Solitude and Leadership

Monday, April 12th, 2010

William Deresiewicz, who taught at Yale for 10 years, gave a speech on leadership to the plebe class at West Point last October:

So what I saw around me were great kids who had been trained to be world-class hoop jumpers. Any goal you set them, they could achieve. Any test you gave them, they could pass with flying colors. They were, as one of them put it herself, “excellent sheep.” I had no doubt that they would continue to jump through hoops and ace tests and go on to Harvard Business School, or Michigan Law School, or Johns Hopkins Medical School, or Goldman Sachs, or McKinsey consulting, or whatever. And this approach would indeed take them far in life. They would come back for their 25th reunion as a partner at White & Case, or an attending physician at Mass General, or an assistant secretary in the Department of State.

That is exactly what places like Yale mean when they talk about training leaders. Educating people who make a big name for themselves in the world, people with impressive titles, people the university can brag about. People who make it to the top. People who can climb the greasy pole of whatever hierarchy they decide to attach themselves to.

But I think there’s something desperately wrong, and even dangerous, about that idea. To explain why, I want to spend a few minutes talking about a novel that many of you may have read, Heart of Darkness. If you haven’t read it, you’ve probably seen Apocalypse Now, which is based on it. Marlow in the novel becomes Captain Willard, played by Martin Sheen. Kurtz in the novel becomes Colonel Kurtz, played by Marlon Brando. But the novel isn’t about Vietnam; it’s about colonialism in the Belgian Congo three generations before Vietnam. Marlow, not a military officer but a merchant marine, a civilian ship’s captain, is sent by the company that’s running the country under charter from the Belgian crown to sail deep upriver, up the Congo River, to retrieve a manager who’s ensconced himself in the jungle and gone rogue, just like Colonel Kurtz does in the movie.

Now everyone knows that the novel is about imperialism and colonialism and race relations and the darkness that lies in the human heart, but it became clear to me at a certain point, as I taught the novel, that it is also about bureaucracy — what I called, a minute ago, hierarchy. The Company, after all, is just that: a company, with rules and procedures and ranks and people in power and people scrambling for power, just like any other bureaucracy. Just like a big law firm or a governmental department or, for that matter, a university. Just like — and here’s why I’m telling you all this — just like the bureaucracy you are about to join. The word bureaucracy tends to have negative connotations, but I say this in no way as a criticism, merely a description, that the U.S. Army is a bureaucracy and one of the largest and most famously bureaucratic bureaucracies in the world. After all, it was the Army that gave us, among other things, the indispensable bureaucratic acronym “snafu”: “situation normal: all fucked up” — or “all fouled up” in the cleaned-up version. That comes from the U.S. Army in World War II.

You need to know that when you get your commission, you’ll be joining a bureaucracy, and however long you stay in the Army, you’ll be operating within a bureaucracy. As different as the armed forces are in so many ways from every other institution in society, in that respect they are the same. And so you need to know how bureaucracies operate, what kind of behavior — what kind of character — they reward, and what kind they punish.

So, back to the novel. Marlow proceeds upriver by stages, just like Captain Willard does in the movie. First he gets to the Outer Station. Kurtz is at the Inner Station. In between is the Central Station, where Marlow spends the most time, and where we get our best look at bureaucracy in action and the kind of people who succeed in it. This is Marlow’s description of the manager of the Central Station, the big boss:

He was commonplace in complexion, in features, in manners, and in voice. He was of middle size and of ordinary build. His eyes, of the usual blue, were perhaps remarkably cold…. Otherwise there was only an indefinable, faint expression of his lips, something stealthy — a smile — not a smile — I remember it, but I can’t explain…. He was a common trader, from his youth up employed in these parts — nothing more. He was obeyed, yet he inspired neither love nor fear, nor even respect. He inspired uneasiness. That was it! Uneasiness. Not a definite mistrust — just uneasiness — nothing more. You have no idea how effective such a… a… faculty can be. He had no genius for organizing, for initiative, or for order even…. He had no learning, and no intelligence. His position had come to him — why?… He originated nothing, he could keep the routine going — that’s all. But he was great. He was great by this little thing that it was impossible to tell what could control such a man. He never gave that secret away. Perhaps there was nothing within him. Such a suspicion made one pause.

Note the adjectives: commonplace, ordinary, usual, common. There is nothing distinguished about this person. About the 10th time I read that passage, I realized it was a perfect description of the kind of person who tends to prosper in the bureaucratic environment. And the only reason I did is because it suddenly struck me that it was a perfect description of the head of the bureaucracy that I was part of, the chairman of my academic department — who had that exact same smile, like a shark, and that exact same ability to make you uneasy, like you were doing something wrong, only she wasn’t ever going to tell you what. Like the manager — and I’m sorry to say this, but like so many people you will meet as you negotiate the bureaucracy of the Army or for that matter of whatever institution you end up giving your talents to after the Army, whether it’s Microsoft or the World Bank or whatever — the head of my department had no genius for organizing or initiative or even order, no particular learning or intelligence, no distinguishing characteristics at all. Just the ability to keep the routine going, and beyond that, as Marlow says, her position had come to her — why?

That’s really the great mystery about bureaucracies. Why is it so often that the best people are stuck in the middle and the people who are running things — the leaders — are the mediocrities? Because excellence isn’t usually what gets you up the greasy pole. What gets you up is a talent for maneuvering. Kissing up to the people above you, kicking down to the people below you. Pleasing your teachers, pleasing your superiors, picking a powerful mentor and riding his coattails until it’s time to stab him in the back. Jumping through hoops. Getting along by going along. Being whatever other people want you to be, so that it finally comes to seem that, like the manager of the Central Station, you have nothing inside you at all. Not taking stupid risks like trying to change how things are done or question why they’re done. Just keeping the routine going.

(Hat tip à mon père.)

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I’m helping people in pain

Friday, April 9th, 2010

In Super Crunchers, Ian Ayres notes that Visa can predict divorce — which leads to more missed payments — from credit-card data.

Now debt-collectors are using a combination of data-mining and psychology to improve their collection rates. In this example, debt-collector Rudy Santana treats a recently divorced man with compassion and suggests that it will really help him find peace to pay back as much of the $29,000 he owes as possible:

Eventually, the man from Massachusetts called Santana back with a proposal. He had spoken to his ex-wife, he said. They wanted to wipe out their debt by paying just $10,000 — only 35 percent of what they owed.

Santana had actually already sought permission from the bank to settle for as little as $10,000. It’s an open secret that if a debtor is willing to wait long enough, he can probably get away with paying almost nothing, as long as he doesn’t mind hurting his credit score. So Santana knew he should jump at the offer. But as an amateur psychologist, Santana was eager to make his own diagnosis — and presumably boost his own commission.

“I don’t think that’s going to work,” Santana told the man. Santana’s classes had focused on Abraham Maslow’s hierarchy of needs, a still-popular midcentury theory of human motivation. Santana had initially put this guy on the “love/belonging” level of Maslow’s hierarchy and built his pitch around his relationship with his ex-wife. But Santana was beginning to suspect that the debtor was actually in the “esteem” phase, where respect is a primary driver. So he switched tactics.

“You spent this money,” Santana said. “You made a promise. Now you have to decide what kind of a world you want to live in. Do you want to live around people who break their promises? How are you going to tell your friends or your kids that you can’t honor your word?”

The man mulled it over, and a few days later called back and said he’d pay $12,000.

“Boom, baby!” Santana shouted as he put down the phone. “It’s all about getting inside their heads and understanding what they need to hear,” he told me later. “It really feels great to know I’m helping people in pain.”

Credit cards grew in popularity once credit-card companies realized there was more money in people who didn’t pay off their balances every month:

Today Americans carry an average of 5.3 all-purpose cards in their wallets, and the average household has $10,679 in credit-card debt, according to the industry publication The Nilson Report.

Canadian Tire doesn’t sell just tires, and studying its house credit card’s purchase data revealed who was risky and who wasn’t:

His data indicated, for instance, that people who bought cheap, generic automotive oil were much more likely to miss a credit-card payment than someone who got the expensive, name-brand stuff. People who bought carbon-monoxide monitors for their homes or those little felt pads that stop chair legs from scratching the floor almost never missed payments. Anyone who purchased a chrome-skull car accessory or a “Mega Thruster Exhaust System” was pretty likely to miss paying his bill eventually.

Martin’s measurements were so precise that he could tell you the “riskiest” drinking establishment in Canada — Sharx Pool Bar in Montreal, where 47 percent of the patrons who used their Canadian Tire card missed four payments over 12 months. He could also tell you the “safest” products — premium birdseed and a device called a “snow roof rake” that homeowners use to remove high-up snowdrifts so they don’t fall on pedestrians.

It’s all pretty obvious in retrospect, isn’t it? (And I shouldn’t be surprised that there’s a whole class of people like me, paying their bills and keeping their floors safe, while watching the birds at the birdfeeder from a CO-free living room.)

American Express is using data to choose which customers to pay to leave:

Selected members — the company won’t say how many — received letters with the voluntary offer a couple weeks ago, according to Molly Faust, an American Express spokesperson. Each letter came with an RSVP code that, when submitted online, immediately cancels that member’s card. Members have until the end of April to pay off their balance, after which they will receive a $300 Amex prepaid gift card. If they do not pay off their balance in time, they do not get the gift card and their accounts will still be closed, Ms. Faust said.

Nicholas Ciarelli also shares some data-mining discoveries from a non-credit-card company, Hunch:

For instance, Hunch has revealed that people who enjoy dancing are more apt to want to buy a Mac, that people who like The Count on Sesame Street tend to support legalizing marijuana, that pug owners are often fans of The Shawshank Redemption, and that users who prefer aisle seats on planes “spend more money on other people than themselves.”

Intriguing.

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Why MBAs Fail at Entrepreneurship

Thursday, April 8th, 2010

Stu Wall began working at a bootstrapped start-up after graduating from Harvard Business School, so he feels qualified to explain why MBAs fail at entrepreneurship:

Group Think – Figure out what’s popular, then do the opposite

MBAs idealize jobs and ideas that used to offer outstanding returns. Private Equity and Hedge Funds offered outstanding salaries to HBS students from 06-08 and thus attracted “top” HBS students. As more talented students pursued these options it became conventional wisdom that everyone should be doing the same.

It turns out we’re good at picking sectors to avoid. The Harvard MBA Index has rightly predicted shorting the stock market when over 30% of HBS students go into finance. In 2008 the index hit an all-time high of 41%. Students aren’t the only ones showing up late to parties — in June of 2000 HBS initiated an ill-fated Silicon Valley Campus.

Howard Aiken has a great quote: “Don’t worry about people stealing your ideas. If your ideas are any good, you’ll have to ram them down people’s throats.” Have the courage to take a path that may not be obvious to your peers.

I’ve mentioned the Harvard indicator before.

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Creativity is not rewarded

Thursday, April 8th, 2010

Everyone says they want creativity, but creativity is not rewarded:

There have been countless studies, too many to cite here, on teacher opinions of creative behavior in classrooms. In one example, a study by Westby and Dawson looked at characteristics of creative and non-creative students, then asked teachers to rate their favorite and least favorite students based on those traits.

First, teachers were asked if they valued creativity and enjoyed working with creative students, and they overwhelmingly answered “yes”. Next, they were asked to look at their own students and rate them on a variety of traits, ranging from highly creative traits, such as being determined, independent, individualistic, impulsive, and likely to take risks, to traits that are associated with low levels of creativity, such as peaceable, reliable, tolerant, steady, and practical. After they rated their students on these traits, they were asked to rate them from their least favorite to most favorite students.

Interestingly, there was a significant negative correlation between the degree of creativity of the student and his favorable rating by the teachers. This means that the most creative students were the least favorite of the teachers, across the entire sample surveyed. Additionally, the students that were rated as favorites of the teachers possessed traits that would seem counter-productive to creative behavior, such as conformity and unquestioning acceptance of authority. On the other hand, these are behaviors that fit well in a classroom setting. Even back in 1975, Feldhusen and Treffinger reported that 96% of teachers felt that creativity should be promoted in the classroom. However, when asked which students they actually liked to teach, they chose the students that were more compliant. Why the inconsistency?

Teachers say they want creativity, but that is not the behavior that is rewarded. In this study (as well as in many others), they found that there is a discrepancy between what teachers, and schools in general, say they value and desire, and what behaviors they actually reward and encourage. Teachers don’t want the student who is always raising their hand and questioning the assignment; they want the student who unquestioningly follows the outline given to them and turns the assignment in on time. After all, what a hassle it would be to allow a student to creatively revise an assignment, even if the new method still met the project objectives. Any type of questioning of the pre-set format is viewed as challenging and defiant behavior. Bad.

Unfortunately, once you leave school, society does not get much more supportive of really creative behavior. The most highly valued employees are the ones who blindly accept the ideology of the company, don’t challenge authority, and do the work that is required of them, no questions asked.

People don’t say what they think, Eric Falkenstein says:

Professors love creative students, as demonstrated by those who extend their work in predictable yet difficult dimensions. The ‘creativity’ is evidenced merely by embracing their-own paradigm shifting work. A truly creative person, like a true risk taker, is seen as a crank in real-time, and indeed on average they are. But sometimes they are right.

Like risk-taking, what these creativity lovers mean is, they like positive surprises. Risk-taking of a regular sort that leads to failure is considered just dumb, or worse, full of hubris. Creativity is great if it generates an obviously valuable thing, otherwise, it’s annoying, and just inappropriate.

I once read an article that accompanied an exposition on the Capital Asset Pricing Model, and its implication that expected return was positively related to risk (via the ‘beta’, now an anachronism). They asked a bunch of well-known portfolio managers about their greatest risks, and each one was an unqualified success. This gives one the feeling that risk is related to return, because in these biased samples they are. Kids, and adults, should know that risk-taking usually fails, and so the only key is to know when to stop, and to keep trying, learning along the way.

Posted in Business, Education, Eric Falkenstein | 1 Comment »

Venture Capitalists Avoid Innovation

Tuesday, April 6th, 2010

Venture capitalists avoid innovation whenever possible, Andy Singleton says:

They claim to be in the business of innovation, but they also talk constantly, often in the same paragraph, about how much they want to avoid innovation.In this latest conversation, the VC said “We look for companies with a product and a proven business model.” This should should sound familiar to you. I wish I could run a video montage of the pictures in my head of VC’s saying how much they want to avoid innovation. Surely you would laugh. If you ask VC’s what they look for, they use words like “traction”, “proven business model”, “reference customers”, and “invest in marketing” or “sales and marketing”. This in itself is a big step forward from “We invest in teams that have done it before” (Greylock partner, 90′s), or “We look for the second time around” (Sigma partner, 90′s). It doesn’t take a genius to understand what they are saying. As much as possible, they want to avoid all innovation (stuff that’s not proven). It’s risky and unprofitable.

VC behavior subsequent to making an investment is also revealing. After looking at hundreds of deals, and falling in love with one particular business plan, and persuading other investors and partners that it’s great, VC’s generally don’t support subsequent changes to the business plan. A self-funded entrepreneur is constantly making major course corrections, to the point of driving his colleagues crazy. VC’s will deny this, but a VC investment is basically a ballistic missile launch, without course corrections. They are likely to just shut down the funding, or even to continue investing a lot of money in a concept that is clearly not creating the forecast level of excitement.

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Crunching Numbers In ‘The Hollywood Economy’

Friday, April 2nd, 2010

Newspapers breathlessly report weekly box-office numbers for Hollywood films, but the box office is not where Hollywood makes its money:

In 2007, the major studios had combined revenues of $42.3 billion, of which about one-tenth came from American theaters; the rest came from the so-called backend, which includes DVD sales, multi-picture output deals with foreign distributors, pay-TV, and network-television licensing.

The only useful thing that the newspaper box office story really provides is bragging rights: Each week, the studio with the top movie can promote it as “Number 1 at the box office.” Newspapers themselves are not uninterested parties in this hype: in 2008, studios spent an average of $3.7 million per title placing ads in newspapers.

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Southwest Airlines’ Baggage Strategy

Saturday, March 27th, 2010

Eric Joiner, Jr. calls Southwest Airlines’ baggage strategy — which promotes checked bags — pure genius:

Southwest Airlines flies a network within the United States that uses basically one airplane. The Boeing 737. For this reason, baggage capacity is fairly consistent with passenger load. Also anyone making a connection is likely to make a connection to another SWA 737, so baggage load factor remains fairly consistent across the network. This has major advantages.

By inspiring customers to check bags, aircraft can be loaded and unloaded much faster than if passengers carry bags onto the main deck and put them in the overhead bin. Anyone who has been on a fully loaded jet recently knows it can take 15-20 minutes just to get the passengers off the plane. The bigger the jet, the longer this takes. Time spent on the ground means time not in the air. Airlines only make money when the jet is flying. By encouraging passengers to check bags and by operating a homogeneous network, SWA can turn flights faster and thus create more profit for the airline.

What you are actually witnessing is an extension of Southwests fuel strategy. SWA has always done a brilliant job of fuel cost hedging. That is buying futures in jet fuel against probable market cost at time of consumption. Turning aircraft faster means more revenue for the fuel already purchased. Consider this a post hedge leverage on the gas in the tank.

Other airlines either dont get it, or can’t. Look at Continental and Delta as examples. If I fly Delta from Phoenix, Az to Savannah, Ga, I am going to fly on a Boeing 757 to Atlanta, then change planes to a regional jet operated by a 3rd party commuter airline like Chautauqua. If I pack golf clubs, a suit case, and maybe my wife does the same, there will be more baggage than the feeder aircraft can accommodate. This is a big problem especially to vacation destinations where scuba gear, skis, golf clubs etc, are part of the bag mix. For this reason, the majors discourage checked baggage.

They don’t want you to bring luggage in the first place because you screw up their network planning. Most majors don’t want you to have ANY bags. They don’t want to carry them and especially they don’t want the liability for tracking and reuniting you with a bag left behind because of network mismatch.

Consumers think the airlines lost the luggage. In fact many times the airline couldn’t accommodate it so they chose to pay a premium to deliver it to you later, often at the cost of your loyalty and future business.

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Why Japan didn’t create the iPod

Thursday, March 18th, 2010

To explain why Japan didn’t create the iPod, we need to look back to the digital gulf that had already formed between Japan and the West when the first 8-bit home computers came out in the late 1970s and early 1980s:

One of the most important factors at this time was the complexity of the Japanese language. Put simply, an 8-bit computer with only 64k of memory simply does not have the capacity to edit Japanese. As an example, the first Japanese word processor to use the modern kana-kanji text entry system was the Toshiba JW-10. The JW-10 was a dedicated word processor with no other functionality. Released in February 1979, the JW-10 weighed 220kg and had a price tag of 6,300,000 yen (around $30,000). Here in the west, we could get similar capabilities with a $300 Commodore Vic-20 connected to a cheap 8-pin dot matrix printer. (In fact, you could argue that the Vic-20 offered better functionality).

So the tech-savvy Japanese had wonderful tech gadgets and game consoles, but they didn’t have home computers:

By the time the iPod was released in 2001, Japanese mobile phones were already e-mail and internet capable. Although personal computer numbers had grown, more Japanese were accessing the Internet through their mobile phone than through a computer, and Japanese manufacturers were locked into the appliance mindset. As an example, consider the Sharp J-SH51 mobile phone released in 2002 which also offered a built-in MP3 player and digital camera. Despite being one of the most advanced mobile phones in the world at the time, the J-SH51 could not be connected to a computer. So how did you get music onto your phone? Well, you took an analog audio cable and plugged it into the aux. out plug on your CD player.

In the west, the home computer was already being viewed as the central hub of the digital age. It was obvious that devices such as digital cameras and MP3 players would need connectivity with the home computer, and that people would transfer pictures from the digital camera to their computer, or would use their computer as the central storage for music files to upload to their iPod or other music player as needed. The iPod, for example, requires a home computer. Without one, there is no way to get music on or off the device.

In Japan, however, things were different. Perhaps the easiest way to understand the Japanese market at the time is to imagine that home computers did not exist. From this perspective, the direction that the Japanese electronics industry took makes perfect sense. Everything needed to be designed as stand-alone appliance. The basis for much of this was the digital memory card, particularly the SD card. Digital cameras and camera-phones stored everything on a memory stick, and offered DPOF configuration options for configuring printing options. Color printers went on sale offering SD card slots so that these photos could be printed without a computer in the middle. MP3 players took a similar turn, offering either analog cable connectivity or SD card slots for music transfers. New stereo systems also offered an additional SD card slot. The SD card was like the new cassette. Record stores even began offering machines that sold digital music directly stored on your SD card. 3G phone handsets were released in 2001, and Japanese telecoms envisioned a world where consumers would buy and download music directly onto their mobile phones. It all makes sense if nobody owns a home computer, and when the mobile phone is the dominant form of Internet connectivity.

The flip-side of all this support for stand-alone appliances that do not require a home computer is that the Japanese electronics manufacturers offered virtually no support at all for home computers. Many devices simply could not be connected to a PC. For those that could be connected, the support software was unfriendly and extremely primitive. Let’s take the SD card as an example. SD cards offered a ‘feature’ called SD Audio whereby music was stored protected by a DRM system. However, only one manufacturer ever produced USB card readers that actually supported this scheme. Even if you did manage to track down the lone card reader that supported SD Audio, you still can’t transfer music to your SD card. In fact, you now had to purchase a special version of RealPlayer (that’s right, you had to pay for free software).

Of course, this kind of situation wasn’t going to fly in the west, where everyone had a home computer. Even in the Japanese market, this wasn’t going to fly. By the year 2000, most of the technical difficulties facing computers in Japan in the 80s and 90s had been resolved, and home computers were becoming mainstream. Japanese consumers wanted PC connectivity from their appliances, and the iPod offered a well-designed, highly functional package. So Apple created the iPod, and Japanese electronics manufacturers were left to re-evaluate a new world where the home computer is the hub for digital media.

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USA Inc.

Monday, March 15th, 2010

John Robb wrote a piece looking back from 2025 at how the loss of trust in the US government — and its ability to pay off its debts — led to a massive sell-off of assets. He doesn’t advocate for USA Inc.; he merely predicts it — and its consequences:

  • Nearly all roadways, from interstates to local networks, became toll roads. Further, toll road wireless billing systems, run by private companies, were expanded to charge for infractions — from speeding to improper turns — of the National Roadway Conduct statutes.

  • Universal K-12 schools were replaced with a combination of public online education and private in-person services. Education had finally become a commoditized in the form of a buffet of national online programs that provided state of the art educational technique tailored to individual needs (mass customization) at a low annual cost — for example, most programs cost less than $5 a day. In-person private education became a luxury item reserved only for those that could pay for the extra services.

  • National security services were privatized in 2020. Those remaining assets that were still intact following the draw down earlier in the decade (many consider the loss of many of these assets due to looting a travesty and blame it on the failure of Congress to privatize sooner) were either sold through public auction or put into use by the private firms that assumed national security duties. In short, the national security system was finally right-sized to meet the needs of the global security environment with the President assuming the permanent role of Chairman of the board for the holding company that ran it. Much of the funding for the newly minted privatized national security system was accomplished through fees for services provided to corporations for protection their assets both globally and domestically.

  • Police and fire services are still in the process of market consolidation. Early efforts at privatization created a plethora of new firms formed by former police departments and other first responders. By 2023, three major providers have finally reached a scale sufficient to offer national coverage and are quickly gaining market share due to their ability to offer quick response to member needs regardless of location and a very comprehensive set of services (from SWAT to hostage negotiation to HAZMAT clean-up). However, much of the country is still reliant on local providers and franchises of varying quality although this is difficult to determine with accuracy due to widespread corporate purchases of police and fire services for their employees.

  • The courts system has been reformed through the use of computerized automation supplied by several major competitive systems. Expert systems can now yield verdicts in seconds pending the input of evidence. This allows rapid resolution of conflict at the both criminal and civil levels. For most that can afford it, legal consul now includes a certified legal systems analyst in addition to a lawyer, for any major court case. Those that can’t afford it are offered automated legal help that can record testimony and gather facts for the case for a fraction of the cost of the previous system.

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On the Hunt for Bottlenecks

Friday, March 12th, 2010

Lean manufacturing, Bill Waddell says, is the application of the old scientific management concept to the entire factory — not just the direct labor slice:

While any number of authors and ‘experts’ with little actual factory experience point out that the original Ford plant had a Time Study Department and Shigeo Shingo did not consider himself fully dressed in the morning if he did not have his stop watch, there was a huge difference. They were not timing isolated operations looking for direct labor cost savings. They were on the hunt for bottlenecks, looking for anything restricting flow. The only time that matters in a one piece flow plant is the longest time in the flow. Reducing any other time saves nothing. (I imagine Eli Goldratt used a stopwatch when he made his much publicized breakthrough in the chicken coop business. As Goldratt quite accurately points out: An improvement at the bottleneck is an improvement in the system; while an improvement anywhere else is a mirage.) Just because these fellows were carrying stopwatches does not mean they saw factories remotely like Taylor did.

Lean practitioners go from one end of the process to the other looking at every action and every cost, looking to optimize the total. The traditional approach puts direct labor and machine operations on a pedestal. Every other activity is first and foremost supposed to optimize direct labor performance to the old Taylor standard. Only after that goal is met should management then pursue the second goal of minimizing the support cost. One can almost envision the operatic soloist alone in the spotlight while the other performers and the orchestra are hidden in the shadows all doing whatever they have to in order to make the soloist look good. In the remaining traditionally managed American factories, it is the machine operator, surrounded by inventory and a gang of material handlers, inspectors and foremen all assigned the task of making sure that, come what may, that operator makes or exceeds the rate for the job. Lean looks at that and says, “Nonsense”.

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Solar Thermal Paired with Natural Gas

Wednesday, March 10th, 2010

Across 500 acres just north of West Palm Beach, the FPL Group is building the world’s second-largest solar thermal plant, with 190,000 mirrors:

But that is not its real novelty. The solar array is being grafted onto the back of the nation’s largest fossil-fuel power plant, fired by natural gas. It is an experiment in whether conventional power generation can be married with renewable power in a way that lowers costs and spares the environment.

This is (almost) exactly what I was discussing with respect to wind power recently. An intermittent alternative-energy plant can produce energy at near-zero marginal cost, but it can’t guarantee energy when it’s needed, while a natural gas plant can’t produce free energy, but it can produce energy right when it’s needed. (At least solar-thermal generation is naturally correlated with when people demand energy to run their air conditioners.)

Under the same ownership, I suspect we’ll see that a kW of “backup” natural gas capacity combined with a kW of seasonal solar capacity has very high capital costs for its sometimes-low, sometimes-high variable costs — so only questionable subsidies and mandates will make solar appear economical, as in Spain, where they agreed to buy solar power for $0.58/kWh.

Posted in Business, Policy, Technology | No Comments »

Death By Competitive Analysis

Thursday, March 4th, 2010

Steve Blank warns startups of the dangers of death by competitive analysis:

In most startups the competitive analysis feature comparison ends up morphing into the Marketing Requirements Document that gets handed to engineering. The mandate becomes; “Our competitors have these features so our startup needs them too. Get to work and add all of these for first customer ship.”

Product development salutes and gets to work building the product. Only after the product ships does the company find out that customers couldn’t have cared less about most of the bells and whistles.

Instead of optimizing for a minimum feature set (that had been defined by customers) a competitive analysis drives a maximum feature set.

This is not good.

Here’s the problem: How did the founder know which features to choose on the competitive analysis table? When I was running marketing, the answer usually was, “We’ll put up whatever axes or feature comparisons that make us look best in this segment to potential investors. What else would you choose?”

At its best a competitive analysis assumes that you know why customers are going to buy your product. At its worst it exists to rationalize the founder’s assumptions about what they are building. This is a mistake — and it is a contributing factor (if not a root cause) of why most startups get their initial feature set wrong.

If you are building a competitive analysis table, do so only after you understand that the features you are listing matter to customers. Most marketers are happy to build feature comparisons. But customers don’t buy features, they usually buy something that solves a real or perceived need. That’s the comparison you and your investors should be looking at — what do customers say they need or want?

The answer to that question is almost never in your building.

Posted in Business, Steve Blank | No Comments »

Wind Power and the Grid

Wednesday, March 3rd, 2010

Carl from Chicago, who oddly knows quite a bit about the grid in Texas, notes that wind power doesn’t have to live up to its commitments:

Power is generally dispatched in the following manner:
  1. The grid control operator makes a request for how many megawatts of power that it needs for the next day.

  2. The various owners of generating capacity (wind, gas, coal and nuclear) submit their available power for the next day.

  3. The wind power is always taken because it has the lowest incremental cost, along with the nuclear power available as well as coal. Then natural gas is selected until demand is equal to supply, with older less-efficient “peak” gas plants turned off if there isn’t enough demand.

The issue is that wind power can’t guarantee its available capacity. In general, if a generation owner “commits” to a certain amount of supply capacity and can’t provide the electricity, then that generation company is charged a penalty for failing to deliver.

In the case of wind power, the generation owners are not penalized if their promised power is not available. All of the other power providers (nuclear, coal and gas) face penalties for failing to deliver.

This issue, the useful capacity of wind power (not its “rated” capacity), and who pays for backup capacity since the wind may or may not be blowing reliably on any given day, is a critical question. Wind in a way is “free riding” on the grid; wind is paid as if it is reliable, when in fact it isn’t, and then the other electricity providers de-facto subsidize wind (again, they already receive Federal and State subsidies) by not charging them for failing to deliver and taking on their pro-rata share of the power needed when the wind farms don’t deliver.

Not only does wind power get a “free ride” on backup capacity, which hurts the gas generators, but the gas generators that do run are also getting a lower per-unit reimbursement because the revenues are set based upon the highest “marginal” cost for electricity; on a given day when there is more wind only nuclear, coal and the most efficient gas plants will be online (along with the wind, which always is in the stack, depending on weather conditions) if there isn’t much demand, so not only do gas plants lose money from not being on but the gas plants that are on receive a lower price for their power.

My thoughts:

The fact that everyone sharing the grid has to play nice, or the whole grid goes down, makes me wonder about the wisdom of breaking up ownership and control amongst so many firms using such disparate technologies. Sorting out everyone’s responsibilities is non-trivial.

It obviously makes sense to use wind power when the wind’s blowing and you’ve already got windmills — the fuel cost is zero, after all — and it doesn’t make much sense to punish a wind generator when the wind’s not blowing — because it’s not negligence that’s causing the unreliability — but the natural gas generator, which is quick to fire up and available on demand, is what’s keeping the whole system from crashing. That would imply that the natural gas generator shouldn’t be paid so much based on how much natural gas gets burned but more on how much capacity it can provide, as insurance.

If the wind and natural gas generators were owned by the same firm, I think the problem would resolve itself — and we’d more clearly see that a kW of “backup” natural gas capacity combined with a kW of intermittent wind capacity has very high capital costs for its sometimes-low, sometimes-high variable costs. Right now, as Carl points out, the wind folks are free-riding on the security provided by the natural-gas folks.

(Another option would be to tie the wind power in with hydro power, which could serve as storage.)

Posted in Business, Economics, Policy, Technology | No Comments »

Betting on the Blind Side

Tuesday, March 2nd, 2010

Michael Lewis tells the tale of hedge-fund manager Michael Burry:

On May 19, 2005, Mike Burry did his first subprime-mortgage deals. He bought $60 million of credit-default swaps from Deutsche Bank — $10 million each on six different bonds. “The reference securities,” these were called. You didn’t buy insurance on the entire subprime-mortgage-bond market but on a particular bond, and Burry had devoted himself to finding exactly the right ones to bet against. He likely became the only investor to do the sort of old-fashioned bank credit analysis on the home loans that should have been done before they were made.

He was the opposite of an old-fashioned banker, however. He was looking not for the best loans to make but the worst loans — so that he could bet against them. He analyzed the relative importance of the loan-to-value ratios of the home loans, of second liens on the homes, of the location of the homes, of the absence of loan documentation and proof of income of the borrower, and a dozen or so other factors to determine the likelihood that a home loan made in America circa 2005 would go bad. Then he went looking for the bonds backed by the worst of the loans.

It surprised him that Deutsche Bank didn’t seem to care which bonds he picked to bet against. From their point of view, so far as he could tell, all subprime-mortgage bonds were the same. The price of insurance was driven not by any independent analysis but by the ratings placed on the bond by Moody’s and Standard & Poor’s. If he wanted to buy insurance on the supposedly riskless triple-A-rated tranche, he might pay 20 basis points (0.20 percent); on the riskier, A-rated tranches, he might pay 50 basis points (0.50 percent); and on the even less safe, triple-B-rated tranches, 200 basis points — that is, 2 percent. (A basis point is one-hundredth of one percentage point.) The triple-B-rated tranches — the ones that would be worth zero if the underlying mortgage pool experienced a loss of just 7 percent — were what he was after. He felt this to be a very conservative bet, which he was able, through analysis, to turn into even more of a sure thing. Anyone who even glanced at the prospectuses could see that there were many critical differences between one triple-B bond and the next — the percentage of interest-only loans contained in their underlying pool of mortgages, for example. He set out to cherry-pick the absolute worst ones and was a bit worried that the investment banks would catch on to just how much he knew about specific mortgage bonds, and adjust their prices.

Once again they shocked and delighted him: Goldman Sachs e-mailed him a great long list of crappy mortgage bonds to choose from. “This was shocking to me, actually,” he says. “They were all priced according to the lowest rating from one of the big-three ratings agencies.” He could pick from the list without alerting them to the depth of his knowledge. It was as if you could buy flood insurance on the house in the valley for the same price as flood insurance on the house on the mountaintop.

The market made no sense, but that didn’t stop other Wall Street firms from jumping into it, in part because Mike Burry was pestering them. For weeks he hounded Bank of America until they agreed to sell him $5 million in credit-default swaps. Twenty minutes after they sent their e-mail confirming the trade, they received another back from Burry: “So can we do another?” In a few weeks Mike Burry bought several hundred million dollars in credit-default swaps from half a dozen banks, in chunks of $5 million. None of the sellers appeared to care very much which bonds they were insuring. He found one mortgage pool that was 100 percent floating-rate negative-amortizing mortgages — where the borrowers could choose the option of not paying any interest at all and simply accumulate a bigger and bigger debt until, presumably, they defaulted on it. Goldman Sachs not only sold him insurance on the pool but sent him a little note congratulating him on being the first person, on Wall Street or off, ever to buy insurance on that particular item. “I’m educating the experts here,” Burry crowed in an e-mail.

He wasn’t wasting a lot of time worrying about why these supposedly shrewd investment bankers were willing to sell him insurance so cheaply. He was worried that others would catch on and the opportunity would vanish. “I would play dumb quite a bit,” he said, “making it seem to them like I don’t really know what I’m doing. ‘How do you do this again?’ ‘Oh, where can I find that information?’ or ‘Really?’ — when they tell me something really obvious.” It was one of the fringe benefits of living for so many years essentially alienated from the world around him: he could easily believe that he was right and the world was wrong.

The more Wall Street firms jumped into the new business, the easier it became for him to place his bets. For the first few months, he was able to short, at most, $10 million at a time. Then, in late June 2005, he had a call from someone at Goldman Sachs asking him if he’d like to increase his trade size to $100 million a pop. “What needs to be remembered here,” he wrote the next day, after he’d done it, “is that this is $100 million. That’s an insane amount of money. And it just gets thrown around like it’s three digits instead of nine.”

By the end of July he owned credit-default swaps on $750 million in subprime-mortgage bonds and was privately bragging about it. “I believe no other hedge fund on the planet has this sort of investment, nowhere near to this degree, relative to the size of the portfolio,” he wrote to one of his investors, who had caught wind that his hedge-fund manager had some newfangled strategy. Now he couldn’t help but wonder who exactly was on the other side of his trades — what madman would be selling him so much insurance on bonds he had handpicked to explode? The credit-default swap was a zero-sum game. If Mike Burry made $100 million when the subprime-mortgage bonds he had handpicked defaulted, someone else must have lost $100 million. Goldman Sachs made it clear that the ultimate seller wasn’t Goldman Sachs. Goldman Sachs was simply standing between insurance buyer and insurance seller and taking a cut.

The willingness of whoever this person was to sell him such vast amounts of cheap insurance gave Mike Burry another idea: to start a fund that did nothing but buy insurance on subprime-mortgage bonds. In a $600 million fund that was meant to be picking stocks, his bet was already gargantuan, but if he could raise the money explicitly for this new purpose, he could do many billions more. In August he wrote a proposal for a fund he called Milton’s Opus and sent it out to his investors. (“The first question was always ‘What’s Milton’s Opus?’” He’d say, “Paradise Lost,” but that usually just raised another question.) Most of them still had no idea that their champion stock picker had become so diverted by these esoteric insurance contracts called credit-default swaps. Many wanted nothing to do with it; a few wondered if this meant that he was already doing this sort of thing with their money.

Instead of raising more money to buy credit-default swaps on subprime-mortgage bonds, he wound up making it more difficult to keep the ones he already owned. His investors were happy to let him pick stocks on their behalf, but they almost universally doubted his ability to foresee big macro-economic trends. And they certainly didn’t see why he should have any special insight into the multi-trillion-dollar subprime-mortgage-bond market. Milton’s Opus died a quick death.

In October 2005, in his letter to investors, Burry finally came completely clean and let them know that they owned at least a billion dollars in credit-default swaps on subprime-mortgage bonds. “Sometimes markets err big time,” he wrote. “Markets erred when they gave America Online the currency to buy Time Warner. They erred when they bet against George Soros and for the British pound. And they are erring right now by continuing to float along as if the most significant credit bubble history has ever seen does not exist. Opportunities are rare, and large opportunities on which one can put nearly unlimited capital to work at tremendous potential returns are even more rare. Selectively shorting the most problematic mortgage-backed securities in history today amounts to just such an opportunity.”

Posted in Business | No Comments »

Thoughts on Commercials

Saturday, February 27th, 2010

Steve Sailer has been watching the Winter Olympics and has some thoughts on commercials:

Speaking of commercials, why don’t advertisers make slight variants of their commercials to keep people from completely zoning out the 73rd time they’ve seen it? They shoot way more footage than they use, so why not whip up alternative versions to keep viewers awake during the Olympics?

Here’s an easy way to keep siblings competitively engaged: shoot three or four different punchlines and then make one slight variation in each version’s set-up shots. That way, somebody who is paying close attention will be able to achieve dominance over the rest of his family by accurately predicting the punchline. It will drive his siblings crazy, so they will also study the commercials looking for clues so they can beat him to the punchline.

Also, advertising agencies keep missing the sweet spot between too boring and too interesting that you don’t notice what brand is being advertised. A lot of prestige ads that run on the Olympics are so expensive, so filled with show-offy scenes from around the world that you often lose the thread before they finally flash the sponsor’s logo for 0.8 seconds at the end. I’m sure those kind of ads win awards — nobody loves to give awards to each other more than advertising people — but are they really effective at selling whatever sponsor that’s revealed at the very end? Especially when the stylistic theme of countless commercials is exactly the same: Despite, or perhaps because of, global diversity, everybody on Earth loves us.
[...]
Instead, why not borrow a trick from cable networks that keep a small logo up on a lower corner of the screen? Hey, this show is on the Discovery Channel! I’ll have to try to remember that. Similarly, put the sponsor’s logo in the corner throughout the commercial. Your ad won’t win any awards and your ad agency might get sanctioned by the Advertising Council for violating the professional ethics of the advertising business by being overly attentive to the client’s interests instead of to your own sense of creative self-expression, but, so what?

Posted in Business, Media | No Comments »

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