Sunday, February 28, 2010

Finding the Sprouts in the Mud

Four articles that I read online yesterday remain in my mind. Three were so full of unsupported assertions and pseudo-science that I wanted to argue with my computer for displaying them. The other one was phenomenal - beautifully written and full of thought-provoking material.

The web is a vast quagmire of thoughts, ideas, and information. Much of it - like the three bad articles that I read - is simply mud. Mud has a purpose. It fills cracks, provides foundation, and holds things together. But in the end, it's dirt - ubiquitous, messy, and replaceable. It doesn't provide unique value.

However, within the vast spans of sludge, there are seeds of knowledge. Some have already sprouted and are growing into mingling vines, intelligent communities that reach out to others and define thought. Some, like the excellent article that I read, have the constitution to become oak trees - strong enough that they can be used to construct and support new thinking. Some have sprouted beautiful flowers of thought - not large or world-changing, but elegant worth admiring. Others still lie dormant, waiting to sprout and become something worthy of understanding and appreciation.

What scares me is that I am seeing more mud. People keep piling it on. In fact, there is so much mud that I'm beginning to wonder if enough people can distinguish the dirt from the seeds, vines, oaks and flowers.

If they cannot, I worry that the swamp will continue to rise. Those who mistakenly believe that they are growing the next oak-tree will layer on another level of silt. First it will cover the fragile, beautiful flowers of expression, and they will slowly be buried in the morass. Then it will envelop the vines, choking connections built over years. If we are truly unlucky and irresponsible, the rising bog could even threaten the large oaks which have grown over hundreds of years.

The quagmire has not overrun the world of knowledge yet. I am still hopeful that it will not. But it is important to recognized that the useful, strong, and elegant ideas in this world require peoples' attention and thought to grow and mature.

Nobody can force someone else to find the sprouts in the mud and tend to them properly, to nourish them and help them to grow. Each person must learn the process through disciplined practice. I hope that people are taking the initiative to learn, because the seeds, flowers, vines, oaks, and those who appreciate them are counting on us.

And as a final note: if you ever feel that this blog is just turning into mud, I want to know.

Saturday, February 27, 2010

Getting Things Right vs. Getting Things Done

In school we are repeatedly taught the importance of getting things right. When we get the right answer, teachers praise us. When we find the wrong answer, they correct us. It happens over and over again, and soon we begin to believe that being right is the ultimate goal.

Then we reach the real world. Problems become vastly more complicated than they were in school. The lines between correct answers and incorrect ones begin to blur. However, the training remains - we still want to be right.

The problem is that searching for a "right" or "best" answer to complex, real-world problems requires enormous amounts of time. Often, searching for it would require so much time that, by the time you found it, it is no longer useful. The world already changed. The problem that you were trying to solve no longer exists.

When facing huge, complex problems in fast changing spaces, searching for the "right" answer is usually hopeless. It's much more useful to find a solution that works . . . it might not work perfectly, but it works. Then you improve upon it. As time passes, you create a series of small solutions that begin to approximate an excellent solution.

Each new problem deserves this question: "When solving this, what's more important: getting it right, or getting it done?"

Friday, February 26, 2010

The 5 Most Important Things That I Learned in Investments Class

Finance is polarizing. Whether you consider it high-powered and sexy or the embodiment of greed and evil (or something in-between), it's here to stay.

There is probably no school in the world that has a greater collection of academic financial minds than Chicago Booth, so I feel extraordinarily fortunate that I am learning the subject here. I learned far more in my Investments course than I could summarize in a single blog post, but here are what I consider to be the 5 most important lessons.

Important note: If you are scanning this and only take away one thing, read (1) carefully and understand it.

5) Most money and investment managers should not have jobs.

Are you invested in mutual funds? If it's a "managed" fund, you might want to re-consider your investment. The manager may sound smart, but they all do. And using their smarts, they try to push people toward "actively managed" funds. Whenever you hear that word, be afraid. It means that you will likely pay higher fees, which is guaranteed lost money.

My brilliant young Investments professor studies how well mutual fund managers perform. What does the research say? Out of the thousands of mutual fund managers in the world, only a handful consistently perform better than a monkey randomly choosing stocks. And there is a certain (not small) portion of managers who consistently perform worse than a monkey randomly choosing stocks.

What does all this mean? If you're in an actively managed mutual fund, it's likely that you're paying somebody for doing work that a monkey could do equally well.1

4) People make predictable mistakes.

People don't like to sell stocks for a loss. They will predictably (and irrationally) hold on to bad stocks which have lost value, opening themselves up to the possibility of more losses. People also love to sell stocks for a gain. They will predictably (and irrationally) sell good stocks that have gained value. Then they miss out on future gains.

There are a number of predictable mistakes like this that people make. Even though they lose money as a result, they don't learn to stop doing it.

If you're planning to invest, either a) invest your money in something reasonable and forget about it, or b) learn the mistakes that people make and read through them before you buy or sell to make sure that you're not making them.

3) Your relationship with risk will be a key determinant of your future wealth.

If you bought $5000 worth of shares in an index fund, and you immediately lost $1000, what would you do? Sell? Buy more? Hold?

It's actually tough to answer that question until you have actually lost $1000. A lot of people say that they would do one thing, but actually do another when the event happens. However, your response to that situation will speak volumes about how rich you can be in the future.

Investment theory teaches that investments should only pay you if you bear risk. And not just any risk . . . risk that cannot be avoided, insured against, or diversified away. You need to be exposed to earn money.

Assuming that you and another person make equally reasonable decisions, the person with more tolerance for risk has more opportunity to be rich in the long term. They also have more opportunities to be poor, remember. However, they worry less about being poor, and that's their advantage.

2) Warren Buffet knows accounting and economics. He doesn't do much academic finance.

If you're interested in picking individual stocks better than other people, Finance is good to know, but it won't help as much as accounting or economics. Finance will teach you to think in the aggregate. You will learn about trends and tools. It will be a great vocabulary and thought lesson, but you will not spend much time looking at individual stocks, their reports, or the underlying economics of the business.

However, if you're wanting to pick stocks better than other people, keep the next and final point in mind.

1) Somebody out there is smarter than you and works harder than you. That person is waiting to exploit your mistakes in order to make money.

Let's pretend that you have $100,000 to invest. If you find a piece of information that earns you an extra 1% per year, you will earn an extra $1000 per year. That's pretty good, and it's probably worth a lot of effort. You might even be willing to pay a smart person $900 to find something that nobody else knows if it earns that extra 1%. If you did, you'd earn ($1000 - $900) = $100.

But wait a minute . . . there are companies out there that have more than $100 million to invest2. If that firm finds the same information and earns an extra 1%, they earn $1 million. They could pay 1,000 people $900 to try and find the information first (and they would still make more money than you)!

Do you still think that you can find that information before they do? Do you think it's more likely that you'll profit from their mistakes or they'll profit from yours?
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If you want to learn more about specifics, I'd recommend starting with books by John Bogle or value investors.


This post is the second in a series of posts that I am writing to share a variety of MBA knowledge that I think would be useful for laypeople. It's meant to help people without an MBA education to become aware of issues that may come up when making important decisions.

The first post: The 5 Most Important Things I Learned in Financial Accounting Class

Please let me know if you thought this was useful. And if you like it, share it with a friend.

1 I'm not an investment advisor, so I can't recommend something else legally. However, I can say that some very smart people who I know invest in index funds . . . and they make sure that the management fees are very low!

2 Some sovereign wealth funds have more than $100 billion (100,000,000,000) to invest.

Thursday, February 25, 2010

To Do This, What Aren't You Doing?

Every hour spent watching TV is one hour that could have been spent learning a new skill.

Imagine that your friend watches TV for 2 hours per day. Assuming that your friend sleeps 8 hours per night, he spends 45.6 days per year in front of his TV. That is 45.6 days that he could have spent mastering something new . . . something that could have changed his life.

When he chooses to watch TV every day, do you think he realizes that he is giving that up?

Tuesday, February 23, 2010

A High Profile Day

One day . . . two big names on campus. . . lots of wisdom. Here are the two pieces of knowledge that really stuck with me.

First, from Hank Paulson - former Secretary of the Treasury.

The prompt: "I think all the MBAs want to know this . . . how do you become CEO of Goldman Sachs and then Secretary of the Treasury?"

The response (approximate):

I always get suspicious when young people come to me and tell me that they've always wanted to do investment banking. They say it like they knew it since they left the womb. You never know what you do well and what you like until you try it. That's why I don't think "career engineers" have it right. Don't plan every step of your career. It just doesn't work.
Second, from Doris K. Christopher - founder and chairman of The Pampered Chef.

The statement, explaining the unparalleled growth of the company and Warren Buffet's reason for purchasing it:

"The Reputation of the company is everything."

Smart people . . . with great big-picture thinking.

Monday, February 22, 2010

Which Class Are You In?

Last week, I listened to a professor discuss a case that our class would have to prepare in two weeks. After he went through several points, he asked if there were any questions. Seeing an opportunity to save a few hours, I asked one.

"There are a lot of numbers in this case. In my managerial accounting class, cases sometimes give incorrectly calculated numbers, or they leave out numbers. Can we assume that the numbers in this case are correct?"

The professor looked at me like I had just revealed my Martian heritage. It was one of those, "come on . . . are you serious?" looks. Then he just asked plainly: "Which class are you in?"

I conceded the point. I was not in managerial accounting class. Then he confirmed that the numbers were right.

I shouldn't have admitted to asking a silly question. I will grant him that I was not in accounting class. However, I'm preparing to work in the real world.

Once I reach the business world, will anybody tell me which class I'm in? Certainly not. Will I know when I can assume that numbers given to me are correct? Nope.

In the future, I must be aware of all of the tools and thought processes that I've learned . . . not just in business school, but throughout my entire life. To be aware of possible problems, I should ask questions like the one above, and many more!

Compartmentalizing knowledge is useful for teaching and learning, but it can be dangerous in the real world.




Note: This professor's comment was off-the-cuff, and I wrote this to point out the comment's implications - not to judge the professor. In fact, I have deep respect for the professor, and he would likely agree with everything that I've written.

Sunday, February 21, 2010

Questions to Ask Before Making a Big Decision

Before making a big decision to do something new, try honestly answering these questions:

  1. If a business associate were considering this decision, would I advise him to do it? If not, why am I considering it for myself?
  2. What is the very worst thing that could happen if I do this? Could I manage if it did happen?
  3. Assume I can't manage the worst case scenario, but I still want to do it. Would people whose thoughts I respect tell me that I'm being silly or irrational?
  4. Do I get excited when I think about the decision? Is that good or bad? Why?
  5. If you're excited, explain your good or bad response to your respected adviser. What does she think of your explanation?
  6. What are the known unknowns1 related to this decision? How material is the unknown information to making the current decision?
  7. What are possible unknown unknowns2 related to this decision? Should thinking about unknown unknowns make me re-assess my answer to the questions in (2) and (3)?
Different angles yield new insights. This is a list of some of the questions that I sometimes ask myself. There are many other possibilities that are equally illuminating.

1 Known unknowns are "what you know that you do not know." For example, I know that I do not know how many people will be reading this blog six months from now. As a result, any decision I make based on an estimate of future readership should be tentative.

2 Unknown unknowns are "what you don't know that you don't know." The classic example is this: Imagine that you are a lone Chicken on a farm. Every day, the farmer feeds you. Over time, you come to regard the farmer as a friendly food bringer. That is . . . until the day that the farmer kills you and eats you. Nothing from your entire life experience as a chicken would help you to predict that the farmer would kill you.
The farmer's plan to kill and eat you (the chicken) is an unknown unknown.

Saturday, February 20, 2010

Experience and Getting Things Right

How comfortable are you buying a gallon of milk? A pair of jeans?

These decisions are frequent and low risk. Anybody who has ever shopped knows what to do with each. Check expiration date then buy. Check size, fit, match, price, then buy.

How comfortable are you purchasing a television?

This decision is a little less frequent, but the process is manageable. Think about your price range. Look for the features that you want. Ask a couple of friends how they like their TVs. Check some online reviews and maybe consumer reports. Find the store that's selling what you want at the best price, and buy.

Now let's push it: how comfortable are you purchasing a car or a house?

Who is honestly comfortable when buying a car or a house (unless the person is a car salesman or a real estate broker)? These purchases are very infrequent. They occur maybe 5-10 times in a lifetime. We don't have opportunities to try and fail. Worse, failure is extremely costly.

What to do in these situations?

I don't know. I've never bought a car or a house.

However, I do know people who have bought cars and houses, so talking to them might be a good starting point.

Hubris is still a tragic flaw. There's no shame in seeking support and knowledge when experience is low and the stakes are high.



Update: I talked with some people who know a thing or two about buying cars. The two best lessons that I learned are written here.

Friday, February 19, 2010

You Think You Make Logical Decisions?

If you think that you make decisions logically, think again.

You may spend time considering the purchase of a new computer. But in the end, the machine that gives you butterflies in your stomach is the one that you will pay for. The black box that costs $500 less but does approximately the same thing . . . meh. If somebody asks, you'll be able to justify buying the more expensive one.

Your mind may weigh the decision. It may list off the pros and the cons. But your heart gets the final say.

If you still don't believe me, then next time you go to the store try this. Stand in the soda aisle and look at a can of Coca-Cola (or Pepsi, if that's your thing) next to a store brand cola. Would you ever buy the store brand? Be honest.

They're both just cans of sugar water. Your mind knows it.

But the heart doesn't believe the mind, and it gets to choose.

Wednesday, February 17, 2010

How to Get Ahead in this Crazy New World? My Take-Aways from a Conversation With the Chief Marketing Oficer of Frito-Lay North America

The world has changed.

Ann Mukherjee knows it. In case you don't know her, she's the mind behind the Doritos "Crash the Super Bowl" competition . . . where Doritos lovers created their own commercials to be aired on the superbowl. Thanks in part to that campaign's smash success, she's now the Chief Marketing Officer of Frito-Lay North America.

My marketing class was fortunate enough to have a discussion with her about marketing, careers, and decisions today. It was phenomenal.

During the talk, she kept coming back to three points. She presented them as simple facts. They were clear to her.

To me, they're more than just clear points. They are "rules" for the future, which many people do not yet understand. People who grasp them and make use of them will be prepared to succeed. Those who ignore them will be left behind. Here they are.

The points are hers. The interpretation is mine.

Point 1: In a world of intelligent people, curiosity and creativity are the differentiators.

It used to be that intelligence was enough to differentiate you. Not so anymore. Logically intelligent people are easier to find than ever before. A post-secondary education is just a foot in the door now. It doesn't mean that you're amazing.

In fact, Ann has shifted some of her recruiting efforts away from top business schools. She's replacing MBAs with design school graduates, as well as people with very strange backgrounds: world travelers was an example she gave.

These people do have to be smart. Don't get me wrong. However, they also need to be on the cutting edge. And what do cutting-edge idea generators have in common? They're curious. Endlessly curious.

But curiosity alone is not enough. These people need to be able to apply their wealth of knowledge productively. They need to come up with new ideas. They need to be able to envision new things. They need to be creative!

Intelligence? It's useful, but it's old news. In a group of intelligent people, the curious and the creative stand out.

Point 2: If you're going to do something meaningful, be prepared to give up control.

Ann illustrated this point with a wonderful story about the Doritos brand. When Stephen Colbert made his decision to run for president, he called Ann. He wanted to bring Doritos into his campaign as a sponsor. He offered them the sponsorship cheap . . . really cheap.

Financially it looked great, but there was a catch. Doritos could have no say in what he did with the brand. Nothing.

They took the offer. That's giving up control.

Most people aren't comfortable giving somebody else (especially somebody like Stephen Colbert) control over something that is important to them. That is good in some circumstances. But sometimes, we need to give up control.

As the idea, the cause, or the movement becomes large, retaining control becomes impossible. Get used to it. Learn how to give up control to the right people at the right times.

Point 3: Authenticity is a competitive advantage.

Ann had a great example of this. She explained, "When you aren't being authentic, Millenials can smell it. When you're trying to sell to them, they know it. And when they catch the scent, they stop listening."

People don't trust like they used to . . . and with good reason! Big Business? Washington? Institutions are ruining the names that took generations to build. Many are repeatedly failing to live up to the promises that they make to people.

Hiding disingenuous actions is nearly impossible these days. People find out. They write about it online. When enough people mass around a subject, the media latches onto it. The story explodes.

A few people and institutions are getting authenticity right. They make a claims. They stand for something. They make promises. Then they follow through without apology. They take the action to keep their own tribe happy . . . even when that action upsets others.

That is authenticity. It is being true to yourself and to those around you. Authenticity is not often looked at as a competitive advantage. In the future, it will be.

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Class today was brilliant. I feel extraordinarily fortunate that I was able to participate in it. It's great to be a student (Chicago Booth rocks!).

Thanks, Ann, for sharing your time and thoughts with us students . . . and thanks, Professor Dhar, for arranging it!

Tuesday, February 16, 2010

When Extra Information Makes Us Dumber

Eric is 57 years old, very intelligent, opinionated, and empathetic. He is interested in politics. He has a beard, glasses and is generally friendly. He plays guitar in a band with some of his other mid-50s friends. The band periodically performs at venues in a nearby city.

Rank the following statements about Eric : (1) is "most likely to be true" to (7) least likely to be true.

Eric is a(n):

  • Member of the top 20% of his college class
  • Car salesman who has been involved in anti-war protests
  • Daily reader of the New York Times
  • Ex-high school track and field runner and never went to college
  • Car salesman
  • Bachelor
  • Daily reader of the Wall Street Journal
Write your answers down.

Now look at two of the responses on the list: "Car salesman who was has been involved in anti-war protests" and "Car salesman." Which one did you rank as more likely?

If you picked "Car salesman who has been involved in anti-war protests," think again. You are logically incorrect. It is impossible that being both a car salesman and an anti-war protester is more likely than just being a car salesman.

However, we really want Eric to be an anti-war protester - a bearded, glasses-wearing, guitar-playing protester. The description just seems to fit! In fact, it fits so well that the information about "anti-war protests" trumps the information about being a car salesman. The extra information that I gave about Eric is both superfluous and misleading.

Next time you make an important decision, take another look. Are you using more information than you need to in your decision process? More importantly, is it misleading you?

Monday, February 15, 2010

The 5 Most Important Things I learned in Financial Accounting Class

You think accounting is boring? Okay, you're right. It can be.

However, accounting is the language of business. It's important. And every once in a while, it's really interesting.

Last quarter, I took Financial Accounting at Chicago Booth. What follows are the five most important things I learned.

5) Accounting is not about giving an accurate picture of a business. It is about compliance with the law.

There is a perception amongst laypeople that financial reports are objective pictures of a company's financial situation. Not true.

There are a number of reasons that managers would want to misrepresent numbers. Their bonuses depend on meeting numerical targets. Investors show a bias toward investing in companies that have certain numerical patterns. Disadvantageous regulations can kick-in when numbers hit thresholds. Reasons for cheating abound.

But cheating is illegal. Hence, businesses do what they must do. They comply with the law - most of the time - even when they don't want to. 1

4) The numbers can tell (almost) any story you want them to tell.

"Creative" is not generally a word used to describe accountants. But after learning about the ways that accountants and bankers manipulate numbers, I started to notice their craftiness.

The truth is that no matter how smart regulators are, an army of accountants is smarter. They are capable of hiding big, big items for a long time. The financial crisis was partially fueled by a particular kind of creative hide-and-seek with the numbers, called off balance sheet financing.

Long story short . . . don't take the numbers at face-value.

3) Often, the most important information about a business is buried deep in the footnotes of hundred page reports.

General Electric's annual report is 144 pages long. In Note 12 on pages 92-94, they discuss loans worth $282.7 billion.

Read that again and actually picture the size of the number: $282,700,000,000. That's no small amount. It's enough to pay 10,096,428 people for one year at $28,000/year.

This note contains the details given about the loans which caused financial problems for banks and GE financial.

2) If you don't understand the business itself, the numbers are meaningless.

Looking at financial numbers without observing the operations of a business is like reading sheet music when you've never actually heard. You might understand the values of the musical notes, but they have no meaning.

Accounting numbers are a reflection of the actions of a business (albeit an imperfect one). They all have an underlying cause. They all come together in specific patterns when the business is making money, and different patterns when the business is losing money. You learn the underlying patterns by observing the business . . . not by observing the numbers.

1) Business people have their own language. They can maintain power partially because others don't understand it.

Business does not require extraordinary mental power. It does require a working knowledge of accounting language if you want to be a manger . . . or if you want to do anything that requires more than a hundred thousand dollars in investments to get going.

If you don't understand your company's revenue streams and basic cost structure, you probably are not ready to be a manager. If you don't know the difference between debt and equity financing, your business probably won't grow beyond the family.

If you don't understand what a "yield to maturity" is, you shouldn't be picking your own bonds. And if you don't understand what "capital gains," "dividend yield," "earnings per share," "common stock," "preferred stock," and "bonds" are, you probably shouldn't be purchasing any individual stocks.2

The point is that business has its own rich and descriptive language. It describes important phenomena that occur every day in the course of business. Those who understand the language are insiders. They are better prepared for success. Those who do not understand the language are outsiders. They are less prepared for success.
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In ten weeks of class and 500+ pages of reading, these were the five best lessons that I learned. I hope this opened your eyes to things you didn't know.


This post is the first in a series of posts that I plan to write to share a variety of MBA knowledge that I think would be useful for laypeople. It's meant to help people without an MBA education to become aware of issues that may come up when making important decisions.

Please let me know if you thought this was useful. And if you like it, share it with a friend.



Notes:


1 In fact, many companies' managers would prefer to abstain from external reporting if they had the choice - privately held companies generally do not create external reports.

2 If you can stand to lose the money that you are speculating, I guess you could, but I still wouldn't recommend it.

Sunday, February 14, 2010

What is Optimism?

Every once in a while, I hear an idea that is so elegant that it knocks me off my feet.

My girlfriend recently had an extremely stressful experience selling her apartment.  A couple of days before the sale closed, she discovered that the agent and the maintenance person were negligent.  Paperwork and repairs were behind schedule.  The buyer was threatening to back out of the deal if they weren't completed.

She worked like crazy - up until the last few hours.  She found somebody to complete the repairs.  She finished the paperwork.  Just in time.

We talked after the ordeal was finished.  She told me about her frustrations, but she seemed comfortable . . . even happy.  Then she said this:

I finally understand what optimism is. 
I used to think optimism was thinking that everything will be okay.  It's not.
Optimism is not passive.  It's active.  It is knowing that no matter what happens, you can take the actions necessary to improve your situation.
Thank you for your sharing your thoughts, honey. 

And happy Valentines day.  I'm so glad to have you in my life.

Saturday, February 13, 2010

What We're Up Against

As hard as you're willing to work, there's somebody who's willing to work harder and sacrifice more. Someone like George Cloutier, who recently did a Q&A with the New York Times.

The title: Fire Your Relatives. Scare Your Employees. And Stop Whining. An excerpt confirms the sentiment:

[Interviewer:] One might argue it’s easier for you to take these hard-line positions because you haven’t had to balance family considerations
[Cloutier:] I would be the first one to say it probably is easier. But the reality is, if you’re not fully committed and prepared to sacrifice what many of us would view as the traditional family role, you have a much higher probability of failing in a small business.
I'm not endorsing his view, but that's the competition.  In response, there are essentially three options:
  1. Work harder than him
  2. Work more effectively than him (smarter, more efficiently)
  3. Work in a space where you won't compete with him
They're not mutually exclusive, but at least one is necessary.

Friday, February 12, 2010

Privacy's a Sensitive Subject

If you've got Gmail, you probably saw an option to add Google Buzz. I'm on it now, and I can see it finding a place in my heart in the future, but there are a number of people who say that it's a privacy nightmare.

Why? Well, Information Week explains that:

Some of those complaining online about Buzz have claimed that the service has exposed their contact information to people who have threatened them or outed the confidential sources of journalists.
I've had no issues with information exposure. Google connected me to 32 people with whom I email pretty regularly, and I easily made those connections private. However, unwanted sharing is something to look out for.

If you've signed up (or not) and you want more information about how to prevent sharing, check out Buzz Off: Disabling Google Buzz.

This is terrible PR for Google, regardless of how big the danger is. My takeaways:


  1. Privacy is very important to some people - more important than ease of use. In this case, Google put ease of adoption above privacy on its list of priorities. Trouble is the result.
  2. The trouble might not be as big as the web is making it out to be - the dissatisfaction may be the loud voice of an upset minority (who may have a right to be upset). We'll see how it affects Google's image in the long run. My guess is that the image won't be hurt much.
 Update:  Critics Say Google Invades Privacy With New Service is the top article in the Technology Section of the paper on 2/13/2010 (though it hasn't made the top 10 articles list overall).

Wednesday, February 10, 2010

When You Put it Like That . . .

Imagine that I give you two options:

Option A: You get $3000 with 100% probability
Option B: You get $4000 with 80% probability, and you get nothing with 20% probability.

Which one do you choose? Remember it.

Now forget about the first game. Let's start over. Imagine I give you the following options:

Option C: You lose $3000 with 100% probability
Option D: You lose $4000 with 80% probability, and you lose nothing with 20% probability.

If you're like most people, you chose Option A (about 80% choose A), and you chose Option D (about 92% choose D).

And if you're like most people, you're irrational - and that's okay.

These two problems are perfect mirror images of each other. If you choose Option B repeatedly, you will gain $3200 on average, which is larger than the certain $3000 that you get from choosing option A. That is, you win $200 more on average by choosing A.

The mirror: If you choose Option D repeatedly, you will lose $3200 on average, compared to a certain loss of $3000 of you choose Option C. That is, you lose $200 more on average by choosing D.

A perfectly rational person would always choose the equivalent choices A and C, or the equivalent choices B and D. To a rational person, A vs. B and C vs. D look exactly the same (and they are the same . . . even though you may still want to tell me that they aren't).

You should like winning money as much as you like keeping money. But you don't. You like keeping money more. In fact, you like keeping money so much that you're willing to take a worse average return -$3200 vs -$3000 in order to prevent yourself from losing money some of the time.

These two sets of options are an example of a psychological trick called framing. When problems are framed as losses, we act differently than we do when they are framed as gains - even if the problem is exactly the same from a rational view.

Framing enters into our lives every day. Friends frame problems to get you to agree. Salespeople frame problems to get you to buy. Politicians frame problems to get you to vote.

If you didn't know about it before, you do now. Watch out for framing tricks. It might help you to act in your own best interests.

Note: this problem is adapted from econoport.

Tuesday, February 9, 2010

Fascinating Social Connections from Facebook Data

Pete Warden, an ex-Apple engineer, has pulled together data from 210 million public Facebook pages. He's begun the process of analyzing the information, and he posted some initial findings in a blog post titled "How to Split Up the US."

I was amazed. Some of the findings would be expected, but some shed light on trends that I had never considered.

If you have 10 minutes, read the post. It's fascinating.

The Debtor's Problem

Allan Greenspan made a brilliant quote on Meet the Press this past Sunday:

"History tells us that great powers, when they've gotten into very significant fiscal problems, have ceased to be great powers."

Indeed. But here's what I really love about the sentence:

Replace the word "powers" with "businesses" and read again.

Now replace "great powers" with "individuals with high hopes and big dreams."

The second one is a little tough: "History tells us that [individuals with high hopes and big dreams], when they've gotten into very significant fiscal problems, have ceased to be [individuals with high hopes and big dreams].

Certainly there are exceptions at each level, but amazing how that works right?

Take-away: plan and act to build a sound fiscal future . . . no matter what the level of work.

Monday, February 8, 2010

Cutting Costs and Creating Benefits

The value equation is simple: Benefits - Costs = Value.

Great business people deal with both sides of the equation, and MBA programs do their best to develop skills to manage with both costs and benefits. However, people generally have a bias. They're either cost controllers or benefit creators.

Costs are relatively easy to measure. We can count them: how many hours did that task require? How much did the company spend on that tool? After everything is counted, we can analyze the costs and find definite ways to become more profitable. The process is rigorous and empirical.

Benefits are more amorphous. I might be willing to pay more for a computer than my friend would because I value it more. On the other hand, my friend might be willing to pay more for cable TV than I would. Quantifying benefits is difficult, and when the numbers are lacking, benefits are tough to analyze.

The problem is that most highly analytical people (think professors) are biased toward dealing with costs, exactly because they can be rigorously analyzed. As a result, the MBA education is biased towards cost-based thinking.

That's an unfortunate situation, because cost savings have a lower limit (you can't produce anything for less than $0). On the contrary, benefits are essentially limitless.

Saturday, February 6, 2010

There's No Value Without Constraints

I didn't understand the concept of value until my time went away.

When I was young, my free time seemed endless. If something were too expensive, I would try to find out how to make it. I assumed that spending 10 hours to build my own toy was cheaper than spending $10 on one. I had time. I didn't have money.

Now my time is scarce. I carefully consider how much time I want to devote to each activity that I undertake. I'm constantly worried about the benefits I receive from what I'm doing. Am I spending my time in the most beneficial way that I could be?

Five years ago, if you would have told me that for $10 you could sell me an extra hour of time that I could use for whatever I wanted, I would have smiled and declined. "I have time. I'll keep my ten bucks."

Today, I'd gladly take your offer if it were genuine. I'm regularly busy from the moment I wake up until the minute I go to sleep. There are not enough hours in the day to do all that I would like to do, and if you could take away one of the items on my to-do list, I'd pay. By saving me time or producing something so I don't have to, you are providing value to me.

There are exceptions . . . I wouldn't pay you to learn for me - I get value from the the information that I'm learning. I wouldn't pay you to watch a movie for me - I enjoy watching movies. But the point remains: because I face constraints in my life, there are still places where a smart entrepreneur could add value for me.

Save me time. Produce something that is useful for me. Create something that makes me happy. I'll pay for those things. I value them.

Friday, February 5, 2010

Change is Going to Happen . . .

Trent has a beautiful post today which discusses the fact that you can never know what's coming next. He writes:

Here’s the truth: an awful lot of lives go through the same progression as my own. Not in the sense of the specific things that change, but in that the specifics of their life change so drastically in even a few years. And we don’t see it coming, either . . .

You’ll lose a job. You’ll change careers. You’ll find a partner. You’ll have a child. You’ll move to another state. You’ll find a new passion. You’ll get sick. You’ll get well. People will leave your life. People will enter your life.

Things will change.

Things will change . . . he's right. As a personal finance guy, he recommends having a well-kept emergency fund (extra cash in the bank) so that you can keep life smooth when the inevitable unforeseen change occurs. It's great advice. A monetary safety net is invaluable.

I'd add another suggestion: build and hone a varied set of useful skills.

I have several friends who are never unemployed unless they choose to be - even in this economy. One person went from carpentry to lab work at a university . . . to volunteering at a clinic . . . back to lab research at a different university. Another went from robotics to programming . . . to real estate . . . to marketing and sales.

These two are endlessly curious. They are building skill sets that they might never use (I can tell you for certain that the lab worker/carpenter can also program in Java and he could pick up freelance copywriting in a couple of weeks if he chose to). These two will always find work because they can do many different things.

This world is changing. The flux may lead to the deaths of entire industries, possibly even yours.

Be prepared for these changes, both financially and mentally. They will be coming.

Wednesday, February 3, 2010

On the Lighter Side . . .

One of the reasons that it's good to be at Chicago Booth: even accounting professors at this school have a sense of humor.

Student (to professor, in class): "I don't have a solution, but . . ."

Accounting professor (interrupting with sarcastic, kind sincerity): "Well that's okay, just go ahead and talk for a while."

Entry number one for best quote from a professor for this quarter.

Two Types of Marketers

I handed in my first marketing assignment today. Shortly after, I learned that there are two types of successful marketers in the world, and I think that they probably have trouble getting along.

The first type is extraordinarily detail oriented. They analyze problems like crazy. They look for each tiny bit of evidence that may affect an action, and they account for all of the pros and cons of a decision. They weave the evidence together to come up with their recommendations.

The second type is abstract and visionary. They absorb the information and work through the big picture. They see the interplay of forces and constraints, which are difficult to pin down with definite statistics. They intuit their way to a solution and pepper in details to support their recommendations.

The class contains both types. The funny thing is that, even with all the differences in style, I can see the talented ones.

The even funnier thing is that the talented ones come to the same conclusions, even if they use different styles.

Tuesday, February 2, 2010

Action : Outcome

The salesman selling snake oil doesn't care if his product doesn't cure buyers' ills. By the time the buyers find out, he's already skipped town.

The congressman who requests $10 million to build a bridge to nowhere in a neighboring state doesn't care that you didn't want your tax money spent on that project. Come election season, you can't vote against him.

The loan officer who packages and sells the loans that she approves doesn't care if the borrower repays. By the time default occurs, the loans aren't on her books.

The salesman, the congressman and the loan officer are all acting rationally. They will not be punished for the bad outcome that results.

Markets are elegant value creating systems. They are the best that we have, and we should avoid restricting them . . . as long as we can assure that actions are connected to outcomes.

Monday, February 1, 2010

MBA Vs. Real World Experience

I've read plenty of opinions in the MBA vs. Real World Experience debate. The whole argument is starting to bug me. For some reason, the discussions always become polarized, and then this happens:
The two experiences and the knowledge gained from each are separated from one-another. Then there's a lot of debate about which is better, which is more useful, whether the degree is valuable, etc. The arguments deteriorate quickly and people start yelling.

In reality, the situation is something more like this:
These two things are not mutually exclusive. The knowledge and experiences overlap. In fact, there is lots of stuff that I'm re-learning in my MBA program that I learned at my previous job. Of course, There's also lots of stuff that I'm learning from the MBA program that I didn't know before, and plenty that I learned on the job that I doubt that my classes will touch.

Now let's take a look at the bigger picture:
The fact is that there are people who use each type of knowledge when they conduct business. If you know both, you can deal with people in both camps, which is extraordinarily useful. Rejecting an MBA education because it's "too academic" is silly - there are plenty of real world applications for the academic tools. Likewise, rejecting a non-MBA for lack of credential is unreasonable - a degree is obviously not necessary for success in business.

What matters is 1) how open people are to new knowledge, ideas, and practices, and 2) what people do with the knowledge and skills that they have. Let's not forget that.