Many firms don’t know their numbers

Saturday, April 7th, 2018

Alex Tabarrok has learned a lot about industrial organization by watching The Profit, a reality-TV show on CNBC featuring businessman Marcus Lemonis:

In each episode Lemonis buys into a failing small-to-medium-sized business and works to turn it around. Lemonis doesn’t invest in a random sample of businesses nor even in a random sample of failing businesses. Nevertheless, the lessons that The Profit teaches are consistent with the new literature on management which has increased my confidence both in the show and the literature.

In the perfectly competitive model, price is equal to average cost and firms operate efficiently at minimum cost. Yet, Syverson finds that in the typical US industry a firm at the 90th percentile of the productivity distribution makes almost twice as much output with the same inputs as a firm at the 10th percentile. It’s not easy to measure inputs or outputs, of course, but even firms producing very uniform products show big productivity differences.

How can firms that use inputs so inefficiently survive? In part, competition is imperfect which gives inefficient firms a cushion because they can charge a price higher than cost even as costs are higher than necessary. Another reason is that small firms eat their costs.

A typical firm on The Profit, for example, has decent revenues, sometimes millions of dollars of revenues, but it has costs that are as high or higher. What happened? Often the firm began with a competitive advantage — a product that took off unexpectedly and so for a time the firm was rolling in profits without having to pay much attention to costs. As competition slowly took hold, however, margins started to decline and the firm found itself bailing. But instead, of going out of business, the firm covers its losses with entrepreneurs and family members who work without pay, with loans which grow ever larger, and by an occasional demand shock which generates enough surplus revenue to just keep going.

The correct metaphor for competition isn’t a boxing match that knocks out the inefficient firm. The correct metaphor is a slow tide. Inefficient firms must scramble for a bit of high ground but as the tide ebbs and flows they can occasionally catch a breath when their head bobs above the profit line. An inefficient firm can survive for years before it inevitably sinks.

The second lesson from The Profit is that management matters and it matters in systematic and fairly easy to replicate ways. If mis-measurement explained productivity differences, Lemonis would not be able to successfully turn firms around. But he can and does. How?

One of the first things Lemonis does in almost every episode is get the numbers right so he can calculate which products are selling and which have the highest price-to-cost margin. Concentrate production on high-margin, big sellers. Drop the rest. Simple; but many firms don’t know their numbers.

Second, in episode after episode, Lemonis cleans up shop. Literally. He cleans the shop floor and gets rid of inventory that isn’t selling. He then arranges the floor to improve process flow (made easier by concentrating production on fewer products). He then creates an inventory system, tracks orders and the inputs needed to create those orders, and takes advantage of costs savings through economies of scale in input purchases.

Can it be so simple? To be sure, Lemonis is a smart guy but very little of what he does takes genius. We know this because we now have robust evidence from India and Mexico that better management increases profits and productivity and that such increases can be sustained over the long run. In the studies from India and Mexico, randomly selected firms were given access to a “management intervention” and their productivity and profits improved and stayed higher for years after the intervention ended.

Moreover, what were these management interventions? Did some bright Harvard grad recommend a complicated swap-options deal? A new chemical process? A new management form? No. By and large, the interventions were simple. Just like the Lemonis interventions.

Communist-style incentives at work

Friday, February 9th, 2018

While we were recently discussing flawed incentive systems, David Foster brought up some Communist examples:

There’s an old story about a Soviet-era factory that made bathtubs. Plant management was measured on the total tonnage of output produced–and valves & faucets don’t add much to the weight, certainly not compared with the difficulty of manufacturing them. So the factory simply made and shipped thousands of bathtubs, without valves or faucets.

He notes that the above story may be apocryphal. The version I heard involved cars and people stealing each other’s windshield wipers.

He continues with a more spectacular example from Viktor Suvorov, who was working on a communal farm in Russia, when the General Secretary of the Party announced that they needed to increase their output, and the fertilizer plant resolved to do its part:

A vast meeting, thousands strong, complete with brass bands, speeches, placards, and banners, was urgently called at the local Chemical Combine. To a man, they shouted slogans, applauded, chanted patriotic songs. After that meeting, a competitive economy drive was launched at the Chemical Combine to harvest raw materials and energy resources.

The heroic efforts of the factory workers filled the plant’s storage tanks to capacity, and the local communes had 24 hours to take possession of their liquid fertilizer:

There was a long queue of trucks of different makes, dimensions, and colours standing outside the Chemical Combine. But the queue was moving fast. I soon discovered that lorries, which had only a moment before been loaded, were already returning and taking up new places in the queue. Every one of these lorries ostensibly needed many hours to deliver its valuable load to its destination and then to return. But they rejoined the queue in a matter of minutes. Then came my turn. My tanks were rapidly filled with the foul-smelling liquid, and the man in charge marked down on his list that my native kolkhoz had just received the first one and a half tons of fertilizer. I drove my lorry out through the Combine’s gates and followed the group of lorries which had loaded up before mine. All of them, as if at a word of command, turned off the road and descended a steep slope toward the river Dneiper. I did the same. In no time at all, they had emptied their tanks. I did the same. Over the smooth surface of the great river, the cradle of Russian civilization, slowly spread a huge poisonous, yellow, stinking stain.

Foster warns us not to get too smug though. If you read the whole thing, he has an example of capitalist stupidity, too.

Three negative archetypes

Thursday, February 8th, 2018

Will Felps, who studies organizational behavior at the University of South Wales in Australia, secretly brought grad student Nick into his experiment, where groups were asked to construct a marketing plan for a start-up, and had him portray three negative archetypes — the Jerk (an aggressive, defiant deviant), the Slacker (a withholder of effort), and the Downer (a depressive Eeyore type):

In almost every group, his behavior reduces the quality of the group’s performance by 30 to 40 percent. The drop-off is consistent whether he plays the Jerk, the Slacker, or the Downer.

“When Nick is the Downer, everybody comes into the meeting really energized. He acts quiet and tired and at some point puts his head down on his desk,” Felps says. “And then as the time goes by, they all start to behave that way, tired and quiet and low energy. By the end, there are three others with their heads down on their desks like him, all with their arms folded.”

When Nick plays the Slacker, a similar pattern occurs. “The group quickly picks up on his vibe,” Felps says. “They get done with the project very quickly, and they do a half-assed job. What’s interesting, though, is that when you ask them about it afterward, they’re very positive on the surface. They say, ‘We did a good job, we enjoyed it.’ But it isn’t true. They’d picked up on the attitude that this project really didn’t matter, that it wasn’t worth their time or energy. I’d gone in expecting that someone in the group would get upset with the Slacker or the Downer. But nobody did. They were like, ‘Okay, if that’s how it is, then we’ll be Slackers and Downers too.’”

Trying a bunch of stuff together

Tuesday, February 6th, 2018

Peter Skillman’s design contest challenged each group to build the tallest possible structure using uncooked spaghetti, tape, string, and one marshmallow — to go on top:

The fascinating part of the experiment, however, had less to do with the task than with the participants. Some of the teams consisted of business school students. The others consisted of kindergartners.

The business students got right to work. They began talking and thinking strategically. They examined the materials. They tossed ideas back and forth and asked thoughtful, savvy questions. They generated several options, then honed the most promising ideas. It was professional, rational, and intelligent. The process resulted in a decision to pursue one particular strategy. Then they divided up the tasks and started building.

The kindergartners took a different approach. They did not strategize. They did not analyze or share experiences. They did not ask questions, propose options, or hone ideas. In fact, they barely talked at all. They stood very close to one another. Their interactions were not smooth or organized. They abruptly grabbed materials from one another and started building, following no plan or strategy. When they spoke, they spoke in short bursts: “Here! No, here!” Their entire technique might be described as trying a bunch of stuff together.

If you had to bet which of the teams would win, it would not be a difficult choice. You would bet on the business school students, because they possess the intelligence, skills, and experience to do a superior job. This is the way we normally think about group performance. We presume skilled individuals will combine to produce skilled performance in the same way we presume two plus two will combine to produce four. Your bet would be wrong. In dozens of trials, kindergartners built structures that averaged twenty-six inches tall, while business school students built structures that averaged less than ten inches.

The result is hard to absorb because it feels like an illusion. We see smart, experienced business school students, and we find it difficult to imagine that they would combine to produce a poor performance. We see unsophisticated, inexperienced kindergartners, and we find it difficult to imagine that they would combine to produce a successful performance. But this illusion, like every illusion, happens because our instincts have led us to focus on the wrong details. We focus on what we can see — individual skills. But individual skills are not what matters. What matters is the interaction.

The business school students appear to be collaborating, but in fact they are engaged in a process psychologists call status management. They are figuring out where they fit into the larger picture: Who is in charge? Is it okay to criticize someone’s idea? What are the rules here? Their interactions appear smooth, but their underlying behavior is riddled with inefficiency, hesitation, and subtle competition. Instead of focusing on the task, they are navigating their uncertainty about one another. They spend so much time managing status that they fail to grasp the essence of the problem (the marshmallow is relatively heavy, and the spaghetti is hard to secure). As a result, their first efforts often collapse, and they run out of time.

The actions of the kindergartners appear disorganized on the surface. But when you view them as a single entity, their behavior is efficient and effective. They are not competing for status. They stand shoulder to shoulder and work energetically together. They move quickly, spotting problems and offering help. They experiment, take risks, and notice outcomes, which guides them toward effective solutions.

Most people aren’t shoplifters

Sunday, January 28th, 2018

TechCrunch looks inside Amazon’s surveillance-powered no-checkout convenience store, which should work just fine as long as all the customers are Amazon employees:

In addition to the cameras, there are weight sensors in the shelves, and the system is aware of every item’s exact weight — so no trying to grab two yogurts at once and palm the second, as I considered trying. You might be able to do it Indiana Jones style, with a suitable amount of sand in a sack, but that’s more effort than most shoplifters are willing to put out.

And, as Kumar noted to me, most people aren’t shoplifters, and the system is designed around most people. Building a system that assumes ill intent rather than merely detecting discrepancies is not always a good design choice.

Fanta was created for Nazi Germany

Thursday, January 25th, 2018

In April 1955, Coca-Cola reintroduced Fanta with a new, orange-flavored recipe. The original version was rather different — and developed in Nazi Germany:

The drink was technically fruit-flavored, but limited wartime resources made that descriptor not wholly accurate. Its ingredients were less than appetizing: leftover apple fibers, mash from cider presses, and whey, a cheese by-product. “[Fanta] was made from the leftovers of the leftovers,” says Mark Pendergrast, who, as the author of For God, Country, and Coca-Cola, revealed this hidden past. “I don’t imagine it tasted very good.”

[...]

In 1895, Coca-Cola’s CEO boasted of its presence in every American state and territory. In 1920, the company’s first European bottling plant opened in France, and by 1929, Coca-Cola was being bottled and drunk in Germany.

In 1933, right when Hitler and the Nazi Party were assuming power, German-born Max Keith (pronounced “Kite”) took over the company’s German subsidiary, Coca-Cola GmbH. Keith was an imposing figure: tall, intimidating, possessing a “little whisk-broom mustache” (not unlike Hitler’s), charming but quick-tempered, and utterly devoted to Coca-Cola. “[Keith] valued his allegiance to the drink and to the company more than his allegiance to his own country,” says Pendergrast. For that reason, he saw no quarrel with boosting sales by tying Coca-Cola to every aspect of German life and, increasingly, Nazi rule.

[...]

The U.S.’s entrance into World War II meant that American companies had to immediately stop all business activities with the enemy. In addition, the German government was threatening to seize “enemy-owned” businesses. General Motors pulled out of Germany (though, Opal, a fully owned subsidiary of GM, still operated there). IBM’s operations were seized by the Third Reich, though controversy exists on how much they contributed to the German war effort. Coca-Cola HQ in Atlanta also cut off communications with Keith in Germany and halted the export of Coca-Cola’s 7X flavoring (the long-mythicized, top secret formula for Coca-Cola syrup).

[...]

Working with his chemists, Keith patched together a recipe within the limitations imposed by wartime rationing. It was basically made from the leftovers of other food industries: fruit shavings, apple fibers and pulp, beet sugar, and whey, the liquid remaining after milk has been curdled and strained during cheese production. To name this concoction, Keith told his team to use their imagination. Joe Knipp, a salesman, pitched “Fanta,” shorthand for the German word for “fantasy.” It stuck.

Fanta saved Coca-Cola GmbH. Sales rose gradually during the war, particularly as other choices became harder and harder to find. It wasn’t simply drunk either. Fanta was popular as a sweetener for soups due to severe sugar rationing, since the drink’s renown earned it an exemption from the rationing after 1941 (though Keith had to use beet sugar). It was likely used for a variety of other cooking and baking needs as well.

“It was Fanta or nothing,” says Tristan Donovan, author of the book Fizz: How Soda Shook Up the World. “It had pretty much market dominance during war time.” By 1943, sales had reached nearly three million cases.

Damore vs Google Class Action Lawsuit

Wednesday, January 24th, 2018

If you haven’t read the Damore vs Google Class Action Lawsuit, you really should. It’s pretty disturbing — yet perfectly believable.

You are quite likely to grind up the humans in the process

Wednesday, January 24th, 2018

Megan McArdle shares some stories of metrics and their unintended consequences:

In December, doctors at a VA hospital in Oregon decided to admit an 81-year-old patient. He was dehydrated, malnourished, plagued by skin ulcers and broken ribs — in the medical professionals’ opinion, he was unable to care for himself at home. Administrators, however, overruled them.

Was there no bed for this poor man? No, the facility had plenty of beds; in fact, on an average day, more than half of the beds are empty, awaiting patients. Was there no money or medicine to care for him? No, and no. Reporting by the New York Times suggests that Walter Savage was, perversely, turned away because he was too sick. Very sick patients tend to worsen the performance measures by which VA hospitals are judged.

If this had happened in isolation, we could simply gape at the monstrosity that bureaucracies are occasionally capable of.

But such examples abound in health care. For example, in the 1990s, New York and Pennsylvania started publishing mortality data on hospitals and surgeons who did coronary bypasses. The idea was that more informed consumers would steer themselves toward the teams with the better statistics — theoretically good for patients, bad for slacking providers. The reality was less ideal: In those states, surgeons seem to have started doing more operations on healthier patients, while turning away the sickest ones who might otherwise have benefited.

From this we can take a few lessons. The first is one that has been well-known to other sorts of businesses: What you measure is what you get, not necessarily what you want. In fact, if your measurement is badly designed, you may get a great deal of something you don’t want.

To illustrate that, look at Wells Fargo, which recently paid a whopping fine because a badly designed compensation system encouraged low-level employees to muck around with customer bank accounts. These machinations generated effectively no revenue for the bank, and annoyed customers, but they did generate income for the employees — and eventually, a stinging, expensive rebuke from the Consumer Financial Protection Bureau.

[...]

I could reel off examples endlessly: purchasing managers who have cozy arrangements to buy a certain amount of product from their vendors in December, and ship it back in January, in order to help some sales director make quarterly targets … universities that compete to turn away as many students as possible, because doing so makes them rise in the U.S. News rankings … law schools that hired their own graduates for temporary make-work jobs in order to boost the schools’ employment statistics. All metrics will be gamed, and the games always have costs. And when the metrics involve our health, those costs can be very high indeed.

Health care and education are particularly ill-suited to management-by-measurement:

Most companies are dealing with reasonably standardized inputs, which can be turned into measurable outputs. But the less you deal with things, and the more you deal with human beings, the less useful productivity metrics are. Human bodies and human minds are both highly variable and immensely complicated. When you are working on them, it is hard to know how much of the final result is a result of your labor, and how much can be credited to the qualities of your initial starting material.

So when we measure outputs, we are getting at best a very distorted picture of the value of the services provided. Modern industrial management is simply not designed for this sort of situation. If you feed human inputs into a machine system, you are quite likely to grind up the humans in the process.

Space is open for business

Sunday, January 21st, 2018

Space is open for business. Rocket Lab has announced, with its successful Electron rocket launch, from its own private launch pad in New Zealand, which reached orbit and successfully deployed multiple small satellites that will map the earth’s surface and track weather systems and shipping.

The Electron rocket is disposable:

It is made of lightweight carbon composite material and has 3D-printed engines to reduce costs and assembly times. It is 17m long, roughly a quarter of the size of rivals such as SpaceX’s Falcon 9 rocket, which can carry satellites the size of a van into orbit. Each Rocket Lab launch costs about $5m, compared to $62m for SpaceX, the company founded by billionaire Elon Musk.

Sunday’s launch was the second test flight by the Electron rocket following an earlier flight in May. On that occasion the rocket entered space but was unable to reach lower earth orbit due to a technical fault. It is planning a third test flight later this year.

Some satellite providers are willing to risk their products on test rockets due the lengthy backlog in launches that has built up as the industry expands. Rocket Lab deployed the three small satellites on behalf of Planet and Spire Global, US-based satellite providers that are deploying constellations of nanosatellites at a low earth orbit of about 500km.

Rocket Lab says its private launch pad on the picturesque Mahia peninsula on New Zealand’s North Island gives it a commercial advantage to many competitors, who use government-run facilities such as Cape Canaveral in the US. The company is licensed to conduct a launch every 72 hours from the remote location, which benefits from the lack of air and shipping travel in the vicinity.

I first heard about Rocket Lab just last year.

The birth of the digital camera

Monday, January 8th, 2018

Former Kodak employee Steve Sasson tells the story of the birth of the digital camera:

I worked for Eastman Kodak Company for over 35 years. I began in July of 1973. I was a junior engineer. My supervisor said, ‘We’ve got a filler job for you. There’s a new type of imaging device called a charged couple device imager; we want someone look at one of these and see if we could do anything useful with it.’

Our conversation probably lasted about 30 seconds, it was nothing.

Most of the parts I used to build it, I stole from around the factory. Digital volt meters and chips, digital tape cassette, prototype box, it looks like an erector set with a blue box on top with a lens stuck on top. And I would output to a television set. We took our first full images in December of 1975.

I folded the camera up, and I walked down a hallway, and there was a young lab technician, her name was Joy. I asked her, ‘Could I take a snapshot of you?’ She said, ‘sure, whatever.’ The tape started to move, that’s how I know I made a picture. I popped it out of the tape player, put it into the playback system. It was quite a moment, because this crazy thing actually worked. Up popped the image. We could see her black hair and a white background, but her face was complete static, completely unrecognizable. Jim and I were overjoyed at what we saw, because we knew so many reasons why we wouldn’t see anything at all.

Joy had followed us in, she looked at the picture and she said, ‘Needs work.’

We filed for a patent, and the first patent for a digital camera was granted in 1978. U.S. Patent 5016107. We started to show it to people at Kodak. Then, it became more interesting.

I thought they’d spend all their time asking me how did I get this to work. They didn’t ask me any of the hows, they asked me, ‘Why? Why would anyone want to do this?’

Would you pay $70,000 for a lunar vacation?

Wednesday, January 3rd, 2018

Would you pay $70,000 for a lunar vacation? That’s what Andy Weir estimates it’ll cost — eventually, in the 2080s, when Artemis takes place. Here are his key points, edited down:

The cheapest way to get mass to LEO (at the time of this writing) is with a SpaceX Falcon 9 booster. They charge $61.2 million for the launch, and it can put 13,150kg of mass into LEO. So right now, that means it costs $4,653 per kilogram.

The commercial space industry, through competition and engineering advances, will settle down to the same fuel-to-overhead ratio as the modern airline industry.

For each flight, I noted the price of each class of ticket, then worked out the take — the total amount of money the airline gets if every seat on the plane is sold at its listed cost. The fuel consumed is based on the flight duration and the fuel consumption rate of the aircraft. The cost of that fuel is based on the market price of jet fuel on the day I looked up those tickets, which was $0.475/kg. (Actually, the price was 38 cents per liter, but I wanted price per kg and jet fuel has a density of 0.8kg/L). [...] So for the rest of this paper I’ll assume a commercial airline spends 16.5% of its take on fuel.

A passenger spacecraft would weigh the same as a passenger aircraft capable of carrying the same number of people.

The commercial space industry will use hydrogen-oxygen fuel.

The thing that matters most about rocket fuel is a property called “specific impulse.” I don’t want to bore you with physics (I’m here to bore you with economics) so I’ll just say this: specific impulse is a measure of how efficient a rocket fuel is. The higher a fuel’s specific impulse, the less of it you need to get a ship moving a given velocity. And hydrogen-oxygen fuel has the best specific impulse known. Also, it creates water as its exhaust, so there are no pollutants. And finally, it’s cheap to produce.

Right now, there are engineering limitations to using hydrogen-oxygen fuel. The main one being that it burns very hot — hotter than any engine can handle. But again, I’m assuming all these challenges get researched and solved by a profit-hungry industry.

The final piece of the puzzle is the cost of hydrogen and oxygen. This was a little harder to find. I was able to find reliable data on the 2002 price of bulk hydrogen, so I adjusted the 2002 dollars into 2015 dollars and got $0.93/kg. As for oxygen, I used the publicly available data on what NASA pays for it — $0.16/kg in 2015 dollars. The reaction requires one part hydrogen and eight parts oxygen (by mass), so the total fuel cost is $0.245/kg.

Okay, we have a ship that weighs 165,500kg and we’re going to put 550 passengers on it. We’ll give them 100kg each for their bodies and luggage. That’s a total mass of 215,500kg.

The specific impulse of hydrogen-oxygen fuel is 389s (yes, the unit for measuring specific impulse is “seconds”. It makes no intuitive sense, just roll with it). To get to LEO you need to accelerate by 9,800m/s. LEO actually only requires 7,800m/s, but you lose around 2,000m/s during the ascent to air resistance and other inefficiencies.

Again, I’m skipping over the physics (Tsiolkovsky’s Rocket Equation, if you’re curious) but those numbers mean we’ll need 12.04kg of fuel for every 1kg we want to put into LEO. We want to put 215,000kg into LEO, so we need 2,594,620kg of fuel.

At our calculated fuel cost ($0.245/kg) that means the total fuel cost for the launch is $637,200.

Now I get to use my airline fuel overhead figure. Airlines have 16.5% fuel overhead ratio and we’re going to assume the space industry will as well. So $637,109 is 16.5% of our total ticket take. And that means our total take is $3,861,266.

Our ship carries 550 passengers, meaning each passenger will have to pay $7,020.48.

According to my research, it takes a total of 5,930m/s of delta-v to get from LEO to the surface of the Moon. More physics and math happens here, but it means that for every kilogram of cargo you want to put on the lunar surface, you have to put 4.73kg of mass into LEO. 1kg of actual cargo, and 3.73kg of fuel to get that cargo to the Moon.

So what’s it cost to put freight on the Moon? Well, it would cost 4.73 times what it would cost to put the cargo in LEO. So, while it costs $35.10 to put a kilogram into LEO, it would cost $166.02 to put it on the surface of the Moon.

You have to get your body to LEO ($7020), and then soft-landed on the moon. So you end up needing the same overhead – 4.73 times the LEO cost. $33,206.87.

So let’s say you want a two-week stay. That’s a total of 28 days of expenses at $800, so $22,400. Round that up to $25,000 because vacations always cost more than you expect. That plus the $45,000 travel costs totals $70,000.

So I ask again: Would you pay $70,000 for a lunar vacation?

The UK’s exam-focused educational system is similar to the one in China

Friday, December 29th, 2017

Puzhong Yao graduated with first class honors from Trinity College, University of Cambridge, and received an MBA from the Stanford Graduate School of Business. He looks at the Western elite from a Chinese perspective — with particular attention to idea’s from Robert Rubin’s autobiography In an Uncertain World:

It was the summer of 2000. I was 15, and I had just finished my high school entrance exam in China. I had made considerable improvements from where I started in first grade, when I had the second- worst grades in the class and had to sit at a desk perpendicular to the blackboard so that the teacher could keep a close eye on me. I had managed to become an average student in an average school. My parents by then had reached the conclusion that I was not going anywhere promising in China and were ready to send me abroad for high school. Contrary to all expectations, however, I got the best mark in my class and my school. The exam scores were so good that I ranked within the top ten among more than 100,000 students in the whole city. My teacher and I both assumed the score was wrong when we first heard it.

As a consequence, I got into the best class in the best school in my city, and thus began the most painful year of my life. My newfound confidence was quickly crushed when I saw how talented my new classmates were. In the first class, our math teacher announced that she would start from chapter four of the textbook, as she assumed, correctly, that most of us were familiar with the first three chapters and would find it boring to go through them again. Most of the class had been participating in various competitions in middle school and had become familiar with a large part of the high school syllabus already. Furthermore, they had also grown to know each other from those years of competitions together. And here I was, someone who didn’t know anything or anyone, surrounded by people who knew more to begin with, who were much smarter, and who worked just as hard as I did. What chance did I have?

During that year, I tried very hard to catch up: I gave up everything else and even moved somewhere close to the school to save time on the commute, but to no avail. Over time, going to school and competing while knowing I was sure to lose became torture. Yet I had to do it every day. At the end-of-year exam, I scored second from the bottom of the class—the same place where I began in first grade. But this time it was much harder to accept, after the glory I had enjoyed just one year earlier and the huge amount of effort I had put into studying this year. Finally, I threw in the towel, and asked my parents to send me abroad. Anywhere else on this earth would surely be better.

So I came to the UK in 2001, when I was 16 years old. Much to my surprise, I found the UK’s exam-focused educational system very similar to the one in China. What is more, in both countries, going to the “right schools” and getting the “right job” are seen as very important by a large group of eager parents. As a result, scoring well on exams and doing well in school interviews—or even the play session for the nursery or pre-prep school—become the most important things in the world. Even at the university level, the undergraduate degree from the University of Cambridge depends on nothing else but an exam at the end of the last year.

On the other hand, although the UK’s university system is considered superior to China’s, with a population that is only one-twentieth the size of my native country, competition, while tough, is less intimidating. For example, about one in ten applicants gets into Oxbridge in the UK, and Stanford and Harvard accept about one in twenty-five applicants. But in Hebei province in China, where I am from, only one in fifteen hundred applicants gets into Peking or Qinghua University.

Still, I found it hard to believe how much easier everything became. I scored first nationwide in the GCSE (high school) math exam, and my photo was printed in a national newspaper. I was admitted into Trinity College, University of Cambridge, once the home of Sir Isaac Newton, Francis Bacon, and Prince Charles.

I studied economics at Cambridge, a field which has become more and more mathematical since the 1970s. The goal is always to use a mathematical model to find a closed-form solution to a real-world problem. Looking back, I’m not sure why my professors were so focused on these models. I have since found that the mistake of blindly relying on models is quite widespread in both trading and investing—often with disastrous results, such as the infamous collapse of the hedge fund Long-Term Capital Management. Years later, I discovered the teaching of Warren Buffett: it is better to be approximately right than precisely wrong. But our professors taught us to think of the real world as a math problem.

The culture of Cambridge followed the dogmas of the classroom: a fervent adherence to rules and models established by tradition. For example, at Cambridge, students are forbidden to walk on grass. This right is reserved for professors only. The only exception is for those who achieve first class honors in exams; they are allowed to walk on one area of grass on one day of the year.

The behavior of my British classmates demonstrated an even greater herd mentality than what is often mocked in American MBAs. For example, out of the thirteen economists in my year at Trinity, twelve would go on to join investment banks, and five of us went to work for Goldman Sachs.

He goes on to describe his “success” at Goldman, what he really learned at business school, etc.

Non-consensus and right

Thursday, December 28th, 2017

If you aspire to do something legendary, Mike Maples argues, the biggest breakthroughs come from pursuing insights that defy conventional wisdom:

In the startup world, this translates to having what PayPal founder and Facebook investor Peter Thiel calls a “secret” or what Benchmark co-founder Andy Rachleff would describe as an idea that is “non-consensus and right.” Before diving into why this is true, let’s summarize these two views.

From his days as a Stanford student, Peter Thiel was influenced by the French philosopher René Girard. I learned of his work a little over a decade ago and loved it. One of Girard’s fundamental ideas is that human desire is mimetic, which means that most of our desires come from our observations of the desires of other people, rather than the desires we generate internally for ourselves. There are lots of implications to this for society, and Peter describes them in his book Zero to One as they relate to startups. The first is that the vast majority of us act out of mimetic desire as if by reflex, starting early in life. We compete for trophies. We get rewarded in school for giving the exact answers the teacher is looking for, but we are often discouraged from providing answers that are too different. “Successful” people often double down on this by seeking education at prestigious Universities, by earning high-paying jobs, and by using the money to live a lifestyle that is broadly desired and admired. It becomes so ingrained in most people’s thinking that it no longer seems to be a conscious choice.

The problem with mimetic desire is that it’s the wrong “personal operating system” for coming up with a breakthrough idea — it is by definition an incrementalist view of the world that emphasizes following the rules and outcompeting others, rather than re-inventing the rules and transcending competition. His second point is that most of us, having been programmed by mimetic desires our entire lives, find it hard not to be reactive to what others are doing. As an investor, I can relate to the many pitches with multiple competitors in a matrix, and their product has more checks than all the others. A typical “mimetic” person will think this way. But a non-conventional founder will notice that chart and immediately two words will come to mind — mindless competition.

[...]

Andy Rachleff views unconventional success through a slightly different lens but with the same broad takeaway. Andy’s argument, influenced by Howard Marks of Oak Tree Capital, goes as follows: Startup ideas have two dimensions. On one dimension, you can be right or wrong. On the other, you can be consensus or non-consensus.

Wrong is always bad. Obviously, if you are wrong, you are wrong. That’s bad. You fail. But being right is not enough.

Most people don’t realize that if you are right and consensus, you are usually not successful enough to make a significant impact. Your startup might be onto a good idea that has customers eager to adopt the product. But as your company races toward product/market fit, it encounters severe obstacles. Because the opportunity is widely believed to have promise, multiple me-too competitors are funded by me-too VCs. As competition floods the market, prices erode, sales cycles lengthen, and more money gets poured into the sector. These markets often turn into a VC funding arms race, and each round of financing comes with massive dilution for the founders and employees. In the meantime, potential acquirers gain increasing power to choose among many worthy and well-financed competitors when they consider M&A opportunities, further capping the upside for founders and employees.

Carlos Slim slashes New York Times holdings

Friday, December 22nd, 2017

Mexican billionaire Carlos Slim has long held an enormous stake in the New York Times, but now he plans to slash his holdings:

Billionaire Carlos Slim is planning to sell more than half of his 17 percent stake in the New York Times Co. to U.S. hedge fund investors, reducing his sway over one of the world’s most influential publishers.

Slim’s businesses earlier this month sold $250 million of mandatory exchangeable trust securities in a private offering that gives the buyers a claim on a 9 percent stake in the New York Times, according to a person with knowledge of the matter. The newspaper’s shares have surged more than 50 percent since Slim boosted his stake in 2015 and became the biggest shareholder.

The deal, which was referenced in a Dec. 6 statement but has gone largely unnoticed, means that when the securities mature three years from now and they automatically convert into Class A shares of New York Times, Slim and his companies will be left with about 8 percent of the publisher’s shares, said the person, who asked not to be identified because the information is private. In essence, the billionaire created a trust, pledged New York Times shares to it, locked the shares up for three years, then sold rights to that stock to investors.

Slim built his stake in the New York Times after lending the company $250 million in 2009 to help it get through the financial crisis. In 2015, he exercised stock options to become the Times’s biggest single investor in a display of confidence in the company even as readers and marketers flocked to the Internet where content is often free and ad rates are cheaper.

With the smaller stake, he’ll lose some of the power he had to vote for Class A directors, a group that can include no more than a third of board members. The Ochs-Sulzberger family — the paper’s controlling owners — hold Class B shares that give them a firm grip on the company. Publisher Arthur O. Sulzberger Jr. will retire at the end of this year after a quarter-century of overseeing the newspaper. His 37-year-old son, A.G., will take over.

Transferring the shares through the hybrid instruments allows Slim to take advantage of deferred tax payments until the transaction is completed, the person said.

My passive investments seem even more passive now.

Handle predicts a shakedown

Sunday, November 26th, 2017

Handle predicts a shakedown, and Arnold Kling sees it as a very plausible scenario:

That is, the capitalists will try to purchase respectability and pay off potential critics that could create real trouble for their businesses by buying ‘indulgences’ in the form of funding donations for certain prominent anti-capitalists, conspicuously and prominently towing the party line in public on the most important ideological commitments, and hiring the right number of the right people for cushy sinecures. If they show they are reliable allies instead of potential threats or rivals, and put enough money where their mouths are, and use their platforms, technological savvy, and expertise to help progressives win elections (e.g. Eric Schmidt wearing his “Staff” badge at Clinton campaign HQ), then in exchange, they will be left alone, and maybe even get some special treatment, favorable coverage, and promotion instead of demonization.

The thing about this shakedown tactic, Kling adds, is that it is like paying ransom in a kidnapping:

It relieves your problem, but it increases the chances that there will be other victims. In the case of a shakedown by activists, giving them hush money relieves our problem but it hands the group more resources to go and shake down the next corporate victim.

Handle has much more to add:

One additional thing to keep in mind is that the overall sector is not merely rich and prestigious and full of big juicy targets, but that many of the most important companies are fundamentally media outlets that have the potential to play gatekeeper roles regarding information and to use that power to influence public opinions and perceptions, or, in the alternative, to bypass the common gatekeeping that is characteristic of the legacy media institutions, or even to become rivals using a different set of standards for information filtering.

So ACORN can shake Freddie down for some hush money, and the progressive elites will support that effort as benefiting one of their coalition’s clients, maybe holding their noses a little, but otherwise whether or not it happens is not a very important issue for them. See also the “predatory loans” settlements.

But Twitter, Google, and Facebook and now the way social informational social points are broadcast, spread, and establishes, and have all kinds of way to subtle or overtly promote or suppress and generally have “jurisdiciton” over who can say what over their platforms. And, currently, none of that power is constrained by statute or the First Amendment or threat of civil liability, which means that power over information can currently be used in ways that circumvent any of the restrictions on direct state action. Amazon and Netflix and the rest are also media institutions to the extent they produce their own content and decide which content to host or not, or in the case of Amazon which services or pages to host. And of course many of these companies recycle and repackage and deliver the content of legacy media institutions, and so can have an enormous effect not just on that industry but to shape the ideological window of accessed messages. Also, Bezos bought the Washington Post for good reason.

If everybody is having their worldview and daily passions mediated by a few private internet companies which are also fundamentally media institutions that “curate” access to all the other media instutions, then it is absolutely clear to progressive elites that these companies pose both the greatest potential threat and greatest potential opportunity in a generation to propagate their views, agenda, and aims. That makes it absolutely essential they be strongly encouraged to get fully on board with the program as soon as possible, and be made to stay on board.

Occasionally, one is going to have to hang (or threaten to hang) an admiral or two pour encourages les autres and to let everybody know who’s boss and who can bring down whom if one strays too far from the path. The obvious thing that makes every technological company liable for demonization and even legal destruction is discriminatory employment practices. Those companies really can’t do anything about that sword of Damocles hanging over their head, and so they will be playing ball to whatever extent necessary to keep it in the air, hoping they will earn the grace of some prosecutorial discretion by so doing.

Now, this permanent prosecutorial threat is a terrific way to launder state action and have ideological regulation enforcement outsourced to private entities that aren’t constrained by the First Amendment or other rules. If non-progressives don’t grasp the overall situation soon and do something about it, then their futures will not be very bright.