The last Friday of every month Ed and Ron will do “Free-Rider Friday.” Most of our shows are “topic” driven, where we dive deep into one subject. Free-Rider Fridays are designed to be “event” driven, whatever issues are in the news that we (or you) find worthy of commentary. In economics, free riding means reaping the benefits from the actions of others and consequently refusing to bear the full costs of those actions. This means Ed and Ron will free ride off of the news, and each other, with no advanced knowledge of the events either will bring up. If you’d like to call-in during the live show, the listener line is: 866-472-5790. You can also participate on Twitter at #ASKTSOE, @asktsoe, or email us at email@example.com.
Ron and Ed were at Sage Summit 2017 in Atlanta and recorded an episode (or two) featuring a great panel discussion on the premise that accounting and innovation are not opposites (i.e. not an oxymoron). While the job description for accounting professionals has largely stayed the same, technologies and laws have come into play to change the way business is done. It is time that accountants alter the way they do business to keep up with the shifting tide.
- Jodie Padar is CEO and Principal of the New Vision CPA Group, a public accounting firm based in the Chicago area. Jody joined her father’s firm a decade ago, bringing her expertise in the areas of taxation, QuickBooks, and small business accounting. As one of the profession’s emerging thought leaders, Jody has transitioned New Vision to New Firm status—adopting advanced technologies and best practices that support web-based client services. This allows Jody to manage her firm at peak efficiency with transparency at the heart of all engagements. Jody and her team provide financial insight and practical strategies to their clients in real-time, not just at tax season.
- Gail Perry is the editor-in-chief of CPA Practice Advisor. She also speaks at many accounting events, trade shows, and webinars. She is the author of over 30 books (including Mint.com For Dummies and QuickBooks 2014 On Demand), and she maintains a small tax practice. Gail is a graduate of Indiana University where she earned a bachelors degree in journalism. She returned to school to study accounting at Illinois State University, earned her CPA, and worked for Deloitte in the firm's Chicago tax department. She has taught college-level accounting principles and personal finance, and was on staff for 10 years at the Indiana CPA Society as a computer applications instructor. Gail was the publisher and editor-in-chief of AccountingWEB before joining the CPA Practice Advisor team.
- Gary Boomer, Visionary & Strategist of Boomer Consulting, Inc., is recognized in the accounting profession as the leading authority on technology and firm management. He consults and speaks around the globe on several topics including strategic and technology planning; mindset, skillsets and toolsets for the future; change management and developing a training and learning culture. He also acts as a planning facilitator and coach to some of the accounting profession's top firms.
- Tom Hood has been executive director and CEO of the Maryland Association of CPAs since January 1997. Armed with a passion for the profession and the drive to move it forward, he manages a staff of more than 30, works closely with the Executive Committee and Board of Directors and oversees the work of numerous committees to promote and protect the CPA brand in Maryland.
See if the following story is consistent with so much that has been written about Generation X, Y, and Z in the recent past by countless “generational consultants:"
- "They get restless after a little while in one place,” said an employer. “For the last few years I haven’t counted on keeping the ordinary fellows more than six months. I just let them go and take the next one who is always dropping in."
- "Madam, I assure you I could just cross the street tomorrow and be paid as much as you give me.” Selfish, satisfied, and capricious, these young people newly emancipated into economic freedom are seldom idle; they work, but they are marking time on the spot they have reached, for they do not perceive any options desirable enough to lead them beyond those they are now enjoying.
An enormous amount of ink has been spilled on this topic, usually along with the different characteristics of the Baby Boomers and Generation X, Y, and Z.
One reason for this increased attention is there are simply more generations interacting in the workforce today than in the past. One reason is life expectancy.
The average knowledge worker today will outlive their employer, with an average active work life of approximately fifty years compared to the average organizational life of thirty.
This translates into the average worker today having many more jobs—and even careers—than those of their ancestors a century ago.
Differences exist, but what is the cause and does it matter
It may be an interesting academic and historical exercise to create lists of the differences between the Baby Boomers and Generation X, Y, and Z, but knowing the nature and nurture traits between the generations does not necessarily assist a company in attracting or inspiring its knowledge workers.
All of this “generational astrology” has all the explanatory power of asking people their signs—it is an incredibly weak theory. And, it is nothing new. Plato complained that the young people of his day “disrespect their elders and ignore the law.”
A more robust explanation for today’s workers—no matter when they were born—is the fact that they are knowledge workers, who are far wealthier than their parents—they grew up in what economist Brink Lindsey calls “The Age of Abundance.”
Wealth provides more options, from extending education, traveling the world, living with parents longer, or simply delaying gainful employment.
John Adams, America’s second president wrote: “I must study politics and war that my sons may have liberty to study mathematics and philosophy and they in turn must study those subjects so that their children can study painting, poetry, music, architecture, statuary, tapestry, and porcelain.”
In an intellectual capital economy there is a far greater range of talents that can be rewarded. America’s best-paid chef, Wolfgang Puck, earned $16 million in 2005 while Takeru “Tsunami” Kobayashi earned more than $200,000 a year for holding the title of the world’s hot-dog eating champion.
It is not the year they were born in, it is their age (that's different)
Another crucial difference in today’s workers is they own more of the means of production in their heads than ever before, which gives them enormous market power in the economy. They understand this fundamental fact better than their predecessors.
When I entered the CPA profession, I believed I was a service worker; today’s students understand they are knowledge workers.
Organizations can lament the fact that Generation X, Y, and Z are not as loyal as their parents, but the fact of the matter is loyalty is a two-way street; it must be earned. No business deserves any loyalty, either from its customers or its associates, until it does something to earn it.
Loyalty is not dead in the business world, but a reason to be loyal may be. The real question is, does the organization deserve the loyalty of its workers?
In tribute to Mark Twain’s quip that history may not repeat itself but it does rhyme, the story above is from 1907. I suppose one generation has always had issues with the next, but it is hardly any reason to treat human beings different. To believe otherwise is to take astrology seriously.
Monty Python Four Yorkshiremen
Friedrich Hayek (1899-1992) was one of the most prodigious classical liberal scholars of the 20th century. He won the 1974 Nobel Prize in economics, published 130 articles and twenty-five books on topics ranging from technical economics to theoretical psychology, from political philosophy to legal anthropology, and from the philosophy of science to the history of ideas.
The focus of our conversation was around the essays published in the free eBook entitled The Essential F.A. Hayek, published by The Foundation for Economic Education, and available for free.
The book contains six chapters.
The Case for Freedom
If we knew our wants/desires, there would be little case for liberty. Liberty is essential to leave room for the unforeseeable and unpredictable
Freedom for the sake of only producing future beneficial effects is not freedom. Freedom is frequently abused, but on balance the good outweighs the bad.
Freedom used by one out of one million could be more important to society than the freedom we all use.
We can’t plan the advance of knowledge—the mind can’t see its own advance. We are dependent on the vagaries of individual genius and circumstance. Freedom in action is as important as freedom of thought.
The use of reason aims at control and predictability, but the process of the advance of reason rests on freedom and the unpredictability of human action.
The Use of Knowledge in Society
The economic problem is not how we allocate “given resources.” Rather, it is that the utilization of knowledge is not given to any one person.
Hayek believed mathematics obscured this issue rather than shed light on it. He wrote:
The various ways in which knowledge on which people base their plans is communicated to them is the crucial problem for any theory explaining economic process.
Scientific knowledge is not the sum total of all knowledge. The knowledge of the particular circumstances of time and place is often just as important, even though not scientific.
Central planning, or statistical information cannot take into account circumstances of time and place.
Millions of people, who couldn’t be identified, move in right direction just by price signals. Hayek called this a “marvel.” We take it for granted, but if it had been the result of human design, it would be the greatest triumph of the human mind.
The Pretense of Knowledge
This was Hayek’s 1974 Nobel speech, where he said, “As a profession we have made a mess of things.”
Economics has tried to imitate physics—“scientistic attitude.”
Our theories are formulated in such terms that they refer only to measurable magnitudes, yet the actions of millions cannot be measured.
“I confess that I prefer true but imperfect knowledge, even if it leaves much undetermined and unpredictable, to a pretense of exact knowledge that is likely to be false.”
In other words, Hayek rather be approximately right than precisely wrong.
He thought that economists needed to cultivate growth by providing the appropriate environment, like a gardener.
Intellectuals and Socialism
Hayek defined an intellectual as a “Professional secondhand dealer in ideas.”
Socialism was never a working class movement, rather it was a construction of theorists, intellectuals.
The philosopher has grater influence over intellectuals than any other scholar or scientist.
Socialists have the courage to indulge in Utopian thought, it’s a source of strength traditional liberalism lacks. No one marches in the streets for capitalism. We must appeal to the imagination.
The Moral Element in Free Enterprise
A free society lacking a moral foundation would be very unpleasant, but it is still better than an un-free and immoral society.
The value of services as determined by the market does not convey moral merit. This is probably the chief source of dissatisfaction with the free enterprise system. It’s why we see continuous calls for “distributive justice.”
Hayek thought this a great merit, since no one would be dependent on their fellow humans to like them personally.
We don’t know in advance if a brilliant idea is the result of years of hard work or luck, so we must allow a man to get the gain even if luck was the cause.
It’s argued that a free market system is more materialistic. It might be, but it also leaves us free to choose other paths.
The way to prevent this is not to have the material means placed under a single direction.
Look at North Korea, Cuba, USSR, or any other communist/socialist country: they are some of the most materialistic societies you’ll ever see.
Free enterprise deals with means, not ends.
Why I Am Not a Conservative
Tug of war between conservative and progressives only affect the speed, not direction of developments.
Conservatives have a fear of change, and use the power of government to prevent or slow change. They have a fondness for authority and lack of understanding of economic forces, are frequently protectionists, a hostility to internationalism, and a strident nationalism.
Conservatives have a distrust of theory, and have a lack of imagination except where experience has already been proven.
Hayek didn’t like the term “libertarian.” Whiggism, historically, is the correct term for ideas he believed.
Whig principles guided James Madison, Thomas Jefferson, and the signers of the Declaration of Independence, and the members of the Constitutional Convention.
Indeed, Washington’s soldiers were clad in the traditional “blue and buff” colors of the Whigs.
Conservative author and National Review editor Jonah Goldberg counters the arguments in Hayek’s essay, offering the conservatives rejoined.
“Conservative” means different things in different cultures—Saudi Arabia, Russia, France, even the UK.
True conservatism demands comfort with contradiction. Notice Hayek doesn’t call himself a libertarian—he rejected the label. He described himself as an “Old Whig.” So did Edmund Burke.
Hayek did say the USA was the one place in the world where you could call yourself a conservative and be a lover of liberty, because conservatives want to defend the those institutions that preserve it. In other words, American conservatism is simply classical liberalism, which ideas inspired the likes of John Locke, Edmund Burke, and Adam Smith.
William F. Buckley, Jr., no shrinking violet when it came to political philosophy, contributed a chapter to the book What Is Conservatism?
The title of that chapter is “Notes towards an Empirical Definition of Conservatism; Reluctantly and Apologetically Given by WFB.”
Conservatism isn’t a single thing. It’s a bundle of principles married to a prudential and humble appreciation of the complexity of life and the sanctity of successful human institutions.
Yuval Levin, another National Review author, defined it thus: “To my mind, conservatism is gratitude for what is good and what works, and strive to build on it, while liberals tend to begin from outrage at what is bad and broken and seek to uproot it.”
Liberty above all else undermines the development of character and citizenship, which Hayek understood.
Conservatives love people for what they are, not what they could be.
Reaches high of $1,300, surpassing gold. Market cap is over $21 billion.
Possible new slogans:
- “Not enough seating, prepare for a beating”
- “Drag and Drop”
- “We put the hospital in hospitality”
- “Board as a doctor, leave as a patient”
- “Our prices can't be beaten, but our passengers can”
- “We have First Class, Business Class and No Class”
- “We treat you like we treat your luggage”
- “We beat the customer, not the competition”
- “And you thought leg room was an issue”
- “Where voluntary is mandatory”
- “Fight or flight - We decide”
- “Now offering one free carry off”
- “Beating random customers since 2017”
- “If our staff needs a seat, we’ll drag you out by your feet”
- “A bloody good airline”
Air travel is not a right, but a privilege, governed by “The contract of carriage,” which is the same for all airlines.
If a flight is overbooked, Department of Transportation rules say for involuntary removals:
- The airline must ask for volunteers
- They must spell out your rights
- They must rebook you, and pay if significantly delayed ($1350 maximum if more than 2 hours delayed, 4 hours for international)
- Must cut a check on-site if you ask
- If you voluntarily give up your seat, you’re on your own
If they bump you for any other reason (weather, flight cancelled, change to a smaller plane, weight-and-balance issues, etc.) these protections don’t apply.
Boom Technology wants to take you from New York to London in three hours.
Robots and Job Loss
File Under: No Such Thing as a Commodity
Water brand Svalbardi sells for $99!
The bottled water industry has grown for 9% per year, for years, reaching a market of $147 billion. “Premiumisation” brands are the fastest growing (defined as priced at greater than $1.30 a litre). Flavored water is 4% of the volume, and 15% of the revenue.
Bottled water consumption surpassed sugary soft drinks in the USA in 2016.
NPR Podcast, Planet Money: The Economy Explained: Episode 759: What’s It Worth To You? March 17, 2017
In the Obama White House there was a Council of Economic Advisors meeting, and they were all waiting for Jack Lew, the US Treasury Secretary to arrive.
One of the economists, Betsy Stevenon, asked the other economists: What’s the tooth fairy paying these days?
Turns out that Delta Dental has conducted a poll for the last 20 years, and $4.66 is the average paid out for a lost tooth. (Ed is cheap. His kids get $10 for the first tooth and $1 thereafter, an average of $1.46 a tooth.)
The astounding thing is that the growth has been over 10% per year!
Economists use “Income Elasticity of Demand” to explain spending. In other words, if you earn 10% more income, do you spend 10% more on each category of spending?
The theory is parents love to splurge on their kids, especially if they are only children.
“Friction Lovers,” The Economist, April 1, 2017
Too much of a good thing can be bad, like travel leading to congestion.
Academic economists in Scandinavian countries term this situation a “Facile externality”: where less efficiency would actually be more efficient.
They claim that innovations which eliminate too much hassle for consumers could inflict a net harm on society.
Jerry Seinfeld: “I love Amazon 1-click ordering. Because if it takes two clicks, I don’t even want it anymore.”
The foregone benefits of hassle (slygge in Danish):
- Frictionlessness encourages bad habits
- Dominoes zero-click pizza buying, open app and in 10 seconds it orders your pizza
- Three out of five Britons say spend they more with the wave of plastic than cash
IKEA effect: people place extra value when devote own labor.
Market can’t solve this problem on it’s own, according to Danilov P. Rossi of DONUT, the UN’s Don’t Nudge—Tell office.
Only government can properly defend the cause of inefficiency.
The Economist magazine will lead by example. From now on a paper knife will be needed in which to separate the pages of your copy.
Isn’t this just a version of the labor theory of value?
Robot or Human Competition for Jobs?
“In Defense of Robots,” by Robert D. Atkinson, National Review, April 17, 2017
Atkinson is president of the Information Technology and Innovation Foundation.
There was a time in America when nearly all sectors—journalists, businesses, academics, etc.—advocated technologically powered productivity growth. Think Walt Disney.
Even socialists. Jack London said:
“Let us not destroy these wonderful machines that produce efficiently and cheaply. Let us control them. Let us profit by their efficiency and cheapness. Let us run them by ourselves. That, gentlemen, is socialism.”
Now theirs an inordinate fear of robots taking most of our jobs, leading Atkinson to coin this phenomenon Robophobia.
The three noteworthy studies predicting job losses:
- Oxford: 47% jobs eliminated 20 years
- McKinsey Global Institute: 45% jobs loss
- PWC: 38% job losses by 2030
Atkinson demolishes these studies for faulty methodology.
It’s predicted, for example, that Long-haul truckers stand to lose 3.8 million jobs. But are these “great jobs”? Truckers have a seven times higher injury rate, and rank in the top five in suicide rates, earning an average annual income of $40,260, which is 17% below the national median.
Autonomous vehicles could save more than $1 trillion, and tens-of-thousands of lives. Do these benefits outweighs the costs imposed on truck drivers? Some good switch to becoming a truck mechanic, who make on average 15% more than drivers.
A lot of these fears suffer from the lump-of-labor fallacy, the idea that there are only so many jobs in the economy.
But there has always been a negative, not positive, relationship between productivity growth and unemployment. In other words, higher productivity growth meant lower unemployment.
Atkinson is against the Universal Basic Income, which he believes will lead to the very thing robophobes warn us technology will bring about: large-scale unemployment. He advocates tax-deferred Lifelong Learning Accounts, similar to the 401(k) retirement accounts.
Economist Donald Boudreaux recently wrote “Robots Substitute for Jobs, Not Human Creativity,” April 26, 2017, on the Foundation for Economic Education website.
He argues what’s more human-like than humans? From the 1950s, the USA workforce increased 160%, from 62 million to 160 million.
Yet the unemployment rate in 1950 was 5.3%; today it’s 4.5%. The labor force participation is 63% today but was 59.2% in 1950.
Believing robots take jobs is based on an incorrect presumption: that the number of productive tasks we can perform for each other is limited.
Boudreaux believes that number is practically unlimited.
So do we. As Ed added, "If your job gets taken over by a robot, it probably sucks!"
Our first show on VeraSage Laws, was Episode #53 on July 24, 2015. In that show, we discussed the five VeraSage Laws:
- Baker’s Law: Bad customers drive out good customers
- Kless’ First Law - He who liveth by the discount, shall ye also perish by the discount.
- Kless’ Second Law - All measurements are judgments in disguise.
- Baker’s Axiom: Ideas are always and everywhere more important than their execution.
- VeraSage adoption of the Second Law of medicine—Prescription before diagnosis is malpractice.
Five More VeraSage Laws
Drucker’s Law of Inversion: Marketing and selling are not complementary, but adversarial. The book by William A. Cohen, A Class with Drucker, Peter Drucker’s first Ph.D. student, is the first place Ron read this thought from Drucker.
William’s Axiom: The default purpose of marketing is not to increase sales, but profits.
Ike’s First Law of Project Management: Plans are worthless, planning is essential.
Bowman’s Law: Hourly billing requires a calculator. Value Pricing requires courage.
Morris’ Postualte: What if Disney entered your industry?
Over the years, many fellows at VeraSage Institute have coined various "laws," such as Baker's Law: Bad customers drive out good customers. In this episode, Ed and Ron will explore more famous, and infamous, VeraSage Laws.
Here is a link to the previous show if you want to listen.
“The philosophers have only interpreted the world invarious ways. The point however is to change it.” –Inscription on Karl Marx’s tomb
“We were among the last to understand that in the age of information science the most valuable asset is knowledge, springing from human imagination and creativity. We will paying for our mistake for many years to come.” –Mikhail Gorbachev
Intellectual Capital: knowledge that can be converted into profits.
- Human (80% of the developed world’s wealth, according to The World Bank)
- Social (relationship)
At the societal level, knowledge can grow even when profits decline.
There’s no such thing as a natural resource—except the mind of man.
According to George Gilder, from his book Knowledge and Power:
- Wealth = Knowledge
- Learning = Growth
You could add to the middle of that syllogism: Entrepreneurship = Learning.
The following is an excerpt from Ron Baker’s book, Measure What Matters to Customers: Using Key Predictive Indicators.
In a few hundred years, when the history of our time is written from a long-term perspective, it is likely that the most important event those historians will see is not technology, not the Internet, not e-commerce. It is an unprecedented change in the human condition. For the first time—literally—substantial and rapidly growing numbers of people have choices. For the first time, they will have to manage themselves.
And society is totally unprepared for it. —Peter Drucker, “Managing Knowledge Means Managing Oneself,” 2000
The term human capital was first used by Nobel Prize–winning economist Theodore W. Schultz in a 1961 article in American Economic Review.
Human capital is like the dark matter of the cosmos: we know it’s out there but we can’t measure it. Once again, Peter Drucker was at the forefront of thought when he coined both the terms knowledge society and knowledge worker, in 1961, and later expanded on this new phenomenon in his 1968 book, The Age of Discontinuity.
Today, knowledge workers themselves own the firm’s means of production—in their heads.
Knowledge Workers Are Volunteers
In today’s capitalist society, labor trumps capital as the chief source of all wealth. Your team members don’t just contribute work, but also knowledge to the firm—they are knowledge workers in the purest sense.
Knowledge workers own the means of production.
In a factory, the worker serves the system; in a knowledge environment, the system should serve the worker.
Knowledge work can only be designed by the knowledge worker, not for them. Unlike work on an assembly line, knowledge work is not defined by quantity but by quality.
It is also not defined by its costs, but by its results.
Thinking in terms of human capital investors lends dignity and respect to the value of each person. The word “human” comes from the Latin Hominem, for man, and the word “capital” from the Latin caput, meaning head.
All capital ultimately springs from the mind. In a strict sense, a company’s knowledge is created only by individuals—albeit some are outside of the firm’s employ—and thus no knowledge can be created without people.
Moreover, the average knowledge worker today will outlive his or her employer, with an average productive work life of approximately 50 years, compared to the average organizational life of 30.
This has tilted the balance of power to the knowledge worker, as Drucker pointed out:
In the knowledge society, the most probable assumption for organizations—and certainly the assumption on which they have to conduct their affairs—is that they need knowledge workers far more than knowledge workers need them.
Yet companies do not seem to understand the worth of their people. They treat them as if they were assets—or equally offensive, resources—rather than as investors of human capital who own their own—hence the firm’s—means of production.
And like most investors, they will go where they can earn a fair economic return—measured in wages, fringe benefits, and other pecuniary rewards—as well as where they are well treated and respected, the psychological return.
Labeling your people as assets is demeaning. Stalin used to say the same thing—and acted on it. People deserve more respect than a phone system or computer.
But labeling employees resources—from the Latin resurgere, “to rise again”—is even worse, as if people were oil or timber to be harvested when you run out.
There is a Chinese proverb that teaches the beginning of wisdom is to call things by their right names.
Your people are actually volunteers, since whether or not they return to work on any given day is completely based on their own volition. Consider volunteer. It’s usually based on a desire to contribute to something larger than themselves. They work hard—some would say harder than at their jobs—for these organizations because they are dedicated to the cause and they have the passion, the desire, and the dream to make a difference in the lives of others. All for zero pay. Why?
I am not suggesting freedom for people “to do their own thing”; that is not freedom, it is license. The flip side of freedom is responsibility. Holding people accountable for the results they achieve, hardly a prescription for anarchy and chaos. When leaders feel they need to tightly control a knowledge worker, they have made a hiring mistake.
There is no better way to demoralize knowledge workers than to have them perform duties that interfere with the tasks they are qualified to do. In all probability, the best way to increase the effectiveness of most knowledge workers is by removing various tasks that distract them from their core specializations. We do not want surgeons piercing ears or nurses spending half of their time completing paperwork (a common complaint).
Far Fewer Knowledge Workers Than We Think
Dan Morris has not let me down. He thinks I’m wrong about most professional firms being filled with knowledge workers; he believes the majority of them are more akin to factory workers in the days of Taylor. Now I know this is a heretical view, but Dan has assembled a very powerful argument to support his assertion. He does not deny professionals have the potential to be knowledge workers. His argument is they are not largely because of the incentives and structures of the firms in which they operate, which function more like sweatshops of yore.
Stephen Covey writes about exactly this in his latest book, The 8th Habit: From Effectiveness to Greatness: “… It’s the leadership beliefs and style of the manager, not the nature of the job or economic era, that defines whether a person is a knowledge worker or not. If he is not perceived as a knowledge worker, that is, if a janitor is not seen as the local expert on janitorial work, then he is a manual worker and not a knowledge worker.”
I do not agree with this definition in its entirety. The major determinant of knowledge workers is that they own the means of production, and they apply knowledge to knowledge to create value. Covey’s requirement of the leadership beliefs and style of management may be necessary conditions, but they are not sufficient, in and of themselves, to define knowledge work.
In the old days, one took their coffee to the office. With Starbucks and knowledge workers, we now take our office to the coffee.
Most professional service firms to measure their team members, they all come from the Industrial Revolution’s command-and-control hierarchies (realization and utilization rates, billable hour quotas, etc).
Dan further supports his argument by stating that leaders of knowledge workers:
- Don’t impose billable hour quotas.
- Understand knowledge workers are paid for ideas, not hours, like union employees.
- Allow at least 15 percent of team member time for innovation and creating better ways to add value to customers. (This certainly destroys productivity under the old metrics.)
- Understand that judgments and discernment are far more important than measurements in assessing performance.
- Are focused on outputs, results, and value, not inputs, efforts, activities, and costs.
- Don’t require timesheets that account for every 10 minutes of their day.
- Trust their workers to do the right thing for the firm and its customers.
- Recognize that individuals have value, not jobs.
- Allow their workers to monetize the value of their output, through stock options or other incentives that share the wealth created by minds, not machines.
- Conduct AARs and other ways to bank their IC
- Select workers who are passionate and self-motivated and don’t need constant supervision.
The purchase of Pixar by Disney, on January 24, 2006, for $7.4 billion in Disney stock. Disney will have to respect Pixar’s culture and continue to let it make quality movies at its own pace, in its own way.
Otherwise, if Pixar’s creative talent leaves, “Disney just purchased the most expensive computers ever sold,” according to Lawrence Haverty, a fund manager at Gabelli Asset Management.
It remains to be seen whether Disney can learn from Steve Jobs’ philosophy: “You cannot mandate productivity, you must provide the tools to let people become their best.”
Knowledge workers cannot be told how to do their job, since many understand the job at hand better than their bosses. They cannot be held accountable for results if their methods are micromanaged.
It is obvious executives who are responsible for knowledge workers are going to have to become much more comfortable with intuition, judgment, and discernment over measurements. You simply cannot manage people by numbers.
Knowledge Workers of the World Unite!
It is time for the firms of the future to remove the sword of Damocles—objective measurements hanging over the head of their workers—and unleash them from a theory no longer applicable to the modern intellectual capital economy.
It requires leadership and vision. It requires knowing you are doing the right thing, not just doing things right. It requires focusing the company on the external results it creates for customers and simultaneously building the type of organization people are proud to be a part of and invest their intellectual capital in. It requires an attitude of experimentation, not simply doing things because that is the way it has always been done. It requires less measurement and more trust.
To paraphrase from the last lines in Karl Marx’s The Communist Manifesto: “Knowledge workers of all countries, unite! You have nothing to lose but your timesheets.”
Why Knowledge Grows
We highly recommend the 2015 book by statistical physicist Cesar Hidalgo, Why Information Grows: The Evolution of Order, from Atoms to Economies.
Economists describe the economy by factors of production, such as land, labor, and capital
Natural scientists use: energy, matter, and information. These two visions are not incompatible
Hidalgo writes that information is physical, in that it’s always physically embodied; it’s not a thing; it’s an arrangement of physical things.
He says the act of giving birth is, in essence, time travel: from the ancientness of her mother’s womb (100,000 years ago babies experienced the same environment) to the modernity of 21st century society.
The difference between the worlds not in the physicality of matter but in the way in which matter is arranged.
Hildalgo distinguishes between knowledge and knowhow:
Knowledge involves relationships between entities, which allows us to predict outcomes of events without having to act them out (tobacco use is bad without having to use it ourselves).
Knowhow is the capacity to perform actions, which is tacit (walk, ride a bike, etc.).
Both are highly constrained, as they are each embodied in human beings.
If you crash a car into a wall: the value lost is not in the car’s atoms but in the way they were arranged.
Eating apples: they existed first in the world, then in our heads.
Apple (computers): they existed first in someone’s head, then in the world.
Both embody info, but Apple is crystals of imagination.
Making crystals of imagination requires enormous amount of knowledge and knowhow.
The maximum amount of knowledge and knowhow a human can accumulate Hidalgo’s calls a personbyte.
When products require more personbytes than any one person can possess, teams and organizations are formed, and they’re limited to a firmbyte.
Cesar did an interview with Russ Roberts on EconTalk, which you can listen to here.
In September 1997, Ron attended the Disney Institute’s Professional Development program, The Disney Approach to Customer Loyalty: Creating Service that Keeps Your Customers Coming Back.
For historical information on Disney University, we drew from the book by Doug Lipp, Disney University: How Disney University Develops the World’sMost Engaged, Loyal, and Customer-Centric Employees (2013).
Van France founded Disney University, which is part of the HR division of Disney, in 1962, seven years after opening Disneyland (the Disney Institute was launched in 1986 and open to the public).
Disney U is the “conscience of the organizational culture,” and Van was instrumental in changing the language: On stage/backstage, Costumes (not uniforms), Audience (not crowds), Theme (not amusement) park, good/bad show.
He wrote a memorandum on September 21, 1962 that challenged Disney’s executives and Cast Members to up their games:
Disneyland will never be completed. We’ve certainly lived up to that promise.
But what about the people who operate it? Are we growing with the show or just getting older?
The trouble with people is that we get hardening of the mental arteries, cirrhosis of the enthusiasm, and arthritis of the imagination, along with chronic and sometimes acute allergies to supervision, subordinates, the whole darned system.
Is it possible that what we have gained through experience, we have lost through habit, and that what we have gained through organization, we have lost in enthusiasm?
He believed “training is not a car wash” that you simply process employees through.
Ed and I prefer the word “education” instead of “training,” mostly because animals are trained while human beings are educated.
Our late colleague, Paul O’Byrne, used to drive the distinction between these two words home by using a question that you’ll never forget: Would you rather your 13-year-old daughter receive sex training or sex education?
Disney’s Park Operation Priorities are as follows:
- Capacity/Efficiency—the first 3 ensure this one is sustainable
Notice that efficiency is last, while the first three all deal with effectiveness.
Van also believed that it was as much about attitude as budgets; money may be tight, but creativity is free; and that budgets are the coward’s way out of any problem.
Van’s Model for educational programs: Make it simple, not simplistic; make it enjoyable; design experiential activities that make it memorable.
Be sure to check out our show (#49) with former Disney Executive Lee Cockerell, who was Executive Vice President of Operations for the Walt Disney World Resort for 10 years.
Other books recommend’s on Disney:
Window on Main Street: 35 Years of Creating Happiness at Disneyland, Van Arsdale France, founder of Disney University
Disney University, Doug Lipp
Think Out of the Box, Mike Vance, former Dean of Disney University
Imagineering Way, The Imagineers
“European country imposes ‘social parasite’ tax on the poor,” March 27, 2017, New York Post (originally published in News.com.au).
Belarus, country of 9.5 million, lies between Russia and Poland, has implemented a “social parasite tax on the chronically unemployed (also known as the “spongers” or “freeloaders” tax).
It’s $233 (a month’s average wage in the country), for those “work shy” for longer than six months.
President Alexander Lukashenko issued Presidential Decree number 3, in 2015. Failure to pay could ultimately lead to imprisonment, redolent of the old USSR’s concept of “social parasitism.”
After protests, the president agreed to delay the tax, but not eliminate it. It’s estimated that one million are out of work in the country.
This story reminded me of a Harvard Lampoon story from the 1970s about how unfair the tax system is to the rich, since they cannot deduct their Rolls Royce’s and private jets, but the poor can deduct all the kids they have.
The difference is, this story on Belarus is real.
“Counsel of protection: the future of insurance,” The Economist, March 11, 2017
the insurance industry is estimated to be $4.6 trillion worldwide.
New York startup Lemonade is a homeowners and renters insurance company, with an app that makes insurance claims easier, and appeals to the digital generation.
It sold 2,000 policies in the first 100 days, 80% to first-time buyers. It uses AI and machine learning to process claims and underwrite policies.
It further rewards under-claiming, giving a share of the savings to your choice of charity (25% Americans defraud insurance companies).
On policy holder used the app to file a claim for a stolen coat, answered a few questions, and in three seconds the claim was paid.
Two Sigma, a large “quant” hedge fund, is also betting number crunching algorithms can gauge risk and set prices better than humans.
Simplesurance, a German firm, has integrated product-warranty insurance into e-commerce sites.
New kinds of risk-prevention services are being implemented thanks to the Internet of Things, such as sensors on incoming water pipes that can detect minuscule leaks, and prevent larger claims for flood damage.
Insurance companies are enticing policyholders with cutting premiums rather than making money from these additional services.
Volvo and Mercedes have announced they are so confident in their self-driving cars, they will not buy insurance at all!
“The wonder drug,” The Economist, March 4, 2017
Digitising the health care industry--$18B of capital has been invested in USA digital startup funding between 2015-2018.
Three groups are fighting over the “heath care value chain”:
- Traditional innovators—pharma, hospitals, medical tech companies
- Incumbent players—health insurers, big pharma buyers, UK’s NHS
- Tech insurgents—Google, Amazon, Apple, creating apps, predictive diagnostics systems, and new devices
Buyers increasingly demand “value-based” reimbursement: If the drug and device doesn’t function, it will not be bought. One analyst says if pharma firms don’t put the patient, rather than drug sales, at the center of strategy, they risk losing relevance.
Also, the point of care will move rapidly into the home where heart condition can be monitored, concussions diagnosed and perhaps even predict the onset of Alzheimer’s, Parkinson’s, menopause, etc.
London-based startup Babylon can schedule an online Dr. appoint for $24, and estimates that 85% of consultations don’t need to be in person.
But government could slow down the diffusion of this technology, as this article makes clear: “Cronyism thwarts telemedicine and other innovations,” by Veronique de Rugy.
High-resolution camera phones are good for diagnosing moles, rash, and even eye exams.
However the California State Board of Optometry launched, with taxpayer money, a PR campaign against one such startup.
Indiana passed a law last year that prevents online eye exams, as did Georgia and South Carolina, while VA is about to do the same.
Also, State Boards in various states prohibit doctors in another state offering telemedicine to its residents.
“A Brief History of Blockchain,” Vinay Gupta, Harvard Business Review, February 28, 2017
In just 10 years:
- Blockchain (could be separated)
- Smart contract, ethereum
- New innovation: “proof of stake” rather than “proof of work” (group with largest total computing power makes decisions).
- Blockchain scaling: now every computer processes every transaction, which is slow. New: figure how many computers are necessary to validate each transaction, divide work efficiently: speed can go head-to-head with VISA, and SWIFT in terms of processing payments.
Dubai’s blockchain strategy: issue all government documents on blockchain by 2020, which was designed by Vinay Gupta, the author of this post.
“Furry profitable,” The Economist, February 4, 2017
VCA, animal hospital chain has a 42,000-square-foot clinic in Hollywood.
VCA was purchased in January by Mars for $9.1B. Mars is second only to Nestle in pet food, and has been getting stiff competition from Amazon, so they are turning towards animal health.
In the USA, spending in pet clinics was $13.7 billion in 2012, and $16 billion in 2016.
VCA will own 1,900 veterinary clinics in America and Canada, four times as many as National Veterinary Associates, its nearest competitor.
The average vet used to be a generalist, but today there are over 40 specialties.
Technically, in many states, it is illegal for corporations to own veterinary practices, but there are ways to structure ownership to get around this.
And since pets count as property, malpractice risk is not very large.
- Ad Agency in UK drops Google - How responsible is Google for links that are associated with other searches?
- The Guardian, 3/28, Robots vs. Human Experts, by Richard and Daniel Susskind - The Susskinds reflect on the reaction to their book over a year and half after its publication. (Listen to Daniel Susskind's appearance on our show.)
- Japan Times, China’s toilet paper thieves - High tech solution to a low tech problem.
- US Obamacare, Congress fails to repeal - The GOP had seven years to think about this and they dropped the ball on the goal line.
- NY Times story stating 39% of colleges have reported declines in international student applications. They attributed this to Trump's election. Tyler Cowan analyzed the story on his blog - One real blooper I cannot let pass.
- Live action Beauty and the Beast, Dan Sanchez, FEE article, Belle's Tax-funded Fairy Tale. Fun, true, and why libertarians ruin everything.
BONUS article: How Beauty & the Beast is an example of anarchy done right.
“Never forget that your weapon is made by the lowest bidder.” –Law Number 20 of Murphy’s Laws of Combat
Simply put, don't do them
We at VeraSage recommend that you do not do RFPs, because they subsidize dysfunctional buying behavior, often being used as a club to extract concessions from the current provider by customers who have no intention of changing suppliers.
Or they are used by price sensitive customers you do not want anyway. We also suggest you charge for an RFP. Why not? The customers are asking you to compete, which has value in and of itself.
If you charged for an RFP, like charging for admission into your firm, it might actually be a process that created some value, rather than merely reciting deliverables.
That said, many firms have to do a certain amount of RFPs. If you do, you should be well versed with what economists call the winner’s curse.
Avoiding the Winner's Curse
In auction markets, economists refer to the dreaded winner’s curse—whereby the winning bidder is often a loser, because obviously all of the other bidders believed the engagement had less value.
In other words, the only request for proposals (RFPs) that buyers will accept are ones you should not make. One of the ways to avoid the winner’s curse is to bid more conservatively when there are more bidders. Thomas Nagle and Reed Holden explain why in their book, The Strategy and Tactics of Pricing:
The more bidders there are, the more likely you will lose money on every job you win, even if on average you estimate costs correctly and both you and your competitors set bids that include a reasonable margin of profit. The reason: The bids you win are not a random sample of the bids you make. You are much more likely to win jobs for which you have underestimated your costs and are unlikely to win those for which you have overestimated your cost.
The only solution to this is, in effect, to formalize the principle of “selective participation.” You do that by adding a “fudge factor” to each bid to reflect an estimate of how much you are likely to have underestimated your costs if you actually win a bid. Needless to say, adding this factor will reduce the number of bids you win, but it will ensure that you won’t ultimately regret having won them.
RFPs have become more commonplace as competitive bidding has replaced negotiation for price buyers. It is as if dysfunctional buying practices have arisen to counter dysfunctional selling practices.
It is important to have some contact with the economic buyer—that is, the person who can actually make the decision to hire you, rather than just the procurement department. You need to find the person who can say “Yes,” not just the ones who can say “No.”
Establishing relationships and having internal advocates in the customer’s enterprise also helps to ensure your value is being considered, not just price.
Another strategy with RFPs is: No surprises. Your potential customer should know everything in your RFP before you submit it. Gaining an understanding of your customer’s expectations, business model—how they make money—and how your company can add value is imperative to increase your odds of a successful RFP, one that won’t suffer from the winner’s curse.
Co-opetition by Adam M. Brandenburg and Barry J. Nalebuff also discuss the following eight hidden costs of bidding that are also worth considering:
- There are better uses of your time.
- When you win the business, you lose money.
- The incumbent can retaliate.
- Your existing customers will want a better deal.
- New customers will use the low price as a benchmark.
- Competitors will also use the low price as a benchmark.
- It does not help to give your customer’s competitors a better cost position.
- Do not destroy your competitor’s glass houses.
Other RFP strategies
- The RFP is not about your firm, it is about the value you will add to your customer—focus on how they will change, not your firm’s history and processes.
- What is your competitive differentiation? If you do not have one, do you expect to be successful with this RFP?
- Always submit options, at various value/price points, with any RFP.
- What would justify the customer paying a premium price?
- Are you dealing with the economic buyer? If not, you probably should not waste your time with an RFP.
- Is the organization using the RFP process as “column fodder”—that is, to beat up its existing firm?
- How you sell is a sample of how you solve—be creative, innovative, and different.
- RFPs do not sell, people do.
- Never submit an RFP to people whose criteria for judging your success are unknown.
- What does the customer expect from their firm? How will you exceed those expectations?
- Do not let the RFP be the first time you “test” your price with a customer.
- Do not be constrained by the customer’s “budget.” As the opening email of this Appendix confirms, budgets are elastic, and if the economic buyer understands the value, the money will be found from somewhere else in the budget.
- See if you can propose on a greater share of the customer’s business.
- Consider charging for your RFP to test the customer’s seriousness, providing a full (or partial) credit if your firm is selected.
- If you win this RFP, what will be the impact on the firm’s self-esteem?
- If you have a 25 percent market share, you should be losing 3 out of 4 of your RFPs. In other words, do not worry about losing more RFPs than you gain.
- Once you submit an RFP, you lose all control and leverage, leaving you asking “Have you made a decision yet?” If your RFP is innovative and surprises the customer, you will change the standard operating procedures.
- Put a deadline on the price. No price should last indefinitely. Three weeks is a good rule of thumb.
- Copyright all your RFPs so the firm retains the intellectual property rights (especially for advertising agencies).
- If the customer asks you to match a competitor’s lower priced bid, be sure to understand the scope of work that the lower price is based on.
- If your RFP is rejected based upon price, ask the economic buyer:
- Do you not believe the value we discussed is accurate?
- Do you not believe that we will be able to create that value?
- Or do you think you will be able to acquire that value from another firm?
Recognizing not all customers are created equal, should be charged the same price, or accepted, or proposed for, in the first place, is essential to avoiding Baker’s Law: Bad Customers Drive Out Good Customers.
Father Robert Sirico is the president of the Acton Institute, He lectures at colleges, universities, and business organizations throughout the U.S. and abroad. His writings on religious, political, economic, and social matters are published in a variety of journals, including: the New York Times, the Wall Street Journal. He is also a parish priest in Grand Rapids Michigan. In his recent book Defending the Free Market: The Moral Case for a Free Economy, Rev. Sirico shows how a free economy is not only the best way to meet society's material needs but also the surest protection of human dignity against government encroachment.
Has the bishop in Grand Rapids given you the dispensation to eat corn beef and cabbage today (St. Patrick’s Day)?
Father Sirico is working on an Italian edition of his book, Defending the Free Market, due out this Spring.
I see, based on your twitter page, that you have met the Holy Father. How did that go? Father Sirico gave the Pope a copy of the movie, Poverty, Inc.
Regarding Pope Francis, is it too simplistic to excuse his thoughts on capitalism as just being due to his Weltanschauung of capitalism equaling cronyism?
On Twitter, one person said, "Since [Father Sirico] propagates views opposite to decades of established Catholic social teaching, however, he ought to be excommunicated.”
Today, I was told in a Catholic Social Teaching Facebook group, when I suggested that federal welfare programs perhaps do more harm than good, he replied, "More harm than good? Wow, not allowing destitute senior citizens and at-risk poor kids starve to death is somehow harmful? We in America are a society, a community, and will be judged on how the weakest among us are treated. And you, sir, get an F.”
I think this is because many people fail to understand the difference between civil society and government. Your thoughts?
Segment Two and Three—Ron
The entire discussion in these two segments were about Acton Institute’s latest movie, Poverty, Inc.
The movie open with this Machivelli quote: “The reason there will be no change is because the people who stand to lose from change have all the power, and the people who stand to gain from change have no power.”
Why does that describe the “global aid system” today?
It’s hard to compete with free. How can markets develop when shoes, food, etc., are given away for free. When Peggy Noonan asks Ronald Reagan: “What’s wrong with socialism?” Reagan replied, “Well, it doesn’t work”
The movie takes on the Christmas song by Band-Aid song (“Feed the World”). It gives the impression that Africa is desolate, that nothing grows there, etc. Yet Africa is rich in oil, diamonds, gold, and other natural resources. The problem is it is disconnected from trade.
The movie shows Bill Clinton admitting he was wrong with regard to Haiti by selling rice so the country could supposedly leap past the agriculture stage of development and skip to the industrial stage.
Agricultural subsidies keeps out poor farmers from selling to rich countries, while rich countries produce surpluses which they then sell/give to poor countries, which drives out of business local farmers.
The dignity of work is so important.
The only antidote to poverty is wealth, yet the poverty infrastructure never discusses wealth creation.
Someone in the movies discusses a conversation where the person says, Now that you survived the earthquake, I hope you survive the arrival of all the NGOs.
There are over 10,000 NGOs in Haiti!
But when you give someone something for free, continuously, not only do you create dependence, but eventually you create resentment as well.
There’s nothing wrong with disaster relief, but when they stay for 40 years we have a problem.
Foreign Aid (“Official Development Assistance”)
Since Post WWII, the Breton Woods system created the International Montetary Fund and the World Bank, and of course we had the Marshall Plan. Even the Catholic Relief Charities receive 70% of its funding from government.
But not one country has ever developed from aid, not one!
Does the founder of TOMS shoes really want people to not have shoes for the rest of lives?
If TOMS shoes is successful within the existing framework, all you are doing is making the existing system more harmful. Doing the wrong thing more efficiently is just creating more harm.
The movie shows a couple who were spending $20,000 to adopt a Haitian child whose mother wants him. Approximately 80% of Haitians kids have at least one parent; they are called “poverty orphans.”
Because orphanages are coveted positions: they provide an education, food, shelter, etc.
One mother got a job, and moved from a tent to buying her own two-bedroom home.
The movie interviews Muhammad Yunus, the microfinance founder. While small and large companies can get credit, the middle-sized business does not. If they do, it can cost 6-10% per month in interest.
As microfinance failed, or perhaps not lived up to its hyped expectations?
Rule of law
Poor countries lack secure private property rights, functioning courts to adjudicate disputes, and most people are locked out of the formal economy.
The economist Hernando de Soto says in 2/3 of world, there’s no rule of law.
No property rights means for the 60-70 million farmers in Ghana, they might have to buy their land 4-5 times. In Peru, it takes 289 days, working 8 hours per day, to start a business. De Soto documents all of this, and more, in his book: The Mystery of Capital.
Rabbi Daniel Lapin wrote in his book, Business Secrets of the Bible: “The opposite of wealth is evil. If wealth is not being created, then evil is being done.”
Do you agree?
Celebrities (the “Icons of charity”)
Bono admitted that commerce lifts more people out of poverty than aid. However, he insists aid is still needed, unless you are “brain and heart dead extremists.” He also insists that we need to move from paternalism to partnership.
There’s not enough talk about wealth creation.
Ron’s Thoughts on the Movie
1. Wealth is the only known antidote to poverty. We only have the word poor because of the Bible.
2. The road to hell is paved with good intentions.
3. Modified Christopher Hitchens quote: The icons of charity are “not friends of the poor, but friends of poverty.” It’s obvious that who benefits from the existing system are all of the players mentioned above, not the poor they sanctimoniously say they are helping.
During the end of our last interview, you said you were considering writing a book on economics and the parable of our Lord. Here is one I often use, but I wonder if I perhaps am taking it too far out of context?
Luke 12: 13 Someone in the crowd said to him, “Teacher, tell my brother to divide the family inheritance with me.” 14 But he said to him, “Friend, who set me to be a judge or arbitrator over you?”
What are your thoughts on the difference between empathy (I feel your pain) and compassion (to suffer with)?
Another word we do not hear talked about much today is “maturity.” It certainly isn’t displayed by both sides of the aisle in Washington DC.
What are your thoughts on sanctuary cities?
Ron and Ed interviewed Tim Williams, a noted author, international speaker, and presenter for major advertising associations, agency networks, universities, and business conferences worldwide. Tim is author of the books, “Take a Stand for Your Brand: Building a Great Agency Brand from the Inside Out,” ranked by Amazon as one of the top ten books on brand building; “Defining the Agency Brand,” published by the American Association of Advertising Agencies is regarded as the standard in agency brand development; and his latest book is Positioning for Professionals: How Professional Knowledge Firms Can Differentiate Their Way to Success. Tim is a major thought leader and consultant to advertising agencies worldwide, specializing in pricing, business model innovation, positioning, and strategy.
Segment One - Ron's Questions
With Hollywood about to release CHPS - The Movie, is this proof that ideas are more valuable than their execution?
In your book, you say, "In business, imitation is not the sincerest form of flattery, it is just lazy," why is that?
Every value prop falls in somewhere in following three areas: points of parity, points of relevance, and points of differentiation, please explain these ideas.
How is a firm defined by what it is NOT?
Segment Two - Ed's Questions
What are the four sides of the strategic box or brand boundaries?
Other than calling which one do professional firms struggle with the most.
What is the complexity tax or diversification discount?
Explain Magic work vs Logic work. Does the line between them shift?
Segment Three - Ron's Questions
How are AI, deep learning and other technologies unfolding in the advertising agency space?
How is it encroaching on the Magic work?
Five holding companies own 85 percent of advertising agencies, are they innovating? If so, how?
Do you see agencies making progress in pricing?
Do you see agencies making progress on getting rid of timesheets?
Some of the world's best know brands were not created with the help of an advertising agency, explain the effect of this on agencies.
Segment Four - Listener Question
Justin asks, “As agency leadership, how should you balance the need for specialization (in order to grow faster) with synthesizing other disciplines to come up with greater innovation?”
Do you view more ideas coming from independent thinking or brainstorming meetings?
Do you see more agencies getting involved in behavioral economics?
What are working on?
Custom doth make dotards of us all. –Thomas Carlyle, Sartor Resartus, III, 1836
If people are supposedly rational, why have the professions continued to apply the wrong theory of value to their services?
The fact that hourly billing is so deeply entrenched and has been widely used for decades proves that is has some advantages.
The case against the billable hour is not that it is not a profitable pricing policy.
Rather, the case being made is that hourly billing is suboptimal (if profitability is your goal), and its disadvantages outweigh its advantages.
The Advantages of Hourly Billing
Hourly Billing is Easy and Efficient
Hourly billing can be handled simply with appropriate time and billing software, turning the pricing function into an administrative task handled by less costly personnel, freeing up the professional team to take care of what is more important—customer relations.
Hourly Billing is Perceived as Fair
Since hourly billing is largely justified based on a firm’s costs and a “reasonable” profit margin, it is perceived as “fair” by customers.
Hourly Billing Provides Market Stability
Since hourly rates remain relatively stable, this provides a desirable stability and predictability among buyers and sellers, as opposed to widely varying prices that may arise under a value pricing scenario.
Sometimes the Customer Demands Hourly Billing
It is rare, but there are instances when customers will insist on being charged by the hour. One encounters this attitude most frequently in the legal profession, and to a lesser extent, in the accounting profession.
Probably because the people hiring the firm were themselves alumni, raised on the virtues of hourly billing. But it is folly to turn this type of power over to your customers.
You control your pricing strategy, not your customers.
They judge your value, but cannot dictate how you price. This is not a large barrier to overcoming hourly billing. The problem is not with customers; it is with the professionals.
Hourly Billing is Required in Case of Litigation
Certain court cases require time recording due to legal precedent, fee shifting, and legal ethical rules.
Bankruptcy requires attorneys to keep time in six-minute increments. If your firm does a majority of this type of work, then you may very well be stuck with the billable hour.
Hourly Billing Leads to Higher Volume
Higher prices would dampen demand for professional services, and some projects simply cannot be quoted upfront without a high price being specified.
Hourly Billing is a Cost-Accounting, Productivity, and Project Management Tool
Hourly Billing Transfers Risk to the Customer
This advantage is truly a double-edge sword. Professionals tend to be risk adverse, and hourly billing places a comfortable floor on their profits.
However, professionals have paid a high “reverse risk premium” to the customer for this floor. If the customer assumes the risk, the professional will only receive their hourly rate; no more, usually less.
Hourly Billing Has Served Us Well, Why Should We Change?
Economist Herbert A. Simon’s autobiography, Models of My Life. Among economists, Simon is best known for his theories of bounded rationality and satisficing.
Bounded rationality posits that both elements of irrational and nonrational behavior bound the area of rational behavior.
Satisficing posits that people search for good enough actions rather than optimal ones. Coupling the concept of satisficing to bounded rationality is how Simon explains how people really make decisions.
Rather than attempting to maximize or optimize, people search for “good enough” actions. Simon writes:
[Even Darwin’s] natural selection only predicts that survivors will be fit enough, that is, fitter than their losing competitors; it postulates satisficing, not optimizing.
The Disadvantages of Hourly Billing
Hourly Billing Misaligns the Interests of Professional and Customer
Even supporters of hourly billing will admit that there exists, right from the start, a conflict between the professional’s interest and the customer’s.
This conflict of interest also exists because in a cost-plus pricing system one way to increase a firm’s revenue is to increase its costs.
Aligning incentives is difficult enough to achieve without the added burden of an inherent conflict in how your price your services.
Hourly Billing Focuses on Hours, Not Value
Whenever professionals have to justify price to a customer, they inevitably resort to discussing hours spent. Marketers would never do this, as they always try to create value in the minds of the customer first, and talk price later.
Hourly Billing Places the Risk on the Customer
Risk is where profits come from. If you offer customers fixed prices you will be able to charge a premium simply because you are reducing their risk.
If this sounds counterintuitive, consider the mortgage market. Which commands a higher interest rate, a fixed rate or an adjustable rate mortgage?
Hourly Billing Fosters a Production Mentality, Not an Entrepreneurial or Knowledge Worker Spirit
Over the decades of the billable hour’s hegemony, the professions have lost sight of the all-important question: “What did we accomplish?” It has been replaced with: “How many hours did you bill?”
Hourly Billing Creates a Nonsensical Subsidy System
An example of a nonsensical subsidy is a tax research project that is billed to the first customer for, say, $10,000. If a second customer appears the following week with the exact same issue, how much should the firm charge the second customer? Following the logic and ethics of hourly billing the answer is clear: you can only charge the second customer for the actual hours spent.
Under this method, one could argue that the first customer underwrote the R&D costs for the second customer. It would be as if a pharmaceutical company charged the first customer for all its R&D, while the following customers were charged just the marginal cost of producing the drug.
Hourly Billing Cannot Price Risk
Completing a divorce for Brittany Spears is fraught with more risk than a couple with limited assets. Risk cannot be priced by the hour. Actuaries have an axiom that is useful to remember: There is no such thing as a bad risk; only bad premiums.
Hourly Billing is not Predictive of a True Professional
One of the most useless pieces of information we can gather as outsiders about a firm, or a professional who works in it, is billable hours. It transmits little information of value, though it does highlight the “finders” (rainmakers), the “minders” (managers), and the “grinders” (technicians)—billable hours are hardly necessary, though, to make this distinction.
Far more meaning is discovered by judging a professional’s customer service attitude, customer defection and retention rates, customer loyalty, profitability and collection speed, creativity and innovation, risk taking, willingness to delegate, teaching and learning skills, and practice development activities. Billable hours shed no light in these virtues, as most need to be judged and experienced, not measured.
Hourly Billing Encourages Hoarding of Hours
David Maister and Patrick McKenna say that “Estimates given to us by our clients of the amount [of work they do] that could be done by someone more junior range up to 50 percent or more of each senior person’s time.
Surgeons piercing ears is not the road to maximum profitability.
Hourly Billing Focuses on Effort, Not Results
Who buys efforts in the marketplace? One brilliant epiphany that occurs while in the shower or driving may be worth more to the customer than 1,000 plodding, ineffective hours spent researching and pondering an issue. Hourly billing simply does not reward creativity and ingenuity. On the contrary, it rewards inexperience, inefficiency, and even incompetence—the slowest horse wins the race.
Hourly Billing Penalizes Technological Advances
Every year, professional firms make substantial investments in technology that allow any given task to be performed in less time. Perversely, under the billable hour, firm revenue will then decline, unless hourly rates keep pace with productivity increases—what economists call the productivity paradox.
Hourly Rates Are Set by Reverse Competition
This means you look at the rates of your fellow professionals operating in your geographical market, make a decision on where you want to fit in on the competitive spectrum, and set your rates accordingly.
Hourly Billing Prices the Service, Not the Customer
In a world where value is subjective, no two customers are alike, and professional firms have the enormous advantage of meeting personally with each and every customer, the mindset of pricing services is obsolete. Instead, the customer needs to be priced.
Hourly Billing Creates Bureaucracy
We estimates that somewhere between 7 and 20 percent of a firm’s gross revenue is spent tracking, reporting, compiling, reviewing, and billing time, an astonishing investment. What’s the ROI? Most firms don’t even ask.
Hourly Billing Does Not Set the Price Up Front
The most absurd and economically illogical effect of hourly billing is how it denies the ability to quote a price before the work begins. Few products or services in the marketplace are purchased without the customer knowing the price in advance.
Hourly Billing Does Not Differentiate Your Firm
Converting their crown jewels of experience, expertise, culture, intellectual capital, and relationships into a commodity, codified in an hourly rate, is no way to differentiate your firm from the competition.
Hourly Billing Does Not Measure How Much Money is Being Left on the Table
Even though one of the major defenses of hourly billing and timesheets is they are essential cost-accounting tools to determine profitability, this method has a glaring weakness: It has no way to capture how much the price could have been.
In other words, how much money is the firm leaving on the table by setting prices too low? No cost accounting, realization, or, timesheet report can answer this question.
When Google began its auction-based AdWords program, CEO Eric Schmidt was petrified it would not set prices as high as Google’s salespeople were getting.
In three short weeks Schmidt’s fears were calmed when the new pricing strategy had doubled revenue.
It became obvious at that point that salespeople were under pricing ads, not over pricing them, which is the direction most pricing mistakes are made.
Without the willingness to test this new pricing strategy, Google would have left untold millions on the table, and worse, if they had been using the billable hour, they would have never learned about it.
Hourly Billing Diminishes the Quality of Life
There is no doubt that morale in the professions is suffering, and one major cause is the relentless pursuit of the Almighty Billable Hour.
This lessening in the quality of life results in a high cost to firms, measured in associate turnover, low morale, absenteeism, ineffectiveness, neglect of practice development, continuing education, and so on.
These costs should be included in any cost/benefit analysis of maintaining hourly billing; these costs, in and of themselves, are likely to dwarf any benefits derived.
Hourly Billing Limits Your Income Potential
This is, without a doubt, the most egregious effect of the hourly billing regime. There are only so many hours in a year. On average, Bill Gates has just as much time on this mortal coil as the rest of us, so why does he make more money? The difference is he does not believe he sells time.
Summary and Conclusions
Oscar Wilde’s line sums up hourly billing with just the proper amount of irony: “He has no enemies, but is intensely disliked by his friends.”
It has become, to borrow a term from the medical profession, an iatrogenic illness—that is, a disease caused by the doctor.
Albert Einstein once wrote, “Our theories determine what we measure.” Hourly billing is the wrong theory that measures the wrong things.
Funny video from North, a 40-person ad agency in Portland, Oregon that has been operating without timesheets since 2011:
Thanks to BJ Lee for his recent iTunes Review:
I thought this podcast was going to be two ivory-tower, automaton-sounding economists discussing how many angels it will take to run a big enterprise. But they have warmly shifted the way my mind words when it comes both to my little online business and freelancing, and to larger economies. And it has made us much more profitable. Can’t wait to pass this wisdom on to my kids. If you love Freakonomics Radio, you will love this podcast. Thanks Ron and Ed!
She’s even more critical of them in this article than in her book.
“Personality Tests Are Popular, But Do They Capture The Real You?”, June 25, 2016, by Annie Murphy Paul
Dramatically Reducing World Hunger
“A hungry world no more,” by Kevin D. Williamson, February 22, 2017, National Review Online
An excellent look at how world hunger has dropped dramatically. Another great, untold story of the power of the free market to alleviate misery and raise the standards of living of the poor everywhere.
Robots Pay Taxes?
“Bill Gates: Job-stealing robots should pay income taxes,” from CNBC.
“The robot that takes your job should pay taxes,” says Bill Gates, Quartz, February 17, 2017.
Here’s the video of the Gates interview:
My only question is if Gates would have been a proponent of taxing Microsoft Office for displacing jobs, and slowing down the diffusion of the software?
Number One Job
According to the Bureau of Labor Statistics Survey, which conducts a survey every two years that extrapolates current trends in various categories of jobs, and predicts the growth over the next ten years, the top job growth, with 108% expected growth, is: Wind turbine service technician.
Of course, this entire industry wouldn’t exist without government subsidies.
Other jobs with expected growth rates from 43% to 27% include: Occupational-therapy assistants, physical-therapy assistants, home-health aides, commercial drivers, nurse practitioners, statisticians, personal financial advisers, and optometrists.
See “Apply within,” from The Economist: The World in 2017.
Mark Cuban, in an interview on Bloomberg TV, said that candidates who excel at creative and critical thinking will be in greatest demand in the coming years. This means more majors in the liberal arts, such as English, philosophy, and foreign languages.
Management Ideas, RIP?
The Economist, Schumpeter, “Management theory is becoming a compendium of dead ideas,” December 17, 2016.
Business schools are the cathedrals of capitalism, and business consultants are its traveling friars. Yet management theory is ripe for a reformation. There are three myths it propounds:
Myth 1: Business is more competitive than ever
The story since 2008 has been not competition but consolidation, with over 30,000 M&A deals done every year, approximately 3% of GDP.
Myth 2: We live in an age of entrepreneurialism
The rate of business creation has declined since 1970s. One cause is a tax system that punishes growth (it’s not a tax on the rich, but on getting rich).
Myth 3: Business is getting faster
In some ways, it’s slowing down (regulations, compliance, FDA drug approval process, etc.).
Language Alert: All transformation is linguistic. Keep your eyes open for stories in the media about Trump reducing “Protections,” rather than “Regulations.”
The glaring weakness in management theory: its naivety about politics.
As a follow-up, in The Economist: The World in 2017, “Practice makes perfect” it reports that China cranks out about 50,000 MBAs every year, less than half the rate in the USA. But these are based mostly on Western knowledge.
It’s private firms that are innovating management methods, such as Alibaba, an e-commerce giant that pioneered escrow in its payment system, and WeChat, the world’s most advanced messaging and payment platform.
Chinese companies are rejecting the Western principle of core competence. Instead, “multiple jumping” is the new fad.
Baidu started as a search company, then moved into mapping and apps, and now AI and autonomous cars.
One Chinese consultant said of multiple jumping: “…the most critical event in global management science in 30 years, and the new inspiration is coming form China.”
Count me among the skeptics. Is Google, or Apple, not multiple jumping? Many Chinese companies rely too much on low prices, which is not sustainable in the long-term. One skeptic pointed out that even Baidu’s sexier investments couldn’t happen without government support.
San Diego Story regarding pricing and personality profiles and an awful sign:
Prices should never be justified by an increase to costs. That said, prices (in this case wages) should not be set by government fiat. I am not sure which is worse.
IBM Watson and H&R Block
AI might do your taxes this year, courtesy of IBM Watson from TechRepublic.
In partnership with H&R Block, IBM Watson's cognitive computing engine will be used to help tax filers maximize their returns.
Pine City, MN high-school only shoots 3s and layups
The Basketball Team That Never Takes a Bad Shot - WSJ (subscription required)
The NBA’s most efficient offenses seek out layups and threes. A high school in Minnesota takes the idea to the extreme.
On Bullet Proof Coffee and Kerrygold Butter
This State Is Now "Protecting" You from Kerrygold Butter by Brittany Hunter
Food bureaucrats cannot stand to see a rule being broken, no matter how arbitrary it may be.
Ed challenges you to to determine if the follow are from his horoscope or a personality profile. See answers at the bottom of the post.
- Horoscope or profile: Some words that describe you are: Directive, Decisive, Driven, and Friendly. You are task-oriented, and you probably get a great deal done. You probably like problem solving and getting results. You are comfortable interacting with others to make things happen.
- Horoscope or profile: If you have been given a task to do that hasn't been explained properly, you may feel at a loss. It's best to go back to the person who assigned the work and ask for more details. This could be temporarily humbling, but remember, it's better to ask a stupid question than to make a stupid mistake.
- Horoscope or profile: It can be very difficult to work with a (Type or sign) as a co-worker. They are very ambitious and very hard workers—in fact, they have a tendency to overwork in order to accomplish the goals they have for themselves or to make themselves look good in the eyes of their managers and supervisors. They will do whatever is necessary to meet goals that will make them look good in the eyes of their superiors and don’t care whose feet they must step on in order to accomplish those goals.
- Horoscope or profile: (Type or sign) are natural-born leaders and embody the gifts of charisma and confidence, and project authority in a way that draws crowds together behind a common goal. (Type or sign) are characterized by an often ruthless level of rationality, using their drive, determination and sharp minds to achieve whatever end they’ve set for themselves.
Carl Jung pondered differences in personalities for a deeply personal reason: his split with Sigmund Freud caused him deep depression. Why did they see things so differently?
He concluded Freud was an extrovert while he was an introvert. Jung believed that personality was dynamic and it could change throughout life.
“Every individual is an exception to the rule. To stick labels on people is nothing but a childish parlor game.”
A midwestern mental hospital is where The Minnesota Multiphase Personality Inventory (MMPI) was created in the 1930s to sort mental patients into diagnostic categories.
It was a 567-questionnaire, and the quantification it provided gave it more validity than inkblots. Starke Hathaway, the developer, became skeptical in old age of assessments, doubting that personality profiling was possible at all.
Myers-Briggs Type Indicator (MBTI), 1940s
- This is the leading profiling test administered.
- 89% of the Fortune 100 use Myers-Briggs
- 2.5 million people each year take it
- Some 2500 profiles are on market
- It’s a $500 million industry, with 8-10% annual growth
- Thrived in the shade of casual neglect
Created by Pennsylvania housewife Isabel Myers, along with her mother Katharine Briggs. Isabel thought the test could bring about world peace:
If President Woodrow Wilson had not been so wrapped up in his own introversion, he would have negotiated more effectively as Versailles, and World War II might have been averted.
Personality profiles were used to combat Frederick Taylor’s “one best way.” It was people themselves that need sorting and shaping, since every position in the company had the right profile fit.
Jesus was an ENTP, so is Steve Wozniak. Don’t ask how they know about Jesus. Of course, popularity does not at imply scientific validity.
Test data is confidential, so cannot be tested to determine effectiveness. The tests are popular among consultants, who are paid good money to administer them in a convivial atmosphere.
The fallacy is the tests measure what we are like and who we are, not what we know, believe, or what we can do. They confuse labeling personality with understanding it. They confirm what people already know about themselves (the “aha reaction”), what psychologists call the permanency tendency. They also tend to validate the positive characteristics we all believe we possess, the so-called Pollyanna principle.
As they say, if you really want to learn what someone is like, marry them or work for them. Annie Murphy Paul, former senior editor at Psychology Today, has written a scathing indictment against these tests, labeling them modern-day phrenology—the “science of the mind” (“bumpology”). A leading Phrenologist was Franz Joseph Gall, University of Vienna, in the 1870s:
- Phrenologize Our Nation, for thereby it will Reform the World!
- Phrenology will improve the prosperity and material good of the next generation and greatly enhance the happiness of the race, besides abolishing poverty and nearly abolishing crime.
- Walt Whitman, Clara Barton (Red Cross), Charles Dickens, Edgar Allan Poe, and Oliver Wendell Holmes were all believers.
- Two US presidents, James Garfield and John Tyler, got readings. Mark Twain was a skeptic!
For business, it could no longer depend on reputation or word of mouth, so personality profiling was too useful not to be true. Rorschach test used thousands of time , the second most popular test among mental health professionals. It was created as a parlor game! Jeffrey Dahmer responses “were normal to the point of being mundane”
The Cult of Personality Testing
The Wall Street Journal wrote that Annie Murphy Paul “draws a veritable quacks’ gallery of modern personality testing. With an eye for the absurd, she makes a compelling case that such tests tell us more about the men and women who put them together than about the subjects taking them.”
Her book, The Cult of Personality Testing: How Personality Tests Are Leading Us to Miseducate Our Children, Mismanage Our Companies, and Misunderstand Ourselves (2004), is essential reading for understanding why these profiles are not at all effective.
Here a few of her more condemning facts:
- [A]s many as three-quarters of test takers achieve a different personality type when tested again (47% by proponents!), and that the sixteen distinctive types described by the Myers-Briggs have no scientific basis whatsoever.
- There is scant evidence that MBTI results are useful in determining managerial effectiveness, helping to build teams, providing career counseling, enhancing insight into self or others, or any other of the myriad uses for which it is promoted.
In 1968, Personality and Assessment was published, by Stanford University psychology professor Walter Mischel. He found the correlation between personality and behavior was .30. In other words, at best personality explained about 10% of behavior. Mischel believed that our actions are driven by situations, not personality.
The Life Story interview protocol, developed by Gordon Allport, is an alternative to sterile personality profiles.
Defined by Our Beliefs, not Our Knowledge or Personality
Professor Erkko Autio, department of management at HEC Lausanne in Lausanne, Switzerland, pointed out the same defects with respect to the current fad of “emotional intelligence” in a letter to The Economist:
It might interest you to know that not a single serious study has ever been able to demonstrate a link between “emotional intelligence” and leadership effectiveness. The most robust and consistent single predictor of leadership effectiveness is, simply, intelligence. Emotional intelligence sells well, but scientific evidence supporting it is almost as solid as that supporting the effectiveness of homeopathy (The Economist, Aug 26, 2006: 14).
Professor Autio is certainly correct in the assertion that intelligent quotient (IQ) is a better predictor of executive effectiveness, as The Bell Curve has scientifically demonstrated. If you were confined to learning one number about an individual to predict their standard of living, you would be hard pressed to find a better one than their IQ.
However, firms are not confined to knowing just one thing about their human capital. As Rabbi Daniel Lapin wrote in Thou Shall Prosper: “You are best understood and appraised by others on the basis of the things you believe rather than on the basis of the things you know.”
Or, we might add, rather than on the basis of your personality or year of birth (see Generational Astrology). [See Ron’s book review of Thou Shall Prosper, and his LinkedIn blog post on Generational Astrology].
We are better off understanding people’s beliefs if we want to even begin to understand how and why the Germans of the Third Reich could carry out their murderous orders in acquiescent servility, or the people who flew airplanes into buildings killing innocent civilians on September 11, 2001.
Trying to simplify the spirituality and soul of a human life by labeling it with a personality type (or even an IQ) is to disregard the uniqueness of individuals, which requires judgment and discernment far more than measurement.
As Peter Drucker once wrote, “There is no such thing as an infallible judge of people, at least not on this side of the Pearly Gates.” Chinese philosopher Lin Yutang, from his book, The Importance of Living:
To me…man’s dignity consists in the following facts which distinguish man from animals. First, that he has a playful curiosity and a natural genius for exploring knowledge; second, that he has dreams and a lofty idealism…third, and still more important, that he is able to correct his dreams by a sense of humor, and thus restrain his idealism by a more robust and healthy realism; and finally, that he does not react to surroundings mechanically and uniformly as animals do, but possesses the ability and the freedom to determine his own reactions and to change surroundings at his will. This last is the same as saying that human personality is the last thing to be reduced to mechanical laws; somehow the human mind is forever elusive, uncatchable and unpredictable, and manages to wriggle out of mechanistic laws or a materialistic dialectic that crazy psychologists and unmarried economists are trying to impose upon him. Man, therefore, is a curious, dreamy, humorous and wayward creature. In short, my faith in human dignity consists in the belief that man is the greatest scamp on earth.
Michael Novak, R.I.P.
Michael Novak was one of Ron’s all-time favorite authors. A former Democrat who converted to the right, and a profound defender of free market capitalism, in the pantheon with George Gilder, Rabbi Daniel Lapin, Father Robert Sirico, Milton Friedman, Deirdre McCloskey, among others.
Here is Father Robert Sirico’s video tribute to Novak:
Answers to Ed's Quiz
Scorpio for February 2017
Myers Briggs Profile
Scorpio - About your sign
Companies use personality tests for a variety of purposes, such as employment screening, assessing leadership potential, fostering corroboration and teamwork, etc. The most widely used is the Myers-Briggs Type Indicator (MBTI), created by Pennsylvania housewife Isabel Myers. This particular test is utilized by 89% of the Fortune 100, given to 2.5 million people each year to identify strengths and enhance teamwork. The Minnesota Multiphase Personality Inventory (MMPI) was developed in 1946 to sort mental patients into diagnostic categories. It was then expanded in an attempt to describe normal people. Of course, popularity does not imply validity. What is worse, most companies keep these tests confidential so the data cannot be tested to determine effectiveness. These tests are also popular among consultants, who are paid good money to administer them in a convivial atmosphere. Helpful or hokum? We will attempt to answer in this week's show.
Ludwig von Mises, economist, author, and one of the founders of the “neo-Austrian school” of economics.
Mises told his future wife: “If you want a rich man, don’t marry me. I am not interested in earning money. I am writing about money, but will never have much of my own.”
Our show was a discussion of the eBook, The Essential Ludwig von Mises, published by the Foundation for Economic Education, available for free.
At last, economics was whole, an integrated body of analysis grounded on individual action; there would have to be no split between money and relative prices, between micro and macro. –Murray Rothbard
Ludwig von Mises (1881-1973), born in Lemberg, 350 miles east of Vienna (today, part of Ukraine).
The oldest of three sons, from a prestigious Jewish family. His father was a construction engineer, who was titled “von” for his work on the Austrian railroads—similar to “sir” in Great Britain, but the title is inherited by all male, and unmarried female, descendants.
Mises entered University of Vienna turn of century, where he read Carl Menger, one of the creators of the subjective theory of value. In 1906, age 25, he graduated with a doctorate of laws, and became the chief economist at the Vienna Chamber of Commerce.
In 1912, published The Theory of Money and Credit, which challenged Irving Fisher’s quantity theory of money.
He finally got a teaching job, but only part time. He failed to be appointed for three reasons: 1) he was Jewish; 2) he was a staunch advocate of laissez-faire; and 3) he was personally dogmatic and intransigent. He was a private man, a confirmed bachelor for many decades, who finally married at age 57.
His younger brother, Richard, earned a PhD in mathematics, who became an aircraft designer. Mises always worried he’d be outdone by him.
Both brothers fought for Austria in the Great War, Mises being an artillery officer at the Eastern front who was decorated for bravery three times.
In 1934 he left Vienna to teach at the University of Geneva. In 1938, Nazis stormed Mises Vienna apartment and confiscated his writings, 38 cases in call.
In the 1990s, Richard Ebeling of Hillsdale College discovered them stored in KGB files in Moscow, over 10,000 pages. What Irony! One of the foremost intellectual opponent of socialism in the 20th century, had his papers in the tender care of the Communist Party of the Soviet Union!
Ebeling has written Austrian Economics and Public Policy, among other works, which describe the contents of some of these papers. Mises personal library is located at Hillsdale College in Michigan
Mises emigrated to New York City in August 1940 (brother Richard was at Harvard). He never got a full-time teaching position, so his salary was subsidized by friends and foundations.
Brother Richard was a member of the “Vienna Circle,” which included members such as Ludwig Wittgenstein and Karl Popper. They favored logical positivism, using empirical evidence to test theories.
Mises rejected this approach, preferring to rely on pure deductive reasoning instead.
Murray Rothbard once asked Mises what he thought of Richard’s book, Positivism: “I disagreed with that book, from the first sentence until the last.”
Peter Drucker, who knew Mises in his youth in Vienna and in New York, said of Mises: “He was the most depressing person I ever saw.” Murray
Rothbard disagreed, said Mises was a “joy and an inspiration.” Mises’ wife, Margit, said: “He wasn’t gentle. He had a will of iron, his mind a steel blade, and he could be unbelievably stubborn.
At a Mont Pelerin Society (founded by Friedrich Hayek in 1947) meeting in 1953 Milton Friedman chaired a session on income distribution. During the discussion, Mises stood up, announced “You’re all a bunch of socialists” and stomped out of room.
During his time at the Vienna Chamber of Commerce, he did support use of “limited trade retaliation” against countries that raised import taxes, to nudge them back to free trade.
In the early 1920s, Austria resorted to hyperinflation, like Germany. Hayek recalled his salary was 5,000 kronen/month in October 1921, then raised to 15,000/month in November and to 1 million/month by July 1922.
The League of Nations sent a commission to Vienna, along with some Austrian government officials, who paid a visit to Mises, asking for his advice on stopping the hyperinflation. “Meet me at 12:00 midnight at this building and I’ll tell you.”
“Hear that noise? Turn it off!” The Building was the government printing office. They did, and inflation ended.
Mises was Hayek’s teacher, and Eugen Bohm-Bawerk was Mises’ teacher.
Mises and Hayek forecasted the Great Depression, Mises being the originator of the Austrian theory of money and business cycles. He thought unemployment was a pricing problem, not a demand-management problem, and felt Keynesian was nothing but special-interest group politicking. Hayek advanced Mises’ theory of business cycles, winning a Nobel Prize in 1974.
Mises died in New York City on October 10, 1973, age 92.
The Foundation for Economic Education ebook: The Essential Ludwig von Mises, contains five chapters, which we discussed.
1. Liberty and Property
A lecture to the 9th Meeting of the Mont Pelerin Society, October 1958
The Greeks and Romans thought freedom was only for the elite. Pre-capitalistic system was based on military conquest and opposed to innovation.
The characteristic feature of capitalism: principle of marketing, to satisfy the needs of the masses.
“If any of the socialists chiefs had tried to earn his living by selling hot dogs, he would have learned something about the sovereignty of the customers.”
“Government is a necessary institution, the means to make the social system of cooperation work smoothly…Government is not a necessary evil; it is not an evil, but a means, the only means available to make peaceful human coexistence possible. But it’s the opposite of liberty. It is beating, imprisoning, hanging.”
2. Profit and Loss
Mont Pelerin Society, September 1951
Bureaucratic management is the only alternative where there’s no profit and loss. Capital does not beget profit, as Marx thought.
It’s the entrepreneurial decision—mental acts, a product of the mind, a spiritual and intellectual phenomenon.
Lenin believed that production could be easily accomplished, since it consists of simple operations.
Taxing profit is tantamount to taxing success of those best at serving the public.
One main function profits: shift capital to those who best deploy it to satisfy the public.
Why is anyone better to expropriate than anyone else? Why shouldn’t immigrant’s wealth be taken by residents of their native country?
There is no third system: the choice is between capitalism and socialism.
3. Planned Chaos
Statoltry: combines idolatry with the state.
No such thing as a scientific ought. Science is only competent to establish what is.
Opponents of capitalism argue it hass no plan? Sure it has plans, just not that of the state, but those of individuals pursuing happinesss.
Capitalism vs. socialism: it’s not a fight over distribution, but which system best serves human welfare.
Marx never distinguished between communism and socialism, nor did Lenin who used socialist in the name of the USSR. In 1928, Stalin, at the Communism International, made a distinction between the two words.
Ending: “What’s needed to stop the trend towards socialism and despotism is common sense and moral courage.”
4. Middle-of-the Road Policy Leads to Socialism
The so-called third way between capitalism and socialism is known asinterventionism, such as price controls, minimum wages, the National Industrial Recovery Act of 1933 (part of FDR’s New Deal), etc.
Mises labeled this third way nothing but “socialism by installments.”
5. The Place of Economics in Learning
Human Action, 4th ed, 1949
Cancer research can help fight disease, but business cycle research cannot stop recessions or depressions.
Economics is abstract reasoning, it can never be experimental and empirical.
There’s no such thing as labor economics, agriculture economics, etc. The same is true of ethics. There’s only one coherent body of economics.
Present-day universities are by and large “nurseries of socialism.”
Economics too important to be left to specialists.
Mises’ Magnum Opus
Human Action, published in 1947, was the culmination of Mises work.
Human Action is to capitalists what Das Kapital is to Marxists.
What’s it about: “Everything!”
Economist Gary North has posited a “fat-book” theory: Producing a revolution requires a fat book. Examples:
- Adam Smith, The Wealth of Nations (1,097 pages)
- Karl Marx, Das Kapital (2,846 pages)
- Joseph Schumpeter (1,260 pages)
- Murray Rothbard, Man, Economy and State (987 pages)
- Milton Friedman, Monetary History of USA (860 pages)
- Deirdre McCloskey, Bourgeois trilogy (2,000+ pages)
- Mises, Human Action (907)
- Baker, The Professionals Guide to Value Pricing
Mark Skousen says this is nothing but the Labor theory of value, since the Communist Manifesto was only 62 pages, and probably the second most influential book in history, next to the bible. The Four Gospels of the Bible are only 177 pages.
Mises built his system of economic though on logic and self-evident assumptions, similar to geometry. He rejected econometrics and mathematics in economics, believing there was no such thing as quantitative economics:
If a statistician determines that a rise of 10 per cent in the supply of potatoes in Atlantis at a definite time was followed by a fall of 8 per cent in the price, he does not establish anything about what happened or may happen with a change in the supply of potatoes in another country or at another time. He has not “measured” the “elasticity of demand” of potatoes. He has established a unique and individual historical fact.
Mises was a dualist who divided nature into two components:
- Human beings, who think, adopt values, make choices, and learn (social sciences)
- Animals and things, mechanical and predictable (physical sciences)
Revolutions to produce new words, and Mises introduced a few.
Praxeology is the study of human action. Then economics was the study of praxeology under conditions of scarcity. As Mises explained:
The field of our science is human action, not the psychological events which result in an action. It is precisely this which distinguishes the general theory of human action, praxeology, from psychology.
Catallactics is a theory of the way the free market system reaches exchange ratios and prices. It aims to analyze all actions based on monetary calculation and trace the formation of prices back to the point where an agent makes his or her choices. It explains prices as they are, rather than as they "should" be.
In every market there are two kinds of fools. One charges too much, the other charges too little. Russian proverb.
There are only three pricing strategies: Skim, penetration and neutral.
Pricing is how we divide up value.
Tim Smith, author of Pricing Done Right, refers to these as price positioning. He believes pricing strategy includes things like segmentation, competitive reaction, and pricing capability.
Price is the primary driver of the purchase decision with penetration pricing.
It can be effective and profitable, yet it is by far the least understood. After all, if your goal is to maximize market share, you could set your price at zero, or negative—pay customers to use it!
The literature is overwhelming: there are more failures than successes with this type of pricing.
It tends to attract the least loyal customers, who are thus the first to defect to a lower-priced offering.
Price cuts easy to match by the competition, then you get neither market share or profit.
Companies who appear to have implemented this strategy successfully:
- Southwest Airlines (Ryanair in Europe is even more profitable)
- Freemium variation of Penetration
One question with all these strategies is: your price compared to what?
- Your offering’s value, or
- Your competitors’ price
Reed Holden has changed his mind on this issue. In his prior book (written with Tom Nagle), The Strategy and Tactics of Pricing, he wrote that it was compared to your offering’s value.
Yet, in Pricing with Confidence, he writes it’s compared to your competitor’s price.
Success Factors with Penetration Pricing
- Begin with strategy from day one
- Operate extremely efficient, constantly driving costs out of the system and sharing those saving with customers
- Guarantee consistent quality
- Focus on core products/customers
- High-growth, high-revenue focus
- Procurement champions
- Little debt
- Control as much as possible (brands, value chain, etc.)
- Advertising focuses on price
- Never mix messages
- Understand your place (there’s room for only a tiny number of companies, in any industry, that can successfully deploy this pricing strategy)
As one pricing manager said: “In a war, the atomic bomb and price are subject to the same limitation: both can only be used once.”
If any of these strategies guaranteed success, everyone would do it. That said, skim pricing can be very profitable, as these companies that use it prove:
It’s not unusual for a premium priced product to have the highest market share. For example, P&G’s Gillette razor, at one point, had 70% of the market.
Success Factors with Skim Pricing
- Superior value
- High quality
- Branding, Marketing (vs. sales)
- Shy on special offers
An excellent example of how dangerous this form of pricing can be because it invites competition is Xerox vs. Canon. Xerox never defended it’s higher position with a lower-priced flanking product.
Contrast Xerox with Apple, which is very adept at protecting it’s high-end value.
Beyond skim pricing is luxury whereby you take advantage of prestige, or so-called snob, effects. For instance, Switzerland is 2% of world’s watch production, yet it produces 53% of value.
The president of USA Porsche once said: “The second Porsche on the same street is a catastrophe.” It obviously focuses on profits, not market share, which might explain why, in 2013, it generated an18% profit margin, higher than any other auto company.
With skim, or even neutral, pricing, if you can offer a world-class guarantee, that can be a very effective strategy.
Such as the guarantee offered by Florida based “Bugs” Burger Bug Killers (BBBK)” exterminators:
- Guaranteed to eliminate to rodents and roaches
- If you or a guest see one, you get a refund of one year of our services
- And we will pay another exterminator for one year
- And to the guest who sees a roach: we will pay their bill, send a letter of apology, and invite them back as our quest
BBBK’s price is as high 10x its competitors.
Michael E. Raynor and Mumtaz Ahmed (both with Deloitte Consulting), in their April, 2013 Harvard Business Review article, “Three rules for making a company truly great,” April 11, 2013, wrote the three rules
- Better before cheaper—in other words, compete on differentiators other than price.
- Revenue before cost—that is, prioritize increasing revenue over reducing costs.
- There are no other rules—so change anything you must to follow Rules 1 and 2.
They also point out that very rarely is cost leadership a driver of superior profitability—Amazon is a good example.
Tim Smith, in Pricing Done Right, says that neutral pricing is the default strategy, and generally the most profitable. It’s also least likely to trigger a price war. Successful examples:
- Seiko watches
Where the basis of competition and the purchase decision is focused on other attributes rather than price: service, features, guarantee, convenience, etc.
Good for no-growth, or slow-growth markets.
It can leave money on table, and it tends to signal average value.
Herman Simon, in his book, Confessions of the Pricing Man, cites a survey his firm conducted and found that managers spend 70% of their time focused on cost reduction; 20% on increasing volume; and only 10% on price. These percentages are the opposite of profit effects of these actions!
Choosing a Pricing Strategy
From Reed Holden’s Pricing with Confidence:
- Understand your value, absolute and relative
- Where’s your offering in the life cycle?
- Industry economics (capacity, fixed vs. variable costs)
- Competitive dynamics
- Consensus (Ron says leadership, the opposite of consensus)
You can use Skim and Neutral across the cycles, but penetration is not optimal during introduction/emerging, mature, or decline phases.
Calexit - A group started collecting signatures to hold a referendum on California's seceding from the United States. Ed's take is if Hillary Clinton had won, we would be talking Texit instead.
Self-Deception - Ed recently attended a leadership workshop on self-deception held by John Engels of Leadership Coaching Inc. A primary source of self-deception is when we equate what is "true for me" with "the truth."
Hitendra Patil article on AccountingWeb, Why Anxiety Around Automation is Absurd caught Ed's attention. It is an excellent piece but is missing the impact of the billable hour model on stalling the needed changes in the industry.
Ed thinks his iPhone and Facebook were listening to a conversation we was having resulting in a ad for Five Guys Burgers showing up in his stream. He did some digging and found an article: which addresses this "phenomenon." - If you’re not paranoid, you’re crazy.
According to a recent paper by Srikant Devaraj and Erik Nessen, "for $0.10 increase in real minimum wage, total hygiene violation score increases between 3.35 and 8.99 percent.” Is the minimum wage actually sickening?
In what is both an amazing scientific achievement and a source of ethical consideration, scientists announced that they can create human-pig embryos.
Hamilton—raise your price!
“Battling bots,” The Economist, January 7, 2017
“When I was 25, having studied economics for 6 years, I grasped suddenly that prices are for allocation, not fairness. When I was 28, an assistant professor with Steve Cheung as an office mate, I grasped that prices are only one possible system of allocation (violence and queuing are others) but socially the cheapest." -Deirdre N. McCloskey, How to Be Human *Though an Economist
Deloitte Invests in Blockchain
Accounting Today, January 14, 2017, “Deloitte opens blockchain lab in New York”
Google’s Business Model Threatened?
“Still searching,” The Economist, December 17, 2016
Border Adjustability Tax
Trump wants to reduce the corporate tax rate from 35% to 15%; Paul Ryan wants 20%. Both want full expensing, and a territorial system, where companies are taxed where they make the product, not on world-wide income as we do now.
But Republicans have proposed a border adjusted tax, whereby you are taxed at the consumption point, not the production point.
It’s very similar to a Value Added Tax, a sort of border-adjusted sales tax, or a cash flow consumption tax.
Corporations could not deduct the cost of imported goods, or interest expense.
Say Rolls-Royce exports a jet engine made in Britain to France: It pays a French VAT on the sale, and British tax on profit.
America currently imposes no VAT on imported goods.
So the border adjusted tax penalizes imports while subsidizing exports.
Boeing and GE love it! Wal-Mart and Target hate it! (the tax could exceed their profits, the cost being passed on to consumers).
Economists say, in theory, this wouldn’t affect trade since it would push up the dollar’s value. To offset a 20% border-adjusted tax, the dollar would need to rise by 25%.
This tax may violate WTO rules.
Steve Forbes writes it could cost consumers $1.2 trillion over 10 years, or more (since future Congresses could raise the rate easily).
“Gain and pain,” The Economist, December 17, 2016
Steve Forbes, “OMG! House Republicans Are Preparing To Hit Consumers With A Horrible New Tax That Will Harm Trump And Hurt The Economy,” January 11, 2017.
“Border Adjustability Is Already Fueling Tax Reform Controversy,” Forbes, December 8, 2016
Driverless Cars and Lidar
“Eyes on the road,” The Economist, December 24, 2016
Trump’s Inauguration Speech
George Will wrote it was the worst inaugural speech in history.
It was short: 1433 words.
Fundamentally optimistic: “We must think big, and dream even bigger.”
He slammed the political class.
Jean-Claude Juncker, primer minister of Luxembourg: “We all know what to do; we just don’t know how to get re-elected after we’ve done it.”