Market-Based Management®

Innovation - Movie Theatre style

An interesting article (Fortune - no subscription required) about the continuing need for innovation within an industry - illustrated in the movie business.

The article discusses the advent of television in the 1950's and the subsequent drop in theatre goers.  The rise of the Megaplex and the impact of cable, digital and high-def television.  The influence of the internet - 8% of theatre tickets are now bought online.  Despite all of these changes, theatres are only slowing moving to the digital format. (The switcing costs per screen are roughly US$100,00).  The article paints a possible picture of the future (as theatres continually strive to stay relevant by providing a product consumers are willing to pay for) -

Earlier in the week you ordered and printed your tickets online from a single Web site (accumulating points for a free vacation). Of course you picked your favorite seats, 12D and 12E. On Saturday a taxi ordered by the theater picks up you and the family at 6 P.M. sharp and whisks you to a steakhouse in the theater complex.

At 7:45 a theater sitter takes the kids to either the chaperoned game zone or a PG-rated feature, while you stroll over to your own R-rated film. You are met by an usher who seats you in a plush swivel chair and takes your afterdinner drink order. The lights dim, and the super-crisp digital print appears on the screen.

Afterward there is the nightcap at the mahtini bahr. Then you pick up the kids and head home via theater cab. If that sounds as if it's worth leaving the house for, theater owners may live to fight for another hundred years. If not ...

It is a powerful reminder that innovation occurs not just in new products but in a myraid of ways, in this case how those products are bundled.  Unless a firm drives creative destruction internally faster than its competitors and potential competitors its just waiting to be driven out of business. The lesson is simple - innovate or die.

Reward Value Creation

One of the more interesting blogs out there is by Gary Becker and Richard Posner.

They typically post two essays per week – one picking a topic and the other responding. They then take comments, reconsider their positions and then post summary at the end of the week. This week they are asking the question, “Are CEOs Overpaid?”

This paragraph caught my attention, and should sound familiar to those who've heard us talk about the MBM Incentives dimension:

“The economics of compensation are fascinating. In the simplest economic model, a worker, right up to the level of CEO, is paid his marginal product — essentially, his contribution to the firm’s net income. But simple observation reveals numerous departures from the model. For example, wages vary across the employees of the same rank in the same company by much less than differences in their contribution to the company, and employees who do satisfactory work can expect real (that is, inflation-adjusted) annual increases in their wages throughout their career with the firm, even though their contribution will not be increasing at the same rate, and eventually not at all.”

Here's a quick way to destroy your company: make sure there's no connection between what employees are paid and the value they create.

The only sustainable way that wages can rise is through increased productivity. Knowing this, and that employee contributions tend to vary (a lot), it is essential that individual employees be compensated in proportion to the value that they specifically create - their "marginal product." Each employee then has an incentive to find the roles that best fit his or her comparative advantage and to focus on creating real value.

Simple, yes? No. For all kinds of reasons. One big one is when a contract or law expressly forbids differentiation in pay - in which case you must honor the contract and obey the law. Absent those, this is a guiding principle to be strived for. There are many challenges to determining an indvidual's marginal contribtion - teamwork synergies, subjective assessments, qualitative measures, errors in attribution, differences of opinion (if not outright fantasies) about what people think they contributed, etc., etc.

The challenge is to strike the right path and be materially correct using value creation and the other MBM Guiding Principles, the five dimensions of the Framework, and the mental models as a North Star. Don't let perfect become the enemy of good in situations like this -- strive for accuracy knowing that precision won't often be possible.

Price gouging on John Stossel

If you missed 20/20 Friday night, or just want a recap, you must check it out.  Stossel starts with, "Price gouging is bad. How can that be a myth."

I really enjoyed Russ Roberts making the point about high prices.  They act like a flag, alerting other businesses to the potential for profit.  As more businesses enter the market supply increases while putting downward pressure on prices.  When a high price reflects economic reality, allowing prices to work helps consumers.    

Some companies do not raise their prices in the aftermath of disasters.  They naively believe they are helping people. And sure, they help the people who do get to buy the product.  Unfortunately, these lucky buyers have no incentive to conserve and buy just enough to get by.  The people who still want the good, and are prepared to pay much more than the normal rate, are worse off because the product isn't available.  The incentive for businesses to supply more is not there. 

Not matter the intentions of policy makers ignoring economic reality is foolish at best.  We must always remember that good intentions are not the same as and should never be confused with good results.

 

From the Annals of Bad Economics

I came across this nugget from a transcript of the dialog between Randy Barnett and Justice Stevens in oral arguments for a Supreme Court hearing (Gonzales v. Raiche) in Nov 2004:

JUSTICE STEVENS: Well, that would reduce demand and increase price, it seems to me. It's the other way around.
MR. BARNETT:Well, it would reduce demand and reduce prices, I think. But...
JUSTICE STEVENS:If you reduce demand, you reduce prices? Are you sure?
MR. BARNETT:Yes. [Laughter]
JUSTICE STEVENS: Oh, you're right. You're right. Okay. Yeah. Yeah.

This is not to say that Justice Stevens doesn't know economics - I'm sure he had Econ 101 like many others. The point is that even very intelligent people, who may know the definitions and concepts of basic economics, often fail to be able to apply them in real time when it matters -- that takes practice.

So practice!