Market-Based Management®

Friday Links

Economix Blog pointed me to an amusing clip of Mr. T discussing the record high price of gold (I pity the fool who doesn't watch it :)).

Thanks to Will for pointing out an article that one day, hopefully will be the basis of a great post. The Atlantic's Megan Mcardle brings us "Starbucks Puts Quality of Quantity." I know a few of the readers are loyal Starbucks fans, so I wonder what they have to say about this? (You know who you are!).

On a similar note, thanks to Peter for point us to this article: "Why Airlines Should be Charging for Carry-Ons." I hope to use this to start a conversation up in the near future, but thought I would pass it on to readers quickly.

If you're a fellow nerd and iPad owner, you might be excited to hear that TED Talks have launched an iPAD app.

 

If you have any interesting links, please leave them in the comments and send me an email: ann.zerkle (at) cgkfoundation.org. Thanks and have a great weekend!

Compared to What?

Comparative advantage.

This mental model comes up often in the MBM world, and I think it's doubly difficult; difficult to wrap your head around (especially if you're like me, a nerd of the English lit variety as opposed to the economics department sort) and difficult to apply day to day.

If you check out the "Science of Human Action" chart in the middle of The Science of Success (pg. 48-49), you'll notice that here--where MBM is boiled down to it's basics--"comparative advantage" comes up not once but THREE times, and it's represented in all levels of the chart: societal, organizational and individual. 

How do we apply this mental model?  First, some basics and to clarify terms. 

• Absolute Advantage: Most people--myself included--at one point or another fall into the trap of thinking that "what I'm best at" is my comparative advantage.  That's not necessarily the case: what we're really talking about is a person's absolute advantage.  If you are the very best at yodeling or typing or problem solving, you have an absolute advantage in those areas. 
• Comparative Advantage: Being really good at something, though, is not the same as having a comparative advantage.  As Ann said in a post earlier this week, said, "The thing about comparative advantage is that there needs to be a comparison. What are you being compared to?"  So, there's the first part: you have to compare your ability in one area to another persons'.  The second part deals with opportunity costs--you only have a C.A. if you have the lowest opportunity cost.  Put another way, you want to ask "Who gives up the least by doing X?" 

So, how do we use this concept?  Asking a simple question can help: "Do I, compared to everyone else available, have the least to give up if I do this task (even if we all know Joe is better at it than me)?"  If the answer is yes, you have the comparative advantage.

Example: Here's a real-life example (the gist of the story is true, but I've made up the dialogue since I wasn't actually there ;-).  An economics professor on sabbatical came to work with a Koch company.  He brings a stack of papers with him as he approaches his administrative assistant, asking, "Excuse me, where's the copier--I need to make some copies." She told him, "Give those to me, I'll do it."  Not wanting to trouble her, he said, "It's no bother, I can do it."  She responded, "I know you can do it, but I should do it because I have the comparative advantage; during the time it takes you to make the copies, you could be be doing more valuable things with your time than I would be--you have more to give up."  So, he gives her the copies, thinks inwardly that he has a lot to learn about this comparative advantage stuff, and goes about his business.  The next day, he approaches the assistance's desk, hands her a stack of papers to copy with a smile, and turns around to go to work.  But she calls out to him, "The copier is around the corner.  You'll have to do this yourself."  "Wait," he said, "I thought you have the 'comparative advantage'?"  The assistant, as it happened, had expertise helping business groups do contracts, and on that particular day the other group's regular assistant was out, and a deadline was pending on a deal worth over $40,000.  Busy, she paused to explain: "Yesterday I did, but today's a new day.  Today, I'm helping the team down the hall.  If I don't help, they won't get done and we'll lose the contract.  If you get paid more than $40,000 an hour, I'll help you make copies...."  [ht to Tony W for sharing the story.]

The tricky thing with comparative advantage is that it requires us to constantly re-assess situations, to constantly examine opportunity costs.  Yes, you probably have the same absolute advantage today that you will tomorrow, but you may not always have the same comparative advantage month-to-month, day-to-day, or even hour-to-hour.

The Broken Window Fallacy

Next week the Associates are reading The Law, by Frederic Bastiat, who is one of my favorite thinkers on the KAP curriculum. However it was Bastiat's "What is Seen and What is Not Seen," which details the broken window fallacy that sparked deeper economic thinking from my freshman-in-college self. I think if folks can understand and apply this one concept, the world would be a much better place.

There are lots of videos out on youtube that discuss Bastiat, but I think this first video gives the best flavor of Bastiat's original example. 

Is this something only policy makers need to worry about? How might the broken window fallacy manifest in the organization?

I'm Being Taxed HOW much?!

Creating as much freedom as possible for principled individuals--while not impinging upon another's freedoms--is one of the fundamental assumptions that MBM rests upon. Whether it be an entrepreneurial employee in the firm, or a citizen in a society, this tends to be critical for long-term prosperity.

In general, every decision a government makes for an individual--whether it be allowing individuals freedom to make choices about what they say, what religion they follow, or how they spend their money--is a tradeoff of freedom for some other thing.

In the link below, you can calculate your entire tax burden (I suggest taking a strong drink of your favorite beverage first). Seen all at once, it's hard not to think about the economic freedoms being given up, and what's being traded off for them. Instead of you deciding to spend that $5,000 on education, a county clerk is spending it on X; instead of you deciding to spend that $10,000 on charity, the state government took it for Y; instead of you spending that $15,000 on your daughter's wedding, a politician is paying for Z (or perhaps to cover Z up). Many of the X's, Y's and Z's the government spends money are good things (national security, for example) but unfortunately many of those things aren't so good, aren't well implemented, and aren't necessarily what you would like that money to be spent on (say, if you're a pacifist supporting a war, or environmentalist subsidizing a farm with heavy pollution).

We believe that--in general--an individual can better use resources (in this case, her money) than a detached individual far away because she is the only person on the earth who is uniquely aware of her wants/desires, knowledgeable about her local conditions, and ultimately will be the one person who bears the accountability of spending her money well or poorly. For similar reasons, we believe that--in general--we want individuals in an organization to use their local knowledge and feel the good-and-bad of the decisions they make where it makes sense to do so (caveat: this doesn't mean we decentralize every decision all the time).

Tax calculator.

Fatal Flaws

Recently, I worked with a group using the book Strengths Finders2.0. The premise is that people should be working on their areas of strength because that's where they'll get the most return. Throughout the session, I used the caveat that I think this is true, except in the case of fatal flaws. Later that week, an Associate started asking me about fatal flaws. My answers were lame, so I started asking around and forming some better thoughts.

All these tests, books, mentoring and other tactics to figure out what you're strengths are, should be aimed at finding your comparative advantage. What can you be the low cost producer of? If we're talking about a sweet project, then are you the low cost producer of that project's output. The thing about comparative advantage is that there needs to be a comparison. What are you being compared to? If it's a project given to a particular team, then the decision maker is going to pick team member with the lowest opportunity cost from those sitting around the table.

A fatal flaw is something that prevents you from sitting around the table again and again. If you have a trait, lack a skill or something that systematically prevents you from even being considered in the comparative advantage conversation, you may have a fatal flaw.  

Here are some things I brainstormed:

• If you struggle with gossip, then despite being productive leaders may be reluctant to put your name on projects that require discetion.
• Someone who lacks basic communication skills will not be called to table to work on opportunities with outside vendors/customers.
• An employee that is "too nice" and doesn't give the tough feedback to teammates may not get their name on the list when leadership considers new managers.

What do you think about the way I defined fatal flaws? Do these examples make sense? What would you tell an inexperienced employee who is worried about having a fatal flaw?

 

Thanks to Ben, John, Andy and Holly for contributing to or inspiring this post.

Friday Links

This article from Seth Godin caught my attention. He writes about thinking of our work as a checklist or a to-do list. I liked this quote: "Perhaps the alternative is instead of thinking, "next!", we can think, "last!" This might be the last time I get to do this." You'll have to read the whole post to get the full context, but I think he might be onto something.

I hope you enjoyed my longer altruism posts, but if they were too long (as I suspect they were), here's a few links to others on the topic. Business Pundit has "Free Markets, Altruism, Human Nature and Public Policy." Tyler Cowen wrote, "Does the free market erode moral character?"

Here's a funny (not ha-ha funny) post about "The 40% Rule."

I'm not a macroeconomist, but I do worry about inflation (as I think many people do). This post might appeal to those of you who have that same worry.

And to end on an amusing one, Megan Mcardle writes, "The IRS Has Bedbugs."

If you have any interesting links, please leave them in the comments and send me an email: ann.zerkle (at) cgkfoundation.org. Thanks and have a great weekend!

Let It Burn?

Here's a question for you: should it burn?

Firefighters in a Tennesse county stood by as a home burned to the ground.  Why?  The owner had not paid the $75 for county fire protection.  Here's the full story:

[ht to Austen.]

So, my question to you is: should it burn?

Should have the fire department let the house burn?
	No: it's just not right to sit by and watch
	No: the possibility of other owners' property being destroyed is too great
	Completely in the middle
	Yes: but I cringe inwardly
	Yes: I'm totally fine with that
pollcode.com free polls

A respect for property rights is a key element that many prosperous countries share in common.  We often speak of property rights as if they're a panacea that cures all social ills.  But, they're not so cut and dry in the real world.  The scenario aboves points to--many would argue--a potential public good problem.  In the firm, legal council, branding issues, IT and many other services are often shared to some point, and their efforst impact nearly everyone.  As much as possible in MBM, we try to internalize costs to the decision maker to avoid these hairy situations--but it's a constant struggle. 

Tragedy of the Commons Versus Collective Action

The mental model of the tragedy of the commons can often be confusing. The history of the term itself comes from something that most of us don't see much any more: cows grazing in the common areas of town (I don't know about most of you, but there aren't many cows in Arlington, VA!). I keep this term straight in my head by focusing on the tragedy part of the phrase. The tragedy is that a resource is being overused. The reason for the resource overuse is that people using it get the benefits, but don't face all (or any) of the costs. Because no one person owns the resource, everyone uses it for all it's worth.

I have always found it easier to understand this by examples:

• Dirty dishes at a frat house;
• Gross team locker rooms; or
• Filthy public bathrooms.

To understand this model, I have to identify the resource that is tragically overused, who gets the benefits, what are the costs, and where is the ownership not working. In an organizational setting these could be some examples:

• An employee having more work than she can handle:
• • Resource: a good employee's efforts
  • Ownership Breakdown: multiple bosses
  • Benefits: work output
  • Costs: partial salary being charged to different departments or from a general fund
• A customer not getting enough attention (phone calls being ignored, etc):
• •  Resource: customer's goodwill or potential business for a company
  • Ownership breakdown: a sales team owns the relationship, but no one person is responsible for relationship
  • Benefit: company or team gets credit for future sales
  • Cost: Salespeople can't spend time with customers they will get individual credit for
• Copier keeps breaking down:
• •  Resource: Copier
  • Ownership breakdown: copier paid for from some general fund, no team/employee responsible for it
  • Benefits: copies are essentially free
  • Costs: too much copying results in machine breaking down well before it might otherwise

You can see that in each example, there isn't an individual owner. The result is that within the organization, no one views the resource as being "theirs." What incentive do folks have in each of these scenarios to take the long-term view and cultivate the resource? Also, given that the person/entity who gets the benefits doesn't face the costs (or the other way around) you can see how even the most principled person would have trouble overcoming the incentives.

So, tragedy of the commons is the result of self-interested individuals reacting to the incentives of a situation. I think wherever a resource is being overused in the organization, walking through the four concepts above may help you to determine if a tragedy of the commons is happening.

The collective action model represents deliberate choices by multiple individuals, usually it means they are agreeing to something. Sometimes collective action helps avoid the tragedy of the commons. I think collective action can work when you have groups that are small or can enforce the collective action:

• A team agrees to take turns bringing in donuts on Friday;
• An organization decides to donate time to fix up the building; or
• A couple decides to stop eating junk food.

These are all things where folks agree to a goal or action and have a way to enforce it. This isn't always the case with collective action. I'm sure we've all been in situations where someone "free rides" off of collective action.

Does anyone have another way of viewing these topics? Were my examples satisfying (or even right)? How do you see these models manifesting in the firm?

Thanks to David who suggested the topic!

Healthcare, Democracy, Market Signals, and 'the Sanest Man on the Planet'

OK, I don't know about the "sanest man on the planet" stuff, but I just watched these videos and found them to be very interesting.  In them, Daniel Hannan, member of the European Parliament, does an excellent job comparing and contrasting the American system for deciding laws with that of Great Britain and other European countries.  

In it, he discusses what it means to believe in "Jeffersonian" principles, many of which bolster our view of the Science of Liberty (the basis for Market-Based Management).  Enjoy, and ht to the American Legislative Exchange Council (ALEC).

[Part 1-3 below]

 

Part I: Altruism in Markets

Almost a month ago, Tyler asked me about altruism in free market theory. I asked a few folks and did some light looking around, and I want to give a special thanks to my colleague Steve who helped me organize some thoughts.

Defining Altruism

The hardest part of thinking about altruism in markets is defining altruism. From Ludwig von Mises's perspective, every choice is self-interested (see Human Action, chapter 1, especially part 4). So, defining altruism as a selfless action is impossible with that view. Instead, I think it's most beneficial to define altruism as actions taken by a self-interested individual who wants to make a difference for others. In my mind, this means one subjectively values the well-being of others. This definition is not perfect, and I have friends that I could argue with about this definition for days... I just wanted to point out that coming close to a shared understanding around this word is the first step to having a productive conversation.

So what role (if any) does altruism play in free markets? One point that is important, but I find less interesting, is the idea that free markets enable societies to be more productive. The more you have, the more you can give away to others. It's hard to care about others when you're starving. This point aside, I want to get to Tyler's question about theoretical basis, not an empirical debate about how wealth relates to charitable giving.

Altruism as a Civilizing Force

Steve pointed to Hume as the source for markets as civilizing forces, but I know Tocqueville better. Thus, I am going to refer to Tocqueville's Democracy in America, particularly the portion about "Associations in Civil Life." Tocqueville marveled at the American way of gathering together to get things done. He referred to caring for the poor, preventing drunkenness, education, justice, churches, etc, which were all done by private citizens forming "associations" with one another. He remarked that Americans didn't even think to go to the government for these services the way his fellow countrymen did. Tocqueville believed this had something to do with the political power being dispersed in a democracy that allowed self-interested people to come together to do such things.

I would argue that these associations were enabled by the free market conditions, which prevailed in America at that time. Many Austrian economists would refer to this as cooperation. In terms of economics, interacting with other human beings can only happen in two ways: cooperation or force. Mises viewed society itself as, "concerted action, cooperation" (Human Action, Chapter 8, first paragraph). Thus, as free markets encourage cooperation as no other system we know does, so do free markets enable altruism. In short, free markets "civilize" people because cooperation is generally of higher valued than conflict. This civilizing force enables altruism.

Altruism Influencing Markets

But how does altruism influence markets? An altruistic person could crowd out entrepreneurs from innovating. If a non-profit or individuals crowd out markets or distort market signals, entrepreneurs will not know there is an opportunity or not have the incentive to innovate. Peter Drucker wrote, "Wherever public-service activities can be converted into profit-making enterprises, they should be so converted" (Innovation and Entrepreneurship, "Entrepreneurship in the Service Institution").

I don't want you to think that I am suggesting that we do away with altruistic organizations or actions. Steve cautioned me to think of altruism in markets as a "tradeoff properly understood." There are certainly places where activities cannot be turned into a for-profit enterprise. Also, we do not live in a free market world and need to understand that there is much that distorts the markets we operate in everyday. Moreover, many interactions between individuals are often not captured in markets with prices (think about when you go to your neighbor's house for a grill out or do family laundry, both activities that create value, but are not part of formal markets). These informal interactions are enabled by the markets, which foster cooperation, prosperity and the ability to see one-another as something other than competitors for food.

And if you'll allow me to get on my soapbox for a moment, I firmly believe that the government cannot be altruistic. Only individuals can be altruistic because it has to do with a subjective valuation (i.e., someone gets joy from increasing others' well-being!). If anything, there is evidence that governments crowd out charitable giving, which I'm using as a proxy for altruism.

 

Relying heavily on input from others, this is my best attempt to put my thoughts together about altruism in markets. Do you see it differently? Did I miss point or miss the bus completely? See my thoughts below for how I think this all plays out in the organization.

Thanks to Tyler for submitting the topic!