Episode #33 - Free-Rider Friday - February 2015

Welcome to this week's “Free-Rider Friday.” Most of our shows are “topic” driven, where we dive deep into one subject. Free-Rider Fridays are designed to be “event” driven—whatever issues are in the news that we (or you) find worthy of commentary. In economics, free riding means reaping the benefits from the actions of others and consequently refusing to bear the full costs of those actions. This means Ed and Ron will free ride off of the news, and each other, with no advanced knowledge of the events either will bring up.

The Soul of Enterprise: Dialogues on Business in the Knowledge Economy is now available on Amazon Kindle

Cover

Ed and I are pleased to announce the publication of our first book together, based on the topics from our show.

The book is available exclusively on Amazon Kindle. You can download the Kindle app for free to read the book on a device other than a Kindle.

The book contains six chapters, which are from our show, combined into logical topics. We also added an Introduction and Epilogue.

Further, we’ve added links to many of the ideas, definitions, books, and other interesting things we cite. It’s a complete digital experience.

The Foreword was written by VeraSage Instiute’s G. Robert Newhart Non-Value-Added Fellow, Greg Kyte, and it does not disappoint. There’s also some funny illustrations by the cartoonist, caricaturist and illustrator Andrew Fyfe from Australia, a pure genius.

Here’s a more detailed description of the book:

The world’s economy has been transformed from a twentieth-century materials-based economy to the Age of the Knowledge-Based Economy — and the currency of this realm is ideas, imagination, creativity, and knowledge. According The World Bank, 80% of the developed world’s wealth now resides in human capital.

Perhaps President Ronald Reagan said it best in his address to Moscow State University on May 31, 1988:

Like a chrysalis, we’re emerging from the economy of the Industrial Revolution — an economy confined and limited by the Earth’s physical resources — into, as one economist titled his book, “the economy in mind,” in which there are no bounds on human imagination and the freedom to create is the most precious natural resource.

Written by Ronald Baker and Ed Kless, hosts of The Soul of Enterprise: Business in the Knowledge Economy, the popular radio show on Voice America’s Business Channel, The Soul of Enterprise: Dialogues on Business in the Knowledge Economy sounds the clarion call that organizations can no longer ignore this seismic shift that has occurred in the economy since 1959. The Soul of Enterprise introduces the three components of Intellectual Capital — human capital, social capital, and structural capital — and how to leverage them to create wealth in today’s economy, by revealing:

• The physical fallacy — why wealth no longer consists of tangible things, but of ideas, imagination and knowledge from human minds

• The best learning tool ever invented: After Action Reviews

• Why Frederick Taylor and the Scientific Management movement was a fraud and the wrong focus for knowledge workers

• The fact that effectiveness always and everywhere trumps efficiency

• The First Law of Pricing: All value is subjective

• The Second Law of Pricing: All prices are contextual

• The Morality of Markets: Doing well and doing good

• Why your organization — and you — need to be driven by a higher purpose than profit

The Soul of Enterprise will inspire and challenge readers to unlock the enormous financial and competitive power hidden in the intellectual capital of their organizations and knowledge workers.

Bill Gates Doesn’t Understand Wealth Creation

Ron mentioned an article from The Economist’s The World in 2015, written by Bill Gates. Some excerpts:

…disease and extreme poverty are not inevitable. In the past 25 years, the number of children who die has dropped by a half. …The number of extremely poor people has been going down at roughly the same rate.

We also know why people are escaping poverty: it is thanks to more productive agriculture, better access to financial services, and the spread of functioning health systems that prevent expensive medical emergencies.

Is he kidding? What’s caused people to escape bone-crushing poverty is the spread of capitalism. Free markets are the cause of all the results he cites, yet he doesn’t seem to understand how markets work.

This never ceases to amaze me. Some of the most successful entrepreneurs, and wealthiest, have no idea how capitalism works. They were able to practice it, but they can’t explain it, or offer a theory in its defense.

It validates William F. Buckley Jr.’s quip: “ The problem with capitalism is capitalists.”

Net Neutrality

Next we discussed the thorny issue of net neutrality. We are both against the recent regulations from the FCC that reclassifies the Internet from an “information service” to a “telecommunication service.”

Can you point to one innovative, heavily regulated industry? Had the government regulated the early days of the computer revolution, we’d probably have Vacuum Tube Valley, most likely in West Virginia.

Even The Economist likes broad rules (fast lanes can’t exceed slow lanes by a certain amount), rather than blanket regulations.

There’s an excellent article by Nick Gillespie at Reason magazine on this issue.

In all fairness, no one has seen the regulations yet. But is there any doubt that once regulation starts, it expands?

Could it be used to require all websites to have a license? Or control content?

I’m sure we will discuss this topic in future shows.

Greg Kyte

Greg Kyte called for the latter half of the show, discussing his work, videos, the Foreword he wrote to our book, and his new business: ComedyCPE.com.

Watch some of his hilarious videos at GregKyte.com, including the above infamous series of queuing up for the Blackberry, Bob’s BBQ, Great Moments in Value Pricing History, Parts I and II, and Billable Hour Scratch & Win.

Episode #30 - Crafting the Value Conversation with Dan Morris

Ed and I had the pleasure of interviewing Dan Morris, co-founder of VeraSage Institute, and one of the world’s leading experts on crafting the value conversation. Dan did a video for the AICPA on the value conversation, which is well worth watching.

We’ve also included an excerpt from the value conversation chapter of Ron’s latest book, Implementing Value Pricing: A Radical Business Model for Professional Firms, as well as some additional books and resources mentioned during the show:

The Value Conversation

Language was invented to ask questions. Answers may be given by grunts and gestures, but questions must be spoken. Humanness came of age when man asked the first question. Social stagnation results not from a lack of answers but from the absence of the impulse to ask questions.

––Eric Hoffer, Reflections on the Human Condition, 2006

Any company that establishes prices based upon value will agree that the conversation with the customer is the most important part of the process. Skipping an in-depth conversation is similar to a contractor attempting to build a customer’s dream home without any architectural plans. The better your firm comprehends the customer’s value drivers, the more likely you will be able to create and communicate maximum value, convince the customer they must pay for that value, and capture that value with an effective pricing strategy custom tailored to the customer.

This is an opportunity for you and the customer to create a shared vision of the future, to analyze where the customer is at this point, and to develop the necessary action plan to move them to where they want to be.

This focus is crucial, because if you do not discus value with the customer, you will be forced into a discussion of costs, efforts, activities, and deliverables, usually by procurement, or some other professional buyer within the customer’s organization. Remember that the customer is trying to maximize the value they receive while attempting to minimize your price. It is far more strategic to engage in a discussion over what the customer is trying to maximize rather than what they are trying to minimize. If all you focus on is price, it can never be low enough. If the customer says your price is too high, what they are really saying is, “I don’t see the value in your offering.” It is not a question of money; rather, it is lack of belief.

Naive Listenting

When I am getting ready to reason with a man I spend one-third of my time thinking about myself and what I am going to say, and two-thirds thinking about him and what he is going to say.

––Abraham Lincoln

Questions require doubt, something salespeople who are experts in what they sell are not comfortable with. After all, we are paid to have the answers, not express doubt; and if you already know the answers there appears to be no need to gather any more information from the customer, chaining ourselves to the limits of our existing knowledge.

For this reason, during the conversation the customer should talk at least twice as much as the salesperson. This is incredibly difficult because it requires self-restraint. Naïve listening is difficult because you think much faster than people talk. While someone is talking, you are usually listening with one-half of your brain and formulating your answer with the other. Active listening is a skill that needs to be developed.

Talkers may dominate a conversation but the listener controls it. Taking notes conveys to the customer that what they are saying is important and that you care enough to record it. It also helps you remember exactly what they said. But most of all—and this is precisely why psychiatrists and psychologists take notes—is the person will provide much more detail. The more you know, the more value drivers you will be able to uncover, and the higher prices you will command.

You also want to deal with the economic buyer—the person who can hire and pay you. Many consultants believe you are wasting your time if you cannot get in front of this person, because most likely you will be dealing with gatekeepers who can only say “no,” never “yes.” This may take a few iterations, but the customer is sending a signal they are not serious if they deny you access to the economic buyer, and you may want to invest your resources in more profitable opportunities—such as servicing existing customers.

Avoid the ever-present temptation to provide solutions to the customer’s needs and wants. That is not the purpose of the conversation at this stage. You are on a value quest with the customer, not in a venue to begin providing solutions. Your role at this point is to ask questions and have the customer formulate—or at least articulate—a vision of the future. Before doctors prescribe, they must diagnose, which is the role you must assume at this stage in the conversation. Anything less is malpractice.

Starting the Conversation

This is one of the most effective statements to utilize somewhere near the beginning of the value conversation, regardless of whether you are meeting with a new or current customer:

Mr. Customer, we will only undertake this sale if we can agree, to our mutual satisfaction, that the value we are providing is greater than the price we are charging you. Is that acceptable?

This establishes the right tone near the beginning of the conversation that yours is a firm obsessed with value, along with the willingness to demonstrate the economic impact that your products and/or services can have for the customer—how it will improve the customer’s life or business. It also subtly suggests that you will not enter into relationships that do not add value for both parties—the exact tone you want to set, as both sides to a transaction must profit if it is to be sustainable.

Questions You Should Ask the Customer

If all patients were the same, medicine would be a science, not an art.

––Sir William Osler, one of the fathers of modern medicine

Something similar to Osler’s statement can be said of questioning—it is an art and skill, not a science. Each customer is unique, and so must be your approach to questions. Just as with naïve listening, one should not be afraid to take the Lt. Columbo approach and ask simple questions. As English mathematician and philosopher Alfred North Whitehead wrote, “The ‘silly question’ is the first intimation of some totally new development.”

Peter Drucker also taught an effective approach to assignments: approach the problem with your ignorance:

I never ask these questions or approach these assignments based on my knowledge and experience in these industries. It is exactly the opposite. I do not use my knowledge and experience at all. I bring my ignorance to the situation. Ignorance is the most important component for helping others to solve any problem in any industry.

There are questions you should ask every customer to assist you in determining just where on the value curve your customer is located. The more information you seek from customers, the better equipped you will be to assess their price sensitivity. Always ask open-ended questions to engage the customer in discussing goals, aspirations, fears, desires, and dreams of the future. This has a tremendous psychological impact, because most people’s favorite topic is themselves. Start with the following questions:

• What do you expect from us?

• What is your business model? How do you make profit?

• What are your company’s critical success factors and Key Predictive Indicators (KPIs)

• How will the services we provide add value to your customers?

• Which of our company’s offerings is of the highest value to you?

• Who is the next best alternative (competitor) to our company?

• What characteristics do they have we do not, and vice versa.

• What is your current pain?

• How do you see us helping you address these challenges and opportunities?

• What growth plans do you have?

• If price were not an issue, what role would you want us to play in your business?

• Do you expect capital needs? New financing?

• Do you anticipate any mergers, purchases, divestitures, recapitalizations, or reorganizations in the near future?

• We know you are investing in Total Quality Service, as are we. What are the service standards you would like for us to provide you?

• How important is our service guarantee to you?

• Why are you changing suppliers? What did you not like about your former supplier that you do not want us to repeat?*

• How did you enjoy working with your former supplier?**

• Do you envision any other changes in your needs?

• If we were to attend certain of your internal management meetings as observers, would you be comfortable with that?

• How do you suggest we best learn about your business so we can be more proactive in helping you maximize your business success?

• May our associates tour your facilities?

• What trade journals do you read? What seminars and trade shows do you regularly attend? Would it be possible for us to attend these with you?

• What will the success of this engagement look like?

• What is your budget for this type of service?

*Do not denigrate the predecessor supplier. First, this insults the customer and reminds the customer of a poor decision. Second, it diminishes respect and confidence in the industry as a whole.

**Even though the customer is changing suppliers, almost certainly the customer liked some characteristics of the predecessor. Find out what these were and exceed them.

Believing Your Worth

There is great nobility in getting paid what you are worth. Nothing is more satisfying than customers who believe—and act on the premise—that they get what they pay for. The best way to achieve this is to have a value conversation.

Book and Resources

• Bosworth, Michael T. Solution Selling: Creating Buyers in Difficult Selling Markets.

• Cohen, PhD, William A. A Class with Drucker: The Lost Lessons of the World’s Greatest Management Teacher.

• Hoffer, Eric. Reflections on the Human Condition.

• Johnson, Robert. Kick Your Own Ass: The Will, Skill, and Drill of Selling More Than You Ever Thought Possible.

• Khalsa, Mahan. Let’s Get Real or Let’s Not Play: Transforming the Buyer/Seller Relationship.

• Marcus, Stanley. Minding the Store: A Memoir.

• Rackham, Neil. SPIN Selling.

• Mahan Khalsa’s free iTunes podcasts on How to Dramatically Increase Sales by Helping Clients Succeed.

• Simon Sinek’s Ted Talk: Start with Why.

Episode #28 - There's no such thing as a commodity

There is no such thing as a commodity. All goods and services are differentiable.

—Theodore Levitt, Harvard Business Review

G.K. Chesterton once wrote, “Competition is a furious plagiarism.” Yet the fact of the matter is there is no such thing as a commodity. Anything can be differentiated, which is precisely the marketer’s job.

Believing that your company—and the products and services it offers—is a commodity is a self-fulfilling prophecy. If you think you are a commodity, so will your customers. How could they believe otherwise?

This notion of selling a commodity is one of the most pernicious beliefs, which leads to price wars, incessant copying of competitor’s offerings, and lack of innovation, creativity, and dynamism. Consider this story from The Tom Peters Seminar:

Transformation. Breaking the mold. Anything—ANYTHING—can be made special. Author Harvey Mackay tells about a cab ride from Manhattan out to La Guardia Airport: First, this driver gave me a paper that said, "Hi, my name is Walter. I'm your driver. I'm going to get you there safely, on time, in a courteous fashion." A mission statement from a cab driver! Then he holds up a New York Times and a USA Today and asks would I like them? So I took them. We haven't even moved yet. He then offers a nice little fruit basket with snack foods. Next he asks, "Would you prefer hard rock or classical music?" He has four channels. [This cab driver makes an above-average amount per year in tips.]

If a taxi cab driver can establish a rapport with a complete stranger in a 15-minute ride to the airport, what is possible with a customer relationship over the course of a lifetime?

The potential for competitive differentiation is only limited by your company’s imagination. Many leaders lament that since their industries are mature, commoditization is inevitable, despite all the empirical evidence surrounding them that this is simply not so.

Commodity + Creativity = Differentiation

Consider candles, an industry literally in decline for the past 300 years. Yet Blyth Industries custom tailors its candles for the specific location, companion, and occasion, growing from $3 million in sales in 1982 to nearly $1 billion in 2010.

Even the declining lettuce business has been differentiated by prewashing it, cutting it up and packaging it—along with some salad dressing on the side—for the customer in order to save time. As a result, from the late 1980s a billion dollar industry was created.

Imagine investing $1 million of your own money into a start-up company selling dolls to girls. Most people would be deterred from facing Mattel and its flagship Barbie doll, but not former elementary school teacher Pleasant T. Rowland, creator in 1985 of The American Girls Collection.

Inspired by a trip to Colonial Williamsburg, she reflected on what a poor job schools do of teaching history, and how sad it was that more kids could not visit this fabulous classroom of living history. In 1998 Rowland sold the company to Mattel for $700 million.

Would you ever pay more for a share of stock—whose price is publicly listed and traded on the New York Stock Exchange—to one broker over another? After all, how can a share of stock be differentiated?

Before you answer, visit www.oneshare.com, where you can only purchase one share of stock at a time, valued primarily as gifts for babies and teenagers. Included in the ten best-selling shares, which you can have framed for an additional price, are Disney, Harley Davidson, Coca-Cola, and Facebook.

Starbucks. If coffee beans and water can be differentiated—not to mention command a premium price—what is the excuse from your marketing department?

Basic economics teaches that it is very difficult to sell something someone else is giving away for free. Yet notice bottled water. Water covers nearly three-fourths of the earth’s surface. Could there be a larger commodity than water? Perhaps this is why Evian is “naïve” spelled backwards?

Charles Revson, founder of Revlon and a man who understood exactly what his customers were buying, illustrated in his famous saying, “When it leaves the factory, it’s lipstick. But when it crosses the counter in the department store, it’s hope.”

Revson refused to believe that what he sold—a relatively straightforward concoction of chemicals—was a commodity, and reportedly spent 45 minutes in front of a seminar of his international marketing executives having a dialogue with a glass of water, attempting to illustrate the meaning of product differentiation. As explained by his unauthorized biographer Andrew Tobias in Fire and Ice:

. . . [T]he water glass caught his eye. He picked it up, held it out in front of him, and said, in his friendliest way, “Hello, glass. What makes you different? You’re not crystal. You’re a plain glass. You’re not empty, you’re not full . . .” and then he began telling the glass how it could be made special . . . by changing the design, changing the color of the water, giving it a stem, and so on.

Avoiding the Commodity Tax

So many companies are prisoners of their past, assuming that the way they have always done it is the only way. Yet it takes creativity and innovation to separate yourself from the competition. Offering only a cheap price is the last refuge of a marketing department out of ideas for creating value for customers.

There is absolutely no excuse—none—for businesses to think of themselves as commodities. Any company can compete on price; it is truly a fool’s game. The commodity trap is a self-fulfilling prophecy, breeding cynicism and stifling creativity, dynamism, and innovation.

Robert Stephens, founder of Geek Squad, said, “Advertising is a tax for having an unremarkable product.” Commodity thinking is the same type of tax.

Do not let your company acquire a core competency in cutting prices by falling into the commodity trap.

Episode #12: The Moral Hazards of Measurements

As long as measurements are abused as a tool of control, measuring will remain the weakest area in a manager’s performance. —Peter Drucker

The illusion of certainty in our measurements creates—to borrow an important concept from the insurance industry—a moral hazard.

Simply defined, people have an incentive to take more risks or act carelessly when they are insured. Fire insurance causes arson; unemployment insurance allows people to not be as diligent in finding a job; life insurance causes suicide, or worse, murder; auto insurance can cause reckless, etc.

Our current cult of calculation, perpetuated by the infamous McKinsey maxim—what you can measure you can manage—creates the same type of risk, offering today’s business executives the illusion of control and mastery of knowledge.

It allows them to substitute statistics for thinking. It gives them a false sense of security where there should exist more doubt.

If we want to peer into the unknown future, our measures need to be linked to a theory, otherwise we are simply predicting the past—since history is the only dimension for which numbers can provide precision. With theory, we can also avoid the moral hazards of measurements so prevalent in today’s society.

Seven Moral Hazards of Measurements

In the Handbook of International Trade and Development Statistics, 1988, per capita output in 1988 in East Germany—one year before the Berlin Wall was pushed over—was placed at roughly seven-eighths of the West German level.

But as any Berlin taxi driver crossing through Checkpoint Charlie after the fall of the Wall could have told you, the economy of East Germany was manifestly inferior to that of West Germany, yet somehow—due to the moral hazard of measurement—those in the know got it precisely wrong rather than approximately right.

Taking into account the following seven moral hazards of measures may assist executives in avoiding these types of errors.

Moral Hazard 1: We Can Count Consumers, But Not Individuals

Singer Joan Baez used to say it was easier for her to have a relationship with 100,000 people than with one person. Stalin’s famous remark that “one death is a tragedy, whereas a million is a statistic” illustrates the danger of lumping individuals into aggregate, amorphous lumps as if they did not have a soul.

Stanley Marcus, the son of one of the founders of Neiman-Marcus, led the store through the difficult Great Depression, and one point he was especially fond of making was there was no such thing as a market, only customers.

In 2003, General Motors sold 8.59 million vehicles, yet each was sold one at a time. The micro level, where the customer interacts with the seller, is inherently a flesh-and-blood transaction. As economist Herbert Stein always used to say, “There is nobody here but us people.”

In the final analysis, markets and consumers are statistical abstractions, whereas customers are human beings who want to be treated specially and individually.

Moral Hazard 2: You Change What You Measure

Scientists call it Heisenberg’s Uncertainty Principle, which applies to all measures: that the observer in a scientific experiment affects the result. Central bankers call it Goodhart’s law: Any target that is set quickly loses its meaning as it comes to be manipulated. People will always find ways to make their numerical targets, even if it leads them to ineffective or, sometimes, unethical behavior.

A further hazard lies in the fact that in order to count something it must stand still, which is why the first statisticians were called “statists.” But people don’t stand still; they are constantly moving, changing, growing.

Moral Hazard 3: Measures Crowd Out Intuition and Insight

Once a measure becomes entrenched as part of the conventional wisdom, it is usually impenetrable to logic, intuition, critical thinking, or better ways to do something. Poverty statistics are a perfect example, as everyone accepts them as a precise measure of those citizens living below what we consider an acceptable standard of living. But how was this measure developed? Where did it come from?

The poverty rate measures the income of the poor, not their consumption, which is a false talisman of someone’s standard of living. It is not what you earn, it is what you are capable of spending; thus consumption should be measured, which would take into account nonreported earnings, noncash subsidies, and other services provided.

It is also a national statistic, and does not take into account regional differences in the cost of living. Further complicating the error, during the Johnson administration’s war on poverty, it was decided the “poverty rate” would be set at an arbitrary three times the cost of the U.S. Department of Agriculture’s economy food plan, as explained by Nicholas Eberstadt in his book The Tyranny of Numbers: Mismeasurement and Misrule.

Using a consumption-based, rather than an income-based, poverty measure, Eberstadt has concluded elsewhere the rate drops from approximately 13 percent to between 2 and 3 percent. Quite a difference, and illustrative of how far off even old measurements can be and how firmly entrenched they remain despite being precisely wrong.

If you have ever been bribed off an oversold airplane—with a free flight voucher, upgrade, or airline money equivalent—you have economist Julian Simon (1932–1998) to thank. Until 1978, and before the airlines were deregulated, travelers were bumped off overbooked planes rather capriciously (the airlines preferred to bump old people and military personnel on the theory they would be least likely to complain) and this caused enormous amounts of customer complaints and ill will.

Worse yet, the problem fed upon itself, because passengers began to expect being bumped and so would book several flights under various names to ensure a seat on at least one. This caused the airlines to increase bookings even more to ensure decent load factors, which of course were measured very precisely.

Had the airlines changed the process and tested Simon’s idea sooner, the airlines and its customers both would have been better off. Simon did not analyze countless numbers and statistics, but used his intuition, grounded by the economist’s theory of human behavior being rational, to solve a quite vexing problem.

Daniel Boorstin, librarian of Congress, wrote: “The greatest obstacle to discovery is not ignorance—it is the illusion of knowledge.”

Moral Hazard 4: Measures Are Unreliable

A country’s per capita gross domestic product increases when a sheep is born but decreases when a child is; or how divorce actually increases the GDP since almost two of every commodity must now be purchased rather than just one.

Picasso once said, “Art is a lie that tells the truth.” It seems in some instances, measurements are truths that tell lies.

Another example of the unreliability of measures is illustrated by the consulting firm Bain & Company’s Web site, where it proudly proclaims: “Our clients outperform the market 4 to 1,” shown over a graph from 1980 to 2012 depicting the S&P 500 Index and Bain clients.

This is the equivalent of the rooster taking credit for the sunrise because he crows every morning. One expects this type of unscientific hyperbole from politicians, not management consultants. I would be willing to bet that Bain’s clients perform better than the S&P 500, thus have more money to spend on consultants.

Moral Hazard 5: The More We Measure the Less We Can Compare

Engage in this gedanken: You (or a loved one) need(s) heart surgery. You talk to nurses, friends, and other people you trust and respect, and two surgeons are consistently recommended to you. You go online to do some research on these two practitioners and discover their mortality rates (i.e., the risk of dying from surgery: surgeon A = 65 percent; surgeon B = 25 percent. Which surgeon would you choose?

I have conducted this gedanken in seminars attended by various educated professionals—who certainly have taken a statistic class or two—and, astonishingly, the overwhelming majority select surgeon B. When I ask why, they say because of the lower probability of death.

Perhaps they think they need to choose between the two without gathering other information. But that is not how I set up the thought experiment: I left it open as to whether they could ask further questions. Not many do.

But wouldn’t you want to know what type of patients the two doctors serve? What if surgeon A takes a disproportionate share of hard cases and thus has a higher failure rate? He or she just may be the better surgeon.

The point is, we simply do not know without gathering more information, both quantitative and qualitative, and making further judgments based on our own risk profile. Seeing the two numbers side by side seems, though, to give people a false sense of precision and, in this case, could lead to a deadly decision.

Moral Hazard 6: The More Intellectual the Capital, the Less You Can Measure It

Ideas only come from sentient beings, not inanimate objects or pets. Since 80 percent of any country’s wealth-creating capacity resides in its human capital, how could it be otherwise?

To complicate matters, a lot of that knowledge is tacit, which is hard to capture in spreadsheets and pie charts. We may be able to count the physical assets of a Google or a Microsoft, but traditional accounting pays no attention to its human capital, what has been labeled the “invisible balance sheet.”

Traditional book value accounting—assets minus liabilities equals equity—can only explain about one-fourth of the value of the market capitalization on the nation’s stock markets. Accountants call the difference between market value and book value goodwill; but that is just a label for their ignorance. In an intellectual capital economy, debits don’t equal credits, because value is subjective and flows from free minds, not tangible commodities.

Data, reason, and calculation can only produce conclusions; they do not inspire action. Good numbers are not the result of managing numbers. As David Boyle wrote in The Sum of Our Discontent (Cloth): Why Numbers Make Us Irrational: “Decisions by numbers are a bit like painting by numbers. They don’t make for great art.”

Moral Hazard 7: Measures Are Lagging

Imagine driving your car with your dashboard gauges informing you of last month’s speed, fuel level, temperature, oil pressure, RPMs, and the rest. This is precisely the status of accounting information: it is like walking into the future backward.

It is a lagging indicator—or at best coincident, assuming real-time accounting takes place. This type of information can only tell us where we have been, never where we are going. Auditors come in after the battle and bayonet the wounded; they are historians with lousy memories.

Summary

The Danish philosopher Søren Kierkegaard wrote: “Life is lived forward but understood backward.” Certainly measures help us reflect on past events and aid us in improving our theories. But they can never take the place of dreams, imagination, passion, and the soul of enterprise where entrepreneurs toil and struggle to create our future.

No measure is capable of capturing the richness of free minds operating in free markets dreaming of better ways to improve our future, and it is folly to believe otherwise. It may even lead us into moral hazards, or a world where we are so preoccupied about measuring past performance we do not take the time to dream about the future.

Other books and resources mentioned

Uncharitable (Civil Society: Historical and Contemporary Perspectives), by Dan Pallotta

The Sum of Our Discontent (Cloth): Why Numbers Make Us Irrational, David Boyle

Minding the Store, Stanley Marcus

Episode #9 - Interview with Rory Sutherland

Rory-Sutherland

We knew our interview with Rory Sutherland, Vice-Chairman, Ogilvy Group, UK, would be an exciting and exhilarating exchange of ideas. It’s safer to say it was an idea explosion, which will be difficult to summarize.

Because he mentioned so many useful ideas, as well as books, here are the major themes and highlights of our discussion.

Rory’s Career and Brief Biography

Pre Ogilvy (1988)

Did you meet David Ogilvy? Did you ever get to stay at his castle?

Rory’s book, The Wiki Man, which we quoted from throughout the interview.

Economics

While sick in bed, Rory read Steven Landsburg’s book, The Armchair Economist, one of Ed and Ron’s favorite economists. Rory also mentioned other economics books he’s read:

• Robert H. Frank, The Economic Naturalist

• John Kay, Obliquity

• Tim Harford, The Undercover Economist; The Undercover Economist Strikes Back; and The Logic of Life

• Richard Thaler and Cass Sunstein, Nudge

• Adam Smith, The Theory of Moral Sentiments (1759); and The Wealth of Nations (1776)

• Matt Ridley, Ideas Having Sex; and The Rational Optimist

• Steven Levitt and Stephen J. Dubner, Think Like a Freak

Rory discussed how Ludwig von Mises became one of his heroes. His book, Human Action, describes his theory of Praxeology, the study of human behavior, and prior science before economics, which is preoccupied with human psychology.

Ed then asked Rory: You wrote in The Wiki Man:

I think the pace of technological innovation is going to slow down. This is not a majority view, but I just think the fundamental innovations we can make just are not that huge.

But what about the driverless car, graphene, 3D printing, space travel, Bitcoin––are they disruptive or sustaining?

Ron challenged Rory on what he wrote:

I’m perfectly happy giving ideas away because an idea is worthless unless it’s executed.

Really? Thomas Sowell’s work, especially in Basic Economics, has convinced me that ideas are, always and everywhere, more valuable than their mere execution.

Try to execute a crappy idea: socialism, communism. As a creative, doesn’t the concept that “good ideas are everywhere” bother you? Good ideas aren’t everywhere, otherwise we wouldn’t get so many crappy movie remakes and TV shows.

Even you cited Henry Ford example in The Wiki Man:

Henry Ford’s reaction to a consultant who questioned why he paid $50,000 a year to someone who spent most of his time with his feet on his desk. 'Because a few years ago that man came up with something that saved me $2,000,000,' he replied. 'And when he had that idea his feet were exactly where they are now.'

For more on the idea that ideas are more valuable than execution, see Ron’s blog post here.

Marketing, Branding and Advertising

Ron asked Rory about Peter Drucker’s statement:

 Because its purpose is to create a customer, the business enterprise has two––and only these two––basic functions: marketing and innovation. Marketing and innovation produce results; all the rest are costs.

Rory wrote:

The purpose of marketing is to turn human understanding into business or social advantage.

On brands, you wrote:

I suggest it is by far the more valuable economic role that brands play: not to be a promise of ultimate superiority but a cast iron assurance of pretty dependable non-shitness.

And you said that you can’t understand brands without understanding “satisficing,” the Northumbrian term that means to choose the first option that is satisfactory; “good enough” (combination of Satisfy + Suffice).

Herbert Simon in his book, Models of My Life, describes “satisficing” and “bounded rationality.” Ron also mentioned Peter Drucker’s autobiography: Adventures of a Bystander.

‘Effing Debate: Efficiency vs. Effectiveness

Humans don’t like pure efficiency. Rory talks about Arithmocarcy and why the most dangerous technology is the spreadsheet.

Math requires calculate solution, then enact it. Hueristics allows us to do both in parallel—i.e., catching a ball.

In The Wiki Man he wrote:

…how, in their endless, dogged pursuit of a false efficiency, organisations can be rendered slightly useless. And stupid.

Remember that the word “dogged” is derived from the word “dog” meaning “energetic and stupid.

…belief in false efficiency is very simple; it comes from the belief that improvement comes from the elimination of apparent waste.

Rory also quoted Jules Goddard, professor at the London Business School and author of Uncommon Sense, Common Nonsense:

Strategy is the art of staying one step ahead of the need to be efficient. (Ed's note: This was the take away quote of the interview!)

Hourly Billing and Timesheets

Ed asks Rory about David Ogilvy taking responsibility for introducing the billable hour to ad agencies, in his book, Ogilvy on Advertising. Probably his biggest mistake.

Rory explains why he did it, and how entrenched hourly billing has become in ad agencies.

Last question for Rory: What’s he Reading now? Some fiction, and Super Cooperators by Martin Nowak. He also highly recommends The Origins of Wealthby Eric D. Beinhocker.

Two of Rory’s Presentations You Need to Watch

TEDtalk

Google Zeitgeist