other 'special' days such as Christmas, New Year's Day and Thanksgiving. (The article at USA Today does not require a subscription)

The motivation of Shaw's compliant is based upon its concern for consumers, from the article

"Besides disadvantaging competitors, a Whole Foods opening would harm consumers, due to lack of choice in the marketplace for consumers to shop and compare prices for the best deal," Shaw's legal department wrote to Reilly (State Attorney General) on Nov. 4.

Amazing! Having one choice is better than no choice. Why not just introduce price controls for groceries, then Shaw's staff could have slept soundly Thanksgiving eve knowing Whole Foods would have be unable to harm consumers?

Working on Thanksgiving, for Whole Foods, would have been completely voluntary and workers would have recieved double pay. However, Whole Foods announced, just before Thanksgiving, it will not violate the law, giving Shaw's the victory it wanted so badly for themselves --- oh, I'm sorry, I meant the consumers.