Episode #250 Preview: INFLUXUS RECIPROCI FALSUM

Confused by the title of our upcoming show?

Don't worry, we'll make Ed explain it all! Just be sure to listen to hear about data dredging and Pearson's correlation coefficient. Trust us, this will be a fun show!

Join us this Friday at 4pm ET / 1pm PT.

  • If you’d like to call-in during the live show, the listener line is: 866-472-5790.

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As always, please check our website for upcoming and previous show notes and recordings, use Twitter to find the show at @AskTSOE or find us on Facebook.

Our wonderful hosts Ed and Ron are on Twitter at @edkless and @ronaldbaker, respectively (and obviously).

Episode #249: The Adaptive Capacity Model

Do You Know the Real Capacity of Your Firm? 

Ed and Ron went through the Adaptive Capacity model this past week on the radio show. The show notes are below. This was a complex topic covered over the course of an hour. It is definitely worth a listen or two!

Maximum vs. Optimal Capacity

All firms have a theoretical maximum capacity and a theoretical optimal capacity. From a strategy perspective, it is essential to see how that capacity is being allocated to each customer segment. Your maximum capacity is the total number of customers you firm can adequately service, while the optimal capacity is the point at which customers can be served adequately while maintaining your competitive advantage and pricing integrity.

Usually, for most professional firms, optimal capacity is between 60 and 80 percent of maximum capacity. 

Insuring a proper amount of capacity is allocated to various customer segments, while offering a differentiating value proposition within each segment, is an essential element of implementing value pricing strategies. It also prevents bad customers—those who are not willing to pay for the value you deliver—from crowding out good customers.

The Adaptive Capacity Model

Think of your firm as a Boeing 777 airplane, similar the one below.

Picture1.png

When United Airlines places a Boeing 777 in service, it adds a certain capacity to its fleet. However, it goes one step further, by dividing up that marginal capacity into five segments:

A. First class
B. Business class
C. Full fare coach
D. Coach
F. Leisure, Priceline.com, and Bereavement fares 

The airlines—and hotels, cruise lines, golf courses, car rental agencies, and other industries with fixed capacity—are adept at managing and predicting their adaptive capacity to maximize profitability. 

Lessons from Yield Management

The airlines understand it is the last–minute customer who values the seat the most and hence they reserve a portion of each plane’s capacity for their best customers. They do this even at the risk the plane will take off with some of those high price seats empty—and that revenue can never be recaptured since they cannot inventory seats. 

Why do they take that risk? Because the rewards of reserving capacity for price insensitive customers comprise the majority of their profits.

Airlines allocate only so many seats to coach, leisure, Priceline.com (or bereavement) seats, which they offer well in advance of the flight. However, no airline adds capacity in order to accommodate these customers. 

This point is noteworthy, as too many firms will, in fact, add capacity—or reallocate capacity from higher-valued customers—in order to serve low-valued customers. This is the equivalent of the airlines putting the upper deck in the back of the plane rather than the front.

Furthermore, many companies will turn away high–value, last minute work from its best customers because it is operating near maximum capacity, usually at the low–end of the value curve for price sensitive customers. This is common during peak seasons; the lost profit opportunities are incalculable.

Many worry about running below optimal capacity and cut their prices in order to attract work, especially in downturns or slow cycles. This strategy is fine, but you must understand the tradeoff you’re making. Usually, that capacity could be better utilized selling more valued-added services to your first–class and business-class customers, who are less price sensitive than new customers.

This way, the firm does not cut its price and degrade its pricing integrity in order to attract price sensitive customers, sending a signal into the marketplace it is willing to engage in this strategy and affecting the perception of its value proposition. 

The conventional wisdom is you have to be at maximum capacity—where demand exceeds supply—to raise prices. But since when do you have to wait to be fully booked to demand a premium price? Do not confuse working harder (supply-side capacity) with working smarter (demand side pricing).

Prices are determined by value created for the customer, not the internal capacity constraints of your firm. How much fixed capacity are you allocating to each customer class? What will be the criteria you use to ascertain where in your airplane each customer sits? By viewing your firm as an airplane with a fixed amount of seats, you will begin to adapt your capacity to those customers who appreciate—and are willing to pay for—your value proposition.

Additional Reading 

Episode #207 Reprise: Interview with George Gilder

Did you catch the reprise of Episode #207 while Ed and Ron were on vacation last week? In lieu of show notes, we have opted to post the transcript of our interview with George Gilder about his book, Life After Google: The Fall of Big Data and the Rise of the Blockchain Economy

The transcript can be found here.

If you would like more on this or want to listen commercial free, please consider subscribing to our premium service at Patreon.

Episode #248: Free-Rider Friday, June 2019

We had another great Free-Rider Friday show! 

Here are Ron’s Topics: 

  • Picking up the Bill,” Bartleby, The Economist, May 25, 2019. Great Yogi Berra line: “I’m not going to buy my kids an encyclopedia. Let them walk to school like I did.”

  • Remember the Polar Bears,” National Review, April 22, 2019.

  • Why the UK Suddenly Is Suffering from a Physician Shortage,” FEE, June 1, 2019.

  • Our VeraSage colleague Paul Dunn sent us another example of the subscription business model: Rent the Runway, where you can rent your wardrobe. The company has become a Unicorn (a startup with a $1 billion+ valuation). Urban Outfitters is also launching a subscription service where you’ll be able to rent up to six items a month. This will help curb “wardrobing”—customers returning clothes after wearing them. The online market for renting clothes was worth $1 billion in 2017 and is forecast to double by 2023.

  • A forum in National Review from May 20, 2019, “In Defense of Markets.” Some excellent points from Jonah Goldberg, Marian L. Tupy, Deirdre McCloskey, Scott Lincicome, and Yuval Levin. 

And Here Are Ed’s Topics:

Episode #247: Memorable Mentors — Tom Peters

Do you have a memorable mentor? We do! 

Well, we tried, but we could not land Tom Peters to be a Guest on The Soul of Enterprise. Instead, we decided to do the next best thing - a Memorable Mentors episode.

On this show, Ron and Ed recapped the career and work of the person whom many claim as the father of the business book genre. His classic, In Search of Excellence, co-written with Robert Waterman, launched his career into a near-Earth orbit. His presentation style influenced both Ed and Ron with his wit and willingness to say outrageous "stuff." 

We discussed the following Tom Peter’s books in addition to In Search of Excellence.

We also discussed the antithesis to Tom Peters:
The Management Myth by Matthew Stewart


Check out some of these related resources.

  • Episode #120: Strategic Planning: Efficient, effective, neither, including a discussion on The modified Seven S Model.

  • Ed’s post “On Client vs. Customer”

 

 

Episode #246: Interview with Chief Pricing Educator Mark Stiving

Mark+Stiving.jpg

Mark helps companies discover how buyers perceive value and how to price offerings to capture more of the value they create. For over 25 years he has studied, led and coached businesses through the lens of pricing, a radically different approach from other business experts. He knows that every person inside your company affects the price a buyer is willing to pay. The prices you achieve ultimately indicate how well the entirety of your company operates. Mark has driven a company-wide pricing initiatives worth hundreds of millions of dollars in incremental profit. He started and sold three companies, improving his championship pricing skills in each one.  Mark will change the way you think about pricing and business as a whole.

From 10 years old to his doctorate studies at UC Berkeley, Mark gets RIGHT into the good stuff in this great interview. Check out the full show notes at this link.

Here are some additional links we mentioned during the show:

Episode #245: Interview with Justin Lake

A Special Episode: Interview with Justin Lake

Especially for those who know someone with diabetes, this very special episode features Justin Lake. The full transcript of the interview can be found here. Here are some of the links mentioned in the show:

Justin also wrote this article back in 2016 which drew the connection between his son's experience and his business of mobile technology.

justin lake.jpg

Justin Lake is an owner and principal at Venado Technologies, a digital technology consultancy. As a lifelong mobile tech enthusiast, Justin has dedicated his career to leveraging modern technologies to improve the effectiveness of organizations with highly mobile workforces. He has held roles in companies including wireless carriers, mobile device manufacturers, mobile managed service providers, and software development teams. And while that experience helps drive much of Justin's counsel with his clients, the real fuel is bringing creativity to every new challenge. Through his own ideas, and leveraging his extensive network of industry professionals, Justin and his team are able to bring value to the digital transformations of the most exciting companies in the world.

Episode #244: Free-Rider Friday, May 2019

Another great show is ready for a listen! This past week’s topic was Free-Rider Friday.

Ed’s Topics 

Ron’s Topics 

  • Happiness economics,” The Economist, March 23, 2019. “In total the world’s population looks roughly equally divided between places where happiness and incomes have moved in the same direction over the past ten years, and places where they have diverged.”

  • We have done a show on Generational Astrology (Episode #142). It’s also a bugaboo of Jonah Goldberg’s, as discussed in his article, “The Silliness of the Generation Conflagration,” National Review, May 24, 2015.

  • Volkswagen, the largest car company in the world, has made the biggest commitment to manufacture battery powered cars, larger than any other car company. Yet VW’s profits and productivity remain woeful, with Porsche and Audi accounting for the bulk of its profits. In the past, it’s been all about saving jobs, with labor unions controlling a lot of corporate decisions. But electric vehicles require 30% less effort, so jobs may be lost anyway. “New wave,” The Economist, March 16, 2019.

  • From National Review on libraries, an interesting analogy: “Assembling a library is a physical act, like gardening. One cannot cultivate flowers and vegetables online without a marked diminution in the experience.” 

Listener Question 

Ron received a great question from Robert Allender in Hong Kong: 

Dear Ron, 

I'm a few episodes behind so just today listened to you telling about your brother.  My condolences. Given what you said about his public speaking prowess, I immediately wondered if there were any videos or audios of him speaking.  I also wondered if you might have in the past penned anything about the specific knowledge he imparted to you on  the subject of public speaking, or if you planned to in the future. Either way, thanks for sharing your memories of Ken with us. 

Robert C Allender  
Managing Director

Episode #243: Team Member Compensation

People have value, not jobs. You price people, not jobs.

So why do people work?

  1. Intrinsic rewards—inherent in the work itself (volunteers)

  2. Opportunity to grow—education, invest in HC

  3. Recognition of accomplishments—storytelling (FedEx Bravo Award)

  4. Economic rewards—Extrinsic, pay, benefits

From Dale Dauten, The Gifted Boss: How to Find, Create, and Keep Great Employees:

Old school is hire someone by offering 20 percent more money. Well, try offering 100 percent more freedom or 100 percent more excitement…Gifted bosses and great employees want the same things from a workplace: 

            Freedom from…management, mediocrity, and morons

            A change

            A chance 


And there are other examples as well:

  • Steve Jobs said Apple was a culture that runs on ideas, not hierarchy (or seniority).

  • Thomas Jefferson: “There is nothing less equal than treating nonequals equally.”

  • Nordstrom: “Your performance is your review.”

In Get Rid of the Performance Review!, Samuel A. Culbert writes that “pay and performance don’t have much to do with each other. Lumping them together is a needlessly stupid, alienating ritual that produces phony posturing, and inhibits straight talk.” 

Here is a summary of Culbert’s theory on what determines pay:

  1. Whether the boss wants to retain the employee

  2. The amount of raise that boss thinks is necessary for doing so

  3. The department’s budget

When a valued employee decides to leave the boss will ask: “What will it take to get you to stay?” There’s no game-playing, or pretense, just the raw truth (of course, people don’t leave companies, they leave managers). 

Ed’s Compensation Model (read more at Ed’s blog post)

  1. Salary

  2. Profit-sharing (team vs. firm)

  3. On-the-spot bonuses

  4. Enhancement of intellectual capital — Knowledge Matrix

There’s an old military saying: “A man wouldn’t sell his life for $1 million, but would gladly risk it for a ribbon or Medal of Honor.” Purpose, probably more than any other factor, drives performance and discretionary effort. If people believe in what the organization stands for, they will pour their heart and soul into their work.


Episode #242: Prices, Profits, and Fairness

Why is an oil or pharmaceutical company condemned for earning windfall profits when market conditions change, while an individual homeowner who realizes a tidy profit off of a hot real estate market is applauded?

Popular movie stars, directors, and entertainment companies can earn above-normal profits without so much as a whisper of public protest. Premium ice creams and chocolates are very expensive and yield profit margins that would have made the “robber barons” of yesterday blush.

Very few of us would continue working at 50 percent of our present salaries. Are we not charging what the market will bear?

Why are individuals and corporations held to different standards? Perhaps it is not so much price that bothers people as it is profits.

Market Competition leads a self-interested person to wake up in the morning, look outside at the earth and produce from its raw materials, not what he wants, but what others want. Not in the quantities he prefers, but in the quantities his neighbors prefer. Not at the price he dreams of charging, but at a price reflecting how much his neighbors value what he has done.
––Friedrich A. von Hayek


Capitalism offers nothing but frustrations and rebuffs to those who wish—because of claimed superiority of intelligence, birth, credentials, or ideals––to get without giving, to take without risking, to profit without sacrifice, to be exalted without humbling themselves to understand others and meet their needs.
––George Gilder


Throughout history the morality of profits and a just price has been debated endlessly, as it should be. The late Father Richard John Neuhaus, in his book Doing Well and Doing Good, explains the ancient debate of a “just” price:

The idea that there is a right amount or a “just” amount always runs up against the question, Compared to what? The conventional answer is that one pays what the market demands, or what the market will bear. From Athens to Elizabethan England to the Great Terror of the French Revolution, societies have experimented with “sumptuary laws” setting limits on people’s income and expenditures. The experiments have never worked out very well, the obvious reason being that it is almost impossible to agree on standards. Few egalitarians, even among the well-to-do, propose a top income limit that is less than what they themselves receive.

 During the Dark Ages merchants could be put to death for exceeding the communal concept of a “just” price (justum pretium, the right price). In A.D. 301, Diocletian, the Roman Emperor, issued an edict fixing prices for nearly 800 items and punishing violators with death. Severe shortages transpired.

In ancient China, India, Rome, and almost everywhere throughout the Middle Ages, all interest charges were called “usury” and were prohibited entirely, making economic progress through lending and risk-taking all but impossible.

Today, so-called “price gougers” are subject to societal condemnation, regulatory harassment, and editorial vitriol. Oil companies are frequently a prime target of public outrage, especially when prices at the pump vary from one city to another.

Pharmaceutical companies are held in special contempt when they charge $5 to $100 (or more) per pill, even if the dosage reduces more costly medical intervention by other means, such as surgery. In May 2000, the late Senator Paul Wellstone claimed, “We have an industry that makes exorbitant profits off sickness, misery, and illness of people, and that is obscene.” So what?

Orthopedists profit from people breaking their leg skiing, just as professors’ profit from students’ ignorance. Farmers profit from our hunger, but in reality they keep us from hunger. Drug companies profit by making us healthy.

The problem with a “just” price is who gets to decide what is just? The free market already provides an answer to this question—whatever someone is willing to pay. There is no objective standard for “fair,” which is why we have free speech rights, not fair speech rights.

Although it sounds heretical, it is not. An old legal maxim teaches: Emptor emit quam minimo potest, venditor vendit quam maximo potest (“The buyer buys for as little as possible; the seller sells for as much as possible”). Ultimately, the customer is sovereign, spending his or her money only when it provides value.

To believe the free market is imperfect with regard to the fairness of prices is to grossly underestimate your own sovereignty as a customer while putting your faith in some anonymous third party—usually a governmental regulatory agency or the courts—to determine what is “fair.”

Yet prices contain a wealth of information that no central agency can possibly possess, which is why wage and price controls have failed everywhere they have been tried (See “A Fair Price Utopia Gone Wrong” Case Study).

If it is immoral for a company to charge premium prices to customers, does it follow it is also immoral for customers to pay low prices? If prices are deemed “unreasonable” why do people pay them? Only unreasonable people pay unreasonable prices.

Case Study: A Fair Price Utopia Gone Wrong

Once upon a time there was a fair price utopia. In it, prices were set according to a theory of fair pricing. The price was based on the average product cost of all firms plus a standard percentage markup. Even if the costs of production for an identical good varied, the price was kept uniform for the customer. Although prices responded dynamically to changing average costs of production, this dynamism was tempered to maintain price stability. There were no unpleasant surprises. Buyers were supposed to enjoy complete transparency and control: by law, they could review the producer’s accounting and participate in determining the price. And the prices of basic staples like bread were subsidized to help the needy.

Beginning to sound familiar? That is because this utopia was the pricing system of the former United Soviet Socialist Republic. It was a pricing system designed to be fair. So what went wrong?

In might have been fair in theory, but not in actuality. Prices did not reflect the value as perceived by the consumer. The determination of value was done by overblown governmental departments based on complex calculations of cost and profit plus distribution costs, as well as consumption value and utility. Consumers had no idea how prices were actually determined. Supply did not respond to demand. Consumer goods were always in short supply no matter how strong the demand.

The system was imposed from above so that consumers had no voice. They consequently felt no compunction about flouting it. The black market flourished. Although in theory all consumers paid the same price, in actuality they did not.

The pricing system was inequitable, unequal, uncontrollable and opaque. The prices were wrong—and that’s not fair.

Excerpted from The Price is Wrong: Understanding What Makes a Price Seem Fair and the True Cost of Unfair Pricing, by Sarah Maxwell, PhD, 2008, page 164.


To believe prices are determined by greed is to believe sellers can establish prices at whatever level they desire, in effect never having to suffer losses or bankruptcy. Homes along the ocean front command high prices, but this does not prove fresh air causes greed. Prices convey information, while allocating resources and distributing income. If sellers are greedy than the counter argument can be made that buyers are also greedy and selfish, since they value seller’s products more than they do their money. Yet only the seller gets blamed. Probably because greed and selfishness do not, at all, explain this behavior.

Perhaps it is not so much price that bothers people as it is profits. Profits have a bad reputation because most people simply do not acknowledge where they come from. Profits come from risk. The entrepreneur gives long before she receives. She pays wages, vendors, landlords, and the other costs of running a business in advance of having anything left over (profits). Very few individuals work for 100 percent stock options, yet business owners, in effect, do exactly this, since profits are only left over after everyone else has been paid.

If it were true that profits caused high prices, then we should witness lower prices in those countries with no profits, such as socialist or communist countries. Yet all of the empirical evidence is to the contrary. Even though profits comprise only 10 percent of national income, they are crucial in allocating the other 90 percent. Of course, since most enterprises do not make an economic profit, perhaps we should say the pursuit of profit is the necessary ingredient. In any event, whenever someone laments a particular industry (or company) is making obscene profits, there is an effective retort: If you believe that, you would be crazy not sell everything you own and buy its stock.

Peter Drucker pointed out, “If archangels instead of businessmen sat in director’s chairs, they would still have to be concerned with profitability, despite their total lack of personal interests in making profits.”

Profits are an indicator that a useful social purpose is being filled and needs are being met. In a free market, no profit could exist without people voluntarily entering into a transaction where each receives more than they give up, what Harvard philosophy professor Robert Nozick cleverly coined “capitalist acts between consenting adults.” This is why George Gilder compares profits to altruism, since in enterprise gift giving precedes voluntary exchange—alter in Latin means “other.” For you to exchange you have to create something to exchange.

The essence of giving is not the absence of an expectation of earning a return, but the absence of a predetermined return. Profits are not guaranteed, and are determined by consumers, not greed. Gilder explains this eloquently:

A profit is the difference between what inputs cost the company and what they are worth to somebody else. It’s the index of the altruism of the process.

The moral code of capitalism is the essential altruism of enterprise. The most successful gifts are the most profitable––that is, gifts that are worth much more to the recipient than to the donor. The most successful givers, therefore, are the most altruistic––the most responsive to the desires of others.

The circle of giving (the profits of the economy) will grow as long as the gifts are consistently valued more by the receivers than by the givers. A gift is defined not by the absence of any return, but by the absence of a predetermined return. Unlike socialist investments, investments under capitalism are analogous to gifts, in that the returns are not preordained and depend for success entirely on understanding the needs of others. Profit thus emerges as an index of the altruism of a product.

 
Economists classify different types of profits as follows: 

Normal profits—The return to the owner, net economic return is zero, where costs include the cost of capital, the market rental rate of capital.

Supernormal profits—Profits in excess of normal profits. Occur when revenues exceed costs, again including the cost of capital. They are often identified with monopoly profits.

Rents—When an agent owns a good that has a special characteristic which, through no effort of the agent, is valuable. Professional athletes or musicians are often given as examples.

Profits from Immoral Activities—Extortion, theft, blackmail, etc.

Windfall profits—When the event causing the profits is a complete surprise to the profit maker. An example is the OPEC oil embargo of 1974.


This view of capitalism being a moral system is certainly not one that is propagated in the mainstream popular culture, where a populist refrain is “People before profits,” and the “bad guy” is portrayed as a businessman twice as much as any other occupation. As if profits and social responsibility are mutually exclusive. They are not.

This view is pernicious and completely out of touch with human behavior. In fact, given the realities of free-market exchanges—where both parties are better off after the exchange—profits are actually an indicator of social value created. Those who believe that earning a profit is morally neutral rather than a morally superior way for a corporation to discharge its responsibility should be asked if they believe deliberately running losses is ethical—particularly if it is with someone else’s money?

Episode #241: Lessons Learned From Our Subscription Economy Workshop

In Memory of Ken Baker

In memoriam Ken Baker

Ron’s brother Ken passed away recently. Ed and Ron spent the first few minutes of the show discussing his impact as Ken’s brother.


Lessons from the Subscription Economy Workshop

UPDATE: “From Fighting Fires to Fire Insurance” - These slides from the subscription economy workshop are now available here.

Ed and Ron recently taught their first workshop in Chicago on the Subscription Economy Business Model. The advantages of this model are many, including:

  • Predictable revenue

  • Not selling services, but creating annuities with a lifetime value that far exceeds whatever you paid to acquire them

  • Collective knowledge of your customers, which is a competitive advantage that cannot be duplicated

  • One-to-one marketing

  • Not pricing a product or service, but rather customer transformation and peace of mind

  • You can predict demand and plan capacity more effectively

  • …and it breaks down silos and creates a true “one-firm” model.

So what did Ron and Ed learn from the attendees? What were the most salient points they took away from this workshop? There are lots of great points in the recorded show audio that you can use and frame for your own business.

On a related note…

Ron will be teaching a Subscription CPE course the CAL CPA Education Foundation on August 8. More information is available here.

A big thank you!!!

TSOE Superfan, Hector Garcia, recorded a great video with Ed and Ron. It’s quick and full of information. Check it out here.

Business For Good?

Learn about B1G1 in about 3 minutes. Check this video out. Then take a deeper dive into the program with these slides.  

Finally…

Some of you may have heard Ed reference his tooth extraction. Well, he’s not going to be able to live this picture down.

ed 500px.png

Episode #241 Preview: Lessons Learned From Our Subscription Economy Workshop

On April 30th and May 1st, Ed and Ron taught their first workshop in Chicago on the Subscription Economy Business Model. The advantages of this model are many, including:

  • Predictable revenue

  • Not selling services, but creating annuities with a lifetime value that far exceeds whatever you paid to acquire them

  • Collective knowledge of your customers, which is a competitive advantage that cannot be duplicated

  • One-to-one marketing

  • Not pricing a product or service, but rather customer transformation and peace of mind

  • You can predict demand and plan capacity more effectively

  • …and it breaks down silos and creates a true “one-firm” model.

Join us for our After Action Review and lessons learned from the participants!

  • If you’d like to call-in during the live show, the listener line is: 866-472-5790.

  • You can also participate on Twitter using the hashtag #ASKTSOE and the Twitter account @asktsoe

  • Prefer email? Shoot us a note at asktsoe@verasage.com

As always, please check our website for upcoming and previous show notes and recordings, use Twitter to find the show at @AskTSOE or find us on Facebook.

Our wonderful hosts Ed and Ron are on Twitter at @edkless and @ronaldbaker, respectively (and obviously).

Episode #240: Interview with Economist Tyler Cowen

For this episode, we talked about a WIDE ARRAY of topics! This was a fast moving show and is well worth a listen or even two. Enjoy!

Tyler Cowen.jpg

Tyler Cowen is Holbert L. Harris Chair of Economics at George Mason University and serves as chairman and faculty director of the Mercatus Center at George Mason University. With colleague Alex Tabarrok, Cowen is coauthor of the popular economics blog Marginal Revolution and cofounder of the online educational platform Marginal Revolution University. Cowen’s latest books are Big Business: A Love Letter to an American Antihero, and Stubborn Attachments: A Vision for a Society of Free, Prosperous, and Responsible Individuals. His research has been published in the American Economic Review, the Journal of Political Economy, Ethics, and Philosophy and Public Affairs. Cowen is host of Conversations with Tyler, a popular podcast series (and one of our favorites) featuring today's most underrated thinkers in wide-ranging explorations of their work, the world, and everything in between. Foreign Policy named Cowen as one of 2011’s “Top 100 Global Thinkers,” and an Economist survey counted him as one of the most influential economists of the last decade. Cowen graduated from George Mason University with a BS in economics and received his PhD in economics from Harvard University. 


Ed’s Questions

  • Tell us what you do as the director of the Mercatus Center.

  • What about the Center for the Study of Policy Choice which you are on the faculty, that has to do with public choice theory, right? (Our show on Public Choice Theory.)

  • In a recent column, in the next twenty you ask what is the most unexpected next transformative technology, you say the automobile, but not driverless cars. Can you unpack that for me?

  • By 2023, according to one analyst believes that one in five cars will be a subscription car, do you think that will be a factor?

  • A lot of small towns get 80% of their budget from speeding tickets. What will be the impact on some of those places?

  • Another column you wrote in April, where you laid out your best argument for a gold standard. Is it possible that technology like Bitcoin or cryptocurrency might help overcome that government interference problem?

  • You haven’t written about Bitcoin in nearly a year; it has lost some of its luster don’t you think?

  • Maybe the best use of blockchain is smart contracts that automatically execute, like brokerage statements based on a percentage of assets, which can be automatically verified by blockchain.

  • I saw a chart today and I thought of you, it said the first time ever there are now more people in the world over 65 years old than people younger than 5 years old. How much of a concern do you think that is from an economic perspective, or is it one at all?

  • We are most productive in our 30s, as Charles Murray pointed out in his book, Human Accomplishment.

  • “I’m going to turn the tables on Tyler and do something with his permission he does on his show, Conversations with Tyler, he asks his guests a list of random things and to state whether they are underrated or overrated, are you ready Tyler? Here we go:”

  1. Behavioral economics

  2. The threat of catastrophic climate change

  3. Canadian literature and poetry

  4. The Electoral College

  5. The prospect of eliminating umpires from calling balls and strikes from major league baseball

  6. The presidency of Donald Trump

  1. Illegal Mexican immigration is a growing threat

  2. Green energy will save us

  3. Bank runs are a thing of the past

  4. The Eurozone is pretty much for everyone in Europe

  5. Bailouts should be incremental

  6. Fiscal stimulus should be temporary, targeted, and timely

  • That’s a really good list, so far unheeded by most, what might you add to it today?

  • In another article you’ve written recently, you noted contrary to what Alexander Ocassio-Cortez and other concerned millennials believe, fear of climate change is justified, it is not, however, a reason not to have children, because those kids of yours are more likely to be part of the solution than the problem. Elaborate more on that.

  • Something you haven’t written about in a while, and I just wanted to see if you’ve updated your thinking on, what do you think about collegiate athletics? Will they continue to grow or will the whole economics be rethought?

  • How do you think football concussions will impact the sport?

  • What are you working on now?

 

Check out Tyler’s newest book!

We referenced this book several times during the interview.


Ron’s Questions

  • I’ve been reading your books for quite a while, and one I found interesting is Create Your Own Economy: The Path to Prosperity In a Disordered World, published in 2009. One of things you say in there is “forget that you saw the movie Rain Man, then you list all the people throughout history who we believe are on the autism spectrum:

    • Nobel laureate Vernon Smith

    • Charles Darwin

    • Thomas Edison

    • Albert Einstein

    • Isaac Newton

    • Vincent van Gogh

    • Thomas Jefferson

    • Alan Turing

    • Steven Spielberg

    • Bill Gates

    • Adam Smith

  •  Obviously autism has been around for a long time. What makes their contributions different now? Does technology like the world wide web help?

  • There’s a lot written about how our brains can’t effectively multitask. You have a counterintuitive response to this. You think multitasking serves a useful purpose. Can you explain that?

  • You point out also that Adam Smith’s pin factory is a parable of autism. When you perform a repetitive task it can be rather than boring and alienating according to both Karl Marx and Adam Smith but you think it’s more a benefit than a cost, why is that?

  • You wrote that most education requires the physical presence of other human beings—education as theater. Do you think traditional brick and mortar colleges will be around 100 years from now, not displaced by MOOCs (Massive Open Online Courses)?

  • What do you think about Bryan Caplan’s argument in The Case Against Education about the signaling vs. human capital effects of higher education?

  • There is something about being with other people versus online when it comes to education.

  • Another thing you mention, which is just fascinating, there are plenty of studies that measure education’s ROI, but what are they comparing education to? No one has compared modern education to a placebo. If you could, what might that study look like?

  • Your book from last year, which I just loved is Stubborn Attachments: A vision for a society of free, prosperous, and responsible individuals, you write, “We need to develop a tougher, more dedicated, and indeed a more stubborn attachment to prosperity and freedom.” Why is that?

  • You also wrote that you hold pluralism as a core moral intuition. What’s good about human life can’t be boiled down to any single value—pluralist theories are more plausible. Do you think capitalism is too materialistic, or defenders of free markets take a too materialistic view, or is it also spiritual, allowing for a more pluralistic good life?

  • We’ve pulled roughly 1 billion people out of bone-crushing poverty in the past decade-and-half or so, do you think we take wealth for granted because it’s all around us, there’s so much angst among young people but yet they live in one of the most prosperous times ever in this history of civilization?

  • You propose a Wealth Plus measure: GDP + leisure time, household production, and environmental amenities. We know GDP is a flawed measure because when a sheep is born per capita GDP rises, but when a human is born, it goes down. Can you explain your Wealth Plus concept?

  • The other thing you are saying is that committing to growth is creating a better future. I’m glad our forbearers did that. Do you think there’s too much focus on alleviating poverty versus creating wealth, especially among developmental economists, or international organizations such as the World Bank?

  • Do you think the best way to fight poverty is to create wealth?

  • Just before we take a break, do you think China will grow old before it gets rich, is there some truth to that cliché?

  • In Stubborn Attachments you discuss happiness and wealth, and survey data on happiness, you pointed out: “Happiness gains don’t dissipate through envy. Better to envy your neighbor’s Mercedes than his horse and buggy. Better still, his supersonic transport.” Is envy a problem? Is that why we see the graduated income tax rates, and “soak the rich” is it just envy?

  • Is there a link between happiness income, only up to a point?

  • You also pointed out that the measurement data can’t capture the gains of longer life expectancy since you can’t poll the dead.

  • Tell us about your latest book, Big Business: A love Letter to an American Anti-Hero, because there’s a lot of negative press about big business, and you’re actually writing a love letter to them?

  • Do you worry that big business is becoming too concentrated (The Economist loves to write about this over and over)?

  • I don’t know if you saw this, but Kevin D. Williamson of National Review wrote a review of your Big Business book (“Big Business: Tyler Cowen’s Compelling Case for Large Corporations”), he points out that “professor Cowen has a great talent for revealing truths that are right under our noses but oddly overlooked, such as: Large-scale corporate enterprises provide a great many jobs; relative to smaller firms, they typically pay their workers more and treat them better, invest more in research and development, are more productive and more innovative, and conduct their business at least as ethically.” On the more innovative, I think most people have the idea that small business are more innovative. Are big businesses really more innovative than small businesses?

  • Do any privacy issues concern you out of Silicon Valley, or are we just giving our data and privacy away?

  • Do you think what the EU has done with the GDPR regulations is that the right approach?

  • As an economist, what would you like to see changed in USA macro, or federal, economic policy?

  • What would you like to replace the current tax system with?

  • What would you like to see on immigration?

  • Do you buy any of the research that illegal immigrants lower the wages of low-skilled workers?

  • What would you like to see in health care?

  • What would you do with Federal Drug Administration?

Episode #239: FRF — Millionaires, Marxists, and Minimum Wage

What a great Free-Rider Friday! This show moved fast and we covered a lot of ground.

Here are Ron’s topics from the show:

 …and here are Ed’s topics: 

 We had a listener question addressed during the show as well: 

We received a great question from Mark Stiving, Ph.D., Chief Pricing Educator, Impact Pricing LLC, and author of Impact Pricing: Your Blueprint for Driving Profits, and host of the Impact Pricing Podcast.

Mark will be our guest on the June 14th, 2019 episode of The Soul of Enterprise.

Here’s his question: 

Your TSOE episode on the death of the timesheet was very thought provoking.  I’m 99% with you on the idea of killing hourly billing, and could be with you on killing timesheets except I don’t know how to answer one question.  How does a company determine Willingness to Accept (WTA)?  

In every negotiation, the buyer has a Willingness to Pay (WTP) and the seller has a WTA.  This is easiest to understand in products.  If a seller has an ongoing business and can buy a product for $100, their WTA is almost certainly some number above $100.  Usually they have a margin floor, say 20%, so their WTA would be $120.  If the buyer’s WTP is $300, there will likely be a transaction, hopefully at a price significantly higher than $120.  However, if the buyer’s WTP is less than $120, no transaction will occur.  

In accounting or similar service type businesses, how do you know your WTA?  It seems you need an estimate of time, (even though you would pay that accountant’s salary even if you didn’t land that job).  If you need to estimate time, wouldn’t having timesheets to track actual vs estimated in after action reviews be helpful?  As you point out, they are probably not accurate, but is there a better way?  I’m looking forward to your answer.  Feel free to answer on the air if you’d like, perhaps on free rider Friday?  

Cheers,

Mark

Episode #238: The Million-Dollar TIP — Using a TIP Clause

It’s All About Baseball…

To start the show off, Ed just had to reference baseball and we - the audience - would expect nothing less. Enjoy! https://www.baseball-reference.com/postseason/1960_WS.shtml

So What Was The Show Really About…

1M+dollars.jpg

One of the most innovative pricing strategies that should be in every firm’s pricing stack is the TIP clause. Most feedback that firms receive on pricing is negative (“Your price was too high”). Or it is ambivalent: “Your price was just right.”

No customer ever discloses how much money your firm left on the table. Innovative pricing strategies, such as the TIP clause, are outward focused and attempt to capture more of the value created for customers, in extraordinary engagements. Having more accurate cost accounting or better project management won’t help you capture this level of value, which is why pricing is the main driver of profitability.


Making the Wrong Mistakes

In 1997, Tim was the managing partner of top accounting firm, and his best, long-term customer (of 20 years) had come to him wanting to sell his $250 million closely held business. He told Tim (and I am paraphrasing here), “You’ve been my CPA for 20 years and I trust you with my life. It is time for me to sell my business and enjoy my golden years. Here is what I want you to do:

  • Update our business valuation to maximize the sales price.

  • Fly with me anywhere we have to go to meet with potential buyers.

  • Be actively involved at every stage of the sales negotiation.

  • Perform the due diligence, along with the attorneys, of the qualified buyers.

  • Work with the attorneys on the sales contract to make sure my interests are protected.

  • Perform tax planning and structure the deal in such a manner as to maximize my wealth retention.

When Ron asked Tim how he priced this engagement, he proudly proclaimed that every hour charged to this project was at his highest consulting rate of $400 per hour, indicating, right from the start, Tim knew there was more value on this project than he would ever be able to pad on a timesheet.

As a result of Tim’s work, the customer received (and saved in taxes) an additional $15,000,000, and acknowledged Tim was directly responsible for this outcome. In Tim’s own words, the customer was “elated.”

Tim then told how he priced the engagement. He reviewed all of the hours from the work-in-progress time and billing system, believed it did not adequately reflect the value he provided, and marked it up an additional 25 percent over the $400 hourly rate.

He then sent out an invoice for $38,000, which the customer promptly—and happily—paid. He believed he was value pricing. He was not—he was value guessing, since the customer had absolutely no input into the price up front, and only a customer can determine value.

When Ron asked Tim what he thought the customer would have paid if he had utilized a TIP clause (also referred to as the retrospective price, or success price), such as the following:

In the event that we are able to satisfy your needs in a timely and professional manner, you have agreed to review the situation and decide whether, in the sole discretion of XYZ [company], some additional payment to ABC [CPAs] is appropriate in view of your overall satisfaction with the services rendered by ABC.

The TIP is being based on the “overall satisfaction with the services rendered,” and not any financial contingency, which is the origin of the acronym TIP—to insure performance.

This TIP clause would be discussed with the customer before any work began. If needed, you could put a minimum price on the engagement (such as $40,000) to cover immediate firm capacity. But in this case, given the 20-year relationship with the customer, even a price solely determined by a TIP would have been acceptable, since the customer was not likely to take advantage of Tim after the services he rendered and the long-term relationship they had. 

In answer to my question, Tim said his customer would most likely have paid him $500,000, a sum I believe to this day is below the real number—but at least better than the $38,000 he finally charged. Nevertheless, since Tim knows the customer better than I do, let us take his number as correct.

Ron informed Tim he had made the Ultimate Accounting Entry:

Tim was providing extraordinary value to this customer—he was at the top of the Value Curve—yet his cost-plus pricing theory prevented him from capturing a fair portion of it. Are we not ruled by our theories? This is why it is imperative to extinguish the cost-plus mentality from your firm.

No one in any seminar we have shared this story with believed Tim would have received less than $38,000 for his services on this engagement. In effect, Tim paid a reverse risk premium—he was assured he would not go below his hourly rate, but in return he gave up the added value the customer already believed he had created. This is not a risk worth taking if you want to maximize your firm’s profitability.

The deleterious effects of this are deeper than just being deprived the value from the work you provided on any one engagement. The problem lies at the very core of a firm’s measurement system and points out how it does not offer the opportunity to learn from lost pricing opportunities, or pricing mistakes.

In his inimitable way, Yogi Berra explains this situation with his quip, “We made too many wrong mistakes.”

When it comes to pricing, the wisdom from Yogi is profound. Tim made the wrong mistake, and here is why: He will not learn anything from it because the firm’s primary assessment is billable hours—once again the billable hour is the incorrect measuring device for value. When the partners review the realization report on this engagement, they will see 125 percent, which is excellent when you consider most firms realize between 50 and 95 percent overall on each hour.

No knowledge was gained by the firm on how to price the next similar engagement in accordance with value—it will simply perpetuate the same mistake, over and over. Being a more accurate activity-based cost-accountant, or even excellent project manager, would also not have helped Tim to capture the value.

This is not meant to imply with value pricing you will never make mistakes. You certainly will. The difference is they will be the right mistakes, because with value pricing, as opposed to cost-plus pricing, you are forced to receive input from the customer as to your value, and have in place pricing strategies that will capture more of that value (like the TIP clause). If you engage in After Action Reviews (AARs), which perform value assessments on each engagement, and elicit feedback from your customers, you will learn from your mistakes and become better at pricing in the future.

Most feedback firms receive on pricing is negative: “Your price was too high.” Or it is ambivalent: “Your price was just right.” No customer ever discloses how much money your firm left on the table.

Innovative pricing strategies, such as the TIP clause, that are outward focused and attempt to measure value have allowed more and more firms around the world to capture more of the value they provide.


Case Study: The Million Dollar TIP

This story comes from Gus Stearns, a partner in an accounting firm, whom I [Ron] met on September 25, 2000 at a conference in Las Vegas. Gus tracked me down at the dinner party, walked me over to the bar, and over a glass of wine told me his amazing TIP story. Here are the two e-mails I received from Gus explaining his success, the first one prior to our meeting in Las Vegas and the second one after:

April 20, 2000

Hello Ron,

I hope the tax season finds you well. I was fortunate enough to be at the Atlanta conference [January 2000] when you spoke and picked up an autographed copy of your book [Professional’s Guide to Value Pricing], which I devoured on the plane trip back.

The engagement which I refer to ($180,000 price) had already started a month or two before and I had used the old standard rate-time-hours routine and billed about $2,000 at a standard rate of $180/hour. After listening to you and reading the book, I was determined to reevaluate the price structure and simply went back to my customer and said, “Guys, this is what I am bringing to the table. It brings a lot of value which is etc., etc. I don’t believe hourly rates based upon time is appropriate. I am unable to place a value on this. I need your help. You tell me what the value of all this is to you. You are the customer and only you can truly establish the value. I know I’ll be happy with what ever you come up with.” This is almost an exact quote.

I left it at that two months ago. I was handed a check for the first installment of $50,000 on the way out at the end of the engagement. I guess this is what you call “outside-in pricing.” I like it.

Gus Stearns, CPA

It gets better, since this engagement was in two phases. Here is the follow-up e-mail from Gus explaining the final result after the job was done:

Hello Ron,

Basically the large engagement was for a previous client that I had hired a controller for. He took over the tax work, at my suggestion, as he was a CPA. The engagement was an exit and management succession strategy, which involved some fairly hefty income tax savings as well. The total time expended was about 100 hours, although a lot of the time was on unrelated things that I did not want to charge for due to the magnitude of the price (we quit using timesheets some time ago).

I used a flip chart in the presentation, pointing out the value of what they were getting. At the end of the presentation, I asked how much they thought it was worth, and suggested $300,000, $500,000, a million? I wanted them to think in big numbers. The CEO was rather excited and said a million. Knowing that this would be difficult to obtain in one fell swoop I suggested $400,000 down and a retainer of $4,000 per month. They agreed but asked that I serve on the board of directors and attend quarterly meetings through 2008, when the note to the previous owners would be paid off. They were also kind enough to put me on salary so I could participate in their pension plan, which is a 25 percent direct contribution from the company. This all adds up to a little bit over $1 million.

Never once was the word “time” used or referred to by myself, or my client. They could have cared less about time. In all of our engagements, I never use the word. By concentrating on value and encouraging the client to participate in the valuation of the engagement our prices have skyrocketed. You were absolutely on-target when you said that accountants are terrible at valuing our services (myself included).

Keep up the wonderful work,

Gus


These types of engagements are certainly not the rule in any firm, they are the exception. Nonetheless, they do arise, and when they do it is critical to recognize the value you are creating, and to utilize innovative pricing strategies to capture it. This also demonstrates why pricing is the most potent lever you have in terms of increasing your firm’s profitability, much more than cutting costs or increasing efficiency. 

We include these stories not because I believe you will earn a $1 million TIP, but rather to illustrate how the cost-plus pricing mentality has placed a self-imposed artificial ceiling over the heads of firms. Never in his wildest dreams would Gus have placed a $1 million value on his work; but the customer did. Does he not deserve it? 

Baldridge Award–winning firm Graniterock instituted such a policy, calling it “short pay.” This provides, in essence, a line-item veto to customers and allows them to deduct any amount of the invoice in accordance with their subjective value of the service provided.

It is not a refund or discount policy; it is a pure service guarantee, because the customer is not required to return the merchandise. Here is how owner Bruce Woolpert explained the advantages of this guarantee:

You can get a lot of information from customer surveys, but there are always ways of explaining away the data. With short pay, you absolutely have to pay attention to the data. You often don’t know that a customer is upset until you lose that customer entirely. Short pay acts as an early warning system that forces you to adjust quickly, long before we would lose that customer.

Will some customers take advantage of Woolpert’s policy? Probably. But consider Nordstrom, legendary for taking back merchandise not even purchased from its stores. It estimates that 2 to 3 percent of its customers take advantage of this policy, yet 97 to 98 percent appreciate the policy and are more loyal—and pay a premium price—as a result.

Do not let the tail wag the dog. If any one customer were to abuse your service guarantee, he would actually be doing you a favor by self-identifying himself as a problem customer. Gladly refund his money and fire that person from your company.


Case Study: Mission Impossible

Santa Monica Freeway

The January 1994 Northridge, California earthquake devastated the Santa Monica Freeway, leaving 350,000 daily commuters no access to Los Angeles. Early estimates predicted at least 12 months to rebuild, at a public cost of $1 million for each day the freeway was shut down.

Innovative constructor C.C. Myers saw it differently. He saw it as a 4.5 month project. Staking his wealth and reputation, C.C. Myers signed a $14.7 million contract with the city, which allowed a maximum completion time of 140 calendar days, with a penalty for late completion of $205,000 per calendar day and an incentive of $200,000 per day for early completion and opening the freeway to traffic.

Mission: Impossible

Approach: Change everything.

Results: Spectacular

Contract time commenced on February 5 with materials and equipment moving to the jobsite that same day and through the weekend, even the final construction plans were not available until February 26. C.C. Myers immediately went to work on a 24/7 schedule with up to 400 workmen on the job. On-site inspectors were used to eliminate delay and rework. Workers were running on the job. Special quick-setting concrete was used. Subcontract bids and awards were made on a daily basis. Work flowed.

Sixty-six days after the contract was signed, the Santa Monica Freeway was opened to traffic, 74 days ahead of schedule.

Source: The Elegant Solution, Matthew E. May, 2006, pg. 135.

 

Episode #237: Interview with ADP's Chief Behavioral Economist Jordan Birnbaum

Another Great Show, This One Featuring Jordan Birnbaum of ADP

Here is some background on Jordan…

Jordan Birnbaum has been with ADP since 2015, as VP and Chief Behavioral Economist. He directs the application of behavioral economics principles into new product development in the human capital management market.  Prior to joining ADP, Jordan was the owner / operator of The Vanguard in Los Angeles, a hybrid media production and live music venue, employing more than 150 people for close to a decade.  He was a founding employee and Senior Vice President, Business Development, of Juno Online Services, playing a key role in a successful IPO and then beating analysts’ estimates for six consecutive quarters.  Jordan graduated from Cornell University with a BS, Policy Analysis, and from NYU with an MA in Industrial / Organizational Psychology. 

We asked and Jordan answered…

This is an instance in which no amount of show notes, regardless of how thorough, could capture the energy and excitement of Jordan as a guest. Our questions for him are below but you really should listen to the show (audio is linked above) in order to truly understand how much depth Jordan brought to the show as a guest.

Ron’s Questions…

  • Tell us about The Vanguard?

  • Did you ever meet the South Park creators?

  • Give us the second answer to Ed’s question on the difference between nudging and manipulation.

    • We had on the show Rory Sutherland. He created a Nudge unit inside of Ogilvy in the UK, and when he was president of the IPA in the UK he was saying: “Hundreds of agencies have developed models for ‘how advertising works.’ What’s needed now is for agencies to base their business on how people work.” Basically, that if ad agencies don’t become behavioral economists they are going to become irrelevant. You read about how these Silicon Valley companies employ behavioral economists, such as Airbnb, Uber, etc. Can you share any examples of how you specifically apply these principals at ADP.


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Check out the white paper on Compass a next-gen assessment and coaching development tool to drive leader and team effectiveness with no installation needed at http://Compass.adp.com .


Ed’s Questions…

  • So, you’re hanging out with Bill Maher on the weekends, you have this great club in LA, and now you’re the VP and  chief behavioral economist at a payroll company. You’ve got to make that leap for me?

  • Ron and I are big fans of behavioral economics, and one thing that has puzzled me that I struggle with in my mind is, where do you see the difference between nudging and manipulation?

  • Then the question becomes who decides what is in someone else’s interest, right?

  • We often talk about pricing and proposal construction. I wanted to get your thoughts on three choices being optimal, is that something you’re seeing as well. Also, what about add-on to options, does that become confusing at some point? Where’s the line between complexity and creating effective choices?

  • If you’re creating a business proposal for a relativity complex engagement, is there a difference between three choices and four choices?

  • Throughout the course of the questions, we touched on many of these: https://en.wikipedia.org/wiki/List_of_cognitive_biases

Episode #236: ET HORA LIBELLUM DELENDA EST

What did we talk about in this episode? Glad you asked!

In ancient Rome, during the Punic Wars, Cato the Elder is said to have ended every speech he delivered before the Roman Senate with the phrase, “ET CARTHAGO DELENDA EST” (and Carthage must be destroyed!). He did this without regard to the subject of his speech. It is in this spirit that we present ET HORA LIBELLUM DELENDA EST which, loosely translated, means, “and the timesheet/billable hour must be destroyed!”  

Topics of Discussion:

  • We discuss an article from Accounting Today, which touches off the debate over the necessity of recording time. The article is, “Timekeeping: Stop wasting time!,” by Alan Conway, published March 18, 2019.

  • We also discussed VeraSage senior fellow Tim Williams’ article, Re-Engineering Your Firm Around Value, from March 20, 2019, reproduced below.


Re-Engineering Your Firm Around Value
Published on March 20, 2019

Tim Williams 

We are what we measure. In life and in business, it’s human nature to align our behavior with the metrics by which we are judged. So if the key measurement in our firm is billable time, guess what kind of internal behavior we’ll get?

The incentives that drive behavior in your firm create either a culture of utilization or a culture of accountability. A culture of utilization promotes and rewards “busyness.” A culture of accountability is centered around productiveness. 

In a firm that makes its money by selling hours, the individual incentive is to record as much billable time as possible and the corporate incentive is to bill as much of this time as possible to its clients. In a firm that makes its money by selling solutions to business problems, the motives are to spend time wisely and effectively. The cultural difference between these two business models can be astounding. 

As the business innovator W. Edwards Deming taught, if management sets only quantitative targets and makes people’s jobs depend on meeting them, “They will likely meet the targets — even if they have to destroy the enterprise to do it.” In Deming’s estimation, more than 90 percent of the conditions that affect a company’s performance can’t be easily tracked and measured. Yet managers spend more than 90 percent of their time monitoring and analyzing some form of measures; most notably, time tracking.

A shadow economy in every time-based firm

This approach creates a shadow economy that saps the time, energy and initiative of professional firms. As H. Thomas Johnson and Anders propound in their book Profit Beyond Measure, “It is not an exaggeration to say that in most organizations today, each person whose work eventually serves customers’ needs is 'shadowed' by another person whose job is to keep track of other people’s work.” Extensive time tracking is “shadow" work that adds an incredible amount of wasted cost to the firm. While professionals in the firm are attempting to create value for the firm and its clients, the “time beast” extracts value. 

Johnson and Anders go on to say, “The perception that the world is quantitative and that business is therefore mechanistic has for the past fifty years shaped all the variants of strategic planning, financial analysis, budgeting, cost management, and management accounting that have been taught by graduate business schools and practiced in large organizations. Executives versed in such practices and who believe that reality is defined by quantitative measurements are like the puppies who believe that the fence defines reality.”

The focus in professional firms should be on doing the work, not manipulating quantitative abstractions about the work (time tracking, billable time targets, etc.). 

A tale of two firms

In Firm A, its time and energy are spent: 

-     Asking team members for estimated hours

-    Preparing estimates of hours

-    Logging hours on timesheets

-    Tracking actual hours spent

-    Collecting and policing timesheets

-    Inputting time data in software systems

-    Producing time reports

-    Comparing and reconciling actual time against estimated time

-    Justifying hours to clients

-     Transferring or writing off hours

Firm B, on the other hand, devotes its energies to:

-     Identifying the scope of value (desired outcomes)

-    Clarifying the scope of work

-    Collecting complete information about assignments

-    Developing more complete briefs and briefings

-    Investing more effort in developing effective solutions

-    Pricing the value of the work (instead of just estimating the costs)

-    Pricing and invoicing the work in phases

-    Managing projects based on actual work completed, not hours spent

-    Paying more attention to scope creep

-     Re-pricing work that exceeds scope

Which of these two firms is likely to be most effective? Most profitable? Which would you prefer to lead or work for?

Value-Led vs. Cost-Led

In place of monthly report detailing how their time was spent (which often takes the form of an invoice), value-led firms produce reports of work completed, problems solved, and results produced. Internal discussions revolve around the effectiveness of the work, not the “efficiency” of the team. 

Instead of obsessing about hours spent, value-led firms turn their attention to measuring what really matters: deadlines met, promises kept, work delivered, and results achieved. One of the notable firms that put value first, the marketing firm Anomaly, puts it this way:

“We don’t do timesheets, ever. We believe they are dishonest and incentivizes the wrong behavior. Our view is that the right people will solve a challenge quickly and should be rewarded for the value of that answer to the client. We’ll back ourselves up on that by putting a significant percentage of our fees against the fact that our work will work. The result is that our meetings are only attended by people who are adding value, not billable hours.”

It's time to stop managing your firm as though your inventory is a fleet of rental cars that must be “busy” to be generating revenue. Your inventory is intellectual capital, and what you sell is value created, not time spent.

 Friend of VeraSage Thomas L. Bowden Sr, an attorney, posted this comment on our VeraSage & Friends Facebook page in response to an article defending the importance of recording time to determine cost:

Thomas L. Bowden Sr. So, you take an arbitrary segment of your staff, assign them an arbitrary number of hours to record and/or work each year, then take an arbitrary portion of your overhead and add it to the salaries of the arbitrarily selected staff, add to that an arbitrary figure for your desired profit, and divide by the arbitrarily chosen number of hours, and voila, that’s your ever so precisely determined “cost” per hour. Now measure your actual hours very precisely or all of those completely arbitrary choices will be completely useless. Of course, they’re useless anyway, because no matter how precisely you measure the wrong thing, it’s still wrong.


Videos Mocking Hourly Billing and Timesheets 

 

 

Episode #235: Free-Rider Friday, March 2019

Another GREAT Free-Rider Friday!

Here are the topics we covered. From Ron…

 

From Ed…

Episode #234: How to Fire a Customer

Overview

All firms have a theoretical maximum capacity and a theoretical optimal capacity. From a strategy perspective, it is essential to see how that capacity is being allocated to each customer segment. Ensuring a proper amount of capacity is allocated to various customer segments, while offering a differentiating value proposition within each segment, is an essential element of implementing price discrimination strategies. It also prevents bad customers—those who are not willing to pay for the value you deliver—from crowding out good customers. 

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Customer Grading Criteria

It has become common for firms to grade customers and focus attention on the “A” and “B” customers and even hold out incentives to the “C” customers to upgrade to higher status. Along with your human capital selection, your customer capital criteria are the most important aspect of crafting your firm’s success. The traditional customer grading criteria are most likely familiar to you; they usually include:

  • Amount of annual revenue

  • Prompt payment history

  • Potential for growth

  • Potential for future referrals

  • Actual referrals

  • Profitability of customers

  • Risk of having customer in portfolio

  • Timing of work (fiscal or calendar year)

  • Reasonable expectations

  • Willing to take advice

  • Profitable and not undercapitalized

 
Certainly these are important criteria and should be made part of any firm’s pre-qualifying process. Ric Payne, Chairman and CEO of Principa, advocates the following 12-point criteria for selecting customers:

  • In business for at least three years.

  • Pleasant, outgoing personality.

  • Willing to listen to advice.

  • Positive disposition.

  • Technically competent.

  • Business is profitable.

  • Business is not chronically undercapitalized.

  • Business is not dominated by a small number of customers or suppliers.

  • Clearly established demand for the product or service.

  • Business has a scope for product or service differentiation through innovative marketing.

  • Business has scope for improved productivity through innovative management planning and control.

  • Business has a strategic plan.

 
These are all good criteria to judge potential new customers, as there is no point in working for and with people whom you do not like, or are indifferent about. Paul Dunn, co-author of The Firm of the Future, wrote this about customer selection and de-selection.

 
Case Study: Grading and Firing Customers

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If there was just one phrase that readers should pin up on their walls, it would be Baker’s Law: “Bad customers drive out good ones.” In every gathering of professionals I'm asked to address, I always ask the question: "How many of us have customers we wish we didn't have?” I've never yet seen such a gathering where fewer than 99 out of every 100 raised their hands in the air (most of them held up in what you might call an enthusiastic way, along with another part of their anatomy—their eyes, literally in the top of their heads, as if to say, “Yes, I have them and what a drag it is.")

You know the customers they're thinking of—the ones that don't pay the bills, the ones that sap your energy rather than build it, the ones you simply don't like being with—the list goes on and on.  Or consider this…imagine you could put the work you do into these 3 categories:

  • I really love doing this type of work.

  • I can tolerate it.

  • If I'm brutally honest, I hate it.


How much of your typical week would be in the bottom two? 

It may come as no surprise for you to read that, for many professionals, the number in those bottom two categories is frequently around 80 percent. Or, to put it another way, they're only loving what they do 20 per cent of the time. Yet they smile through it because they're getting paid. As David Maister points out in his book True Professionalism, there is another "profession" that says, "Pay me the money and I'll fake it.”  Some call it the oldest profession in the world.

So why does the profession prostitute itself so frequently? Maybe it's because many (most?) in the profession have been, as one practitioner in the United Kingdom put it to me, "indiscriminate" about the customers they work with. To put that more bluntly, if it looks like the customers have a checkbook, they take them on. Some don't. 

Take Tom Weddell of the Newburgh- and Poughkeepsie-based practice, Vanacore, DeBenedictus, DiGovanni & Weddell (try answering the phone there!). Weddell, forty-two years old [at the time] and the youngest of the partners, had been appointed managing partner just six weeks before he attended a four-day program I presented in Chicago. Weddell really got the message. On the way home from the program, he said this to his partners, “Clearly, there’s so much for us to do to implement this material. I want to know right now if you’re with me.”

It was a completely general question with no implied reference to “re-organizing” the firm’s customer list. "Well, yes, of course Tom," they replied. “Are you certain?” Weddell asked. “Yes, we’re really with you Tom.”

So the next day, Tom went into his office early. He got a full list of the firm’s customers and copied it 27 times (the number of team members he had at that time). He gave it to each member with the instruction, "Circle everyone's name on this list who you don't like dealing with and give it back to me by 11:00 a.m., please." That was his only criterion. The other partners had no idea he’d done this at the time (Weddell presumably was taking them at their word that they were “with him”).

That afternoon, Weddell took every customer whose name was circled and fired them (nicely). He even recommended another accountant they might like to try, who would welcome them with open arms. By 4:00 p.m., the job was done. Weddell had gotten rid of the customers—along with $64,000 worth of revenue.

When Weddell told the team what he'd done, they cheered! At 4:15, the other partners, who by now realized what had happened, called a meeting. In essence, the message was, "We're not sure we're with you, Tom!" But three months later, the partners were absolutely sure.

Weddell showed me his financials and pointed to the additional $300,000 worth of revenue the practice had generated in the period. And he made this wonderfully simple point: “We couldn’t have gotten that unless we’d created $64,000 worth of space.”

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Do you have any customers taking up space? Many firms are trying to be all things to all people. Yet they’re advising their clients to be “selective” when those clients choose customer segments. The answer really does come back to that earlier comment about professionals choosing their clients “indiscriminately.” Want to prove it? Take out your latest firm brochure (if you’re still one of the people who believe in brochures) and mark anywhere on it where it specifically says something like, “You’ve got to be special to be one of our clients.” I doubt you’ll find it. Even your brochure or your website probably implies that all customers have to do is breathe and you’ll take them on.

After years of “preaching” this message, I’ve never known any firm to regret that they took action in the way that Tom Weddell did. You won’t either. Bad customers drive out good ones.


When a firm accepts a new customer, it is not merely closing a sale; it is beginning a lifelong relationship. We select our spouses, friends, and other important relationships very carefully, why would we not perform a proper amount of due diligence before selecting a customer? If the customer is worth having, he or she is worth investing some time and resources in determining if she is a good fit for your firm. 

Reed Holden has a wonderful saying: The price isn’t wrong, the customer is! The essence of strategy is choosing what not to do. Saying no to a new customer is not necessarily easy, but it is vital if you want to accept only those customers who are pleasant to work with, have interesting work, and enhance your firm’s intellectual capital.

Complexity kills a business and by accepting any customer—especially those that do not fit your purpose, strategy, and value proposition—you are adding a layer of bureaucracy that will starve your best customers and put them at risk of going elsewhere. To manage this inevitable effect, let us now explore the Adaptive Capacity Model for professional firms.


The Adaptive Capacity Model

Think of your firm as a Boeing 777 airplane. When United Airlines places a Boeing 777 in service, it adds a certain capacity to its fleet. However, it goes one step further, by dividing up that marginal capacity into five segments (the percentages shown are suggested capacity allocations for a professional firm):

  • A. First class (5 to 8 percent)

  • B. Business class (15 to 24 percent)

  • C. Full fare coach (30 to 50 percent)

  • D. Coach (15 to 35 percent)

  • F. Discount/Priceline.com (10 to 20 percent)


Your firm has a theoretical maximum capacity and a theoretical optimal capacity, and it is essential to see how that capacity is being allocated to each customer segment. Your maximum capacity is the total number of customers your firm can adequately service (not how many hours you have), while the optimal capacity is the point where customers can be served adequately and crowding out does not affect customer behavior. Usually, for most professional firms, optimal capacity is between 60 and 80 percent of maximum capacity.  

Too many firms will, in fact, add capacity—or reallocate capacity from higher-valued customers—to serve low-valued customers. Furthermore, firms will turn away high-value, last-minute work for its best customers because it is operating near maximum capacity and usually at the low-end of the value curve for price-sensitive customers. This is common during peak seasons, where high value projects will arise from customers, but the firm is at maximum capacity and cannot handle the marginal work. The lost profit opportunities because of this are incalculable.

Firms worry about running below optimal capacity and cut their prices to attract work, especially in the off-season. This strategy is fine, but you must understand the trade-off you are making. Usually, that capacity could be better utilized selling more valued services to your first-class and business-class customers. This way, the firm does not degrade its pricing integrity to attract price-sensitive customers. According to most pricing consultants, one of the leading causes of pricing mistakes is the result of misallocating capacity to low-value customers due to the fear of not running at optimal (or maximum) capacity.

Remember, the objective of pricing is not to fill the plane; it is to maximize the profit over a given time period. If that can be done at 60 percent capacity, so much the better, as the excess capacity can be invested elsewhere.


How to Fire a Customer

What happens when your plane becomes filled with too many “C,” “D,” and “F” customers? Many consultants to firms estimate that the average firm contains between 10 and 40 percent of “F” customers. It is never easy, but it is necessary, to remove these customers from your firm. Start with those customers whose personalities clash with the culture of your firm, or whose character is in question. Once that is completed, then you can focus on removing other low-valued customers (such as the “Cs” and “Ds”). These customers are usually the ones who complain most vociferously about your price; and the debilitating effect is that we tend to listen to them the most and this effects how we price our “A” and “B” customers. One caveat: Be sure you have done everything within your power to turn a low-value customer into a high-value customer. The fact of the matter is, your customers are not going to get better until you do.

All that said, how should you fire a customer? There are many strategies, some more effective than others. Many firms in the early days of implementing this strategy would simply raise their prices by a factor of two or four, and to their surprise, a super-majority of the customers remained with the firm (an indicator of just how much money professional firms leave on the table through suboptimal hourly billing).

Nevertheless, it is strongly advised that you not utilize this strategy. The goal is to remove the customers, not simply increase their price. Getting two or four times more from an “F” customer does not make him a “C,” “B,” or “A” customer (this is the ethic of the world’s oldest profession, not of true professionals).

A phone call or a meeting is the best—and most dignified—strategy. You may line up other professionals as potential referral sources (one of your “D” or “F” customers could be his “A” or “B” customer); or, some firms have even sold off these customers to other firms. Here is an example from a CPA firm of a possible conversation you might have:

“Mary, we need to talk about how well we’re working together. We need to be sure that the range of services we offer matches your needs. Here in the firm we want to work with people where we can add significant value to their business, rather than just crunching some numbers and filling in some tax returns for them.

“This means we are reducing the number of clients we work with and increasing the range of services we provide for them. We’re working with them on growing their businesses by offering consultative services. Naturally, this means that our price levels are increasing, too. Many of our clients are comfortable with that extra investment because of the value we are providing them in return.

“Mary, unless I’m very mistaken we simply can’t provide you with that value. It seems to me that your needs would be better served by an accountant who just wants to stick to the numbers.  How do you feel about that?”


The Forced Churn

In the mid-1990s, Lake Tahoe began a major renovation, where many older motels, stores, and other buildings were bulldozed down by the lake, just on the California side of the state line. A local newspaper article claimed that for every new room added, somewhere between two and three would be lost. Obviously, the developers were shifting up the value curve by constructing higher-end hotels, time-shares, condominiums, and so forth. Why shouldn’t (some) firms remove somewhere between one and four customers for every new one added? This led to the concept of what we have since labeled the forced churn.

As a way to upgrade your firm’s customer base from “C,” “D,” and “F” customers, each time a new customer is obtained, you would fire somewhere between one to four old customers. Of course, the exact ratio would depend on how many “C,” “D,” and “F” customers your firm has and what factor the leaders are comfortable with.

Not only would this free up capacity to serve new customers, it would shift the firm up the value curve, allowing your plane to add more full-fare coach, business-class, and first-class seats. By implementing this strategy gradually, many firms feel more comfortable upgrading their customer base, and their sense of security is not jeopardized by firing a large number of customers all at once.

Tom Peters is fond of making this point: “It’s axiomatic: You’re as good—or as bad—as the character of your Customer List. In a very real sense, you are your Customer List.”

Our colleague Tim Williams likes to say that a firm is defined by the customers it doesn’t have. The most successful firms in the world today turn away more customers than they accept because they have a rigorous prequalifying process and they understand that, ultimately, bad customers drive out good customers.


Tools to Help You Get There

During our live show (the recording is linked at the top of this post), we referenced several tools to help you get to a better understanding of your customer mix.

The Customer Likability Score

Click for a larger version

Click for a larger version 

Episode #233: Pricing at Starbucks

Pricing at Starbucks and Six Tactics You Should Know About 

In this show, Ed and Ron discussed the following post: 

6 psychological tactics behind the Starbucks menu,” Kent Hendricks, March 20, 2018

So What Are The Tactics?

  1. Why you like the drinks at the center of the menu

  2. Why you’re most likely to select the Grande size

  3. Why looking at three columns of prices makes you spend more

  4. How Starbucks uses the attraction effect to frame your choice between a Grande and a Venti size

  5. Why the Starbucks menu doesn’t include a dollar sign

  6. Why Starbucks prices end in .95 instead of .99 

…And What Are The Behavioral Effects Behind Each Tactic?

  1. The Center Stage effect

  2. The Comprise effect

  3. Lower price on left (first): We spend more

  4. The Attraction effect frame Grande and Venti

  5. No Dollar Sign

  6. Prices end in .95 instead of .99

Let’s talk in more detail about number 5. Currency symbols get you to think about money which makes you less likely to spend said money. $20 and 20 and twenty are all semantically the same thing but there is a big difference in salience. The $ symbol is a symbol of cost and it reframes your thinking. The $ symbol represents what you are losing, not getting.

Number 6 poses an interesting tactic as well. The 99 in .99 signals a low cost but the 95 in .95 signals high quality. For Starbucks, the .04 loss (1.33% per transaction) more than makes up for the high quality perception and the positive effect on their brand.

Parting Thoughts 

“Summaries of human behavior explain a great deal but predict very little,” Robert Sapolsky.

We can observe behavior in aggregate, then seek to explain that behavior. However, we cannot do the reverse. We can’t use an explanation of behavior in aggregate to predict how any single individual will act.