Top 10 Business Myths Part II
Ron Baker: They are the top business myths. What's myth number seven?
Ed Kless: You're throwing a quiz at me of my presentation?
Ron Baker: I'm giving you a test.
Ed Kless: Number seven is about strategic planning. It begins by determining a revenue target, and we decided that that was not the case. In fact, it began by looking at value rather than that. Just to really do a quick countdown, because we're going to deal with myths five through one today, but just in the interest of completing the picture and providing contexts, I want to let you know that myth number 10 is that differentiation can be achieved by saying you are customer-focused. The emphasis there of course is on the saying. Of course, every business says they're customer-focused, so the actual differentiation is only achieved via very few select elect companies, and that we just can't have people to saying that they're customer-focused because it really doesn't differentiate at all. Myth number nine is that the customer is always right. I mentioned that Harry Selfridge never said this although he is reported to has said it. What we decided with myth number nine is the problem with that is that it would mean that all innovation would cease because it would mean that if the customer was always right, well then they would be leading us from an innovation standpoint. Clearly, that's not the case. It’s companies that actually innovate. Myth number eight is the business as a Science and requires data to make decisions. I used a really fun long two polysyllabic word called logical positivism to describe this. This just basically means that just because there are numbers does not mean it's scientific. I think that's where people fall down. We also went out of our way to point out that we're not against all data, but just that you really need to pay attention to it and don't let it cloud your judgment. I think we know that was somewhat a retailing of some of the things we talked about with moral hazards of measurement too, but just put it into a business context. As we mentioned, myth number seven was that strategic planning begins with determining a revenue target. We said that the better way was to look at value on that. Myth number six was that leadership is about changing other's behavior. We said that that was really a manipulation. Ron, you and I both like the Peter Block definition of leadership, which is that leadership is about confronting people with their freedom. We gave some stories about how we think that should take place. Ron, I'm going to turn it over to you, and after just introducing myth number five, which is that focusing on efficiency makes your company more effective and the origins of this myth, I, for me, lead directly back to you in some conversation when I first met you that have evolved into what is called the Diverse Age Institute with all honor the effing debate, E-F-F.
Ron Baker: Ed, I've learned this from Peter Drucker and Steven Cavy, and others, but the difference between efficiency and effectiveness. We talked about this on our very first show when we declared our independence from the tyranny of taylorism, and that is that efficiency is just a mindless ratio. It’s some type of outputs divided inputs, whereas effectiveness is defined as doing the right thing. Since we can be efficient at doing the wrong thing, efficiency shouldn't be the focus. I think that's what you’re getting here with this myth that if we focus on efficiency, it will be more effective. That's obviously not the case because, again, you can be efficient at doing the wrong thing.
Ed Kless: In which case, why bother? I think we've told the story of the insurance company that decided it was a good idea to get their life insurance policy into the hands of their policy holders within 48 hours of it being signed. Of course nobody in their right mind cares when the life insurance policy arrives just as long as that’s enforced because you're not thinking when you get it in the mail, "I hope I execute on his puppy today." They were terribly efficient but at the wrong things, but even worse than that though is that long term, it can lead to complete stagnation of the organization. Then this going back to Drucker's point is that the last buggywith manufacturer was the most efficient.
Ron Baker: You may disappoint too in that first show where you said the more you focus on efficiency, the more inward looking your organization gets as opposed to outward looking to the customer in adding value.
Ed Kless: That's exactly correct, and your customer does not care about your efficiency at all. Just like we've mentioned that they don't care about your costs. They don't care about your efficiency. No one goes into an organization or any store, any professional organization going, "I hope these guys are really efficient," and because the customer doesn't care about it, it's just something that we shouldn't put forward as being the preeminent thing that we worry about in our organization. This is where people get trapped, right Ron, with us because that they think that we are then the anti efficiency that we should go back to Quill Pens. That is absolutely not what we're saying.
Ron Baker: Yes, because Peter Drucker is pretty explicit about this. A business is not paid to be efficient. A business is paid to create wealth outside of its four walls or in his terms greater customer. We could be efficient with things, but we can't be efficient with people. It's one of the things that we've talked a little bit about it, but maybe it's worth it to reiterate the point that we humans don't like complete efficiency. We inherently trust organizations that have resources to spare. This is why banks put big steel vault inside their banks to give you that feeling of security and protection. Even though with the advances we made in metals, they wouldn't require those big doors and with the round wheel lock and all that. It's done for psychological reasons to make us feel safe and that out money or belongings are secure. It goes into that whole thing that people are repelled by efficiency. We joke but it's true. I don't want an efficient marriage. I'm not even sure what that means.
Ed Kless: Well Pittman, Maggie said the opposite of love isn't hate but efficiency. I just love that quote because it is what does it mean to describe your relationships not only with your spouse and loved ones' kids, but with anyone, with your boss, with the folks that work with you. "Oh, we have a very efficient relationship.” It's repulsive actually.
Ron Baker: I remember driving the Key West, and I saw a sign. In fact, I think I took a picture of it. It said, "Efficiency apartments." It just gives you an image of what that's going to be like.
Ed Kless: It sure does.
Ron Baker: It's going to be pretty sparse. It's not going to be a [inaudible 00:07:13]. The other thing I think we can say about this as well is that efficiency is rather tactical, whereas effectiveness is very, very strategic. Again, efficiency is not a table. It's a table stake. It's effectiveness that creates competitive differentiation and competitive advantage in the market. Think about Apple. Think about Nordstrom. These organizations are effective at customer service and all of that. They're not necessarily the most efficient. Just look at the way an Apple store is laid out. That has nothing to do with efficiency.
Ed Kless: No, it's sometimes anti efficiency, the way that they've got them laid out. I find that their ... but they're purposefully looking to give you some space to see things. If we were like every other store, you wouldn't be able to see from one end to the other because they'd have billboards in front of you saying, "iPad is over here." They don't want that. They want you to feel at home. They want you to feel as hi tech as the product is.
Ron Baker: Ed, I would even go with this and say about this myth that it's actually the exact opposite. I do believe that if you focus on being effective, you can actually become more efficient. I think the great example here is the After Action Review. The after Action Review Initially is not very efficient. However, not only does it make you more effective the next time you go to do a project, but it also makes you more efficient. Focusing on effectiveness is what makes you more efficient.
Ed Kless: It sounds like we should do a whole show on after action reviews, Ron.
Ron Baker: Well, I think we are going to.
Ed Kless: That's right.
Ron Baker: That's next week's topic, I think. We've been talking about it a little bit. We've talked about it on replacing the performance appraisal. Since it's one to the key replacements for that, and we said we'd do an entire show on it. As you know, it's worth an entire show because folks, we do believe it is just the best knowledge management tool ever devised by civilization.
Ed Kless: Before we leave this topic, Ron, there's two things that I wanted to state. The first is that originally, this myth read something different. I'm going to say them on the show here, but it was too inflammatory. Whenever I presented it this way, it just made people insane. I phrased it like this. I said, "Effectiveness ..." The myth was efficiency always in everywhere is more important than effectiveness. That's the myth. I would counter it by saying, Effectiveness is always and everywhere more important than efficiency.” Boy, that's the thing that cut people insane. That can't be. There are times, efficiency is more important.” Oh my God!.
Ron Baker: I think I actually wrote that in my book, Ed. I do take a lot of [inaudible 00:10:24] for that. It's not a popular statement, and yet it's absolutely true. If you just think again that we can be efficient at doing the wrong things, then that knocks it. It checkmates them.
Ed Kless: It really does. Before we leave this topic, we have mentioned this word, but I think it's worth spending a little bit more time than we have in that past, and that is efficaciousness. If we're blowing people away by talking about effectiveness, then they're quite not ready for efficaciousness, are they?
Ron Baker: No, but it is a better word. We talked about this being one of those 10-dollar words that you'd never see on somebody's website, although you do see it ... I bet you do see it on pharmaceutical companies because the medical profession uses this word a lot. In fact, the first time I heard that word, Ed, was from a customer who was both a lawyer and a doctor. We were working on something that was very complicated for his tax returns, and he looked at me. He said, "Ron, I trust you're going to do whatever is most efficacious." When he walked out of the office, I ran to the dictionary. "What a great word." What a great word because to create the desired effect or the optimal effect ...
Ed Kless: The optimal ... What I love about it is the maximization.
Ron Baker: That's what knowledge workers should be doing.
Ed Kless: Of course, and that's what the customer wants too. It’s not only for you to be effective, but the maximum possible benefit. It's beyond that. That's where I really think that's where the value. We, in a sense, have linked these three concepts back to cost, price, and value, right? We say cost is obviously a concern about your efficiency. Effectiveness is a concern about your price. That's really what the customer is looking for, but it's at a minimum, your effectiveness. Efficaciousness is really the concept of value which goes above and beyond the price that they're paying.
Ron Baker: Right. Of course, that is something that you're trying to maximize. That is something that you want to maximize is the business, and also your customers want you to maximize it, or they want maximum value from you. Therefore, your interests are completely aligned as opposed to cost or price where your interests are not aligned, because they would like a lower price, and you would like a higher price, but your value or interests are completely aligned.
Ed Kless: By the way, that's never going to change because they'll always going to want a lower price. Let's just accept that.
Ron Baker: Since we emerged from the cave and started borrowing for lowing costs, I think the customer has worked to get the best deal possible.
Ed Kless: They certainly have.
Ron Baker: Myth number four I think is very, very thought provoking, because it's increasing market share leads to increased profitability. I have to tell you, I think this is so endemic. It certainly deserves the label of conventional wisdom in nearly every business.
Ed Kless: As you say, it's more conventional and not so much wisdom. I have been at conferences, where a certain former CEO of a very large technology company was screaming, ranting back and forth at the top of his lungs. "Market share..." He was ...
Ron Baker: Freedom [crosstalk 00:14:00].
Ed Kless: Exactly. He was nuts. Anybody who is understanding who that reference is has probably seen that. He's a very intense person to begin with, but it just shows you how endemic it is that even this top guy at perhaps the world's largest software company at one time anyway would be so susceptible to this myth that thinking it's all about the creation of market share. What I find fascinating about this one is that there are very interesting parallels to the market share myth the smaller and smaller you go, because if you believe the market share myth, you also then believe that it's all about raising revenue in your organization. Raising revenue, getting bigger revenue is the same thing as increasing market share. It's fair to say that. It also then means that every customer is then therefore a good customer, because any revenue that we get is good revenue because it increases our market share. This is the faulty logic chain that really is a problem for a lot of organizations because not every customer is a good customer. Not every customer is a fit for your organization. If you believe it's all about market share, well it just means you've got to take every single customer that's willing to pay. I've been consulting for years, and one thing that I have said to people is, "Look! If you want me to double your revenue in a year, I can do that without even thinking about it. It would be easy to double your revenue. I'll put you out of business doing it, but I'll double your revenue."
Ron Baker: The term itself market share came in to play around sometime in the 20th century, or 1920's, '30's something like that. I think the first used was in the 1940's in a printed article. It was actually a term that was used by anti business writers that we're talking about, and I trust in all of the market share and concentration and things like that. What really linked this myth to the business world was a 1975 Harvard business review article by a professor by the name of Robert Buzzell. The title of the article was "Market Share: A Key to Profitability". Boy, this was the conventional wisdom. They say intellectual ideas and ideas percolate out of academia. In this case, this was certainly a big one. It hung around for quite a long time. I still think it's there. It's like taylorism. It still haunts us.
Ed Kless: It absolutely is there. It's all over. The funny thing is that it's so easily falsified. You need not look any further than General Motors and Toyota to falsify this. I think this is one of the examples that is used in the great book by Richard Miniter "The Myth of Market Share", where he says, "General Motors ..." I think at the time of the writing still had a 60% plus market share. They've since now fallen below 50% than they were. It went back above back and forth with the ...
Ron Baker: I think they're around 20.
Ed Kless: Are they way down now?
Ron Baker: Yes, maybe below absolutely.
Ed Kless: What I was thinking was not just the market share, but it was number one in the market. I'm sorry. They were number one in the market for decades, but slowly became less and less and less profitable over time simply because as I like to joke that if you look at General Motors’ balance sheet, you quickly realize that they're an automobile company. I'm sorry; they’re a pension fund that happens to make cars.
Ron Baker: Well, in this book "The Myth of the Market Share" by Richard Miniter … By the way, he is a former editor at the Economists. I just think he's a fantastic writer. This is a thin little book, folks, and highly, highly recommended, even though some of the examples are outdated, because in the book, if you remember, he's touting Dell was both a market leader and a profit leader, a market share leader and a profit leader. He cites a study, and I think it would probably still be true given what we know that 70% of the time, the highest market share company is not anywhere near the company with the highest returns. It's usually the third or fourth one down. That's true 70% of the time. That should just dispel this notion that growth for the sake of growth, the whole top line, we need to grow. We need to get market share. This is insane. one of the point that I love that he makes is that if you're concerned about being a market share leader, you tend to focus on your competitors as opposed to being a profit leadership model where you've become focused onyour customers and adding value. What better proof of that is there than Apple.
Ed Kless: Absolutely, who as I understand it, with about 50% of the market share right now for the smartphone market place. I've seen reports that anywhere from 70% to, get this Ron, 125% of the profit in the space. People will go, "How can they have 125% of the profit?" Because the others are losing money.
Ron Baker: Ed, I don't think it's even 50%. If I remember right, they're down around 30 or 40% in the U.S.A.
Ed Kless: I think that's the gap.
Ron Baker: It varies by country, but I've seen some of the same reports. I haven't seen the 120%, but it certainly wouldn't surprise me. We know that Sony is attaching a 100-dollar bill for every TV that leaves. One of the things that Miniter points out in the book is that market share is a result; it's not a cause. You were talking about General Motors having 60% at one time. I believe they did of the entire U.S. market. It reminds me of Sears. At one point, Sears and Roebuck was 1% of this country's GDP. They had a massive market share, and a little guy from Bentonville, Arkansas took them out. Sam Walton, he wasn't focused on market share. It was the result of him giving a better deal to the customer. The market share, it's a result. It's not the cause.
Ed Kless: Right. I guess if anything is true, you can focus on profitability and then if you want, you can choose to grow market share. I guess, an example potentially could be if BMW, which I believe is still the most profitable automobile company, if they wanted to grow market share, they probably could, but they are so focused on the ultimate driving machine that they really don't want to grow market share. That's not who they are.
Ron Baker: You can look at the failure with Mercedes Benz trying to go and grow market share with their smaller class of Mercedes. All it did was it tarnished their brand. My philosophy on this, Ed, now interesting to get your take is I always say, "Look! Go for profit share, and market share will take care of itself."
Ed Kless: I totally agree with that. That's really the message when I delivered this presentation is, "Look! Grow profitability. Make sure that you're focused on being profitable. Then if you want, if your organization supports it, then you can grown into other market segments or just expand in the current one if you want, but then that leaves you to say, "Well, do we want to reinvest our profits in that or we're just happy where we are?" Are we making enough profits for the size of our organization now, and not really want to get so much bigger? Like the whole efficiency and there is the church of efficiency inside businesses, there's also the church of scalability too. People say ...
Ron Baker: Economies of scale.
Ed Kless: Economies of scale, and unless you have scalability over your business, well then, why bother? That's nonsense.
Ron Baker: There's some truth to it in terms of technology companies. Google obviously is very scalable, but I think this is also a word issue. When you say scalability, I'm thinking of economies of scale in the traditional meaning. What we know these days is that economies of scale is actually diseconomies of scale. Let's also point out since probably a good chunk of our audience are professionals and professional firms, there are no economies of scale on a professional firm. A law firm doesn't get more efficient when it has 1,000 lawyers as opposed to 500 lawyers. It just doesn't.
Ed Kless: I could probably make a pretty convincing case that it gets less efficient.
Ron Baker: Probably, we could. When we were in Canada recently, and I watched you do a session, and it wasn't this one but it was another one on strategy. You said something I liked that was actually pretty profound. It was a throw-away line. You said, "If you think about a startup when you're a startup, all you're focused on is the customer and how do we add more value. Then as you start to get bigger, you start to turn inward and worry about these things like market share and revenue and efficiency and all of that." When you said that, it reminded of Starbucks. Starbucks didn't set out to grow market share. They set out to create a third place to go and to make people passionate about coffee. As a result, they grew and have market share just like Walmart.
Ed Kless: They've done it very well, but as a result to being extraordinarily profitable in their first store, or second store, or third store.
Ron Baker: I think the way to sum this up is to say revenue is vanity, but profit is sanity.
Ed Kless: I like that.
Ron Baker: I remember working with a top 50 insurance company. They sat around and they told us that, "Oh well, we'll go up to a 15% negative gross profit on an insurance sale." We're like, "What are you a 501C3? What do you mean a negative gross profit? Why would you even sell a policy of a negative gross profit?" They said, "Well, we need growth." I guess, we'll make it up in volume.
Ed Kless: That's an old accounting joke, isn't it?
Ron Baker: It is. It's insane. Focus on … One of the things that Miniter does say in his book is not just to focus on profit. It is actually that he does talk about value and innovation to the customer and all of that. That's I think what we would say, "If you focus on value and adding more, then the profit is going to take care of itself. Your market share will also take care of itself."
Ed Kless: I absolutely agree, Ron. Myth number three is that excessive profits must be because the company is doing something evil. There are so many things wrong with this one, Ron. It's hard to start, but I'm going to pick on the first, which is, "Who gets to define excessive?" Do I define the excessive as 2%, 5%, 15%, 50%, 75%, 500%? What's excessive?
Ron Baker: Can I just add, Ed? Over what time period, I'm sure oil companies can make a fortune in some years when full profit is in other years. They don't do very well. Nobody says a peak during those bad years.
Ed Kless: Well, they say they're trying to hide the profits. That's what they say, Ron.
Ron Baker: I also like to quote the late Senator Paul Wellstone, who said probably the most stupid thing I've ever heard regarding enterprise. He said, "An industry ..." He's talking about the pharmaceutical industry. He said, "This is an industry that makes exuberant profits of sickness, misery, and illness of people. That's obscene." I know he's no longer with us, but this is such a stupid argument. It's like arguing that farmers make money of our hunger. That's just ludicrous. Farmers keep us from hunger, and pharmaceutical companies keep us healthy.
Ed Kless: Right. They're not playing off of sick. They are there to make as well when we're not. The whole notion is just completely silly because as I said, there is no objectivity behind excessive. Of course as Milton Friedman points out, it's always the other guy who is greedy. You and I aren't agree. It's the other people.
Ron Baker: It's always the other guy. It needs to be said, Ed, and we said this in the corporate social responsibility show a few weeks back that most companies don't make a profit. Certainly, startups and things like that, but even if you calculated return on capital, most companies aren't really making that much of a profit. A profit is only about 10%, 12% of our national income. However, it's so important to the allocation of resources, because it provides an incentive but it also transmits information about what consumers value. If you think about a country who had an experiment in the Utopian in fair price, where prices were going to be set scientifically and based on costs, and there would be no ripping people of. We put people before profits and all that when you see that stupid bumper sticker. That was the old USSR. It didn't work out really well. They had fair prices but their store shelves were empty.
Ed Kless: What's the story of [inaudible 00:28:19] when he went and met with Margaret [inaudible 00:28:21] about the department store and asking, "How did you get all of the stuff here," and she said, "I didn’t, prices do.”
Ron Baker: He was in an appliance store. He was amazed with the variety and colors of washing machines and refrigerators. He asked her, "How did you do all these?" She goes, "I didn't." She just looked at him and just incredulously and said, "I didn't do it. Prices do this." This is a long standing debate if you go back into theology or philosophy, the concept of a just price. I wanted to get your take between the word just and fair price, because it's never couched in terms of a fair price. If you read the historical literature on this, it's actually talked about as a just price. What is the difference?
Ed Kless: It's been misinterpreted. This is a fascinating story. This was pointed out in a video that I saw on ReasonTV. We'll have to post it with the show notes, but the idea of fair is an Anglo-Saxon concept. It's only in English. I think there is a notion in German as well. The idea of fair is an Anglo-Saxon concept. This happened when we were up in Canada. I talked specifically about the subject, and we had some French speakers in the room. I said to them, I said, "Can you translate the word fair to French?" They came back, and said, "Juste." I said, "Okay great. Can you translate that back to English?" She said, "Just." I said, "See?" If you go one to other, you’re not getting … Fair and just are two different things. In fact, the Anglo-Saxon opposite of fair, you have to go to baseball to understand. It's fair and foul. We would say a fair price, meaning just, but we would never say a foul price. That's odd. What do you mean by a foul price? I guess, bad smelling. It doesn't really make sense because the concept is different. What is meant by a just price is one that's accepted by the customer. If the customer pays, by definition, it's just.
Ron Baker: That's a great analogy with the fair and foul from baseball. I've never thought about it in that framing. That's excellent. When I hear people say, "That price is unreasonable," and they buy it anyway, I'm like, "Well, only unreasonable people pay unreasonable prices." What a stupid comment. If you buy something, by definition, it must be fair unless you were coerced or there was fraud or something like that. The other thing I think that has to be said here is some of our favorite definitions of profit. Certainly, George Gilder's definition that profit is an index of your altruism, which I love because it's outward directed. Peter Drucker also says that profit is the price that we pay for tomorrow. It's profit that funds innovation and RND and all these other great things. I'm always fascinated that it does seem to be that people aren't so much repelled against high prices. It seems they are more offended by high profits. I just wonder, Ed, why we don't feel that way about actors or movie stars or athletes. Even when somebody sells their house at an enormous profit, you usually end up giving them the pat on the back, but when a business does it, they're evil.
Ed Kless: Right. We mentioned this in the last show too. It's like it's okay for somebody to make $15 million developing violent video games, but God forbid, you should make $500,000 as the head of a company that's seeking a cure for a disease because that should be done not for profit. It can get a little crazy.
Ron Baker: The way I sum this up, Ed, is, "Hey! This is capital stocks between consenting adults."
Ed Kless: I love that. That's so true. Well, number two on our myth list is the price is based on cost. This one, we've told the Far Niente story I think in a few episodes. We'll skip that. If you want to listen, listen to it on older episodes. There's lots of storieys that illustrate this idea that price is not based on costs. I think my favorite one is the Hewlett Packard printers. This is an apocryphal story. I'm just making up the story as we go along, but it's true to actually what happens. You say go to Best Buy, and you were walking in the printer alley, and there's three Hewlett Packard printers. There's the 710, the 730, and the 750. There is the price under each of them. The 750 is the most expensive. The 710 is the cheapest. Other than the price, the big differentiator between those three printers is going to be the speed at which they print, so eight pages a minute. Then the next one up to 730 is 12 pages a minute. Then the highest one is the 750 might be 16 pages a minute. Think about this. If you were the engineers at Hewlett Packard designing the 700 series printer, do you a) design the 710 and figure out a way to speed it up, or do you b) design the 750 and slow it down? Of course, the obvious answer is b. You design the 750 and then they strip value out of it. In a lot of cases, what they've done is they've then go and write code which they put on a chip, and they stamp into the sucker and say, "Don't print so fast. You're not a 750. You're just a 730."
Ron Baker: Which actually costs some more.
Ed Kless: Exactly, and that's the point. I told this story in front of grooms of cost accountants who just basically fall off their chair and quivering in a mass of jelly of the side of their chair, because they can't process this.
Ron Baker: That's something impossible or is priceless.
Ed Kless: Exactly. How is that possible?
Ron Baker: It's the same with FedEx, isn't it? They do a three-day delivery. It actually does cost them a little bit more at the margin because it's in their system longer as opposed to an overnight delivery. That's a heck of a lot cheaper to send something three days than overnight.
Ed Kless: Worse than that, we've talked to some people that worked at FedEx. They said that if you've got a priority item and the standard overnight, the priority and overnight you get at 10:00 in the morning. Guess what? The standard overnight is on the truck, and they’re going to drive away and come back four hours, five hours later.
Ron Baker: That's right. They're going to make you with because that's what you ... Your price is [inaudible 00:35:03] which you paid for. That's the value trade off that you made. The other thing about this, Ed, is Henry Ford was a really interesting guy. In his autobiography “My Life and Work” I think from the 1920's, he has a great line that I just absolutely love. He says, "No one knows what the cost ought to be." If you think about that, that's pretty profound. I think this is the philosophy behind this target costing, where you target the cost after you know the value and the price you're going to sell it for. Of course, that's determined by how much the customer is willing to pay, their income, a whole host of factors, but the cost is last. The cost is not first like costs accountants think. It's actually last. Henry Ford was a genius at figuring out better ways and cheaper ways course because his strategy was to lower the price and sell as many as he could.
Ed Kless: The way I like to think of it is okay, price is not based on cost. Price instead justifies your cost. The fact that I can get x price for this means that I can justify whatever the cost go into, which are theoretically would have to be x-, otherwise, you're not going to be in business too long or as we said earlier, you're just making up in volume. It's not that difficult to put a price higher than your cost. My eight-year-old son who was able to do this when he was four watching basketball games could tell the difference between two different numbers, and say that, "Okay 105 is greater than 84."
Ron Baker: If it was true, Ed, that price is based on cost, then no business would ever go out of business because anybody can just take a cost and mark it up with desired profit instead of price. Businesses go bankrupt all the time. Why is that? Because they don't produce anything of value. Logically, it's got to be value driving price, and it's got to be price driving cost.
Ed Kless: My friend, that is the [codagra 00:37:09] right there. If this were true, and so many people believe it is, no business would go out of business. That's flat out the illogical conclusion from this.
Ron Baker: Yet, Ed, costs plus pricing is still endemic. I know there's a lot of reasons for it, but I think the big one is something that we've talked about before and even talked about it with Roy Sutherland is this idea that it satisfisies. It's good enough. It's simple. People understand it. It's good enough.
Ed Kless: We can calculate it. We can calculate it. You can't calculate the price. If you're basing it on value, it becomes a nonformula. It becomes a judgment. As we've talked about on this show many times, people like to get something that they can measure. They don't like the notion of being a judge at all.
Ron Baker: Folks, this is a big one. Price is not based on cost. Cost is actually based on price. It is head shuttering for me Ed. As a former cost accountant when I first learned this, it took me a while. I really wrestled with this, but now, it is definitely the way the world works. Final, I feel like I'm opening the envelope here, and tada. Do we have a drum roll? Business myth number one, boy, I have to tell you. You nailed this. This is brilliant. Go ahead.
Ed Kless: Business is a zero sum game. Boy, how pervasive is this one, sir?
Ron Baker: Yes, all over the place. I partially blame accountants for this. I partially blame the ubiquitousness of sports analogies that we use in business, because obviously, sports, one team loses. One team wins, and also politics. This is [crosstalk 00:39:10].
Ed Kless: Politics is [crosstalk 00:39:09] game.
Ron Baker: Business isn't. Why not?
Ed Kless: Well because both sides benefit from the transaction. There is a couple of really interesting things just about that word. First of all, the word transaction, trans, it means beyond, so it's beyond the action. Beyond the actual thing that's happening here is something magical, something intense. I think John Stossel ... At least, this is where I saw it first. The first to point this out is what he called the Double Thank You moment. That moment in an exchange where you get the cup of coffee, and you give your $4. You bought. You say thank you to the barista, and the barista says thank you to you. It's an odd construct, isn't it Ron to both say thank you. The only reason why you would say thank you to someone is because they just did something for you. They did something that benefited you. How is it that we both benefited? Well, I wanted the coffee more than I wanted my $4, and Starbucks wanted my $4 more than they wanted the coffee. Therefore, we both benefited from that transaction beyond the action. Starbucks obviously made a profit because they paid their people and the barista and all that stuff for less than $4, but I wanted the coffee more than $4. I wanted the pleasure of drinking a Starbucks latte on a beautiful fall afternoon.
Ron Baker: Ed, this concept of a transaction is certainly true at the micro level, but let's just talk a minute about the macro level because this is true on a macro level. I can't tell you how many times I've had conversation with people, and I say, "Are you worried that China or India or any country for that matter is getting rich?" "Well yeah because they're taking our jobs and bla, bla, bla." It's the same fallacy. I want China to get rich. I want India to get rich, because the world's wealth is not a zero sum game. It's not like a pizza. If I eat more, you have to eat the box. It doesn't work that way. If China finds the cure for cancer, we'll all be better off. It drives me crazy, this zero sum thinking. I understand its geo political issues and military issues, but from just an economic perspective, we want the world to be wealthy first, because it's the only antidote to poverty that we know of.
Ed Kless: Exactly. The way I like to describe this one too is I personally think we got a really good deal going on with the Chinese. They send us TVs. We send them green pieces of paper.
Ron Baker: I know it's the equivalent of writing letters to the North Pole, and getting toys.
Ed Kless: Rock on.
Ron Baker: Absolutely. We got actual tangible things or goods and services we can use. I think this goes back to something that we've talked about in the first and second law of marketing shows that we did as well. This concept that value is subjective, the misses, the legal [inaudible 00:42:12] misses point or the marginalist’s point that all value is subjective, and another thing that's really interesting about this too is [inaudible 00:42:22] point about the restaurant. If you can't make a distinction from a value perspective between the chef who cooks the food and the person who sweeps the floor, because enjoying good food in the restaurant, it smells like a sewer is not very valuable. I think that is what's driving value here is this holistic concept. Obviously, when we buy something, we're receiving more value than the cash we're paying. That's actually what's generating wealth. How can it be zero sum? It goes back to the Gordon Gekko movie too, doesn't it, Wall Street.
Ed Kless: It does. When there's a scene with Gekko where he is talking to Charlie sheen's character. I forget. Was that Butter or whatever? He says, "It's a zero sum game. Wealth isn't created or destroyed, really transferred from one perception to the other like magic." I agree that it's like magic, but I disagree with the zero sum game thinking. In fact, here is a great illustration of the magic piece of it. I forget which economist came up with this idea. Ron, you might know. Imagine if the port of Long Beach or on the port of Long Beach, I came up with a fantastic machine that allowed you pour corn into it and out would come cars. You would be held as a hero. All you're going to is ship corn to this place; pour it into this machine, and outcome cars. Yup, that's all you got to do. They would think that I am the greatest being that has ever worked the planet. That is actually what the port of Long Beach does. What's incredibly magical about it is that we put in corn and outcome cars, but here is the thing. They want our corn way more than we do because we have a surplus of it. We want the cars because not that we have a surplus of them but because they can produce them perhaps better, faster, and cheaper than we can, so we get a better deal, so we can spend our money on other things.
Ron Baker: It would be hard for us to live as a society if we just had to produce everything on our own. It'd be crazy. I love this because if there is one myth I could just dispel for most people's mentality, it would be this idea, the zero sum game. That myth needs to be broken.
Ed Kless: It is. It is so ubiquitous and everywhere. When we're talking about the China and the TVs and all of these is governments don't trade. People do. Thank God there is not one big office of TV order taking down in Washington, D.C. trying to figure out how many TVs to order from China every year. I'm telling you; that's not going to work.
Ron Baker: At some point, we need to do a whole show on the whole trade deficit and just where that abysmal talking about the moral hazards of measurement, what an abysmal measurement it is. When Apple sends the iPhone to be assembled in China, and then when it ships back to us, did you know that the accountant is a Chinese export at the full value, even though they added maybe $10 worth of cost to the thing?
Ed Kless: We're going to sell it for double that here, any aftermarket.
Ron Baker: Totally, it distorts our trade statistic so that the trade deficit is absolutely the most meaningless number that I can think of.
Ed Kless: It's an accounting fiction is really where that comes down to. It's not really a deficit. It is the wrong way of even thinking of it. It's like a score card. We win. They lose. That's nonsense. It was I guess Bastia who said that, "Buy that logic if all exports are good and imports are bad. We should hope that all ships sink at sea."
Ron Baker: I love Bastia, the wickedest sense of humor. That's one of my favorite lines from him that we should sink the ships at sea. That way, the world would just have exports with no imports. Well yeah, but it would be a lot poor. I think the other thing that needs to be said here too is this idea of wealth. People think of wealth, and they think of money, stocks, all of these types of thing. We know it's human capital, but it's also manifested in the amount of goods and services that we have available. I'd rather be a wealthy person today than a wealthy person 200 years ago when there was really nothing to buy.
Ed Kless: Absolutely. Well, that concludes our thoughts on the top 10 business myths. We hope you had enjoyed it, and ...